Reason.tv: In Defense of Payday Lending

Few industries are more reviled than payday lending, which primarily services the working poor by offering short-term loans at high interest rates. Payday customers borrow an average of $350 for a period of two weeks, or until their next paycheck comes in. The money is handed over on the spot, once the payday store can verify that the customer has a job, earns enough to afford the loan, and hasn't recently defaulted with another vendor. Payday loans are in high demand: There are 22,000 payday storefronts in the United States and in 2009 they loaned a combined $35 billion.

And yet the industry is fighting for its survival. Montana just voted to make it illegal for the payday-loan industry to operate profitably, so lenders are loading their wagons and wheeling out of "The Land of the Shining Mountains." They've already moved on from Oregon, New Hampshire, North Carolina, Arizona, Georgia, and Washington, D.C, because of similar regulations. The annualized interest on payday loans runs about 400 percent, but the reality is that payday firms see returns closer to 10 percent, or about the same as other less-demonized financial service providers.

Now there's a danger the federal government will quash the rest of the U.S. payday industry. The Frank-Dodd Financial Reform bill, passed in July, created the Consumer Financial Protection Bureau (CFPB), which posseses the power to regulate paydays at the national level for the first time. The vaguely written law doesn't allow the CFPB to cap interest rates, but regulators have the latitude to enact other rules that would obliterate profits, such as limiting the number of payday loans a customer can take out over a set period of time.

Payday critics, such as the Center for Financial Responsible Lending (which declined our interview request) argue that payday stores "trap" their customers and practice what "amounts to legal loan sharking."

Reason.tv's Nick Gillespie looks at payday loans—why people depend on them, why they're expensive, and the assumption at the core of every attack on the industry: that the working-poor are too stupid to manage their own money.

The story features payday antagonist Gary Rivlin, the author of the recent book Broke USA; George Mason law professor Todd Zywicki, who has studied paydays; and Greg Fay and Saran Goubeaux of Hometown Cash Finance, a small chain of payday stores in Ohio.

Two studies are citied in this story: the Federal Reserve's 2007 look at the effect of booting paydays out of George and Virginia, and the 2007 Vanderbilt-Oxford University study that reveals that, contrary to the claims of industry critics, paydays aren't exceptionally profitable.

For more info, read Katherine Mangu-Ward's October 2009 feature story on payday lending in Reason Magazine, and her Wall Street Journal review of Rivlin's Broke USA.

Approximately 5 minutes.

Produced by Jim Epstein, with help from Dan Hayes, Josh Swain, and Michael Moynihan.

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Comments

[albo]

Thank you, Mr. Rivlin, for your well-honed moral sense and fervid desire to inflict it upon the rest of us whether we want it or not. You're a secular saint.

[Angry Liberal]

They're making profit on ignorant poor folks! You can't have that! They should be just giving them money without any expectation of it being returned, especially with interest! On top of that, we need to tax them 95%! Those poor people need more money, you know! But, don't touch my money. I'm struggling!

These companies prey on the simple minded poor folk by enticing them with easy money and extort them with high interest rates! No one should profit off the poor.

[albo]

No one should profit off the poor.

Yeah. Like landlords and grocery stores, right?

[Angry Liberal]

Of course! Their food should be free and live in free housing! We have to do all we can for them poor folks! But don't make me pay more taxes! Make them rich folks pay! They deserve to pay more, because we're entitled to their money!

[The Donald]

Screw the poor....they can't afford lawyers!

[Pip]

Screw the poor? Have you seen the poor? They tend to be pretty ugly. Who wants to screw ugly?

[snortimer]

Don't forget employers.

[p90x]

Yea I think that sounds about right.

[Colin]

One thing is for certain: the real loan sharks will love this new regulation.

[Voros McCracken]

That's the thing I will never understand. If there's demand for a service, and that service is made illegal, a black market will emerge to provide the service.

Now for certain services (murder for hire and so forth) that's the chance you have to take. But for something like this? You won't be protecting anybody, just moving the poor people in need of the service into the realm of quasi-criminal behavior.

If their goals are what they say they are (protecting the poor), the last thing in the world they should want to do is make the service illegal. There are any number of things they could do that would better help those seeking such loans than making pay day loan services illegal.

[Old Mexican]

Few industries are more reviled by the economic ignorant and the populist charlatan than payday lending[...]

There. More accurate.

[Old Mexican]

Reason.tv's Nick Gillespie looks at payday loans?why people depend on them, why they're expensive, and the assumption at the core of every attack on the industry: that the working-poor are too stupid to manage their own money.

Actually that's at the core of ANY attack on ANY industry and personal freedom: "People are simply too stupid to do anything, ergo, we need government!"

That's how it works.

