Bacon's Rebellion

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Payday Lending, Do-Goodism and Unintended Consequences

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by

James A. Bacon
in

You can’t accuse Donald P. Morgan and Michael R. Strain of being on the payroll of the payday lending industry. They are staff economists of the Federal Reserve Bank of New York. That’s why we need to pay attention when they conclude in a November report, “Payday Holiday: How Households Fare after Payday Credit Bans,” that payday lending is less burdensome on the poor than cutting off their credit.

Do Gooders have trashed the payday lending industry for usurious terms and conditions that allegedly mire poor and working-class citizens in a “debt trap.” Buying that logic, the state of Georgia permanently closed all payday lending in 2004, and North Carolina followed in 2005. (Virginia is still debating the issue.)

Morgan and Strain ask the question: Are poor/working class people better off as a result? The answer: No. In both states, the economists documented that the number of bounced checks, complaints against debt collectors and personal bankruptcies increased in Georgia and North Carolina relative to other states.

The main beneficiaries of the ban, it turns out, are conventional banks. Write Morgan and Strain: “On average, the Federal Reserve check processing center in Atlanta returned 1.2 million more checks per year after the ban. At $30 per item, depositors paid an extra $36 million per year in bounced check fees after the ban.”

Bacon’s bottom line: Poor people don’t need Do Gooders meddling in their affairs to pursue their own economic self interest. Let the payday lenders stay in business. The only legitimate role of government is to ensure transparency — to make sure borrowers understand the terms and conditions of the loans — and to prevent fraud. Otherwise, government meddling doesn’t help the poor, it hurts them.

(Hat tip: Chris Saxman. Photo credit of Advance America: Andrew Bain.)

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12 responses to “Payday Lending, Do-Goodism and Unintended Consequences”

  1. Brian Kirwin Avatar
    Brian Kirwin

    You’ve made a good argument for allowing the industry to exist, but you also made a good argument that they should live under the interest rate caps that other lenders must.

    Level playing field, right? No special favoritism, right?

  2. Jim Bacon Avatar
    Jim Bacon

    Good question, Brian. I’m no expert on the subject, so I’m winging it here… The problem with subjecting payday lenders to the same interest cap as other lenders is that the economics of the industry are very different. There is unavoidable overhead associated with processing a loan, whether it’s $10,000 for a car to be repaid over four years, or $300 for a payday loan to be repaid within two weeks. But they payday loans are much smaller, so they have to charge more for paperwork and processing. They are best equipped to determine how much to charge for a loan.

    The best way for government to ensure that payday lenders don’t rip people off is (a) to promote competition for small loans in the marketplace, and (b) to require transparency of lending terms and conditions.

    Having the government set rate caps is inherently arbitrary. Brian, you’re not actually supporting that idea, are you?

  3. Larry Gross Avatar
    Larry Gross

    somewhere in your “bottom line” I’d like to see some words that reflect whether or not it is possible that the “word” vulnerable fits under some circumstances.

    In other words. is there such a concept of consumers being the target of predatory practices and those practices are a legitimate focus of government?

    If you think there is no such thing as a vulnerable consumer (rich or poor)…then I’d not agree…

    is it “buyer beware” – period – no exceptions?

    where do you draw the line?

    Brian made the good point I think.

  4. Brian Kirwin Avatar
    Brian Kirwin

    Jim, are you proposing to eliminate the current interest rate caps on all other lenders?

  5. Anonymous Avatar
    Anonymous

    I thought it was interesting that your analysis was based on economists studies of whether people were better or worse off: studies which included second layer parties, like the commercial banks.

    RH

  6. Kevin Avatar
    Kevin

    Back in October, the Military Lending Act went into effect to prevent predatory lenders from gouging our military families. It imposed a 36% cap on payday, auto title, and refund anticipation loans because the financial trouble caused by those products was actually becoming a security threat. Don’t you think all citizens deserve the same protection from predatory lending?

  7. Anonymous Avatar
    Anonymous

    Jim:

    This industry and Banks may well become irrelevent.

    Check out http://www.prosper.com

    This concept partially eliminates the need for both.

  8. Vivian J. Paige Avatar
    Vivian J. Paige

    I would love to see a comparison of what happened before payday lending when into effect and what happened afterwards.

    Brian’s point is one that I keep trying to make: if you believe that government shouldn’t meddle, then there should be no interest rate caps at all. Absent that, payday lenders should be subject to the same rules as everyone else.

  9. Jim Bacon Avatar
    Jim Bacon

    Anonymous 1:03, That links gets a “cannot display the web page” message for me. But to your point: If some entrepreneur can devise a way of meeting the needs of the payday loan market more efficiently than the present companies — in an online transaction, perhaps? — then, bravo! I would love to see the existing industry disintermediated by the Internet if the Internet can do a better job of serving the market.

    Vivian: Capping interest rates is not likely to be effective. The payday lenders will create a new charge, calling it a “processing fee,” or something like that. If we regulate that, too, then the Payday guys pull up their stakes and leave.

    Back to the point I made on an earlier post: If the fees are so unconscionable, and the profit margins of the payday lenders supposedly so fat, why doesn’t an altruistic group set up shop, charge “fair” fees and interest rates, rack up a huge market share, and put the payday guys out of business?

  10. Anonymous Avatar
    Anonymous

    In India, do-gooders have put their money where their mouth is and started making micro-loans themselves.

    Competition and profit works better than legislation.

  11. Vivian J. Paige Avatar
    Vivian J. Paige

    Jim: re: calling it a processing fee – I’m sure you are aware of the Rapid Refund loans that H&R Block, Jackson Hewitt and the other tax prep companies have. A number of years ago, they thought they could get around the interest rate disclosure rules by calling the fees charged something similar. (IIRC they called them RAL fees – RAL stands for refund anticipation loan.) There was a ruling – can’t find it right now – that those fees had to be included in the calculation of the APR that is disclosed to the borrowers. So, essentially, calling it something else doesn’t change the fact that it is still interest.

    Level the playing field – either do away with interest rate caps for everybody or have the same rate apply to everybody.

  12. Anonymous Avatar
    Anonymous

    Jim:

    The Link worked for me.

    Try this link from the Freakonomics guys instead.

    http://freakonomics.blogs.nytimes.com/2007/11/28/adopt-and-prosper/

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