The Volokh Conspiracy
Mostly law professors | Sometimes contrarian | Often libertarian | Always independent
As I have illustrated previously, The New York Times has come completely off the rails when it comes to "news" coverage of consumer credit issues. Indeed, it appears that the paper is not even making an effort to distinguish news reporting from editorializing, as its Christmas Day article, "Rise in Loans Linked to Cars Is Hurting Poor" indicates. (The title in the url is equally suggestive—"Dipping into auto equity devastates many borrowers.")
This particular article focuses on the use of auto title pawns and is lumped in with the Times's ongoing "news" coverage of the growth in subprime auto lending (which again, as the chart in this article itself shows, still remains well below the percentage of loans in the pre-crisis period). What purchase-money subprime auto loans has to do with auto title pawns is never explained, but they are entirely different markets with entirely different lenders and entirely different consumer protection issues.
Now, to be sure, auto title pawns have high APRs and raise distinct consumer protection issues from other types of fringe lending products. So one should certainly pay attention to these products and the consumer protection issues that they raise. But if one really wants to understand whether this is a useful product for those who use it, it is important to understand who uses auto title pawns, why they use them, and what would happen to them if the product were not available.
The Times story instead provides a couple of anecdotes—and to be sure, they are sad stories and reflect the unfortunate underside associated with this product. But based on academic research, we also know that the couple of sad stories that the Times reports here are completely unrepresentative of who uses auto title pawns and why—and, more important, what would happen to consumers if the product was regulated away.
At the outset though, I should note that it appears that the reporters never even considered many of the relevant questions that they would need to ask to understand whether their blanket condemnation—"Rise in Loans Linked to Cars Is Hurting Poor"—is actually true.
Start with the first story of lab technician Caroline O'Connor, "who needed about $1,000 to cover her rent and electricity bills, believed she had found a financial lifeline." While the cash apparently helped her avoid eviction and having her electricity cut off (this is inferred, since the article doesn't report it), she ended up defaulting on the loan and having the vehicle repossessed, which is obviously sad. But is O'Connor's story representative of the market for auto title pawn loans?
A few years ago I wrote the first major article on auto title pawns (summary version here) based primarily on interviews with industry participants. Since that time, law professor Jim Hawkins has written two superb articles based on in-depth interviews with auto title pawn customers (here and here, the latter co-authored with Kathryn Fritzdixon and Paige Skiba and sporting one of the best law review article titles ever). (For simplicity of reading, I will refer to both of those articles interchangeably as "Hawkins.") And here's what the data generally show based on that research (we also discuss auto title pawns a bit in chapter 8 of "Consumer Credit and the American Economy"):
1. Auto title pawn customers are different from payday loan customers: It is often assumed that all of those who use various fringe lending products are more or less the same. This is not true. Most notably, auto title pawn customers are distinct from payday loan customers. Auto title pawn users typically fall into three categories:
(1) Independent small business, such as landscapers, handymen, etc.: These businesses essentially use their pickup truck or van as a source of liquid working capital to, say, buy several hundred dollars of sod and bushes on Monday for supplies and labor a yard job which they then pay back on Wednesday or Thursday. Business is unpredictable so traditional small business loans aren't useful for these businesses. Moreover, these liquidity needs often exceed the amounts allowed for payday loans under state laws (where permitted at all).
(2) Unbanked: Auto title pawns (as with traditional pawn shops) are heavily used by unbanked consumers. Payday loans require a bank account against which a check can be drawn, so while there is some substitution between payday loans and pawns (both auto and traditional), those who use title pawns often are unable to access payday loans (in addition, those who use payday loans often see overdraft protection as a closer substitute than title pawns). Title pawns do not require a bank account and can generate cash quickly. Auto title pawns also have two substantial advantages over traditional pawns: first, cars are worth more than traditional pawned goods (the average pawnbroker loan is estimated to be about $70); second, one huge benefit of auto title pawns is that the consumer retains use of the collateral during the loan, rather than having to surrender it. As gold prices soared in recent years, traditional pawns became capable of generating more cash, as jewelry is one of the most common type of goods pawned (especially by women). But as gold prices have fallen, the value of pawned jewelry has fallen as well.
