Is the Enmity Justified for Payday Lending
Hello everyone! Thanks for swinging by today. Let’s talk about the enmity held for the payday lending industry. For those of you who do not follow J$ over at Budgets Are Sexy I wonder why the h*** not?! He’s a long time PF blogger and he shares great things on his site. I have been a long-time reader myself and participate frequently in the comments section of his blog posts.
Late last week may have been the only time ever I’ve seen something on his site that I didn’t necessarily agree with and was quick to share my thoughts in the comments. That post was related to payday lending and basically compared it to devil worshipping…ok maybe it wasn’t that bad. But I thought it was fair to take the side of payday lenders, employees, customers and many others who do not agree with his post.
In the comments to that post, you will see that I referenced a Freakonomics podcast that defends the payday lending practice. Today I thought I would highlight some of the main points from that podcast, research conducted by the New York Federal Reserve (Liberty Street Economics) as well as other research and considerations that I’ve learned over the years from knowing folks in the industry.
I am not a lover of payday loans or the industry, I just want to present the other side of the story. I realize that being a proponent or advocate of the payday industry is not a popular view, and that is not my position. My position is simply defensive of the industry and consumers who benefit from its products don’t lose access to it. As such, I’m trying to be an objective observer and I feel compelled to shed light on the industry in this manner.
What is a Payday Loan?
Payday loans are relatively small loans and are intended to be short term, repaid on payday (hence the name). These loans are typically used for emergencies when you’re strapped for cash and can be a bridge to payday. They are designed to be a quick solution to a short term problem.
Research shows that over 90% of the users of payday lending products are satisfied. It’s not cheap, but it offers help. What is important for consumers to know is that if they are going to take out a loan, they should make sure they have the means and ability to repay it quickly which is most often the case.
While this is not an ideal way of borrowing money or to make ends meet, consumers are happy with its products and service and so therefore it seems they have a place in our society and shouldn’t be condemned for it.
How do I know consumers are happy? Besides the research showing over 90% have confirmed their satisfaction, the Consumer Financial Protection Bureau (CFPB) has also confirmed it. While the CFPB is primarily responsible for trying to shut down the payday industry (as we’ll discuss further below), in response to Freedom of Information requests (FOIA), it revealed more than 12,000 positive testimonials, or more than 98% of all comments. Further, while complaints have been minimal (approximately 1.5%), they have also declined over the last five years.
So if the consumers are happy and there seem to be few problems in the industry, why is the CFPB so dead-set on reforming it? Let’s jump into that next…
Obama, the CFPB and the CRL
Obama hates the payday industry and when he created the CFPB it was with the intent to crack down on payday lending. They are not looking to reform or regulate the industry, they are looking to shut it down.
Another big player in the debate on payday lending is the Center for Responsible Lending (CRL). The CRL was founded by a credit union and many funders include banks and other mainstream financial institutions; all of whom would have a substantial amount to gain from the elimination of payday lending.
So while there may be points to be made against payday lending, I think it is important to keep in mind who is really behind the push to “reform” it.
The CFPB is all about enforcement of their agenda and seems to care little about the actual consumer or the businesses it is trying to regulate. Let me provide some examples:
- Every month the CFPB issues a breakdown of consumer complaints by industry. Every month payday lending has the lowest number of consumer complaints (as confirmed by the FOIA request outlined above). Seems to be a lot of focus on a problem that consumers don’t think is there.
- The CFPB holds small business panels for review and comment on rule making, yet it appears this is just for cover. Often times their members attend the meetings, take attendance, make introductions, and then walk out and aren’t even present for the review panel.
- Two years ago, the CFPB issued a Civil Investigative Demand letter against World Acceptance (one of the largest installment lenders in the country) and yet have not released or disclosed what exactly they’re investigating or contorting what the Company did wrong. They have also done this a lot with debt collection companies.
- The CFPB’s rule making process takes into consideration very limited research. For example, the research completed by the New York Federal Reserve (NYFR) wasn’t factored in by the CFPB.
Questionable practices if I do say so myself.
What Freakonomics did in the podcast was to interview folks who do not have a horse in the race, academia. And primarily research from the New York Federal Reserve (NYFR).
So let’s discuss some of the salient points and see if the CFPB is just trying to throw the baby out with the bathwater.
Primary Issues with Payday Lenders
- High Interest:
One of the main gripes is that the annualized interest rate can be very steep, in some instances up to 400%. But again these are intended to be short term. And since the loans are small (the average is $350), the fees need to be reasonable to entice the lender to make the loan (i.e. make a normal profit). For example, for every $100 borrowed, the current fee is around $15. From a consumer standpoint, that isn’t much to pay to get out of a quick bind. And when considering it is a labor intensive process to make a bunch of small dollar amount loans, it needs to be at that level to cover the labor costs and other general business costs and provide a normal profit. This has been confirmed by the NYFR.
