Possible Restrictions on Payday Lending

A Wall Street Journal story, “Payday Lenders Strike a Defensive Pose,” discussed the growing Congressional interest in restricting payday lending, and the attempts by the industry to clean up its act around the margin.

By any standard, payday lending is predatory lending. Typical terms are $15 for every $100 borrowed for two weeks. That’s 390% a year. Your friendly loan shark doesn’t even charge that much.

And the industry does not simply help tide people over on an emergency basis between paychecks. The typical customer borrows seven times a year, and 5 to 10% don’t pay their loans off on time and become subject to additional “rollover” fees.

13 states have more or less restricted the product out of existence; the other states have some limits. Congress passed a law last year that put a ceiling on loans to members of the military at 36%, which was aimed at curtailing payday loans (where could you find a lower risk target? You have the US Treasury as your creditor. Members of the armed services can’t quit; they have to be discharged). Yet while federal restrictions are being considered, and the lenders themselves have proposed some voluntary restraint (letting borrowers put a freeze on their interest payments and enter into an extended payment plan; ads to advocate the responsible use of credit), two states states are considering relaxing their rules to permit payday loans for the first time.

The Journal presents two sides of the argument:

Consumer advocates and industry officials paint starkly differing views of payday lending. Consumer groups cite studies by the Center for Responsible Lending, a North Carolina nonprofit advocacy organization, which concluded in January that “the industry relies almost entirely on revenue from borrowers caught in a debt trap.” Lenders cite a January study by Donald Morgan, an economist at the Federal Reserve Bank of New York, which concluded that “payday lending represents a legitimate increase in the supply of credit, not a contrived increase in credit demand.”

I took a very quick look at the Morgan study, and it looks like a very good piece of work with a gaping hole at its core. His conclusions, that consumers in states with payday loans are less likely to be denied credit and not more likely to miss a debt payment, are based on the 1995 and 2001 Surveys of Consumer Finance. That’s an in person survey, not data from the banks which would REALLY be able to tell you how many people went into arrears. There is no way to know how much underreporting there is. And “missed payment” is a yes/no question. There’s no mechanism for counting multiple missed payments, which is clearly possible with payday loans.

So we have one questionable study, sadly from a very well regarded source, versus common sense. It’s clear consumers use payday loans way way beyond emergency needs. It’s clear the interest rates are breathtaking. The free marketers of course argue the rates must be “fair” otherwise there would be more entrants who would compete the price down. Well, first, there are barriers to entry (you need stores, vaults, cash delivery and pickup, etc.). Second, maybe enough people have moral objections to preying on the poor so as to deter entry.

Why are the powers that be so leery of intervening? Partly it is because the payday lenders can hire lobbyists and PR firms while their victims can’t. But we also see lending as somehow different, say, than consumer safety.

People today accept restrictions that would have been unthinkable 40 years ago. Parents in the 1960s would never have accepted having their children be required to ride in the back seat. They would have seen it as an invasion of their privacy. Yet here we have something which is not internal to a household, but between an individual and a vendor, a product with a history of being detrimental to many users, and yet the government is wary of intervening.

Let’s make a different comparison: ephedra. Ephedra, which is a stimulant which initially came from a Chinese herb, ma huang, and has various synthetic cousins. It was widely used as a weight loss aid. It was one of the very few OTC products that was actually effective (it is a thermogenic agent, which means it raises body temperature, so you actually burn more calories).

Ephedra is now illegal in the US. Why? Because it could be and was sometimes abused. Ephedra is nastily synergitic with caffeine, but too many users either took too much ephedra and/or took it without paying attention to their caffeine intake. Baltimore pitcher Bechler died of heatstroke, and ephedra was also implicated (if you read the headlines, you heard only about the ephedra).

But ephedra was also a threat to the drug industry. It was cheap and worked. Informed insiders, namely doctors who consult to sports teams, tell me that the problems, particularly deaths, attributed to ephedra were greatly exaggerated (example: 9 out of 10 emergency room visits attributed to ephedra were actually cocaine, and other illegal stimulants accounted for the bulk of the balance).

Also remember you can die from too much caffeine, or even too much water (a woman recently perished after a water-drinking contest in California). An overdose of acetaminophen (Tylenol) will produce liver damage and can also kill you. Acetaminophen causes an estimated 450 deaths in the US a year, and a rising proportion of cases of acute liver failure (39% in 2001 and 49% in 2003). Even though there are other effective painkillers, acetaminophin is still sold without restrictions of any kind.

So in ephedra we have a product that has produced tangible benefits for a lot of people, but has also killed a few people. Rather than take measures to make sure it’s used responsibly, the product is banned. But other products that have killed more people and have more substitutes are still on the market.

And in payday loans, we have a product that is used irresponsibly by a quite a few, perhaps many, people, and we aren’t certain of its benefits (how many users have a gambling or alcohol problem that these loans are enabling?). But as with ephedra, how it is regulated has little to do with the real costs and benefits, and a lot to do with the spending power of the interests on either side.