[John]

"Payday customers borrow an average of $350 for a period of two weeks, or until their next paycheck comes in."

In a perfect world, yes. The empirical reality, however, is very different. More than 75% of payday loan borrowers are repeat customers servicing multiple debt obligations to a variety of high-cost small loan providers. While payday loans are written as two-week loans, the renewal/rollover routine means they create much longer-term debt traps for borrowers. Industry reps aren't shy admitting that the repeat borrower is vital to maintaining profitable operations.

"The annualized interest on payday loans runs about 400 percent, but the reality is that payday firms see returns closer to 10 percent, or about the same as other less-demonized financial service providers."

Loose (or nonexistent) underwriting = higher default rates = thinner profit margins. Not a surprise. More importantly, though, how is the profitability of a financial services product relevant to determining whether that product should be proscribed? We don't regulate out of existence lead-paint toys because their manufacturers are reaping insuperable profits; we regulate them because they are harmful.

"...the assumption at the core of every attack on the industry: that the working-poor are too stupid to manage their own money."

Classic strawman. Consumers in every marketplace exhibit common behavioral heuristics and cognitive biases which results in decisionmaking that may not reliably promote their substantive welfare interests. This doesn't mean these consumers are "too stupid to manage their own money"; it simply means that, especially when viewed in light of the demographic characteristics of the borrowing populations who use alternative financial services, the downside risks of bad decisionmaking (and the spillover effects they impose on third-parties) may justify paternalistic interventions.

E.g.

http://www.ericposner.com/Contract Law in the Welfare State.pdf

Finally, the article has cherry-picked the most favorable empirical studies available on the issue of payday lending and consumer welfare. I have not yet had an opportunity to read the Zywicki article, but the 2007 Morgan/Strain study employs an impoverished conception of "welfare reduction/enhancement" and should therefore be taken with a giant grain of salt. Certainly, the vast majority of behavioral economic studies of the industry to emerge in the last 4-5 years are skeptical of the idea that payday lending has the sort of "smoothing" effect on households in financial distress.

[robc]

See the linked study - in GA and NC late fees/check bouncing fees went up more than the cost of payday loan fees/interest. So while thats a bunch of dumb decisions, on aggregate, the dumb people were making the most efficient dumb decisions.

[robc]

My interpretation: "regular" banks are scummier than payday loan banks.

[cynical]

It's pretty easy not to write a check that you can't cover, actually.

[snortimer]

We don't regulate out of existence lead-paint toys because their manufacturers are reaping insuperable profits; we regulate them because they are harmful.

We regulate them because they are unpopular. That they are unpopular because they are harmful is irrelevant. Being harmful in itself is not the reason we regulate things.

[Ryan Olcott]

Classic strawman.

"Strawman" my rear. The Jacket suckers that silly author into showing himself to be a duchebag whe he asks him the simple question ~"would you have been better off if that line of credit hadn't been extended to you". His sputtering answer was very nearly: "but I wasn't an idiot spending my money on big screen TVs". You can't get away with calling the argument a strawman when they explicitly use it. Their contempt for 'lesser mortals' is palpable.

Consumers in every marketplace exhibit common behavioral heuristics and cognitive biases which results in decisionmaking that may not reliably promote their substantive welfare interests.

Which is just a more verbose way of saying 'everyone else is an idiot that can't be trusted to manage their affairs as well as I could'.

Although I do disagree with that same line: ""...the assumption at the core of every attack on the industry: that the working-poor are too stupid to manage their own money."

For those that argue for these and similar regulations it isn't just an assumption, they treat it like a self-evident axiom. No argument convinces them otherwise - they're all a bunch of misanthropes.

[Realist]

SOS!

[robc]

Result of Federal Reserve Study:

Dumb people act smart in aggregate.

[sloopyinca]

Payday critics, such as the Center for Financial Responsible Lending (which declined our interview request) argue that payday stores "trap" their customers and practice what "amounts to legal loan sharking."

This is so true. There's a payday loans place near where I live, and on slow days, they roam the neighborhoods and force people at gunpoint to take money from them. It's quite frightening.

[Tman]

That's nothing. You should the roving gang of McDonalds characters in my neighborhood that chain people to barbers chairs and forcefeed them delicious french fries. That Grimace guy will sit on you and pour chocolate shakes down your throat.

It's just terrible. They must be stopped.

[Andrew S.]

Unfortunately, nothing can kill the Grimace.

[LL]

If I die, make sure they know it was the Mutabo virus and NOT something else.

[Jordan]

Imagine my surprise that Chris Dodd and Barney Frank are behind this. There isn't any part of the financial sector those guys haven't screwed up.

[T]

Man, I bet pawn shops are gonna love the shit out of this law if it passes. They'll be the only source for some quick cash for poor people. Cha-ching!

