American Financial Services Ass'n v. Federal Trade Commission

TAMM, Circuit Judge,

dissenting:

The Commission’s decision to ban security interests in household goods and future earnings is in excess of its statutory authority to regulate unfair trade practices. Although rationalized in terms of “market imperfection” and “consumer choice,” the Commission’s action reflects nothing more than its paternalistic judgment that lenders should not extend credit to low-income consumers. Such a judgment not only violates the approach to consumer protection outlined in the Policy Statement but also will have the practical effect of forcing needy consumers out of the credit market. I therefore dissent.

I. Introduction

Two venerable principles of administrative law control the determination of whether the Commission has exceeded its authority in this case. First, the words “unfair trade practice” set forth a legal standard and must, therefore, gain their final meaning from judicial construction. FTC v. R.F. Keppel & Bros., Inc., 291 U.S. 304, 314 , 54 S.Ct. 423, 427 , 78 L.Ed. 814 (1934). See also Office of Communication of the United Church of Christ v. FCC, 707 F.2d 1413 , 1423 (D.C.Cir.1983) (“it is the quintessential function of the reviewing court to interpret legislative delegations of power and to strike down those agency actions that traverse the limits of statutory authority”). Informed judicial construction of the statutory language depends, however, upon “enlightenment gained from administrative experience.” FTC v. Colgate Palmolive Co., 380 U.S. 374, 385 , 85 S.Ct. 1035, 1042 , 13 L.Ed.2d 904 (1965). Courts therefore traditionally accord respect to an interpretation of a statute by the agency charged with its execution. Red Lion Broadcasting Co. v. FCC, 395 U.S. 367, 381 , 89 S.Ct. 1794, 1801 , 23 L.Ed.2d 371 (1969) (such a construction “should be followed unless there are compelling indications that it is wrong, especially when Congress has refused to alter the administrative construction”). Thus, while we “give great weight to the Commission’s conclusion,” FTC v. Cement Institute, 333 U.S. 683, 720 , 68 S.Ct. 793, 812 , 92 L.Ed. 1010 (1948), “the final word is left to the courts.” Atlantic Refining Co. v. FTC, 381 U.S. 357, 368 , 85 S.Ct. 1498, 1505 , 14 L.Ed.2d 443 (1965). Cf. FTC v. Colgate Palmolive Co., 380 U.S. at 385 , 85 S.Ct. at 1042 (“[Wjhile informed judicial determination is dependent upon enlightenment gained from administrative experience, in the last analysis the words ‘deceptive practices’ set forth a legal standard and they *202 must get their final meaning from judicial construction.”).

Second, for a reviewing court to determine whether the Commission’s exercise of authority has “warrant in the record” and “a reasonable basis in law,” Atlantic Refining Co. v. FTC, 381 U.S. at 368, 369 , 85 S.Ct. at 1505, 1506, the Commission must, of course, articulate the reasons for the choices made. These reasons can be supplied by neither appellate counsel nor the court itself. The Commission’s decision-making must be tested by the basis upon which it purports to rest; if the decisions made do not reasonably conform to the | policies expressed, the court may not affirm. See SEC v. Chenery Corp., 318 U.S. 80, 95 , 63 S.Ct. 454, 462 , 87 L.Ed. 626 (1943) (“[A]n administrative order cannot be upheld unless the grounds upon which the agency acted in exercising its powers were those upon which its action can be sustained.”).

II. The Definition of “Unfair” in the Policy Statement

Application of these basic principles to this case begins with the Commission’s 1980 Policy Statement. Issued in response to congressional concern over the extent of the Commission’s authority to regulate commerce, the Statement provides an authoritative interpretation of what trade practices can properly be regulated as unfair. The Statement outlines a market-oriented, non-paternalistic. test, conditioning Commission intervention in the marketplace upon a finding of a market failure that prevents consumers’ purchasing decisions from regulating the market. Once a market failure is identified, the Commission may proscribe practices resulting therefrom that are “injurious in their net effects.”