And keep in mind, this isn’t a risk free loan. While applicants are required to have a job and a bank account, that’s it. There is no collateral like pawn shops.
Let’s think about payday lending in another fashion. One alternative to a payday loan is to overdraw your bank account. The consumer isn’t dumb, they’ve done the math and realize a payday loan is cheaper than a handful of overdraft fees from the bank which can be up to $35 or more for a single overdraft!
The consumers aren’t unwitting and desperate. They are aware of the costs and do not consider themselves as being preyed upon by the industry. And this isn’t coming from me, this too is coming from research by the NYFR.
By evolving to the 36% cap that the CFPB proposes, that would take the $15 fee to $1.38! Establishing a cap like that would clearly be a death sentence for the industry. Who would make a two week loan for only $1.38 (7.5 cents / day)! It just doesn’t make economic sense.
And the Freakonomics podcast makes an interesting point about how you can view a payday loan as renting money for two weeks, then of course you have to pay it back. Similarly, there is a business for renting cars for short periods of time which are then returned. If you look at the rate you pay for renting a car compared to the value of the car, you are paying a similarly high rate. Yet the CFPB doesn’t make any fuss about this.
Furthermore, because the payday industry is extremely competitive, the market tends to drive fees down.
Conclusion: the fees associated with payday loans aren’t the problem.
- Spiraling Fees:
Spiraling fees implies that fees get greater over time if a payday loan is rolled over. That isn’t industry practice, however. The fees associated with a rollover are the same as the initial fees.
Conclusion: Not applicable and irrelevant.
- Trapped in a Cycle of Debt
Yes, another huge gripe and certainly not a positive attribute. They NYFR acknowledges this appears to be the problem. Ideally you could target individuals who are more prone to incessantly rolling over the payday loans, but the counter to that is the increased costs put on the system to gather data from the consumers and screen them more thoroughly would not be economical. And this isn’t me talking, this is the opinion of the NYFR.
However, there is limited research on the topic and it appears to be mixed. In 2011, an economic research paper was published documenting a study where a randomized control trial was completed where one group of borrowers were given a traditional high interest rate loan and another group of borrowers were given a zero interest rate loan. The conclusion was that both groups were equally likely to roll-over their loans again.
Although little research is available on rollovers, the conclusion the NYFR makes is that they are the ultimate problem, but that further research should be conducted. Will the CFPB listen, no. Instead, they intend to throw the baby out with the bathwater.
The basic premise of the debate is on one side Obama and regulators wanting to “reform” the industry and payday advocates are saying that it will ultimately kill off the industry and leave borrowers in the lurch. So what’s the answer, is payday lending a benefit to society or not…?
Is Payday Lending a Benefit to Society?
Research is mixed here as well. Oregon, for example, recently capped its rates from 400% to 150%. As an economist might predict, the industry was exited in mass. Washington, a neighbor state with lots of similarities to Oregon, also considered similar legislation but ultimately didn’t. This presented a nice natural experiment for researchers to determine the benefit.
The results? The research concluded payday consumers were worse off in Oregon as a result of the legislation.
A different study was based on use of payday lending by military personnel. The study looked at the use of payday lending outside of military bases and how it impacts our military operational readiness. The study looked at personnel data including job performance and military readiness and could look at various state laws on payday access.
The results? Greater payday access negatively impacted active personnel operational readiness.
Another example may be forthcoming with South Dakota which has a ballot initiative coming up this November to vote on whether to cap rates at 36%. The industry view is that it will likely pass and the industry will fold soon thereafter. We’ll have to wait to see the outcome here…
As I commented on J$’s original post, the payday lending industry is an easy target. But is it misguided? Or is it a symptom of a larger problem? Remember, that to get a payday loan you need to have a job and a bank account. So what does it say about our economy and constituents who have a job, but cannot afford spontaneous and unexpected expenses. Is the bigger problem a lack of good paying jobs, wage deflation, or financial literacy (which is my cash cow)? What should we do about these issues? Well, the next Freakonomics podcast was on the pros and cons of a guaranteed national income…Aren’t their podcasts always so thought-provoking!?
Allow me to reiterate that I am not an advocate for the payday loan industry and neither am I involved in the industry. But I am an advocate of complete disclosure and I hope this article helps show there are two sides to the story. For those of you who are interested to learn more in formulating your own view of the industry, I’d recommend the linked resources throughout the article including the Freakonomics podcast and the research reports found on NYFR which both offer fair, unbiased and balanced viewpoints (previously linked above).
Thanks for taking a look!
The Green Swan
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