(3) Larger loans: The final category of people are those with impaired for whom payday loans simply do not generate enough cash. According to the NYT story, Ms. O'Connor needed $1,000 for bills. Under Missouri law, payday loans are limited to $500, so even if she preferred to use a payday loan it appears that it would not have generated sufficient funds. Those who use fringe lending products almost never have access to credit cards, either because they don't have them or they are maxxed out already.
2. Those who use auto title pawns have limited options: Those who use auto title pawns, as with other fringe lending products, typically have limited credit options. As we discuss extensively in "Consumer Credit and the American Economy," those who use these products typically have a high demand for credit but highly-restricted supply. They tend to be younger, lower-income, and in the early stages of their household lifecycle, during which credit demand is high. As just mentioned, these consumers typically don't have bank accounts and lack access to credit cards and higher-quality credit.
Most notably, according to Hawkins's research, 8.5 percent of those who use auto title pawns report that if they could not pawn their car they would have had to instead sell the car outright in order to generate needed cash for bills. I'm not a mathematician, but by my estimate if you have to sell your car then that increases your likelihood of losing access to your car to 100 percent. Hawkins also found that this figure—8.5 percent—exceeded the number of people who actually lose their car to repossession as a result of taking on auto title pawn. So by depriving consumers of the possibility of borrowing against their car equity and potentially keeping the car, prohibiting car title loans will instead require many consumers to sell their cars in order to access their equity, while losing the use value in the meantime. It is hard to see how consumers are made better off by being forced to sell their cars in order to access the equity rather than giving them the option of borrowing against it instead. (This would seem to be an obvious point, but it seems to have never occurred to the reporters at The New York Times that one alternative to pawning a car would be to have to sell it instead.)
3. Consumers use auto title pawns for pressing expenses: Non-business users of auto title pawns (and other fringe lending products) use them for pressing expenses and emergencies. They have limited savings and use these loans for needs such as rent or mortgage, utility bills, unexpected expenses, or medical bills. Indeed, a common use of auto title pawns is to finance needed repairs to the car itself to keep it operational. You cannot wish away the need for credit, and restricting a source of supply (auto title pawns) does not eliminate consumer need for credit. According to Hawkins, 18 percent of title pawn customers said that they would have had to pay a late fee on their bills if they couldn't get a title loan.
4. Title pawns provide limited risk of financial breakdown: As Hawkins has noted, one striking feature of most fringe lending products is that they present limited risk of financial breakdown to consumers. To be sure, the risk of an auto title pawn is not trivial—the loss of a car and the potential consequences associated with that. But as a financial matter, risk is limited. The risk of an auto title pawn loan, for example, is limited to loss of the car. Unlike, say, credit cards or credit card cash advances, which can generate finance charges and fees that can cause the balance to increase and potentially dig a hole for consumers, auto title pawns are non-recourse and so the consumer's exposure is limited. Payday loans are similar—the borrower's risk is limited to the consequences of not paying the original amount borrowed (there may be ancillary costs, such as bank overdraft fees, but note that the payday lenders have no incentive to make repeated draws because they don't benefit). Also, unlike payday loans (in some states) or credit cards, the borrower can only have one auto title loan outstanding at a time.
5. The risk and consequences of repossession are not as extreme as might be supposed: The risk of auto title pawns is obvious—the consumer might lose his or her car. This can be especially consequential if it is necessary for the consumer's work, and there could be follow-on negative effects. Fortunately, these consequences—while certainly concerning and tragic—are much less common that the Times's article suggests. And it turns out that those who use these products are not as stupid as the Times's reporters imply they are. Consider:
(1) To repeat the point: For many of those who use auto title pawns, the alternative is to sell the car, which results in a 100% likelihood of losing possession.