Contrary to the majority’s suggestion, 1 the Statement can guide the court in resolving the issues raised by petitioners in this case. Although it does not identify what specific conduct constitutes unfair trade practices, the Statement does establish limits to the “Commission’s discretion under its unfairness jurisdiction.” Federal Trade Commission, Companion Statement to the Commission’s Consumer Unfairness Jurisdiction 6. As the majority recognizes, the principle limitation placed upon Commission authority is that it cannot, consistent with the Policy Statement, intervene merely because “it believes the market is not producing the ‘best deal’ for consumers.” Majority opinion (Maj. op.) at 982. Determining what “deal” is best for consumers presumes that consumers are unable, without the benevolent guidance of the federal bureaucracy, to make purchasing decisions for themselves. Such a paternalistic approach to consumer protection is “fundamentally incompatible with the liberal assumption that each person is the best judge of his or her own needs.” R. Reich, Toward a New Consumer Protection, 128 U.Pa.L.Rev. 1, 14 (1979). The Commission instead must “rely on consumer choice — the ability of individual consumers to make their own private purchasing decisions without regulatory intervention— to govern the market.” Policy Statement at 7. At the same time, “certain types of seller conduct or market imperfections may unjustifiably hinder consumers’ free market decisions and prevent the forces of supply and demand from maximizing benefits and minimizing costs.” Maj. op. at 976. In such instances of market failure, the Commission may take corrective action “to halt some form of seller behavior that ... takes advantage of an obstacle to the free exercise of consumer decisionmaking.” Policy Statement at 7.

Because no market responds perfectly to consumer choice, any market could conceiv *203 ably be subject to wholesale Commission regulation. The reviewing court’s first task, therefore, is to ensure that the Commission’s intervention is a genuine response to a market failure “which prevents free consumer choice from effectuating a self-correcting market,” Maj. op. at 981, and not a disguised attempt to impose a paternalistic purchasing decision upon consumers. To perform this task adequately, the court must insist that the Commission sufficiently understand and explain the dynamics of the marketplace. Furthermore, unless the Commission manifests an understanding of how the market responds to consumer choice, it cannot measure the costs and benefits of Commission intervention.

If the Commission has identified with sufficient clarity the impediment that blocks the market’s natural allocation, it may be appropriate for the Commission to intervene. Whether intervention is appropriate, and if so, what form it should take, can only be answered by weighing the costs and benefits of the Commission’s action. 2

III. Application of the Unfairness Test

A. Market Failure or “Reasonably Avoidable Injury”

The Commission discusses market failure in terms of what the consumer can “reasonably avoid”; if the consumer can “reasonably avoid” the practice, there is no market imperfection and, hence, no justification for intervention. The most common example of an injury consumers cannot “reasonably avoid” occurs when a seller has failed to disclose a risk involved in the exchange. Although the Commission states that the consumer’s ability to shop and bargain for credit remedies is constricted by fine print and technical language, it found not only that consumers generally understand the consequences of default, 3 but that more information would not. lead to different consumer decisions. 49 Fed. Reg. at 7746-47. Moreover, while it is true that creditors present standard form credit contracts on a take-it-or-leave-it basis, everyone in this proceeding recognizes that such contracts are the only efficient method of conducting loan transactions. Id.; Presiding Officer’s Report at 76, J.A. at 410 (“It is, beyond doubt, absolutely necessary to use form contracts in the interests of both creditors and consumers. Without such aids the consumer credit marketplace could not function in a reasonably efficient manner.”). Creditors, therefore, do not unfairly take advantage of a market imperfection by imposing upon consumers hidden risks. Discussion by the Commission and the majority about standard form contracts and fine print is thus empty rhetoric, completely irrelevant to the market analysis.

Lacking any evidence of inadequate or undisclosed information that would distort consumer choice, the Commission alternatively concludes that consumer choice is *204 restricted because consumers do not have access to standard form contracts that do not contain the provisions in question. This conclusion rests on one of two premises — one factually incorrect, the other theoretically bankrupt.

First, the Commission could mean that consumers generally do not have access to loan contracts without these provisions. This is wrong as a matter of fact. Millions of consumers acquire credit each year without pledging any collateral. Millions more, forced to do business with pawnbrokers or loan sharks, do not even have access to loan contracts with these provisions. It is not simply common sense and everyday experience, however, that refutes the Commission’s finding. The Presiding Officer found that “[i]t was generally agreed that consumers shopping among different classes of creditors would find differences in terms offered by banks as opposed to finance companies.” J.A. at 404 (emphasis added).

