Restricting Credit to the Unsophisticated -- And Are You Really Any Better?

After years of arguing that expanded credit is critical for the poor, and attacking banks for "red-lining" poor and minority districts, the liberal-left of this country has reversed directions, and has decided that the poor can't handle credit.

No matter how much folks want to paint the recent mortgage problem as some sort of fraud perptrated on homeowners, the fact of the matter is that in large part, lenders lowered their income standards and a lot of those folks now can't pay.  While we have yet to see any specific legislation beyond bailouts, it is impossible for me to imagine any reaction-regulation that does not have the consequence (intended or not) of restricting credit to the poor.

But these restrictions are not limited to the housing market.  Many states, for example, are cracking down and even outright banning payday loan companies, often the last resort (legal) credit source before people turn to the loansharks.  First in Ohio (via Mises Blog)

  If Ohio's 1,600 payday-lending stores want to continue operating past this fall, it
appears they will have to find something else to offer besides payday loans.

   A hotly debated bill that effectively would spell the end of the short-term,
high-interest payday-lending industry in Ohio sailed through the Ohio Senate yesterday despite
pleas from lenders that their stores would close and 6,000 employees would be put out of work.

   The Senate was unable to find a compromise that both satisfied payday lenders and
eliminated the debt trap that bill supporters said forced too many borrowers to take out new loans
to pay for old ones. So it did what the House did last month: dropped the hammer.

   "I think everybody said there is just no way to redeem this product. It's
fundamentally flawed," Bill Faith, a leader of the Ohio Coalition for Responsible Lending, said of
the twoweek loans. The industry "drew a line in the sand, and the legislature kicked the line aside
and said we're done with this toxic product."

And perhaps soon in Arizona.  Yes, the interest rates are astonishing, though the dollars involved are seldom huge for the short life and small size of the loan.  And, as an extra added bonus, Tony Soprano does not send someone to break your legs if you don't pay (the Sopranos being the only alternative provider once payday loan companies are illegal).

So, for those of you oppose payday loans, you are welcome to comment below about what a bad idea they are.  However, I challenge folks to criticize payday loans without simultaneously implicitly expressing disdain for the intelligence of payday loan customers, or trumpeting your ability to make better decisions for payday loan customers than they can make for themselves.

However, for those who think they are ever so much smarter than payday loan customers, who are charged a lot of money for small liquidity boosts, consider this:  Let's say you take out $40 each week from an ATM to keep you liquid and that the ATM fee is $1.50.  You are therefore spending $1.50 or 3.75% for a one week liquidity boost of $40, which you must again refresh next week.  Annualized, you are effectively paying 195% to get liquid with your own money.  For this kind of vig, at least payday loan customers are getting the use of someone else's money.

  • MJL

    RE: ATM fees as an implicit loan rate

    That's why the cognoscenti join a credit union that has reciprocal agreements with other FCUs to provide fee-less ATM access to the whole customer base. Works for me.

  • Rolo Tomasi

    That ATM example is great, I think I'll use it the next time a payday loan argument comes up. Also, I find it outrageous when the likes of Gov. Arnold try think they know what's best for other peoples finances, California's budget gap is $16 Billion! The government is the last place to go for advice on borrowing money.

  • Dr. T

    The ATM example is wrong, because you aren't getting $40 of liquidity per year, you are getting $2080 per year with total fees of $78 (3.75%). The fees aren't really interest: they are convenience fees so you don't have to waste time and fuel driving to a bank branch.

    I still agree that payday loan centers should be legal, just as I agree that most of the people who use them are foolish about money.

  • Bill

    Nice to see that we aren't alone on the west coast with a legislature that is sure that it knows what is best for the "little people."

    I bet the legislative critters pushing this really think they are doing great things while they push the working poor out of the lifeboat. Yes, you need to manage your money better (or make more of it) if you need these payday loans. But what do they think these folks will do after they are cut off?

  • Joe

    Can you accept that SOME number of payday loan offices intend to loan people money they won't pay back in anticipation of the fees, and penalties? That to some extent they count on many of their customers making the payment on loan 1 by taking out load 2? Is your *only* solution to let the buyer beware?

  • http://distributedrepublic.net Brandon Berg

    Dr. T:
    The fees aren't really interest: they are convenience fees so you don't have to waste time and fuel driving to a bank branch.

    That's the whole point. Payday loan fees aren't interest, either--they're processing fees. With any loan, there are three components to the APR: Interest, processing fee, and risk premium. With a large, secured, long-term loan like a mortgage, interest dominates the other two components.

    But with small, unsecured, short-term loans, processing fees dominate the total cost. Lending $400 for two weeks at an APR of 10% gives a return of about $1.50. Even if there's no risk of default, that's not going to be enough to pay the rent and utilities, hire staff, etc. Most of the cost is processing fees, followed by risk premium, and finally interest.

  • Morgan Dubiel

    What is the most shocking is just how ignorant politicians are of the needs of the populace they serve. No one is forced to get a payday loan. It is a free will transaction. Without these types of businesses what opportunities are there for the poor or working poor to get loans? Here is a typical scenario: to borrow $20 they will pay back $40 next pay day. That is an annual rate of 5200%. This is a real scenario from actual participants. It occurs all the time. Payday loans are a bargain.