(2) Most vehicles subject to auto title pawns are not the consumer's only means of transportation: According to surveys, roughly 70-80% of those who use auto title pawns have more than one car. Moreover, the cars that are pawned are typically older and less valuable vehicles, so they are pawning a secondary car. Perhaps most surprising, almost 5% of title pawn customers said that if they lost their cars to repossession they'd simply buy another car. (This is presumably because they could finance the car, so even if they don't have enough cash on hand to redeem their old car, they could presumably make monthly payments on a replacement). Only 15% of title pawn customers said that the car that they were pawning was their only way to get to work. As Fritzdixon, Hawkins, and Skiba note, "Less than 15% of borrowers stated that they would have no other way to get to work. While not insignificant, this small percentage suggests that the dire consequences that critics predict are unlikely to occur for the vast majority of title borrowers. Rough calculations would place the percentage of title borrowers who lose their jobs as a result of title lending at 1.5%."
(3) Most estimates find that approximately 4-6% of vehicles that are pawned are eventually repossessed-less than the 8.5% of those who said that they would have to sell their cars to get cash if title loans were not available. Some of those who have their cars repossessed subsequently redeem the cars. As Hawkins summarizes, "repossession rates…are much lower than previous research has indicated."
(4) Many defaults on auto title loans are because the car is totaled or breaks down. In fact, it appears that only about half of defaults on title pawns actually result in repossession. This is because, as noted, these are typically older cars to begin with and they have a substantial risk of major mechanical failure for which repairs exceed the cost of vehicle. Title pawn lenders are not named as insureds on the vehicles. Like traditional pawn loans, the structure of title pawns essentially creates an option for the consumer to either pay or walk away, and where the car becomes worthless the consumer can walk away.
(5) Contrary to the assertion that lenders have leverage and can pressure consumers to redeem their cars at any cost, Hawkins found that very few title pawn customers said that they would prioritize those payments over payments such as rent, utilities, medical payments, and groceries (a majority said that they would prioritize their title pawn payments over credit card bills). This is because lenders have much less leverage than supposed-as noted, most consumers have more than one car or access to other transportation, the loans are non-recourse, and in many cases the cars are old and inoperable.
6. Consumers generally understand the costs and risks: Surveys of consumers who use fringe lending products consistently find that although these products are expensive, consumers who use them generally understand that they are costly. They may not be able to state the APR, but they do know the finance charges and other terms. In fact, one common reason given by many consumers for why they use products like payday loans and auto title pawns is that the products are simply and easy to understand. Many of them have had bad experiences with more complex products such as bank accounts and credit cards and so opt for these simpler products. Restricting access to them, therefore, appears to be grounded solely in paternalism, not in a lack of proper disclosure and the like.
At root, the fundamental problem with The New York Times's article is that people are not as stupid as the Times reporters think that they are. Consumers use auto title pawns for a variety of complex reasons and those who use these loans typically do so because they are better than the alternatives—eviction, utility cutoffs, or the like. Many of those who use them look like consumers but are actually small businesses. And only a small minority are consumers who are risking their only transportation or only way to work by taking a loan—most have another vehicle in the household and almost as many say they would simply buy a new car, if their car was repossessed. Based on the best available estimates, the percentage of those who say that they would be forced to sell their car to get needed cash if title loans weren't available actually exceeds the number of those who are estimated to lose their cars to repossession.
Finally, for unbanked consumers—whose ranks have swelled as a result of the Durbin Amendment and new regulations on overdraft protection—auto title pawns are one of the few remaining sources of liquidity available to meet urgent expenses.
Auto title pawns certainly raise unique and important consumer protection questions but it is unwise to simply dismiss them as "hurting the poor" without doing even the slightest bit of research to actually understand how the product is used.