Saving Private Ryan From Greedy Lenders

A congressional crackdown on gouging soldiers creates a new regulator: The Pentagon

The Defense Dept. is about to become a major financial regulator, and that's throwing lenders for a loop. Pentagon officials and consumer advocates pushed Congress this summer to help the many thousands of service members incurring excessive debt, some of whom have lost security clearances as a result, making them ineligible under Defense rules for deployment to Iraq. The main culprit, the Pentagon said, are so-called payday lenders, which cluster around military bases and charge as much as 800% interest to provide soldiers with cash advances against their paychecks. Congress gave the Pentagon broad new authority to cap interest rates on most consumer loans to more than 1.4 million active-duty personnel and their families. Not surprisingly, payday lenders objected that they will be hurt and that their customers, who often have poor credit, will be left with no place to turn.

Now even mainstream lending institutions and traditional financial regulators say they fear the hastily written law will have unintended consequences. "From our perspective, the scope of the measure that was enacted is so broad that we're still trying to get our arms around it," says Diane Wagner, a spokeswoman for Bank of America BAC . Among the uncertainties: whether the law applies to existing loans, and also what happens when any of the 1.2 million reservists or National Guardsmen are called to active duty.

Lenders and regulators say the measure's rate caps put in doubt the legality of debt consolidation loans, credit-card cash advances, student loans, overdraft protection, and other types of finance for soldiers and their dependents. "Every day a lightbulb goes off in the lending community with ways this could limit or restrict credit to our military," says Andrew Barbour, a lobbyist for the Financial Services Roundtable, which represents such institutions as Wachovia WB , American International GroupAIG , Merrill Lynch ML , and Capital One Financial COF .


Kevin Mukri, spokesman for the Office of the Comptroller of the Currency, which regulates national banks, adds: "To my knowledge, this is unprecedented—giving consumer credit regulation to the Defense Dept. I wouldn't know how to write a regulation for bombers."

Outgoing Senate Armed Services Committee Chairman John Warner (R-Va.), however, stands by the law, which he backed. "Congress has an absolute responsibility to protect members of the military and their families from such unfair practices," says a spokesman.

The law, which was attached to a defense bill last fall and will take effect on Oct. 1, 2007, establishes a 36% cap on interest rates for most loans to military members and their families. Unlike most credit regulations, the new law requires the annual percentage rate for military loans to include all fees. Factoring in fees can push the APR beyond the law's cap. Home mortgages, auto loans, and credit secured by personal property are exempt.

Lenders say stiff penalties for violations of the new law may scare off institutions. If a lender unwittingly provides a loan with an improper rate to a service member's spouse, the loan becomes invalid and doesn't have to be repaid. If the lender "knowingly" violates the law, it is subject to fines, and its employees can even get jail time. Avoiding these missteps could be complicated by separate laws that prohibit lenders from asking about marital status.

One lender worrying about such ambiguities is Cooperative Bank in North Carolina, which serves Marines and their families at Camp Lejeune, south of the Outer Banks. CEO Rick Willetts says of the new law: "This is a well-intended idea that is opening Pandora's box."

By Dawn Kopecki

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