The Consumer Financial Protection Bureau (CFPB) is finishing up new regulations that could ultimately shut down payday lenders, and there’s no indication they’ll change course. Some members of Congress have tried to stand up for the state-regulated version of the industry, but the tide is against them.
Last year, an advocacy group launched an ad campaign during the Discovery Chanel’s Shark Week, painting the payday loan industry as a bunch of vicious predators. And celebrities John Oliver and Sarah Silverman joined forces, begging people to “literally do anything else” besides take out payday loans.
While surely full of good intentions, these people are making value judgments rather than rational arguments, and value is subjective—even when it comes to topics like fees and interest on small loans. It may be difficult for some people to grasp, but payday lenders actually provide access to the economy for millions of people who would otherwise be shut out.
These companies provide small-dollar loans to people that banks won’t bother with, and there’s ample evidence that borrowers actually like the services they’re paying for. According to the Pew Charitable Trusts, more than 12 million Americans borrow over $7 billion per year from these firms.
And there are now more than 20,000 payday lender locations in the U.S., compared to fewer than 15,000 McDonald’s restaurants.
These facts suggest that payday lenders are providing a valuable service, but advocacy groups like Pew, as well as federal regulators, don’t see it that way. Instead, they seem bent on killing this industry in the name of protecting people.
Richard Cordray, the CFPB director, recently told the House Financial Services Committee, “There’s [sic] some ugly kinds of credit out there that we have seen that are quite predatory, I can’t in good conscience just leave that alone.”
Well, there’s some faulty economics surrounding this issue, not to mention hypocrisy, condescension, and misplaced hostility toward free enterprise, and I can’t leave that alone. (Yes, I always have a ton of things to write about.)
To start with, the term “predatory” is nothing more than an emotional expression designed to smear legitimate business transactions and further an ideological agenda. If a lender commits fraud, then he or she should be punished for fraud.
But terms like “ugly” and “predatory” have no objective meaning in regards to private contracts, even if a third party thinks the interest rate on a loan is “too high.”
There’s no doubt that some consumers make bad decisions from others’ point of view, but nobody has an ironclad grip on the single “right” way to look at those decisions. Nobody, that is, except the consumers making their own subjective choices.
What looks like a debt trap to Cordray and his CFPB staff could look perfectly normal and even necessary to a consumer. Policymakers should start with that assumption instead of the one they currently rely on, which paints the industry as predatory.
Supposedly, payday lenders seek out complete fools who aren’t capable of making choices that help them improve their lives. Even worse, they actually seek out people they know won’t be able to pay back their loans, thus sucking even more money from their prey, who are left with no choice but to take out new loans.
What a genius business strategy: find customers who can’t pay you back so that you can force them to pay you higher fees. No flaw in that logic.
Furthermore, the CFPB’s own complaint database doesn’t support the notion that so-called predatory lending is a systematic problem. From July 2011 to August 2015, consumers lodged approximately 10,000 complaints against payday lenders.
Ignoring that these are unverified complaints, and consumers could be complaining about all sorts of issues (or possibly taking advantage of the system to lower their debt), more than 12 million people per year are using payday loan services.
So that’s just under a tenth of a percent comparing four years of (unverified) complaints to one year of transactions.
An even bigger knock against the CFPB’s approach is new research by Columbia’s Ronald Mann. This newly published survey is—as far as I can tell—the first direct evidence that what the CFPB calls a debt trap is nothing of the sort.
Most people, it turns out, actually understand that they’ll be rolling over a payday loan before becoming debt-free. But they still do it. (If the borrower had a large income, I suppose even CFPB bureaucrats would just call this refinancing.)
Mann’s principal research question was whether borrowers could accurately predict when they would be debt-free for an entire pay period. Mann reports:
Almost 60 percent of respondents managed to become free of debt either before or within two weeks of their predicted date of clearance. To put it conversely, only 43 percent failed to clear themselves from debt within two weeks of their predicted date and less than half were late by more than a week. That is, of course, not an insignificant share, but it does suggest that a strong majority of those using the product have a basic understanding of what will happen when they borrow.
Indeed it does.
This highlight obscures another interesting fact in Mann’s work: borrowers’ average prediction error was close to zero. In other words, payday loan users were just as likely to overestimate the time it would take them to be debt-free as they were to underestimate how long it would take.
Furthermore, demographic characteristics did little to explain borrowers’ prediction error.
Combined, this evidence suggests that there is no systematic problem with so-called predatory lending.
The evidence certainly doesn’t justify a national regulatory framework that goes farther than the state regulations already in place. Especially when we consider that the new federal rules are likely to shut millions of people off from access to credit.
Nonetheless, the CFPB appears poised to crush the payday loan industry by imposing ability to repay rules on payday lenders. These rules are not yet complete, but if they’re anything like the ability-to-repay rules imposed on mortgage lenders, then payday lenders should start looking for new work.
These rules require lenders to “make a reasonable and good faith determination based on verified and documented information that the consumer has a reasonable ability to repay the loan according to its terms.”
Yes, it’s true: the general idea behind making a loan is getting repaid. So while the ability-to-repay rules may seem superfluous, there’s a downside: they give the borrower the right to sue the lender for misjudging the borrower’s ability to repay the loan.
This fact alone has the potential to kill the industry, because it will no longer be worth making these small (typically $200 to $500) loans. One lawsuit would easily wipe out the expected profit on a small dollar loan, even one that’s rolled over several times.
The CFPB would save a ton of time if it simply directed payday lenders to give away $100 bills, and then ask the Federal Reserve to make emergency loans available to the companies.
By imposing these stringent rules, the government will be able to point to alleged market failure and then more easily create government-backed institutions to make payday loans.
If the Postal Service offered basic banking services—nothing fancy, just basic bill paying, check cashing and small dollar loans—then it could provide affordable financial services for underserved families, and, at the same time, shore up its own financial footing.
There’s also a provision in Section 1205 of the 2010 Dodd-Frank Act. This provision turned a local San Francisco program (Bank On USA) into a national program by making Community Development Financial Institutions (CDFIs) eligible to compete with payday lenders.
CDFIs receive nearly $300 million in taxpayer subsidies each year, all in the name of promoting economic growth in low-income areas.
So, government says private companies can’t be trusted to make loans to low-income individuals, but taxpayer-backed agencies can. That’s nonsense on stilts.
The only difference is, when private companies make too many bad loans, they go out of business. When federally backed agencies do it, they stick taxpayers with the bill and keep on lending irresponsibly.
And somehow, we’re supposed to believe it’s perfectly acceptable for the federal government to borrow at least $8 trillion over the next decade, while simultaneously promoting 30-year fixed-rate mortgages to “low-income” individuals.
But those silly consumers rolling over $200 loans, those are the people who need to be second-guessed, limited, and protected from themselves.
A much better solution would be for Congress to leave payday loan companies, and their customers, alone.
Originally published in Forbes.