Second, the Commission could mean that high-risk consumers do not have access to loan contracts that do not contain these provisions. Some consumers, to be sure, cannot avoid these provisions in loan contracts, an “obstacle to the free exercise of consumer decisionmaking.” Policy Statement at 7. This phenomenon reflects a market failure, however, only if one is willing to accept the proposition that the high-risk consumer should be free to choose the same credit as the credit-worthy consumer. Under the Commission’s reasoning, since not every driver can choose the lowest insurance premium, by selling more expensive automobile insurance to the high-risk driver, the insurer takes advantage of an “obstacle to free choice.” The only obstacle to free choice identified by the Commission is the level of risk the borrower, like the insured, brings to the transaction.

The Commission’s analysis of the credit marketplace mocks the approach to consumer protection outlined in the Policy Statement. In the Policy Statement, the Commission asserts that the status quo is presumed to be the product of a well-functioning market. . In the Credit Practices Rule, the Commission turns this presumption on its head: it proceeds from an a priori vision of the mix of options that would be available in a “well-functioning market,” and, with little difficulty, concludes that the existing market, which does not provide that mix, is “imperfect.” As the majority recognizes, the Statement prevents the Commission from intervening whenever “it believes the market is not producing the ‘best deal’ for consumers.” Maj. op. at 982. Yet this is precisely what the Commission has done in this case. It simply identifies a particular class of consumers (those who cannot avoid loan contracts without security interests in household goods and future earnings) and concludes that those consumers ought to have access to credit without pledging household goods — that is, those consumers ought to have credit at a better price.

This is not to suggest that the credit marketplace responds perfectly to consumer choice. To justify its intervention, however, the Commission must at least rationally explain how the market fails to respond to consumer choice. Allowing the Commission to intervene when it does not know the “obstacle to free choice” essentially reverses the presumption that each person is the best judge of his or her own needs. Such a paternalistic approach to consumer protection is fundamentally incompatible with the limits imposed upon the Commission’s authority in the Policy Statement.

B. The Cost-Benefit Analysis

The Policy Statement’s definition of “unfairness” provides that for an unavoidable consumer injury to be unfair, “the injury must not be outweighed by any offsetting consumer or competitive benefits that the sales practice also produces.” Policy Statement at 6. Business practices entail a mixture of costs and benefits for consumers. Purchase money security agreements in automobiles, for example, can be a great cost to consumers because, upon default, consumers must forfeit the automobile, in *205 many circumstances a vital necessity, or face costly refinancing agreements. The security agreements cannot be deemed unfair, however, because the benefits of the trade practice — making credit available to those who wish to purchase automobiles— clearly outweigh the costs.

The Commission makes two fatal errors in its cost-benefit analysis of security interests in household goods. 4 First, in measuring the costs of these security interests, the Commission fails to separate the injury caused by these creditor practices from the financial and emotional hardships, that inevitably accompany default. Second, in evaluating the offsetting benefits of these provisions, the Commission never squarely addresses the single critical question: the extent to which the intended beneficiaries of the Rule depend upon the ability to pledge household goods and future earnings to acquire credit.

1. Injury Caused by the Credit Practices

The Commission identifies several harms supposedly “caused by” security interests in household goods. First, household goods are necessities and forfeit of these necessities causes harm to the consumer and his family. This consequence of default, however, is not unique to security interests in household goods. Household goods — indeed houses themselves — can and will still be seized under other permissible credit remedies, such as a home mortgage or a purchase money security interest. Moreover, the Commission found that relinquishing household possessions to a pawnbroker in exchange for credit is not, in fact, “consumer injury.” 5 Thus, a lender may hold a borrower’s television set from the time a loan is made and keep it if the borrower defaults. According to the Commission, this is not a consumer injury. If the lender allows the borrower to use the television from the time the loan is made and, in extremely rare circumstances, 6 picks it up when the borrower defaults, he engages in an “unfair” trade practice.

