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On Subprime and Payday Loans

August 29, 2007, 8:17 am

I haven't had much to say about mortgage markets, mainly because what is going on is so obvious and straight-forward I wouldn't have thought it needed comment.  Even smart financial people get caught up in speculative bubbles, as was demonstrated in the late 1990's when they put money into some really dumb Internet investments.  New credit products can be difficult to price, since much of the costs come after the initial sales are made (in the form of defaults).  So some companies mispriced a new product, some others got caught up in a speculative bubble, same-old same-old.  This too will pass ... unless of course the government does something really stupid like bail some of these guys out, and then it will happen over and over again because no one will have an incentive to change their behavior.

I am afraid I also don't have tons of sympathy for the borrowers.  By definition, since most of these subprime loans were little or nothing down, folks are not losing their life-savings and equity, because they didn't have any equity.  They are being forced to move out of their house in the same way a tenant might if he couldn't make his rent payments, except in this case the "rent" was tax-deductable.  I do feel some sympathy for consumer borrowers who were enticed into borrowing against their home rather than through some sort of consumer loan, thus endangering their house to buy that big screen TV.  But who did the enticing - wasn't it the government, who provides a huge subsidy for home equity lending (via the mortgage interest deductibility on income taxes) versus other forms of borrowing?

But here is the amazing thing to me:  the same politicians who demagogue payday loan companies for providing loans that are too expensive can simultaneously demagogue subprime lenders for loans that were too cheap.  They criticize the same banks now for being too free with credit to the poor that they have criticized for years (via redlining suits and such) for being too stingy with credit to the poor. 

It's almost as if politicians don't really care what lenders are doing, they just want to find an excuse to get a few sound-bites on the local news back in their district and issue some legislation to expand federal power in the banking industry.

Tags: , , ,
Category: Economics
  • Jim Collins

    "It's almost as if politicians don't really care what lenders are doing, they just want to find an excuse to get a few sound-bites on the local news back in their district and issue some legislation to expand federal power in the banking industry."

    Bingo!

  • garble

    I’m with you most of the way. I do feel some sympathy for people who already owned substantial equity in their home and were convinced to borrow against it on a subprime loan without a good understanding of the terms of the note. I have no sympathy for the people who hold the notes or originated the loan. But it’s not hard to bury the specifics of a loan in complicated verbiage or bait and switch the borrower in a high pressure sales technique. You buy a bad insurance policy because of deceptive sales approach you’re not that badly off. You buy a bad 2nd mortage and you are.

    Payday loan companies suck. They base their profit on the fees and penalties associated with default. My father owns a retail space and was approached by a payday loan company that wanted to open a branch there. Under the business plan they explained to him he’d loan his customer 100$ and hold a check for 116$. Than he’d sell the check to the parent company for 125$ and they’d turn it over to internal collection for 400+. Thy also explained that usually people would come back and repeat the process to stave off default.

    He felt that loaning people money you didn’t expect them to pay back was unethical and didn’t pursue it.

    I’m fine with lowering the regulations on the banking industry but I’d like to see Bankruptcy laws re-written to further discourage risky loans.

  • http://www.creativedestruction.com/blog Sameer Parekh

    "almost"?

    Try "precisely".

    Garble -- how would the parent company make money paying $125 for a $116 check?

    Loaning someone money you don't expect to pay it back isn't unethical, it's stupid.

  • garble

    The parent company makes money because they send a 400$ bill to collections after fees and interest and penalties. They did collection in house. Part of the franchise deal required the use of their collection service. The loan contract was not particularly clear either. It wasn’t obvious how much money you were going to owe if were one day late.

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  • Bob

    Mr. Collins,

    Your father was approached by a scam artist. There are legitimate payday loan companies that make money straight-forward (loan $100 for $15 for 2-4 weeks, get paid back, done). Why were they wanting YOU to open the business if they were going to make $400?

    And, you are fine with LOWERING the regulations on the banking industry?! You either work for them or do not know of what you speak.
    They already have a scam called "universal default", don't have to state the APR or interest rate on overdraft loans, can hold your own deposit for up to 15 days for no reason (there used to be no limit), even though it has cleared in a day. THEY rewrote the bankruptcy regulations, excluded themselves or credit cards from the 36% cap to lending to the military and are now behind the move by the credit reporting agencies to exclude "authorized users" on reporting. That is where your dad might have put you on a credit card to help establish credit for you when you were young. Soon, no more. That will effectively lower credit scores across the country.

    Oh, and the Great Subprime Meltdown of 2007 has less to do with bad loans than a panic in the secondary and tertiary markets of the loans sold to greedy investors. And, before you speak, I have firsthand knowledge of all of these (and more) and have survived.

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  • http://www.myspace.com/bruceberquist Bruce

    I recently read a Reuters news article, written by Nick Carey, Mar 23rd, 8:15pm ET, titled, "’Pay day’ loans exacerbate housing crisis". I would like to clarify that there are some great inaccuracies and bias in this story that really must be pointed out.

    I have had extensive experience with pay day loans, and, though I agree that the APR (annual percentage rate) is quite high, and people can get into trouble when they do not use these loans as they are designed to be used, this news report highly exhagerates the cost of a loan. Read from the article as follows;

    "A pay day loan is typically for a few hundred dollars, with a term of two weeks, and an interest rate as high as 800 percent. The average borrower ends up paying back $793 for a $325 loan, according to the Center."

    This is not accurate! And there was much more inaccuracy than this in the article.

    A pay day loan from a legitimate financial retailer generally costs about $15 for every $100 up to $500. This means that for a loan of $100 for 15 days the charge will be $15, totalling the loan at $115, which must be quoted as an APR of 365%. the actual total pay off for a $300 loan is $345.

    In reality it is only a fee that is being paid, not interest. However, government regulations require that it be quoted as interest, as an APR.

    The only way that a short-term loan, a pay day loan, could build up to the absorbitent amount qouted in the news story, is if the loan were to be "rolled over", which is highly illegal in nearly every state that regulates these loans, so, thus, it would be highly improbable that there would be an average of borrowers that pay such amounts.

    Pay day loans are for exactly what they are named. A short term small loan to be paid off by the next pay date of the borrower.

    These loans have saved many a borrower, in a temporary financial pinch, to pay some bill(s), from much harsher penalties and costs that are incurred by banks and credit institutions if checks do not clear or payments are late.

    The proper use of a pay day loan actually shows a personal and professional level of responsibility when it is used properly.

    Yes, people do mis-use these loans, people get into trouble, people borrow beyond their means, and there are less than savory lendors who do not do what is right in order to avoid such disasters for their borrowers.

    Pay day lendors must exercise great responsibility to protect borrowers and potential borrowers from becoming victims of borrowing beyond their means. That might even mean turning down a less than able and questionably qualified customer from borrowing.

    I am disturbed to also hear lawmakers and politicians who are buying into mis-information and threaten the reasonable management and existence of a very useful and helpful service to many people.

    Bruce - Washington

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