In yet another example of finance double-speak, major financial players have moved into that netherworld of the functional equivalent of loansharking known as payday lending.
While in theory short-term loans can be a boon to cash-strapped individuals, in practice, the usurious interest of payday loans result in many borrowers falling into a debt treadmill. The Pentagon was so concerned about the way that payday lending could wreak havoc with the lives of combat personnel that it restricted the rates that could be charged to military personnel to 36%. The industry howled that rules would drive payday lenders out of the business of serving the armed forces (they had previously been targeting bases). I suspect that result was a feature, not a bug.
In 2008, the Wall Street Journal reported on how payday lenders targeted the elderly. This extract gives you some insight into the business model:
The crowd represents the newest twist for a fast-growing industry — lenders that make high-interest loans, often called “payday” loans, that are secured by upcoming paychecks. Such lenders are increasingly targeting recipients of Social Security and other government benefits, including disability and veteran’s benefits. “These people always get paid, rain or shine,” says William Harrod, a former manager of payday loan stores in suburban Virginia and Washington, D.C. Government beneficiaries “will always have money, every 30 days.”
The law bars the government from sending a recipient’s benefits directly to lenders. But many of these lenders are forging relationships with banks and arranging for prospective borrowers to have their benefits checks deposited directly into bank accounts. The banks immediately transfer government funds to the lenders. The lender then subtracts debt repayments, plus fees and interest, before giving the recipients a dime.
As a result, these lenders, which pitch loans with effective annual interest as high as 400% or more, can gain almost total control over Social Security recipients’ finances….
An analysis of data from the U.S. Department of Housing and Urban Development shows many payday lenders are clustered around government-subsidized housing for seniors and the disabled…
But some industry critics say fixed-income borrowers are not only more reliable, they are also more lucrative. Often elderly or disabled, they are typically dependent on smaller fixed incomes and are rarely able to pay off their loans quickly. “It’s not like they can work more hours,” says David Rothstein, an analyst at Policy Matters Ohio, an economic research group in Cleveland. “They’re trapped.”
The latest sighting, via the Associated Press (hat tip April Charney) is that bigger, more reputable-looking banks are offering payday loans, but predictably calling them something else, in much the way that the term “escort service” is meant to imply something more refined than “prostitution”. From the Clarion Ledger:
Perhaps muttering, if you can’t beat ’em, join ’em, big banks are now aping the payday lending industry and offering short-term loans at rates that once were called usurious.
The banks are not calling them payday loans and say there are safeguards that distinguish them from payday loans. But, it’s still a short-term note. Wells Fargo, for example, offers its loans for direct deposit customers. As The Associated Press has reported, it says customers can only borrow up to half their direct deposit amount or $500, whichever is less. Its fees are cheaper too, at $7.50 for every $100 borrowed.
That still amounts to a 261 percent annualized interest rate over the typical pay cycle. The amount of the advance and the fee are automatically deducted from the next direct deposit.
The article does point out that Mississippi has put restrictions on payday loans. The maximum loan is $400 and the charges are limited to an equivalent of an interest rate of 572% a year. Since there appears to be no restriction on how many loans a consumer can have at any time, this legislation doesn’t cut it as a fig leaf.
If you watched Congresscritters grilling Elizabeth Warren in July, several pressed her on whether she would use the CFPB’s power to ban products. She ducked the question. There is something very diseased in our society when a public official can’t cite the Pentagon’s stance and say there are interest rates that are intrinsically damaging to consumers and therefore should not be permitted. A loan with an effective annual interest rate of over 50% is the financial version of an exploding toaster.