Another Opportunity for 'Progressives' to Put Their Money Where Their Mouths Are

by Don Boudreaux on April 29, 2009

in Regulation

Roger Meiners has this great letter in today’s Wall Street Journal:

Payday Loan Bill Cuts Choices for Poor

Michael Calhoun, the head of the Center for Responsible Lending, asserts (Letters, April 18) that payday loans should be capped at 36% APR and endorses H.R. 1214, The Payday Loan Reform Act of 2009, for imposing limits.

At that rate, a loan of $200 for one month would generate $6 in interest. If Mr. Calhoun and the bill’s sponsors really think one can run a payday business by charging such a rate, they should set up shop. It is not hard to do. Clients will flock to their outlets instead of the “predatory” lenders they criticize.

The payday loan market is highly competitive and provides a needed service primarily for low-income people. Just let those folks try getting an instant loan from Citibank for $200 for one month. If H.R. 1214 is enacted, it will be back to thugs serving the low-income borrower market. That’s a “reform”?

Prof. Roger Meiners

University of Texas-Arlington

Arlington, Texas

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{ 19 comments }

Morgan April 29, 2009 at 9:39 am

I can certainly see some circumstances under which high interest loans might be "predatory". They involve diminished capacity on the part of the borrower or misrepresentation of the terms of the loan.

Perhaps the bill's sponsor (Rep. GutiƩrrez; D-IL) believes that no one would accept the terms of the payday loan unless one or the other of these conditions applied. But that belief can be verified (or falsified) empirically.

Is anyone aware of an attempt to do so?

Don Boudreaux April 29, 2009 at 9:49 am

Morgan,

I agree that sometimes what looks to be legitimate bargaining resulting in legitimate contracts are, in fact, instances of fraud or incapacity on the part of one or the other of the parties.

But standard contract law has well-developed and nuanced ways of protecting parties from such abuse and incapacity. There's no need for top-down "protection" imposed by legislatures.

tw April 29, 2009 at 9:57 am

I don't know what the interest rates are at the payday loan places (thankfully so), but let's assume that they're currently getting $50 in interest for a one-month $200 payday loan. If this law goes through, and the interest is capped at $6 per month, then won't the firms institute some sort of loan application form with, in this case, a cost of $44 per successful application?

John Dewey April 29, 2009 at 10:09 am

Won't this legislation increase the crime rate? I'm not meaning the crime of "thugs" who ignore lending laws. Rather, reduction in short term credit should increase property crimes by those who previously had access to payday loans. If one needs money to feed children – or an addiction – he or she is going to get it somehow. If one hasn't the funds to repay thugs who will cause bodily harm, he or she will get the funds somehow.

Perhaps the "The Payday Loan Reform Act of 2009" should be retitled "The Burglary and Theft Incentive Act of 2009".

Joshua Herring April 29, 2009 at 10:16 am

What's intersting to me is that the people who propose these bills surely know their arguments don't make sense. I, for example, have never been, and never anticipate being, in a situation where I would be prepared to accept a loan at even 25%APR, let alone the 36% at which the authors of this bill propose to cap the rates. I cannot help but think that the same is true of Mr. Calhoun and the bill's sponsors. Recognizing this, surely the next step in their reasoning should be "OK, given how irrational it seems to me to take a loan at 36% interest, there must be something really important against which they have to balance that cost – something to do with their circumstances that I can't imagine." The fact that they cap interest at 36% rather than something closer to what they would be willing to pay for an emergency loan (say, 20%) seems to indicate that they DO entertain this consideration. And if they do, why not just go ahead and make the extra step of saying "Oh, well, if I can't understand their circumstances, maybe I shouldn't interfere with their preferences?" But no, somehow we never make it to the final step. Puzzling.

I_am_a_lead_pencil April 29, 2009 at 11:58 am

Willing buyer.
Willing seller.
Transaction undertaken.
Disputes settled per common law.
End of story.

Minimum wage laws, usury laws, licensing laws and a whole host of other wealth restricting mechanisms all go away if we adhere to the outline above.

Flash Gordon April 29, 2009 at 12:01 pm

I think the typical payday loan is around $500 and costs about $50 for a month. That works out to an annualized rate of over 100% but to someone who really needs the $500 right now it might be worth it.

If you live in Chicago you can get a "juice loan" on the street where $500 will cost you $50 for a week. Plus, they really don't want you to pay back the principal, they would rather have the $50 a week for the rest of your life. That might not be a very long time if you ever have trouble coming up with the $50 some week.

Even if you ever do pay back the principal the record of your payment might get lost so that you'll have to pay it back again. And again. And you will. Or else.

I'd say to the politicians that they ought to focus their attention on the very real predatory lenders, and not the honest and harmless people running payday loan businesses.

Chris April 29, 2009 at 1:02 pm

There is a clear difference between interest or service charges paid for a two to four week loan and an annualized effective interest rate. The Federal Truth in Lending Act makes it mandatory for lenders to calculate annualized effective interest, which leads to misleading 300-400% APR figures that alarm misinformed people. In Texas, lenders are capped at 10% and credit service organizations generally charge $15-20 for every $100 dollars lent out.