Second, the Commission states that the threat of losing household goods increases the likelihood that debtors will forego valid defenses. The credit practices still available to creditors, particularly purchase money security interests, however, pose a far greater risk that debtors will forego valid legal defenses. The creditor who sells defective household goods, for example, is subject to a much greater array of defenses than is the creditor who simply loans money.

Third, the Commission states that the threat of repossession may cause the consumer to default improvidently on other loans to avoid repossession of his household goods. Defaulting on another loan, however, could only be “improvident” if the creditor remedies of that other loan were more onerous than the remedies threatened by the creditor. If this other loan has more onerous creditor remedies, it is difficult to see the marginal cost of these less onerous creditor provisions. If, on the other hand, the creditor remedies under this other loan are less onerous (a much more likely situation), it is not unwise to default. Moreover, the recognition that the threat of repossession may cause the debtor to choose to default on another loan is fundamentally inconsistent with the Commission’s entire notion of the causes of consumer default. In determining whether the trade practice is unavoidable, the Commission states that default is beyond the debtor’s control. On the other hand, in *206 assessing the marginal cost of the trade practice, the Commission assumes that consumers faced with repossession will deliberately default on a loan not so secured to minimize their losses. The Commission cannot have it both ways.

Finally, the Commission states that the “unique” threat of repossession of household goods causes consumers to enter into costly refinance arrangements. The Commission contends that these horrible agreements “may reduce or defer monthly payments on a short-term basis ... at the cost of increasing the consumer’s total long-term debt obligation.” Maj. op. at 974. See 49 Fed.Reg. at 7764-65. A creditor, therefore, unfairly takes advantage of a market imperfection by refusing to discharge debtors’ contractual obligations unilaterally or by refusing to lend more money free of charge. Until the Commission can wish into being a world in which debtors do not owe money and the use of money is free, the courts should require, I think, a less fatuous approach to consumer protection.

The economic hardships that inevitably accompany indebtedness and default will remain despite the prohibition of these creditor remedies. The Commission, therefore, grossly exaggerates the beneficial impact of the Rule. The Rule does not eliminate the need for credit, does not provide debtors with any more cash with which to discharge obligations, does not make default a less likely occurrence, does not relieve the financial and emotional hardships that accompany default, does not insulate household necessities from forfeit, does not protect consumers from unscrupulous lenders intent in any event upon breaking the law, and does not lessen the compounding burden unpaid debts place upon debtors.

2. Offsetting Benefits

Security interests in household goods benefit consumers to the extent that they enable consumers to acquire credit without resorting to the pawnbroker or the loan shark. The Commission, however, never squarely addresses whether any consumers’ access to credit depends upon their ability to pledge household goods as collateral. 7 Instead, it evaluates the impact of the Rule — not upon the high-risk consumer it purports to protect — but upon the creditworthy consumer who needs no protection from these “abusive” credit practices in the first instance.

The Presiding Officer considered this question and came to the following conclusion:

However, this record does support the conclusion that the ability to take household goods as security is of very great importance to finance company creditors and that loss of this right would undoubtedly have a very considerable impact on their operations and upon the availability of credit to consumers.

Presiding Officer’s Report at 162, J.A. at 494 (emphasis added). In a feeble attempt to weaken the force of the Presiding Officer’s conclusions, the Commission states that the definition of “household goods,” narrowed since the Officer’s report, would address the problems of availability. Thus, the Commission notes, under the new definition of “household goods,” consumers may still pledge works of art, antiques, jewelry, video tape recorders, home computers, and the like. Similarly, the Commission puts great stock in the finding that forty percent of finance company clients are homeowners and therefore have other assets to pledge. Furthermore, the Commission states, banks, which seldom take *207 security interests in household goods or future earnings, remain available to the consumer.

What happened to the high-risk consumer the Commission so vividly describes when assessing the hardships caused by the creditor remedies? That consumer owned household goods of “little or no value.” He had no cash with which to pay back the loan, no assets to liquidate to prevent the forfeiture of household necessities or the imposition of “costly refinancing arrangements.” In assessing the impact of the Rule upon the availability of credit, the Commission converts the distraught debtor into a homeowner, able to acquire credit without pledging his household goods because he can always visit his suburban bank or pledge his handy Matisse. The problem with the Commission’s analysis is that the Rule unfortunately does not make the poor rich, or the high-risk consumer credit worthy. The Commission proves only that security interests in household goods cost the high-risk consumer more than they benefit the credit-worthy consumer.

