Move to Pull Consumer Protection Rule Heightens Debate over Payday Lending
npr.org
npr.org
Regulations do add overhead, sure, but how else can we prevent companies from acting in ways that are detrimental to society? Capital finds the shortest path to profits, and without rules, it becomes a quick race to the bottom. For example, payday loans. I would love to make 20+% return on capital. Who wouldn't? And, acting purely as a business-owner, I'm would be required to use every trick, no matter how shady, in order to win. Why? Because I know my competitors will.
Unfortunately, as history repeatedly shows, tricking people is usually the quickest way to make profit. Regulations are necessary, but there should also be continuous effort to decrease the overhead costs without sacrificing the intent.
In the absence of regulations on interest rates, competition hammers the interest rate down to the lowest it can be before some other venture can provide superior returns.
I don't think this is true, at least for payday lending. People seem to be trying quite hard and failing to make hefty profits.
Payday lenders apparently run a pre-tax profit margin below 10%, while consumer financial services in general are around 30%. Real estate and vehicle leasing are also up around 15%, so there's plenty of money in lending people valuable things. (Sub-10% is not a low profit margin, broadly, and it's hard to find any more detail. But industries without significant unit costs often run at or above 10%.)
About 20% of opex for payday lenders is apparently defaults; that "revolving set of people" point is quite true, but it also means lenders have badly incomplete information about their transactions. I don't mean to be glib, but it turns out that it's pretty hard to turn a profit when your business involves giving money to strangers without collateral. Realistically, I'd expect much higher profits for shady tax preparers and other people who can load all the risk of imperfect information onto their customers.
* This is essentially what credit unions do with signature loans.
They really don't which makes comparisons impossible or very hard work.
(Hopefully obvious sarcasm is obvious, but one can never tell.)
I'd say that if they were savvy enough to comparison shop, they wouldn't be payday loan customers.
Look at the person in the article, Angela. She started out @ $300 for approximately $75.00 interest (25%). But now she owes who-knows-how-much with a yearly interest rate of 300%! Yet she still thinks she could pay it back!
She did this because she doesn't trust herself with credit cards; the truth should be she shouldn't trust herself to borrow and pay back loans without incurring further debt and higher interest rates.
Had she actually comparison-shopped, she would've found that a credit card - if she could get one - would likely have had a lower interest rate over the same time period, and couldn't rise anywhere near what the yearly rate she has now with the payday loan company.
This is definitely predatory lending; these companies are lending to people who don't seem to have an understanding of certain basic financial concepts, or if they do, they don't have any clue how it will impact them.
It would be a different case if the borrowers all knew that "yes, this is a crap loan with bad interest, but I don't have a choice, and I know I have to pay it back fast or I'm hosed". Some of them do. But I would wager that the vast majority don't, for a variety of reasons, not all of them due to ignorance (I imagine for some there might be some cultural and/or language barriers as well).
These companies are taking extreme advantage of this, to their profit and to their customers detriment.
The really astounding thing are their customers, like Angela, who seem to think all of this happening is a good thing. I just really don't understand this kind of mindset, of borrowing money at any and all costs with little to gain in the end (it isn't like all of these people are borrowing money to make an investment in some manner, to make a larger gain and pay back the loan with extra in their pocket - maybe some are, but I doubt they are in the majority).
If you need an unsecured loan for something you can't afford to pay cash for today, you likely won't be able to afford to pay off the loan for it tomorrow. If you can - then you must. You don't just keep taking out more loans to keep covering the old loans (which is how a lot of these lenders work; the borrower finds they are unable to pay back the loan plus interest when the note comes due, so the lender extends the loan and ups the rate a bit - rinse and repeat until they default).
In my mind it's profiteering on the backs of impoverished people.
Understanding how short duration, risk and operational overhead affects the rate is key to effective regulation in this industry.
BANKS don't even give out personal loans at such absurd rates.
To clarify, payday lenders exploit people by a) encouraging loans for bad reasons, b) hiding details from financially illiterate people, c) trying to keep competition out of their market, d) not publishing comparable rates. But the actual business margins are not as good as 50-400% sounds due to the high volume/short duration/default risk.
