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Payday Regulation and Financial Security

posted by Adam Levitin

The payday loan industry is running scared these days; the industry definitely feels that it is in the CFPB's cross-hairs. Accordingly, it is not surprising to see the industry trumpeting a new poll of payday borrowers' attitudes about the payday experience. 

Three thoughts about this poll.  First, the value of the information it contains often seems quite limited by the nature of the questions and the respondents.  

Second, even if the poll really supports the interpretation put forth by the payday industry--that most payday consumers like the product--it hardly addresses whether payday loans should be regulated. At best, the poll suggests that banning payday products outright without reasonable short-term small-dollar (STSD) credit alternatives would leave some unmet consumer demand. The regulatory issue with payday loans is not just a binary regulate or not question. Instead, there are a number of regulatory options that would limit the features of payday loans that are particularly problematic, namely rollovers and refinancings that turn payday loans from being short-term to longer-term.

Third, the whole debate about STSD credit regulation kind of misses the point, however, which is why so many consumers are likely to turn to relatively expensive forms of STSD credit. The demand for STSD credit appears to be largely a function of middle and working class financial insecurity. That's the real issue that needs to be addressed.  I flesh these points out in more detail below.

1.  The Survey.  The survey was of a sample of past payday borrowers. That's the only sample that's going to be able to report on ex-post satisfaction, but there's a huge rationalization problem that's likely to bias any survey results. The psych literature knows this bias well.  Many of the questions in the survey play right into this.  For example, "The vast majority of borrowers indicate that they value having the option to take out a payday loan." Well, yeah--if you ask someone who has taken out a payday loan in the past if they value having an option, of course they are going to say yes. Options always have value and past borrowers are particularly likely to recognize that value. Or how about "96% of borrowers assert that they use payday lending responsibly." No surprise there. How many people are likely to admit to being irresponsible?  

That said, what really struck me were how many payday borrowers were supportive of regulation and how inconsistent attitudes toward regulation seem.  On the one hand, an overwhelming majority of respondents think that payday borrowing should be their choice, not the government's. And two-thirds of borrowers oppose either requiring credit bureau checks before lending or restrictions on the number of loans they can take out in a year.  But roughly the same number of respondents favor government limits on dollar amounts of loans and about 40% favor rollover/extension restrictions. This is odd because limiting the amount of loans can get you to a very similar place as limiting the number of loans. This makes me think that something funny is going on with the survey and the way questions are phrased or the like. But maybe payday borrowers have a particularly nuanced view of what regulation should be. 

2. So What? The whole argument that payday loans are helpful to some consumers based on consumers' ex-post evaluationsstrikes me as largely irrelevant in the regulatory discourse. Of course consumers have STSD and emergency credit needs. But that is hardly a justification for a laissez-faire attitude toward payday lending. Even if one takes the data produced by payday lenders at face value and accepts that there are many happy payday customers (even if that happiness is only via rationalization), it hardly follows that there is no need to regulate. Instead, at best, the argument put forward by the payday industry suggests that regulation should be trying to identify when payday lending is welfare enhancing and when it isn't and to restrict non-welfare-enhancing lending.

Put another way, payday regulation isn't a binary regulate vs. not issue. It is possible to allow payday loans but place limits on them that help ensure that STSD loans are available for consumers with legitimate needs while also ensuring that there is clear and consistent cost (and collection) disclosure and that loans aren't constantly rolled over or refinanced resulting in a debt trap.

To wit, one possibility would be to restrict the number of rollovers or the number of new loans a borrower may take within a certain time period. This is something that some states have done, although the effectiveness of such restrictions is limited by geographic arbitrage:  borrowers can either go to another state or borrow via an on-line payday lender. This suggests that for payday regulation to be effective, it must be done nationally. Moreover, if payday regulation takes the form of rollover/refi limitations, it would seem to necessitate some sort of national database that lenders can check before lending. (As the CFPB is prohibited by statute from adopting a usury cap, that's not on the table.)

3.  The Big Picture.  The payday lending industry does have one very powerful point:  there is clearly a real demand for payday loan and other STSD credit products:  credit cards, overdraft, title loans, RAL, pawn, etc.  To some degree consumer choice between these products is dictated by assets/income:  a consumer without a car can't get a title loan, and a consumer without a job (or self-employed) can't get a payday loan. A fruitful area for academic study would be examining exactly how consumers decide between STSD products--I suspect that they are not really shopping around based on cost of credit, but based on a host of other factors, such as convenience.  Nor is all borrowing seem totally rational. For example, some people take out payday loans when they have available line on their credit cards, meaning that they are borrowing at 300% APR when they could instead be borrowing at perhaps 36% APR.  But other factors like where a credit card can be used might affect this decision. If you need to pay the power company, and it doesn't take credit cards, then it isn't really an alternative to a payday loan.

It may well be that consumers are not making wise decisions (in a welfare maximizing sense) when picking between STSD products. If so, that suggests a need to think about how to reform STSD markets to get consumers making better decisions, and also suggests that if consumers are shopping for products based on something other than price that merely improving disclosures isn't likely to have a lot of effect on consumer behavior.  

But there's a bigger issue lurking behind STSD credit, which is the lack of a savings safety net for many consumers. Figure that the typical payday loan is maybe $200-$300.  If a consumer has $500 in savings in the bank, there's little reason to get the payday loan for an emergency unless the emergency costs more than $500.  In other words, the demand for STSD credit would seem to be heavily driven by limited savings, which is a function of middle and working class consumers having stagnant earnings, rising costs (health care, child care, housing, transportation, education, etc.), a tax system that favors capital over labor, etc. all resulting in many households having little or no savings and thus nowhere to turn when hit with an unexpected expense except to STSD credit. (I'm leaving out other sources like friends and family.)

If we really want to address the high costs of STSD credit, the real issue to address is consumer demand. As long as we have an economic system that offers very little security to many middle and working class consumers, we're going to be facing a problem of demand for STSD. Sadly, many of the same laissez-faire opponents of STSD credit regulation also oppose any attempts create greater financial security for middle and working class families. 

Comments

What do you think of the small-dollar alternatives being offered by employers? Today's WSJ (Mon. Dec. 16) had an interesting article about Sonic restaurants offering short-term, high-cost loans to employees.

I share your sense, Adam, that the survey results are fully consistent with government action. For instance, one way to interpret the survey is that consumers with high personal discount rates really value income smoothing. Which we pretty much knew before the survey.

But delivering income-smoothing benefits to consumers does not require the continued existence of pay-day lending (though that would of course be more palatable it were subject to the kinds of improvements you're suggesting). Why couldn't we have a (partially subsidized) government loan facility instead? Just like with student loans, we should cut out the middle man.

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