Milton Recht April 29, 2009 at 2:07 pm

According to an April 14, 2009 Wall St Journal article by Robert DeYoung, payday loans are cheaper than bank overdrafts and consumers make informed, rational choices before using payday loans. A NY Federal Reserve Bank 2007 study by Donald Morgan, "Defining and Detecting Predatory Lending," found that payday lending is non-predatory, does not have a higher delinquency rate and makes credit more widely available.

DeYoung writes, "But new research suggests that most payday borrowers are more rational and informed than critics believe. A January 2009 study by Gregory Elliehausen at George Washington University found that payday borrowers make informed choices. About half of the 1,173 payday borrowers he surveyed considered other credit alternatives — such as bank, credit card, or personal loans — before taking out a payday loan. Over 80% lacked sufficient funds in their bank accounts to meet their expenses, so by taking out a payday loan they avoided expensive checking account overdraft fees. Nearly 90% said they were either very or somewhat satisfied with the transaction.

A November 2008 FDIC report on overdraft protection provides the context. According to this exhaustive study, the average APR on a two-week checking account overdraft is 1,067%, more than double the rate on the typical payday loan. Worse, a large percentage of banks studied by the FDIC take deliberate measures to increase the frequency of customer overdrafts — such as displaying account balances on ATM screens only after the overdraft has occurred, and increasing the number of insufficient funds checks by clearing large customer checks before small ones. Compared to these overdraft practices, payday loans are transparent."

Banks are using their lobbying strength and misinformation to protect their high fees and prevent competition.

The Wall St Journal article is at http://online.wsj.com/article/SB123966856055415377.html.

The Federal Reserve Bank of NY study is at, http://www.newyorkfed.org/research/staff_reports/sr273.html

TrUmPiT April 29, 2009 at 2:12 pm

Funny how the rich can borrow at the cheapest rates, while the poor have to borrow at usury rates. I would say that this ridiculous state of affairs requires some kind of government intervention, I believe. A good economist would see the irony and try to suggest a solution. A bad economist should have their degrees and tenured positions revoked and be outsourced to a 3rd world trained economist who will work for much less, work harder, and better. I want the education monopoly (thug throat throttling, and extortion) to end now.

tw April 29, 2009 at 2:48 pm

TrUmPiT,

The reason for the disparity in interest rates charged is pretty simple: The price of money is higher for those who have a higher likelihood of not being able to repay it, or repay it in a timely manner.

And how would you try to define usury? When does it begin? How do you factor in inflation and a host of other factors?

Adam Keith April 29, 2009 at 3:03 pm

"Funny how the rich can borrow at the cheapest rates, while the poor have to borrow at usury rates."

Simple, the people who loan to the poor run a greater risk than those that loan to the rich.

So, therefore, they balance this risk with higher interest rates.

How is this greed or immoral? It's just the way this works.

Government forced companies to loan money to lower-income brackets. Look at where that has gotten us.

Crusader April 29, 2009 at 3:08 pm

No amount of contract-law can protect stupid people from themselves. It's called social Darwinism.

Crusader April 29, 2009 at 3:11 pm

Shorter TrUmPiT:

"Just tax the rich more and give it to the poor".

Christopher Renner April 29, 2009 at 4:44 pm

tw,

Armpit has probably posted hundreds of similar screeds on this blog and has yet to ever attempt to define anything. You can't argue with something that's not by any means an argument.

EJ April 29, 2009 at 5:51 pm

TrUmPiT,

The primary reason why paday loans have such high interest rates is because they are such small amounts. Any loan has a fixed cost of making the loan (someone has to process the application). So in order to carry this fixed cost to the borrower, over a short perior of time and low amount it translates into a large percentage. If you charged 10% on a two week loan for $500 bucks that would only 47 cents. Thats not profitable. Add to the fact that they are unsecured and they go to high risk borrowers. Payday loans are not designed to be long term forms of funding. They are designed so when someone is in a jam, for a small fee, 25 bucks say, they can get 500 dollars advanced to them. Payday loans are very compeditive and therefore profits are limnited. Payday lenders dont make that much and the market has already brough the prices down to the marginal cost of supply the loans.

mgroves April 29, 2009 at 6:10 pm

A law like this was passed in Ohio, and it is infuriating! The next alternative to these payday loans is overdraft fees, which are much more predatory and expensive, and not covered by these types of laws. Payday loan places have incredibly high customer satisfaction rates to boot.

Yes, they can be abused, but I guess I've always been of the opinion that adults are able to make adult decisions and live with the adult consequences.

John April 30, 2009 at 8:03 am

If this bill makes payday loans unprofitable, then the intent must be to put them out of business.
So one must ask why.
Is it to protect consumers? Yeah right.
My cynical guess is that the sponsors of this bill have friends in the banking industry who see dollar signs in the form of overdrafts and other fees.

I've always believed that anyone who seeks power cannot be trusted with it.

Fred Cash April 30, 2009 at 12:53 pm

I agree with Chris's comments and people are very informed about these loans and know what they are getting into. The fact that we are limiting options for people that need them in this economy is completely the wrong course of action and needs to be looked into further with some real numbers, rather than the fake numbers that many critics like to use for these types of loans. They try to scare people with a high APR, but these loans are not paid over a year and they don't have installment payments, so how can we use APR to justified the amount that these loans cost. Many states cap the amount to $15 per $100 borrowed, which is 15%. I know credit cards and other loans that are much higher than this, but I don't hear as many critics complaining about these loans.

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