ment credit. I am here as an independent witness and do not represent Michigan State University.

The proposed bill, S. 1740, or the Truth in Lending Act, requires "the disclosure of finance charges in connection with extensions of credit." Most of the problems associated with the bill center on the meaning of "disclosure," and, parenthetically, the meaning of "truth.” We should recognize that at the present time most finance charges are disclosed to consumers. Over the past half century there has developed in association with each segment of the credit market a particular method of stating the finance charge. It is true that sometimes the finance charge is buried in the selling price of the merchandise. This is exemplified by charge accounts in retail stores and by most credit card arrangements. In other instances, the finance charges is included in the monthly payments, and consumers must subtract the balance of the loan received or the unpaid balance on goods financed to determine the dollar finance charge. However, in the great bulk of cases, the credit charge is disclosed in some manner-sometimes as a percentage per month or per year, sometimes as a dollar amount. Credit unions, consumer finance companies, banks with revolving check-credit plans, and retailers offering revolving-credit accounts state their finance charges as monthly percentages. In part this method developed through legal decree; in part it is the method best suited to the nature of the business. Mortgage lenders present the major portion of their finance charges as annual percentages and a minor portion, in form of "closing costs," as dollar amounts. Statement of the finance charge as a dollar amount is the typical practice of commercial banks and sales finance companies in financing installment sales. Indeed, disclosure of the finance charge in this manner is a legal requirement in a number of States and a fair trade practice of the FTC for automobile financing.

The crux of the matter rests with the manner of disclosure. "Truth" is defined by implication as presentation of "a simple annual rate.” Since this feature represents a basic change in present practices of disclosure, the remainder of my analysis will be concerned with the impact of this proposal.

There appear to be two main reasons advanced for the presentation of finance charges as annual rates. The first is stated in the declaration of propose of the bill; namely, that "economic stabilization is threatened when credit is used excessively." The second purpose was implicit in much of the testimony last year on S. 2755. This is the argument that statement of charges as annual rates will enable consumers to shop more effectively for credit. Let us examine each of those arguments in turn.

PROMOTION OF ECONOMIC STABILIZATION

It is difficult to see how statement of finance charges as annual rates will promote economic stabilization. First of all, it has not been established that there is, or has been, an excessive use of consumer credit as suggested in section 2 of S. 1740. Second, if there is an excessive use of credit, it has not been shown that statement of finance charges as annual rates will curb the presumed excessive use. The demand for

credit is a derived demand, a demand secondary to the demand for new cars, washing machines, and other consumer durables. Will the young housewife forgo the installment purchase of a washing machine when the finance charge is stated as an annual rate? I do not know, but I suspect not.

It would appear that the most reasonable argument that can be advanced for the interest-rate form of statement as a means of promoting economic stabilization is along the following lines. In times of boom, finance rates would be high, and consumers would be discouraged from use of credit. However, during periods of recession, finance rates would decline, so that consumers would be encouraged to purchase goods on credit and stimulate recovery. This argument suffers from a number of defects. In the first place, it overlooks the fact that the consumer is usually buying a product or service with his credit. A large reduction in the cost of credit will cause only a small percentage reduction in the time price of the product purchased. Second, it is very unlikely that consumer finance rates would be sufficiently flexible to affect consumers' use of credit. Interest rates paid by credit institutions are only a small portion of their total costs of providing the credit service. For example, during 1958 interest costs of sales finance companies in Indiana absorbed only one-third of gross income. Moreover, because these companies obtain a fairly large proportion of their funds from long-term borrowings, this portion of their interest costs is not immediately responsive to changes in money rates. At the end of 1960, the four largest independent sales finance companies obtained about half of their borrowed funds under longterm commitments.

What does all this add up to? Let us assume that a consumer is considering the time purchase of a $100 radio, but is waiting until finance rates decline. Let us say that at the peak of the boom, when short-term money costs 6 percent, his finance charge would be $8 on a 12-month contract, or an effective annual rate of about 14.8 percent. In the recession that follows, money rates are cut in half; they fall to 3 percent. Sales finance companies are now able to obtain short-term loans at half their earlier cost, and they pass the full reduction along to consumers. If we assume the sources and costs of funds described earlier, it can be shown that the total finance charge to the consumer will decline to $7.33 from $8, and the annual rate will decline to 13.5 percent from 14.8 percent. The overall effect of the reduction in the finance charge will be to cut the time price of the product by six-tenths of 1 percent. Thus, even a dramatic change in money rates will produce a relatively minor change in consumer finance rates and a negligible change in the time price of a product.

The inflexibility of finance charges is supported by historical data. The Federal Reserve Board's study, part 1, volume L, page 59, on consumer installment credit showed that over the 10-year period from 1946 through 1956 finance charges per $100 of unpaid balance on a popular-priced passenger car varied by no more than 10 percent. Over the same period average bank rates on business loans doubled. Logic and historical evidence suggests that we cannot expect statement of consumer finance charges as annual rates to promote economic stabilization.

PERMIT CONSUMERS TO COMPARE FINANCE RATES

The assertion that statement of finance charges as annual rates would permit consumers to shop more effectively for credit has a much greater appeal. From our economic training we recognize that markets function better when both buyers and sellers have full information. It is most reasonable, and with the best of intentions, to suggest that all consumer finance charges be converted to a single form, such as a simple annual rate of interest on the monthly unpaid balance.

In spite of the industry's arguments to the contrary, it seems likely that consumers will understand enough about annual percentage rates to recognize that 12 percent is higher than 10 percent. The real problem is whether or not properly comparable rates can be presented to the consumer in writing prior to the consummation of each credit transaction. This will not be possible in a large proportion of consumer credit transactions, either because the finance charge can be concealed or because the annual rate cannot be calculated.

