Credit Slips

Asymmetric Paternalism

With the growing evidence on behaviors that deviate from the rational-choice model, a discussion on paternalism is taking center stage. As an economist, I am pretty averse to taking choices away from people, but can we have our cake and eat it too? Enter “asymmetric paternalism.”

“A regulation is asymmetrically paternalistic if it creates large benefits for those who make errors, while imposing little or no harm on those who are fully rational..."

Are Payday Loans as Profitable as We Think?

No. These firms have ordinary profitability despite astonishing interest rates.

My recent study with Jeremy Tobacman finds payday lenders’ firm-level returns differ little from typical financial returns, notwithstanding their effective annualized interest rates of many thousand percent. Standard financial data (on stock returns and SEC filings) and loan-level data from a payday lender are consistent with an interpretation that payday lenders face high per-loan and per-store fixed costs in a competitive market.

Why Do People Use Payday Loans?

Economic models of borrowing and saving offer a hat trick of (not necessarily mutually exclusive) explanations for why people would borrow on high-interest credit like payday loans: 1) Consumers may heavily discount the future, 2) Consumers may experience shocks that cause large, unanticipated variation in their immediate consumptions needs (such as car repair or emergency room visits), and 3) Consumers may have overly rosy forecasts (of either the shocks they will face or their own self-control).

Jeremy Tobacman and I recently put these three theories to real-world data on payday loan borrower behavior and found that behavior is consistent with people being at least partially naïve about their own self-control.

Do Payday Loans Cause Bankruptcy?

Anecdotes about the effects of high-interest payday loans abound, but these correlations don't tell us about the causal impact of borrowing at 450% APR. Simply observing payday loan borrowers' in financial distress can't determine which direction the causality goes.

Jeremy Tobacman and I have found a clever way to sort out this causality issue and can answer at least this question: "Do Payday Loans Cause Bankruptcy?" with a decisive "Yes."