Payday Lending

Consumers Need More Options, Not Fewer

Efforts in Virginia to outlaw payday lenders may salve consciences but they won't do anyone else any good.

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Say there's a corner gas station, call it Jimmy's, charging what seems like a ridiculous amount of money for a gallon of regular unleaded. How might Jimmy's be induced to bring the price down?

One option would be to put another gas station that charges less nearby. This would bring price competition, increase the available supply of gas and reduce waiting time at the pumps. It also probably would induce Jimmy's to entice customers through other means, such as selling drinks and snacks or hiring a mechanic.

Another option would be to pass legislation forbidding "predatory gas stations" and force Jimmy's to cut its prices or face the wrath of state regulators. This would make gas no easier to get, do nothing to cut waiting times at the pump and give Jimmy's no reason to improve its products and services.

To Virginia lawmakers, and many others, Option B is definitely the way to go.

The commonwealth has taken that approach to payday and car-title lenders. In 2008, Virginia imposed regulations on payday lending that soon produced impressive results: Payday loans fell 84 percent, and some payday loan companies left the state. But car-title loans soon proliferated in their place, and critics of what some call predatory lending are still not satisfied. Chesterfield County has debated whether to permit them and where they should be allowed. Fairfax could restrict where payday and car-title lenders may operate as well.

Virginia Attorney General Mark Herring (D) has denounced what he calls "pernicious" lending practices and promised to crack down on them. He has lots of company. Many critics fault storefront lenders for charging usurious fees, letting borrowers pile up fees by taking out loan after loan and "preying on vulnerable people," especially the poor and minorities. (That last charge is incorrect: Whites and minorities in similar financial circumstances take out payday loans at similar rates.)

The critics certainly have an emotionally appealing case, one in which soulless corporations seem to take advantage of poor people's pressing needs to squeeze them for money they badly need, trap them in a cycle of dependency and then seize their cars or hound them mercilessly if the borrowers don't pay up.

Advocates of tougher regulation often point out, for instance, that federal law prohibits charging members of the military or their dependents more than 36 percent interest, and contend a similar cap ought to apply to everybody. What they don't mention is that the cap could affect not just lenders with DayGlo color schemes but traditional credit unions, too. A proposal to extend the cap to all forms of credit drew protests from credit unions in May, when the chairman of the National Credit Union Administration warned that the move could end up "outlawing affordable credit union loans" because "when fees are included, many credit unions' short-term loans would exceed the proposed 36 percent" universal cap.

The credit unions still wanted the cap, they just didn't want it to apply to their own financial services. This suggests they were interested not in protecting service-members from high-interest loans, but in making more of those loans themselves. It's also worth noting that traditional banks also can sock it to service members with hefty fees, as a 2014 story in The Wall Street Journal revealed. Banks near military installations often charge high service fees even for depositing funds, and allow service members to make overdrafts, but then impose high fees for each instance, draining their savings and causing more overdrafts.

The story cited an FDIC study reporting that "a $20 debit-card transaction incurring a $27 overdraft fee repaid in two weeks equates to an annual percentage rate, or APR, of more than 3,500 percent." That makes a payday lender's $15 fee on a $100 loan, which equals an annual interest rate of 391 percent, look pretty good by comparison.

That might help explain why, as one recent study published in the Fordham Journal of Corporate & Financial Law put it, "payday lender profit margins are less than half that of their mainstream lending counterparts." (In fact, "profit margins of payday lenders are far below those of Starbucks. The profit margins of Starbucks for the measured time period were just over 9 percent," more than double the margin for payday lenders.) Why? Because payday "loan losses account for a very high percentage of operating costs." Bad debt makes up 26 percent of the cost of operating a payday loan operation.

This isn't surprising when you learn that the customers of storefront lenders often have bad credit, which could drive up the interest they would pay on a loan at a traditional bank, or prevent them from getting such a loan in the first place. What's more, storefront lenders offer non-price benefits some borrowers find appealing. Defaulting on a storefront loan won't lower your credit score; you don't have to have an account with a storefront lender to borrow from it; etc.

Perhaps critics of the storefront lending industry think they could do better by charging what they consider reasonable interest rates, and still stay in business. If so, then they are missing a golden opportunity to get rich by not entering the market themselves. If people who take out payday and car-title loans are presented with the chance to borrow the same money at lower rates, then surely they will take it.