[John]

At interest rates that range from 40-60% and with secured loan products that do not create a debt trap for borrowers.

[T]

You don't hang around poor people much, do you? If they're so bad at money management, the pawn shop will end up owning all their stuff. Or they'll be repeat pawn shop customers, pawning the same shit over and over and paying the interest every month. And I'm curious where you get 40-60%. Is that the monthly or the annual? Here, it's 20% a month or 240% annual.

[roystgnr]

If you think a payday loan customer is trapped (rather than charged based on his higher risk of default), it will only take a small fraction of your own savings to prove it. This isn't exactly a railroad or a utility, here; you can compete with trivial capital investment and zero government assistance.

Just, er, don't spend *all* your savings trying to prove that poor people are all kind souls temporarily down on their luck who will return your money posthaste. Even if you're right the majority of the time you'll find the exceptions add up.

[Brian from Texas]

You got be careful who you lend money to. More than once I had to break out the piece of garden hose to get the return on my investment.

[Danny]

For some debtors, a payday-loan transaction is "rational" or "value-maximizing" and they would be worse off without access.

For others, it isn't ? the loan is "non-rational" or ill-advised, based on scarce or faulty information, and they would be better off without access.

Which predominates, and whether a better, or worse, or merely different, "equilibrium" between debtors and lenders will be reached in the absence of payday lenders, I have no idea.

I would hope that a creditor class that sees fewer ways to get blood from stones will redirect capital to more productive and socially beneficial uses, but who can know for sure?

I can say with confidence that this is not goverment "overreach" on anybody's "rights," properly defined. It is nothing more than a legitimate, democratically-chosen limitation on which types of contracts the taxpayer will undertake to enforce.

Creditors have no pre-existing natural "right" to government enforcement of any particular lending agreement they think they can get a debtor to sign, and debtors have no pre-existing natural "right" in the converse.

"Freedom of contract" is the ultimate "positive" freedom. It has not the slightest resemblence to free speech or freedom of religion, or the right to keep and bear arms. Freedom of contract is a right only in the sense that housing is a "right" ? or health care, or public education, is a "right."

I wish the consumer-protection forces luck in this reform, but there are no guarantees. The informed observers who saw the current economic meltdown coming knew ahead of time that we were "over-financialized" and our system was lopsided, but whether we have the willpower and the insight to change that is an open, and doubtful, question.

[John]

"It is nothing more than a legitimate, democratically-chosen limitation on which types of contracts the taxpayer will undertake to enforce."

A very good insight, particularly in light of the fact that payday loan agreements are routinely secured by SSI and unemployment benefits.

[robc]

It is nothing more than a legitimate, democratically-chosen limitation on which types of contracts the taxpayer will undertake to enforce.

False. There is a difference between refusing to enforce a type of contract and banning it.

[John]

Could you explain what the differences (practical, theoretical) are?

[steve]

I wonder when these defenders of the poor, Montana, Oregon, et al are going to ban lotteries since they clearly impact the poor as differentially as payday loans. Oh wait, they raise money for the state....

[Payday Lending Rep]

The opinions of millions of hard-working payday advance customers have been lost in the debate over payday lending. Their voices are overshadowed by critics who have never actually used the service, and it's great to see a piece like this that treats payday loans fairly and gets the facts right. Our customers are real people who use payday advances to solve real problems.

The Center for Responsible Lending, a front group that rails against payday lending, is among those set to benefit greatly if payday lending is restricted or banned. Reports from the Center for Responsible Lending purposely deceive consumers and policymakers by using "evidence" that simply does not exist. CRL takes data points from various sources, applies their own convoluted math and passed it off as information confirmed by state regulators and third parties.

[tiffany jewellery]

good topic

[Jimmy]

I'm with John a few posts up and many other.

It's not hard to figure out how much comes in every month and balance that with how much goes out.

As a former guy in the payday industry, the folks who get these loans are not properly prioritizing their expenses. The number of emails that came through from Iphones and other higher end devices to our support group is high.

They want instant gratification and no amount of legislation is going to fix poor money management coupled with "Needing" something now.

Some Lenders are more responsible than others, but in the end - it's up to the consumer.

[nike shoes UK]

is good

[Kevin Durant Shoes]

so perfect

[Boston Market Coupons]

Of course, in times of emergency we kinda need money

[Grace.P]

I think this situation with trapping the poor using these same day cash loans
seems to be all-in-all quite fair to me. I mean: "you fooled me once, shame on you, you fooled me twice, shame on me", right?

[CharlieSummers]

There are definitely ways that short term loans can be used properly. If someone has overdue bills, or is at risk for eviction, they might be their only choice. In addition, they give customers the ability to apply from the comfort of their home.