You can extrapolate 400% from this example.
Consider me obscenely interested in understanding the math to break down measuring risk such that you end up with 400% annualized interest on a, say $1000 loan.
Again, even traditional banks don't hit applicants with poor credit this hard. Personally, I paid off a personal loan with my credit union down in Texas, only financial institution that would give me one with my credit. 18%.
I have yet to find anyone who can provide a convincing argument for why such a high interest rate is warranted compared to traditional lending sources who will have the exact same concerns and risks but charge demonstrably less.
Edit: in response to your edits, I think your credit union example is a good one. That is exactly why credit unions are valuable; they have a local/regional reach similar to payday, but they are cheaper, and they will lend to people that Bank of America, Chase, etc. won’t touch.
They do allow me to keep cash in my savings and still pull from this "credit", so for example I can transfer everything to savings and let my rent hit this "credit line", but if I'm not careful this is way more expensive then a payday loan.
Here’s a startup I really like that I think solves this overdraft problem effectively. They charge something like $1/mo for their service which likely isn’t sustainable standalone, but could work as a standard account feature at a bank/CU. https://www.dave.com
But for people who desperately need money now, and have no other choice, they're forced to accept these rates. It's profiteering on the backs of the very weakest people in society. That's obscene to me.
If this is indeed is a valuable service to society, cap the rates, and force them to be disclosed up front.
https://www.consumerfinance.gov/about-us/newsroom/consumer-f...
The rates are much more reasonable when you consider that.
Neither is true.
It's quite likely that the company making 20% has a much higher marketing budget than the 15% one. People can't choose the cheaper option if they don't know about it.
The race to the bottom you're describing is a failure of the market to consider for their customers, and that's where regulation steps in.
Too bad the people writing policy don't follow that rule. It seems like they're eager to use policy to meddle in things that are working and won't use it to fix things that are broken.
Sure you'd love to make 20% returns, and so would literally every person who has cash. If there were a pool of people willing to pay 20% interest without the risk of default or non-payment, then everyone would be out there lending to them, and the market would saturate, and someone would say "hey, I could get more customers with 19% interest", and so on, until you basically can't charge more interest than nominal market rates for interest. That's the "race to the bottom" of capitalism, not the increased number of shady tricks that you would pay to get the 20% return.
The reality is somewhat different from two axes. One is the regulatory axis; you can't just up and start making payday loans; there are huge regulatory burdens that come with it that exist as a moat to keep out new players in the market by increasing the cost of compliance.
The other is more direct and unrelated to regulation; the 20% is not realistic -- non-payment and default do exist, and you have to collect in order to avoid making huge losses, so with the total costs involved, the actual rate of return on this class of loans ends up being not much better than free-market interest rates anyway; you can get additional returns by improving quality of service or offering better features, or reducing the cost of collections, or, in this case, using the ability to charge fees to try to recoup some of that loss.
So what you end up with is a system where the problems inherent in #2; subprime lending is risky and encourages taking advantage of customers, which leads to regulation, which makes things worse by limiting the competition, and eventually leads to a spiral where we keep thinking that we can solve the problems caused by the previous regulation with more regulation. And eventually someone breaks out of the cycle by offering the same product but just slightly different enough to not be covered by the regulations; they take over the market and then everyone copies them, and then we start the regulation game again.
I've been thinking about that a lot: while there are certainly some over-regulated industries, when you dig into the "why" on any particular rule you usually find some horror story.
The problem is more complicated. "Regulation" (as it's usually done via a regulator) creates centralisation, usually. IE, fewer, bigger players. It creates a rigidity, where the way things are is locked in, incumbent companies and ways of doing things become hopelessly intertwined with regulationary systems.
Regulation also tends strongly towards bureaucracy, and it's impossible to tell where a company's bureaucracy starts and the regulatory bureaucracy begins. I've seen this happen in companies. "Compliance" becomes a magic word that justifies senselessness, wins every argument, and puts lawyers in command.
Idk what the answers are. Like you, I think there are plenty of problems that cannot stand. Left totally unregulated, payday loans gets very ugly. Pushed to the black market, it gets even uglier.
