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Fringe Banking, Financial Distress, and the Consumer Financial Protection Agency

posted by Jim Hawkins

I'd like to say thanks again for the chance to share some thoughts at Credit Slips.  I've really enjoyed the comments.  I wanted to end with a post about a current issue before Congress. 

One reason it is important to know what financial distress means and to understand the relationship between fringe banking and financial distress is that policy makers consistently use financial distress to justify intervention into fringe markets.  Because financial distress creates externalities, it is a powerful tool to justify regulation.

A speech President Obama made late last year arguing for the Consumer Financial Protection Agency (still working its way through Congress) is a good example of how this works.  To make the case for the CFPA regulating payday lending, the President gave the example of a women who'd taken out a payday loan.  He linked the product to wide-spread financial distress: "Abuses like these don't just jeopardize the financial well-being of individual Americans—they can threaten the stability of the entire economy."  As I have argued, I think this claim is really hard to make out.  Financial distress might justify the CFPA regulating credit cards or mortgages, but I don't think it justifies regulating on the fringe.

Relying on a link between fringe banking and financial distress distracts from the other persuasive arguments for creating the CFPA.  And, in other contexts, it leads to regulation aimed at solving the wrong problems.  People using fringe banking need protection, but we need to rethink regulation aimed at preventing financial distress because it solves a problem that I don't think exists. 



You don't think payday lending should be regulated - or better yet, shutdown?






Take it from someone in the trenches - payday loans are the crystal meth of financial products.

What you see in the trenches is the outcome of an individual already in financial distress. The demand for payday loans is a derived demand which begins with some other event. Regulate the payday lenders all you want and some other product will fill the void. Until we cure the need for credit by those that are credit constrained we will never eliminate the supply of high interest loans targeted at them.

AMC, I was ready to jump in with my own personal rancor, but when I finished reading Jim's post, I thought it was pretty reasonable.

I think it's clear that the fringe products abuse and go further than they should in exploiting the people that need them. Jim seems to acknowledge that regulation and protection is worthy in this area.

I think it's easy to focus on fringe banking issues because many of the examples of people who use them are already so despondent and desperate.

However, Jim seems to be advocating that policymakers need to keep their "eye on the prize" and regulate the non-fringe products that *pushed* people to use fringe products. Of that I completely agree. It seems like the current credit card legislation has been a mere softball pitch, and much can be done to fully inform consumers of their true costs.

I'm sorry, but 400% interest rates loans are an evil in and of themselves.

Part of the problem is certainly non-fringe financial products. In addition, a large part of the problem is innumeracy - many Americans just can't do the math to understand their budget and what a 365% interest rate means in the context of that budget. And that means that the financial disclosures don't undo the false impressions left by the advertisements.

Payday loans may not start the downward spiral, but it certainly greases the skids. And if you think payday loan companies actually adhere to the FDCPA, you haven't seen them in action.

My state banned payday loans. I haven't seen anything spring up to be as widespread and pernicious as what was banned. There are alternatives which are better - many credit unions do similar lending without the usurious interest rates. Those kinds of alternative lenders - like the prime mortgage lenders during the expansion of the housing bubble - get crowded out by the payday lender happy (and misleading) little TV advertisements, and the shear number of lenders that were out there: more than the number of Burger Kings and McDonalds combined prior to the banning of these loans.

Payday loans should be banned on a federal level, and yesterday would be a good time for the ban to take effect.

Compare the number of these payday loan parasites with the number of McDonalds and Starbucks, nationally and by state:


I agree with the facts of the original post, but AMC makes good points to. Can't we consider payday loans industrial pollution that needs to be regulated, not for any big-picture financial issues -- but "air quality" issues. We have to face the facts, the airs of legitimacy are all over payday loans, bail bonds, plastic surgery loans -- people (or sheeple), has some unfounded faith that any legal business is well-regulated in the public's interest. That's another "put" we have to worry about interfering with the free-market.

In general, people should come back to basics. Save, save, save, don’t spend money that you don’t have and relied less on credit cards and loans. Just the way our wise grandparents did it.

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