Payday Loan Industry in the News
Some legislators held a hearing the other day on the harms caused by the payday loan industry. Combest has linked toseveral news stories about the hearing. Although payday loan companies may not be popular, and defending them might not be the easiest road to take, but here at the Show-Me Institute, we have written a few pieces in defense of them.
I think one of the commenters in the Columbia Daily Tribune story accidentally made our point when he or she said that payday loan companies are “legalized loan sharks.” Yes, they are, and if you ban them or regulate them out of existence, they will be replaced by illegal loan sharks. Former Show-Me Institute policy analyst Justin Hauke said it very well in his article when he summarized:
At least with a payday lender, default is settled in court. In the black market, it usually involves a crowbar.
I found it somewhat unbelievable that an economics professor advocated that people who loan money at high rates, because of the heavy risk that this market entails, should go to prison:
In a rebuttal, Bill Black an associate professor of economics and law at the University of Missouri-Kansas City and expert on fraud, said the profit earned by payday lenders is equal to a “giant sucking sound” of dollars headed out of the state. The interest paid to the lenders is money not going to buy groceries, pay utilities or cover rent. It’s a financial black hole, he said.
“In any period of human history other than about the last 15 years, it would have been a crime,” Black said of the lending practice. “And people who charged those interest rates would have been in prison, which is where they belong.”
So, let me get this straight. If two adults engage in a voluntary loan transaction, in a free country like ours, one of them should go to prison? I can’t imagine what other areas of our life Professor Black supports regulating. Based on the above statement, I can’t imagine any aspect of our lives the government wouldn’t belong in. Just terrifying.
As long as the industry can show that they are operating above the board – no hidden fees, step up charges, etc…. then they should be free to operate as they choose. If their pricing is too high then eventually someone will step in and take their business away.
Comment by Mike — November 19, 2009 @ 7:36 a.m.
A lot of the people who today take out payday loans would have gone to a pawn shop in the past. What kind of effective interest does a pawn shop charge? I bet it’s not 1% above prime.
Comment by Mike S. — November 19, 2009 @ 3:07 p.m.
There is a lot of moral hazard in the crowbarless short-term loan industry. If you know they aren’t going to break your jaw if you dont pay, the incentive to default is higher.
Comment by vroman — November 19, 2009 @ 4:14 p.m.
Just like if you install a metal spike pointing at your heart on your car’s steering column, you’ll be a safer driver. But the increased specific probability of death in the event of a crash isn’t necessarily a good tradeoff for the decreased general probability that a crash will occur in the first place.
Comment by Eric D. Dixon — November 19, 2009 @ 4:49 p.m.
I wasn’t saying black market version is better, just explaining why white market short-term lenders have to charge higher premiums: they are facing increased moral hazard, bc they DONT have violence option.
Comment by vroman — November 22, 2009 @ 6:15 p.m.
Suppose someone needs a short term loan and is considered a credit risk. They get a loan from either a payday loan store or a loanshark. There are certain factors which prevent them from paying back which they can control, and some factors which they cannot. If we assume that the interest rate is sufficiently remunerative to cover the possibility of a default beyond their control then the question remains “how do the lenders best incentivize the borrowers to work hard to manage the things they *can* control which enable them to pay back?” High interest rates and threats of violence are both expensive from the point of view of borrowers. The point, I think, is that violence is abhorrent and we would prefer if there were a healthy market of competing options for people who find themselves in the situation described in the first sentence of this comment.
Comment by Josh Smith — November 23, 2009 @ 11:20 a.m.