Montana Wants Money for Nothing

When states vote for cheap payday loans, they wind up with no loans at all.

On Tuesday, Montana voted overwhelmingly to cap interest rates for payday loans at 36 percent annually. Similar caps passed in the last election cycle in Ohio and Arizona, limiting the amount companies can charge when making small loans to customers. The ballot results make Montana the 18th state to institute such caps.

Many of the three-quarters of Montana voters who approved the cap likely thought they were voting for cheaper short-term loans. But that's not what will happen in the Big Sky State. When the rules of the game change, so do the players. Instead, the passage of the rate cap means the state's payday lenders will pack their (money)bags and hit the road.

When Arizona's payday loan rates were capped at 36 percent in June, payday lenders immediately started checking out. Joe Coleman, president of the Financial Service Centers of America, told USA Today that Montana will be no different: "As has been the case in other states, because of the numerous costs involved, virtually no operator can offer the product at that rate, and all of them will almost certainly go out of business," he says.

In Washington, D.C., when the rates payday lenders could charge were capped, some firms continued to offer one-stop banking services to the poor—like check cashing and pre-paid debit cards—while killing the payday loan component of their business. But a far more common reaction to interest rate caps is for payday loan companies to flee the state. (Ironically, the one councilman who saw this coming in D.C. was also the guy who introduced the proposal to cap the rates: Former mayor Marion Barry ended up casting the only vote against, saying "We are putting this industry out of business.")

For supporters of the caps, this is a feature, not a bug. Groups like the Center for Responsible Lending call payday lenders "abusive" and their rates "usurious." The group noted in a triumphant post-election press release that "studies show that payday lending is associated with unpaid bills, credit card delinquency, bank overdrafts, closed bank accounts and bankruptcy." They're right, of course, that people who use payday loans tend to be in financial trouble. They're also right that the loans aren't cheap. Without regulation, annual rates for payday loans range between 200 and 400 percent interest annually. That sounds outrageously expensive. But those figures don't reflect the way people actually use the loans. Borrowers typically pay between $10 and $20 for $100 in quick cash. They give the payday lender a post-dated check set for a week or two in the future in exchange for money today to pay for car repairs, doctor's visits, or other expenses.

Booting payday lenders doesn't eliminate the need for quick cash, however. And caps like the one Montana just passed may make life much harder for people living on the margins.

Academic research on the subject supports these anecdotal findings. In Oregon, a 2007 law effectively capped rates at $10 per $100 and imposed a minimum borrowing term of one month (as opposed to the more typical one- or two-week loan for $15 per $100). At the end of  2006, six months before the cap kicked in, Oregon's Consumer and Business Services Department reported 346 licensed payday lenders. Seven months after the cap, that number had fallen to 105. In September 2008 it was 82. In a December 2008 working paper, Dartmouth economist Jonathan Zinman concluded that former payday customers in Oregon ended up using less desirable alternatives such as overdrafts and utility shutdowns, and that "restricting access caused deterioration in the overall financial condition of the Oregon households." In summary, "restricting access to expensive credit harms consumers."

And when payday loan companies leave, people deal with cash shortfalls in other, less desirable ways. When payday lenders left Georgia in 2004, households "bounced more checks, complained more to the Federal Trade Commission about lenders and debt collectors, and filed for Chapter 7 bankruptcy protection at a higher rate," Federal Reserve research economists Donald P. Morgan and Michael R. Strain found in a February 2008 study. And they found similar results after the payday lenders cleared out of North Carolina in 2005 as well.

Montana learned something from the 17 states that have already capped rates. If you take away one way to get quick cash, people will find another. The same ballot initiative also limited car title loans on similar terms, after seeing a boom in popularity of these higher-stakes loans—if you fail to pay, they take your car—in states that have previously instituted caps. But no amount of legislation will abolish the need for quick cash. All it can do is limit the options people have available to meet that need.

Katherine Mangu-Ward is a senior editor at Reason magazine.