    What the pols are really saying to the clients of payday loan programs is "go without". You don't need it or go to the black market and get it. These decisions are typical of the feel good solutions in which the cure is the poison. Like doctors we should demand that our "governing class" first do no harm.

  • Morgan Dubiel

    What is the most shocking is just how ignorant politicians are of the needs of the populace they serve. No one is forced to get a payday loan. It is a free will transaction. Without these types of businesses what opportunities are there for the poor or working poor to get loans? Here is a typical scenario: to borrow $20 they will pay back $40 next pay day. That is an annual rate of 5200%. This is a real scenario from actual participants. It occurs all the time. Payday loans are a bargain.

    What the pols are really saying to the clients of payday loan programs is "go without". You don't need it or go to the black market and get it. These decisions are typical of the feel good solutions in which the cure is the poison. Like doctors we should demand that our "governing class" first do no harm.

  • Jim Hart

    FIAT MONEY... The only organization besides the FED who's figured out how to leverage it appropriately is organized crime (the mob)..(I know, I know, redundant right? The FED also conducts organized crime) Who do you think invented the sub-prime mortgage market? Of course it was the loan sharks trying to launder their money. Ha.... Like they are really worried about Countrywide going broke now.

  • Mike

    It's amazing how many coworkers jump so easily onto the "payday loans are evil and thus must be eliminated/regulated" bandwagon. What about banks and credit card rates? Back in the days when I lived in apartments, each time I moved I would have to use a cashier's check to pay the deposits. Having a bank account, I naturally went to the bank to get these checks.

    The bank charged $4. The bank upset me, so I decided to try an online based bank. I ended up keeping both accounts for over a year, because I feared not having the ability to get a cashier's check when I needed one. I heard that you could get one from the supermarket. Assuming that supermarkets were in the business of food, not money, I thought their fees would be higher.

    One day, I decided to go to the supermarket to get a cashier's check. I was pleasantly surprised. I don't remember the fee, but it was less than $1. WOW! I closed my local bank account and have used the online ever since. I have since opened a checking account at a local bank, only because they now hold my mortgage loan, so the checking account is free no matter what.

    What's the point of my comment? The $4 is stupid. But I learned that, and I found an alternative. I would like to hear from the people who were literally saved by payday loan stores. I believe they are the "silent majority". By limiting the choices of stores, limits competition.

  • jhc

    One factor behind the rise of payday loan companies was the change in rules for credit union lending. This is the story according to a guy who used to work for me. He had run a credit union before switching careers.

    Prior to the Keating 5 S&L bailout mess, credit unions were able to give members unsecured short-term loans. So members could get a 'payday loan' at fairly reasonable rates from their CUs. Then the S&L bailout caused a change in regulations such that CUs could no longer give unsecured loans, regardless of size. Naturally they stopped making small loans because of the paperwork overhead.

    Since the market abhors a vacuum, the payday loan companies stepped in to fill that niche.

    Brought to you by the Law of Unintended Consequences...

  • Rocky Mountain

    I don't really understand the way the payday loan works so someone please explain it. But let me make a guess. Joe Workingstiff has got some bills and day-to-day expenses coming up that he can't meet fully until he gets his check. So to be able to meet his upcoming obligations he goes to Bob's Friendly Payday Loan Corp. and shows a pay stub from an earlier paycheck and gets a short term loan - is this more or less in line with how it works? What other security does Joe have to offer other then a stub and an ID?

    In truth this sounds like a very bad deal if people are getting in another hole because of the way the loan works. It's all good enough to talk about "the little people" being able handle themselves, but I see so many people walking around my little home town that appear to be absolutely baffled by all the new technology flying around that a neon sign promising $$$$ is like a moth to flame. The people commenting herein should try and remember there is another class of people that can't "run the numbers" like you can and they can be pretty easily exploited. Yes, there are some who figure things out but by the time they do the bagmen have built their McMansion.

    The other thing I would ask is that if the "little people" are so capable then why are they getting into this fix at the rate which makes it possible for other more capable people to exercise their freedom by stuffing their pockets?

    People on this blog are fond of pointing out government incompetence, thievery, and perfidy but it seems difficult for you to imagine that a private sector effort could be equally criticized.

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  • Reformed Republican

    However, I challenge folks to criticize payday loans without simultaneously implicitly expressing disdain for the intelligence of payday loan customers,

    The people commenting herein should try and remember there is another class of people that can't "run the numbers" like you can and they can be pretty easily exploited

    *snicker*

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    Payday loan customers applaud the payday loan industry mainly because, when used properly, they are the fastest and safest way to get out of an unexpected financial fallback. An old saying asks the question, "If something isn’t broken, than why fix it?" This is a perfect question to direct to many politicians who are attempting to or have outlawed the entire industry in many states. Of course, many people who are living beyond financial wealth would agree with this action and bond to fix something that isn’t broken. They have even inspired presidential hopeful, Barack Obama, to join their inexplicable motion. On November 4, vote for the peoples’ right to financial freedom and independence.

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  • Erica

    I think that payday loan stores should continue to exist. But I also think people who abuse them, credit cards or any other type of loan should not be allowed to ask for help when they get into trouble, they should not be allowed to declard baankruptcy and make everyone who didn't act stupidly pay for them.

  • http://personalmoneystore.com/moneyblog/ Payday Loan Advocate

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