Will Payday Loan Regulations Kill the Market?
The Springfield News-Leader today features a good op-ed about current plans for regulating Missouri’s payday loan industry.
Good bit:
The FDIC found that payday loan fees were justified by the costs and risks associated with offering such loans. The FDIC also found competitive products like bounced checks carrying APRs of up to 3,500 percent.That APR calculation – designed to compare competing, long-term forms of credit – is why a 36 percent APR cap, as proposed in current Missouri legislation, would ban short- term loans in the state.
If imposed, a 36 percent rate cap would mean lenders could only charge about $1.38 per $100 borrowed. At such a low rate, lenders simply can’t cover their costs – such as rent, employee salaries and benefits.
As I’ve written before, I’m opposed to payday loan regulation because:
- I view payday loan transactions as legitimate, consensual business interactions between relatively rational actors.
- The empirical evidence suggests that payday loans constitute a useful service. I look, for example, to Donald Morgan and Michael Strain, who show that increased access to payday loans reduces the volume of bounced checks. I also look to Edward Lawrence and Gregory Elliehausen, who find that payday loans “satisfy a real financial need within a certain segment of the population.” As I cite these authors, I’m fully willing to concede that there is literature out there that disagrees with their claims. The reading list I composed earlier lists some of those papers. In a future blog post, I will attempt a more detailed comparison of the methodologies employed in the different studies.
- If payday loans are useful, then limiting or eliminating the payday loan market will drive consumers to underground or black markets. This is not favorable, for reasons that should be self-evident.
- I think the most legitimate critique of payday loans is that it disadvantages the politically weak who have, for example, little access to legal recourse. If that’s the case, the better solution would be to reform the political/legal apparatus, rather than the payday loan market. Opponents can argue that this is less feasible, and they would be correct, but if the market is driven underground, then these people would have no legal recourse anyway.
My main concern now is the third. Those who seek to regulate payday loans toe a narrow line between tempering the market and hobbling it. Unfortunately, it looks as though the proposed reforms are poised to do the latter.
After attending the hearing on payday loans in Jeff City last week, I got the impression that they might make some kind of compromise that would basically have no effect on payday lending but would still give the impression of doing *something*. They can cap the interest at 36% APR while allowing the companies to charge a large origination fee that would make up the difference. I’m not saying that’s what will happen, but it was floated, and the industry representatives were not adamantly against it.
Comment by John Payne — April 7, 2010 @ 5:04 p.m.
Abhi,
Check this paper by Morgan and Strain out. http://www.newyorkfed.org/research/staff_reports/sr309.pdf
Comment by Eapen Thampy — April 7, 2010 @ 6:14 p.m.
@Eapen: I link to the paper in my post (under point 2). Did you not see the link or are you suggesting that I read it more thoroughly?
@John: Interesting. I wonder how certain sponsors feel about that, specifically Mary Still.
Comment by Abhi Sivasailam — April 7, 2010 @ 6:28 p.m.
Dude, I completely missed that.
Comment by Eapen Thampy — April 7, 2010 @ 6:35 p.m.
Barring the ABA taking meaningful steps to reduce the cost of legal education (and by extension the cost of legal services) would you support a subsidy for legal representation to people who have valid claims against payday loan providers but can’t afford representation?
Comment by Eapen Thampy — April 8, 2010 @ 12:03 a.m.
Eapen
The subsidies you propose already exist, and are carried out under the auspices of the Legal Services Corporation. For example, see: http://www.lsem.org/Consumer_33.aspx.
Comment by Mike — April 8, 2010 @ 10:32 a.m.
I’m aware of the existence of LSM and also aware that their funding is minimal.
Comment by Eapen Thampy — April 8, 2010 @ 10:43 a.m.
I’m aware that their funding is minimal: I work there for free because they cannot pay me. That said, the social problem associated with the pay day loan industry is not due to a lack of legal services. Many, if not most, individuals who have legitimate claims against pay day lenders are able to acquire free legal services. The real issue is that many people misuse pay day loans (and similar services), and the lenders have legitimate legal claims against them. The solution to the underlying problem is educating people how and when to use (or not use) services like pay day loans.
Comment by Mike — April 8, 2010 @ 11:08 a.m.
Mike, do you have any data available?
Comment by Eapen Thampy — April 8, 2010 @ 11:58 a.m.
Data are available, but I do not have the specific citations at the moment. I will dig through my files and try to get them for you.
Comment by Mike — April 8, 2010 @ 2:50 p.m.