EASE OF CONCEALING FINANCE CHARGES

On installment sales transactions, retailers are free to set the cash price of their products and their finance charges, subject to limits imposed by various State laws. Thus, the size of each of the components in the total time price is a matter of discretion. Dealers in automobiles and other consumer durables and those engaged in home repair and modernization could easily drive the finance charge into the cash price of the product or service. As a result they could quote very low financing rates to attract customers from direct lenders, such as commercial banks, credit unions, and consumer finance companies. To illustrate, assume that the cash price on a used car is $800 as shown on table I below. With a downpayment of $200, the principal amount to be financed would be $600. On a 2-year contract with an add-on finance charge of 9 percent per year which would be quite high, the dollar finance charge would be $108, and the time balance $708. The annual rate of charge is about 17.5 percent. If required to state his charges as annual rates, the dealer could raise his cash price to $887, an increase of only 11 percent. A downpayment of $200 would leave a principal amount to be financed of $687. The addition of a finance charge of only $21 would bring the time balance to $708, as before. But now the dealer is in a position to advertise low financing rates of less than 3 percent per annum. He can urge consumers to finance with him rather than through their credit union at 12 percent. Moreover, the consumer would have every reason to believe that he could rely on the truth of the rate disclosed in this manner, for it would be in accordance with the "Truth in Lending Act" administered by the Federal Reserve Board.

(The table referred to follows:)

TABLE 1.-Recalculation of terms on installment sale to lower effective annual rate of finance charge

1 The rate is calculated using the constant ratio method of converting the dollar charge to an annual rate Source: Robert W. Johnson, Methods of Stating Consumer Finance Charges (New York: Graduate School of Business, Columbia University, 1961), p. 96.

Dr. JOHNSON. This burial of finance charges in the price of the product financed has been common practice for some years in the case of FHA-insured and VA-guaranteed loans. When the market rate on mortgage loans is above the permitted rate, the builder often absorbs a portion of the finance charge and then passes it on to the buyer in the form of a higher price on the house. On these loans the charge is stated as an annual rate as required in S. 1740-but in these cases there is no truth in this form of rate statement.

IMPOSSIBILITY OF CALCULATING ANNUAL RATES

On many types of consumer credit it is not feasible to calculate annual rates so that they may be stated prior to the consummation of the credit transaction. In this category we should list revolving credit, check credit, and possibly installment credit granted by mail

order concerns.

Let us concentrate on the problems associated with revolving credit offered by many retailers. Assume that I have agreed to pay $20 a month on a revolving-credit account at a department store in Lansing, Mich. Suppose that on July 15, I purchased a $20 item. If this is all that I buy during July, the store will add 30 cents to the unpaid balance at the end of the month. Should I pay the bill promptly on August 1, I will have paid 30 cents to use $20 credit for 15 days. This is an annual rate of 36 percent. But if after purchasing the first $20 item I wander off and make another purchase of $20, my annual finance rate will decline. If I make $20 payments promptly on August 1 and September 1, my annual finance rate will be about 27 percent. With each additional item I purchase my annual rate of charge declines closer and closer to 18 percent. If you wish further complications, let me point out that there is also a minimum monthly charge of 25 cents. The sales clerk cannot know my unpaid balance at the moment she sells me a shirt for $5, nor can she know what additional purchases I will make after I leave her counter. She cannot possibly tell me the annual rate of finance charge that I will

pay on the purchase of that shirt prior to the consummation of the transaction.

Check-credit plans whereby consumers may borrow from commercial banks by signing special checks involve impossible complexities similar to those provided by revolving credit accounts. At present such concerns as Sears, Roebuck & Co. publish a table in their catalogues showing the exact amount of the dollar finance charge the customer will pay, depending upon the price of the item purchased on installment. While the complexities surrounding conversion of these finance charges to annual rates may not be insurmountable in the case of mail-order companies, they may be so great as to interfere seriously with this method of serving consumers.

Consequently, under the proposed legislation the consumer shopping for a refrigerator might find that the credit union or commercial bank would quote a financing rate close to 12 percent, the credit appliance store a rate of 3 percent, and the department store unable to quote any rate at all on its revolving credit plan. Is this full disclosure?

DIFFICULTY OF IDENTIFYING THE FINANCE CHARGE

There are numerous problems in defining the dollar finance charge. Look down the list of disbursements included under "closing costs" on a mortgage bank fee, tax history, survey fee, attorney's fee, title insurance, credit report, and so on. Which of these are part of the finance charge and which are not? To reach a fair and truthful conclusion would require scrutiny of almost every transaction. Moreover, many of these fees have their counterparts in charges on consumer installment credit. Uniform treatment of such fees may easily conflict with many State laws that now limit the finance charges on small loans and installment sales transactions.

DIFFICULTY OF CONVERTING DOLLAR CHARGE TO ANNUAL RATE

Too much has probably been made of the diverse answers that can be obtained with the various formulas available to convert the dollar charge into an annual rate. Some one formula could be selected by the regulatory agency and simply defined as the proper method of making the conversion.

However, use of a standard formula would force consumers to adjust their payments to the uniform mold required by the formula. Consider the schoolteacher who would like to buy a $265 refrigerator in May, pay $50 in June, $75 in September and October, and the balance of $83.15 in November. I have been teaching rate calculations in industry programs over the past 5 or 6 years, and I can assure you that none of my students can make this calculation, nor can I.

There are so many deviations possible on consumer credit contracts the number of days to the first payment, the regularity of payments, the size of the last payment. Some indication of the variation one encounters in practice is suggested by the survey made by the Federal Reserve Board of new car buyers in 1954 and 1955. In calculating annual finance rates, we used the constant-ratio method of converting dollar charges to annual rates. Even with the use of an