And, in fact, that's exactly what they do. A recent piece from the Federal Reserve Bank of New York cites research showing that greater competition yields lower fees. Specifically, "each additional payday firm per 1,000 residents in a given Zip code was associated with a $4 decline in fees." Put a gas station across the street from Jimmy's, and watch prices fall. Perhaps a better answer to high fees is to permit more payday and car-title lenders rather than fewer.

Granted, some people think the correct number of storefront lenders is not more or less but zero. Assume for the moment that they prevail, and that they neither set up their own loan operations, nor succeed in coercing banks to make  short-term loans to people with bad credit. Will this eliminate the need for short-term loans? Of course not. It simply will drive borrowers to seek help from even less savory sources, such as loan sharks or offshore lenders that lie outside the reach of any regulation at all. That might salve some people's consciences, but it won't do anybody else a bit of good.

This article originally appeared in the Richmond Times-Dispatch.

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  1. “Another option would be to pass legislation forbidding “predatory gas stations” and force Jimmy’s to cut its prices or face the wrath of state regulators. This would make gas no easier to get, do nothing to cut waiting times at the pump and give Jimmy’s no reason to improve its products and services.”

    The same assumptions lead to businesses improving services and products under price controls, because volume would be their only method of increasing profits. Regulation would then mean gas becoming easier to get, lower waiting times, etc. It isn’t so black and white as “if X, then Y”. Payday lending is already highly competitive; the only method of significantly increasing consumer choice is allowing the Postal Service to conduct community banking.

    1. Look, it’s a Berntard in the wild! Even citing one of Bernie’s dumbest ideas. Is there anything the Postal Service can’t do?

    2. Wow, somebody who thinks that price controls lead to greater supply. You must be a #BernVictim with that grasp of economics.

      1. Yea that is a pretty odd take imo

    3. Don’t bother commenting here. If you’re not a slave to the idea of free markets curing absolutely everything, you’re a communist and can go away. Nobody wants to conduct a good debate here.

      1. Because slaying strawmen is just the kind of debate we need, comrade!

        Don’t bother commenting here.

      2. If you’re not a slave

        We’re not much into slavery here either. It’s one of those dangerous, libertarian “freedom” things, ya know?

      3. Some beliefs are like a flat earth and there is no point in refuting them point by point. Denying the very concept of demand and supply is one of those.

        Just like shooting water up out of a hose appears to defy gravity only to the feeble minded, you can find situations which appear to defy reason, such as luxury goods selling better with higher prices, but a moment’s reflection will show that people are buying the status, not the good itself, and status is directly related to price.

        In this particular case, Bozo makes the bald statement

        The same assumptions lead to businesses improving services and products under price controls, because volume would be their only method of increasing profits.

        which is pure poppycock. Price controls are only imposed because prices are naturally rising, and prices being prices, they generally only rise because costs have gone up. Very few businesses actually raise prices just to be unfriendly, precisely because it does decrease how many they sell and opens them up to competitors taking away their business. In reality when costs force price rises, all price controls do is mean the business would have to take a loss to keep selling the product, so the natural outcome is to stop selling the product entirely, not to add more expenses to make the loss even greater.

        Bozo here seems incapable of understanding such basic reality, or at least incapable of acknowledging it, and thus the derision he so rightly deserves.

    4. Not sure if serious. Where is the incentive to improve products with price controls? What if the price control is set at price = cost…how would this help profit?

      Also not sure how regulation makes gas easier to get and lower waiting times. Regulation throws obstacles into the road…it does not make things easier.

      Can you actually name businesses that improve their product and services by way of price controls?

  2. They think that outlawing low-wage jobs means that every single person will have a high-wage job…

    They think that outlawing cheap housing (through onerous building codes) will guarantee that nobody ever sleeps in squalor again…

    And now, they think that they can guarantee an infinite stream of cheap, accessible credit by outlawing loans with interest rates that the legislature deems to be “predatory”.

    Is it just me, or are progressives kind of stupid?

    1. Do you mean some sort of stupid or some special kind of stupid?

    2. This is a rhetorical question, right?

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    …………………. http://www.4cyberworks.com

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