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Usury 2.0: Toward a Universal Ability-to-Repay Requirement

posted by Adam Levitin

There's bi-partisan legislation pending that would prohibit the practice of installment lenders sending out unsolicited live convenience check loan:  you get an unsolicited check in the mail.  If you cash it, you've entered into a loan agreement.  

The debate about check loans has turned on whether consumers understand what they're getting into.  The legislation's sponsors say consumers don't understand all the terms and conditions, while the installment lender trade association, the American Financial Services Association, argues that there's no problem with live check loans because all the terms are clearly disclosed in large type font.  

This debate about consumer understanding and clarity of disclosure totally misses the point.  The key problem with check loans is that they are being offered without regard for the consumer's ability to repay.  For some consumers, check loans might be beneficial.  But for other they're poison.  The problem is that check loans are not underwritten for ability-to-repay, which is a problem for a product that is potentially quite harmful.  Ability to repay is the issue that should be discussed regarding check loans, not questions about borrower understanding.  Indeed, this is not an issue limited to check loans.  Instead, it is an issue that cuts across all of consumer credit.  Rather than focus narrowly on check loans, Congress should consider adopting a national ability-to-repay requirement for all consumer credit (excluding federal student loans).  

Traditionally, lenders only loaned to borrowers they thought could repay the loan.  The borrower and lender were in a partnership of sorts--the lender's success depended on the borrower's success.  That's often not the case in today's consumer credit markets for several reasons.  First, the originate to distribute model of securitization may result in the original lender wanting to simply maximize loan volume without regard for loan performance.  Second, that same type of agency problem may play out within a lender—a loan officer who is compensated based on loan volume may not care if the borrower can repay.  Third, in a world of cross-selling, a lender may be willing to have a loss-leader product in order to gain access to a consumer for other products.  And fourth, there's "sweatbox lending"—some credit products have such high interest and fees that even a few months of payment will offset loss of principal due to an eventual default.  Sweatbox lenders are incentivized to increase loan volume, even if default rates increase. 

Given changes in the lending world, one cannot assume that a lender will only loan to consumers who have a reasonable likelihood of successful repayment.  That's where "ability to repay" requirements come in.  The trend in consumer finance regulation is to have ability-to-repay requirements.  There's a lot to like about ability-to-repay requirements.  They go to the core question in consumer credit regulation of whether an extension of credit is beneficial or harmful.  Credit can be a godsend, but if a consumer lacks the ability to repay, credit is a curse, not a blessing.  At best it pushes the problem off into the future.  

This is why I'm so skeptical of postal banking proposals that include a credit component as a payday loan alternative—the main policy problem with payday loans isn't that they are too expensive.  It's that many borrowers cannot repay even if the loans were interest free.  Sure, a cheaper loan is better than a more expensive one, but it's all beside the point when the borrower isn't just illiquid, but has expenses that exceed income.   The Micawber solution ("something will turn up") isn't a recipe for financial success.  Given the negative externalities that follow from consumers getting credit they can't handle, having some sort of capacity check seems reasonable given that we can no longer rely on the market (lenders' own self interest) to reliably provide this check.  

Usury laws were the traditional mode of consumer credit regulation.  While usury laws are still on the books and are an issue for non-bank lenders, they don't meaningfully apply to banks because of  Supreme Court's 1978 Marquette decision and the subsequent state parity laws and amendment of the Federal Deposit Insurance Act.  Whatever one thinks about usury laws, they are a blunt tool.  While most usury laws have fixed rates, even those with floating rates have an arbitrariness about them.  What makes a particular rate or margin the right level?  Shouldn't it depend on the borrower?  The bluntness of traditional usury laws makes them administratively easier, but it also renders them both too broad and too narrow even if one accepts them as a good mode of consumer protection.  

It should be no surprise, then, that the move in consumer credit regulation has been away from the bright lines of usury laws to more flexible "ability to repay" standards:  

  • Credit cards (2009) by federal statute.  
  • Mortgages (2010) by federal statute.
  • Payday loans (2017) by federal regulation.  
  • Auto loans (2017) through Santander's settlements with the Massachusetts and Delaware AGs' offices (the implication of those settlements has not been generally recognized).  

Ability-to-repay is a standard, and as such it has within it the flexibility that usury caps lack.  It looks at the specifics of the borrower, so it isn't one-size-fits-all.  It also looks at the terms of the credit product overall, not just its interest rate.  Thus, payment structures can be considered in ability-to-repay analyses.  Ability-to-repay isn't quite the same as a suitability standard, but it still looks at the interaction of the product and the borrower, not just one or the other.  

Ability-to-repay's flexibility is both a feature and a bug.  The bespoke nature of the analysis makes it much less administrable than a bright line usury cap.  Not surprisingly, we have seen regulatory safe harbors for credit cards, mortgages, and payday loans that create new bright lines, making ability-to-repay something closer to usury caps in terms of administrability, while also preserving the flexibility for lenders that want to try something different to do so.  Ability-to-repay standards are definitely not the same thing as traditional usury laws (and Congress has never thought of them as equivalent), but we might still think of ability-to-repay as Usury 2.0. 

What's puzzling is that ability-to-repay has been adopted piecemeal, product market by product market.  Congress has never taken up the idea of an across-the-board ability-to-reay requirement.  The logic of ability-to-repay transcends particular products, however.  It's time to push for a general "ability-to-repay" requirement for all consumer credit, excluding federal student loans, with the CFPB authorized to enact safe harbors thereunder.  (I've carved out federal student loans, but income-driven repayment programs are basically a back-end ability-to-repay requirement that adjusts payments and ultimately even principal to the borrower's financial capacity.)   

Moving to a national ability-to-repay requirement with federal regulatory safe harbors would help harmonize the crazy quilt of state usury laws, which vary substantially among states and by lender types (as opposed to by products).  I recognize that a federal standard might in some cases be less protective than individual states' laws currently, but we do have a national consumer credit market, and it's hard to say that any obvious winning formula has emerged from the laboratories of democracy in this instance.  Instead, all we have are elaborate attempts by non-bank lenders to end-run state usury laws through rent-a-bank and rent-a-tribe arrangements.  So while I get the focus on check loans, Congress should really widen its lens and consider addressing ability-to-repay across the board.  

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