Itoh, I feel like we should reject the choice between known-2-be-bad regulatory regimes and the often worse problems they attempt to solve.
My best guess would be to try and make micro-lending a public or charitable service. Maybe it just doesn't lend well to a for-profit business model... But, I don't really know.
It's the baptist and bootlegger problem: https://en.wikipedia.org/wiki/Bootleggers_and_Baptists
> "Such a coalition makes it easier for politicians to favor both groups. ... [T]he Baptists lower the costs of favor-seeking for the bootleggers, because politicians can pose as being motivated purely by the public interest even while they promote the interests of well-funded businesses. ... [Baptists] take the moral high ground, while the bootleggers persuade the politicians quietly, behind closed doors."
When I took the classes in the late 90s, it was basically "learn how to bake this one thing and hand sew a ripped cloth." A few years later when my sister was in high school, home ec wasn't even a class anymore. I'm not sure if the class still exists in any US public school system. However, my parents remember being taking it in the 60s and being taught to make a household budget and balance a checkbook, in addition to cooking and basic mending/repair.
Point is, the education piece teaching people to manage money used to be there, and has been purposefully removed.
That's fine, we can outlaw and drive it underground, just as we tried with alcohol, and just as we do now with various drugs. Sometimes society would rather pretend demand for some products doesn't exist.
I'm not saying don't make loans to people who can't repay them easily...but I'm also not not saying that.
"The invisible hand" isn't perfect and sometimes regulation helps push people towards better options. We don't let anyone provide medical services and assume the market will sort it out, so there is at least a _potential_ argument that the same should be true for financial services.
Sounds like debt bondage.
This is how payday advances worked for most people before the age of complex payroll systems. You used to be able to ask your boss to get payed early for the time you had already worked. Now that is really hard because "the system isn't set up like that"
You can find out more by googling it.
Payday loans are much more akin to debt bondage, in that they are _often_ the start of a debt cycle that is extremely difficult to break.
People are working on this from a tech perspective, but we are not there yet. In other countries this would be a lot easier to implement because the underlying banking infra is just more sophisticated and modern.
No, it's really hard because systems (technology secondarily, primarily policy and administrative controls) are set up to prevent the discretion that practice relied on because it was a giant and frequently exploited opportunity for embezzlement, favoritism, and unlawful discrimination (including quid pro quo sexual harassment) by line and middle managers.
It's not just an incidentally unsupported function.
Sure, but it's not free to the employer (aside from making cash flow timing less predictable, regulating and monitoring are not free) and the contribution to the bottom line is dubious (it may even be negative: the employees for whom such a benefit would be most attractive may not be the employees a business most wants), so the business case for doing it rather than leaving employees to existing credit mechanisms is weak.
OTOH, there seems an obvious social benefit to having either this or same-day pay (which is also not free compared to status quo alternatives) as a norm, so that's maybe a role for government rules (either mandates or incentives.)
removing regulations may not reduce fees, but adding new ones will almost certainly increase them, since they necessarily increase the overhead for the business.
These products are designed to be deliberately deceptive. They exist to prey on the desperate and uninformed.
I honestly don't know the point of the Obama-era rule referenced in this article. To me this is simpler:
- "Fees" that scale with the loan size aren't fees. They're interest and should be legally treated as such. This would subject the loans to state usury laws.
- Providers should disclose what the annual interest rate is for the loan the borrower is intending to take out.
- Payday loans should be prohibited from being mortgage loans. This is an esoteric point but in some states to get around state laws on payday loans, they're treated as mortgage loans. This also adds the problem that someone could lose their house from payday loans.
- Come to think of it, primary residences should be excluded from being taken to repay payday loans.
In some ideal libertarian-ish world, these payday loan shops would still be allowed to exist, but nobody would use them, because they would recognize them as a bad deal. This is not the world we live in.
I'll just link to the google results regarding profit margin, because my first result was from adamsmith.org, and I'm at least trying to present my evidence neutrally.
https://www.google.com/search?q=profit+margin+on+payday+loan...