Rather than address the Presiding Officer’s conclusions, the Commission wishfully insists that creditors should extend credit to low-income, high-risk consumers without requiring from them security interests in household goods. 49 Fed.Reg. at 7766. Such security interests are of no real value to the creditor, the Commission reasons, because they do not deter default. Default cannot be deterred by security interests because it flows from circumstances beyond the debtor’s control. This is nonsense on stilts. First, according to the record, twenty-five to thirty percent of defaulting debtors do so because of circumstances within their control. Five percent default because of “debtor irresponsibility”; twenty-five percent because of “voluntary overextension.” Id. at 7748. The Commission never considers, however, whether eliminating these security interests would increase the number of debtors who default because of “voluntary overextension” or “debtor irresponsibility.”

Second, even if every default occurred for reasons beyond the debtor’s control, the Commission’s conclusion that security interests do not deter default is a mammoth non sequitur. The Commission’s reasoning is this: household goods security interests do not deter those who default; therefore, by eliminating the security interest the rate of default will not increase. By the Commission’s logic, the existence of criminal laws does not deter those who violate the law. Can we therefore repeal the criminal laws and expect no impact upon crime? Of course not; just as we evaluate the impact of criminal laws upon those who do not violate the law, so must we evaluate the impact of security interests upon those who do not default. As the Commission found, a majority of consumers face financial trauma that could result in a default. 49 Fed.Reg. at 7748. Yet only a small number of consumers actually default. Id. This disparity is explained to some extent by the varying degrees of financial trauma that individual consumers undergo. Unrebutted evidence in the record and a healthy dose of common sense also suggest, however, that the more equity a debtor has in collateral the less likely he is to default. See Bureau of Social Science Research, Federal Trade Commission Proposals for Credit Contract Regulations and the Availability of Consumer Credit 129, J.A. at 1518 (the ratio of the value of collateral to the size of the loan “is the principle determinant of the probability of default”). If, as common sense and record evidence suggest, security interests in household goods do deter default, lenders will rationally refuse to extend credit to at least some consumers who have no other assets to pledge. See Presiding Officer’s Report 162, J.A. at 494 (elimination of household goods security interests “would undoubtedly have a very considerable impact ... upon the availability of credit”). Derailed by its faulty logic, the Commission never makes the critical finding of how many low-income consumers, the intended beneficiaries of the Rule, will be unable, because of the Credit Practices Rule, to obtain credit.

*208 IV. Conclusion

The flaws in the Commission’s analysis form an intriguing pattern, a pattern resulting from the imperfect superimposition of the “market failure” and “consumer choice” rationale upon a simple, paternalistic judgment: those whose access to credit depends upon the pledge of meager household goods and future earnings would be better off if creditors were unable and unwilling to extend to them credit. If this is the rationale underlying the Rule, most, if not all, inconsistencies in logic and shortcomings in evidence disappear. The imperfections of the marketplace need not be understood because it is not the obstacle to free choice that the Commission wishes to prevent but the free exercise thereof. Similarly, the harms caused by these practices need not be separated from the harms that inevitably accompany default because, if excluded from the credit marketplace altogether, these consumers will avoid not only these security interests but also all the other attendant hardships of default. Consumers who do not seek credit will, of course, avoid “costly refinance agreements” and never default “improvidently” on other loans. The Commission need not evaluate the impact of the Rule upon the intended beneficiary because the intended beneficiary, in its benevolent judgment, should not be seeking credit in the first instance.

The consumer law specialists involved in this case have at least been forthright in their support of the Credit Practices Rule. People who must pledge household goods or future earnings to acquire credit, they testified, would be better off without credit. Presiding Officer’s Report at 162, J.A. at 484. Although held with genuine compassion, this belief cannot form the basis for the decision. First, it assumes that government intervention will eliminate the need for credit and that these people will not find credit elsewhere. Credit will be made available to them, however, by the pawnbroker or, worse, the loan shark, whose “creditor remedies” are infinitely more severe than those banned by the decision. Second, “these people” are not children. To suggest that “they” are incapable of making such decisions for themselves replaces healthy respect for the choice of the individual with unwarranted confidence in the wisdom of those who happen to be in power. Aware that such an approach to consumer protection is antagonistic to the basic principles outlined in the Policy Statement submitted to Congress, the Commission has couched its purely paternalistic judgment in terms of the market failure and cost-benefit analysis with enough skill to sneak past a court anesthetized by a misplaced deference to agency authority. If judicial review is to have any meaning, however, agency action must be tested by the basis upon which it purports to rest and not by an agenda hidden from the court. See SEC v. Chenery Corp., 318 U.S. 80, 95 , 63 S.Ct. 454, 462 , 87 L.Ed. 626 (1943). Tested against the approach to consumer protection outlined in the Policy Statement, the Commission’s decisionmaking must fail. I therefore respectfully dissent.

. The majority displays a remarkable ambivalence toward the Policy Statement. The Statement, the majority promises at one point, provides "tangible guideposts for review." Majority opinion (Maj. op.) at 969. It chooses, however, to ignore these guideposts, finding instead that the Policy Statement "falls short of providing any concrete guidance to the court in resolving the issues raised by petitioners in this case,” id. at 972, and offers no more than “an abstract definition of unfairness.” Id. at 971.

. In reality, two closely related balancing tests must be made. First, the Commission must determine whether the specific trade practice involved actually harms consumers, that is, whether it is "injurious in its net effects.” If the benefits of the trade practice to the consumer do not outweigh its costs, the trade practice is unfair. Even the prevention of an unfair practice, however, may not justify federal intervention. Thus, a second, more general, cost-benefit analysis must be made: whether the unfair trade practice can be profitably regulated by the federal government. As the Commission states in its Policy Statement, this includes an assessment of the “burdens on society in general in the form of increased paperwork, increased regulatory burdens on the flow of information, reduced incentives to innovation and capital formation, and similar matters.” Policy Statement at 7. Furthermore, as we stated in American Optometric Ass'n v. FTC, 626 F.2d 896 , 910 (D.C.Cir.1980), "principles of federalism” dictate deference by the Commission to "states’ exercise of their police powers.” In measuring the general regulatory burden, therefore, the disruptive effect federal regulation would have upon state regulatory schemes must be considered.

. In almost ninety percent of the loan contracts, the household goods taken as collateral are listed on the loan contract. Presiding Officer’s Report at 157, J.A. at 489. In such instances, the Commission notes, there is "little question either that a security interest has been given or as to the scope of the coverage.” 49 Fed.Reg. at 7762.

.Much of the criticism leveled at the cost-benefit analysis of household goods security interests also applies to the Commission’s cost-benefit analysis of security interests in future earnings. I do not specifically address the latter, however, because the practice is already thoroughly regulated in the states where it is commonplace. See 49 Fed.Reg. at 7756.

. 49 Fed.Reg. at 7767 (”[t]he record furnishes no evidence" that giving a pawnbroker a possessory security interest ”cause[s] any injury”).

. As the Commission recognizes, defaults occur in only a fraction of transactions, and actual seizure occurs in but a "tiny fraction” of defaults. Brief for Respondent at 21; 49 Fed.Reg. at 7763.

. The majority seems to place great weight on the econometric analysis conducted by various participants in the rulemakings, evidence which "by all accounts, contains deficiencies which prevent definitive answers." Maj. op. at 987. In spite of these deficiencies, however, the majority insists that the evidence reveals that the Credit Practices Rule "would have only a marginal impact on the cost or availability of credit." Id. at 33. What is "marginal" apparently is in the eyes of the beholder. The econometric studies revealed that the Credit Practices Rule would cost in 1979 between $623 million and $10.6 billion in increased interest rates. J.A. at 1528. I would agree, however, that the Rule has a "marginal” impact on credit availability: that is, those consumers currently at the margin will be forced out of the credit marketplace.