Van Doren on Payday Loans
By David Henderson
The Consumer Financial Protection Bureau (CFPB) recently proposed the elimination of new payday lending rules created under the Obama Administration and imposed in 2017. Payday lenders are frequently vilified—a recent New York Times editorial declared that the CFPB “betrayed financially vulnerable Americans last week by proposing to gut rules…that shield borrowers from predatory loans”—but recent evidence indicates that the predatory costs of payday loans may be nonexistent and the benefits are real and measurable. Thus, the original regulatory restrictions were unnecessary.
Most Americans take access to credit for granted, but many lower-income Americans have difficulty meeting the requirements to get a credit card or take out collateralized loans. With minimal approval requirements that are easier to meet—often just a bank account statement, a pay stub, and a photo ID—payday lenders offer short-term, uncollateralized loans. These loans are advances against a future paycheck, typically about $100-$500 per loan, and customers usually owe a fee of around $15 per $100 borrowed for two weeks.
These are the opening two paragraphs from Peter Van Doren’s excellent post today, “The CFPB and Payday Lending Regulations,” at the Cato Institute’s Cato at Liberty site. The whole thing, which is not long, is worth reading. (Disclosure: Van Doren is the editor of Regulation, which I write for regularly)
He lays out the evidence that payday lending is competitive. He also points out that a large component of the payday lending fee is not properly seen as interest but is, rather, a fixed charge for the transaction. In that sense it’s not much different from the ATM charge you pay when you use an ATM affiliated with a bank other than your own.
When I taught my students about interest rates and pointed out that usury laws are price ceilings (and they had seen earlier in the course the problems caused by price ceilings on apartments and on gasoline), they got it. But usually someone in class pointed out that they had had enlistees who had got payday loans to buy the latest video game or Xbox. (Recall that the majority of my students were U.S. military officers.) The student raising the point usually objected to allowing payday loans or, at a minimum, advocated tight limits on the interest rates that could be charged.
I got caught off guard by this the first time it came up. But the next time I was ready. I asked if any of them had ever paid a $3 fee to use an ATM not affiliated with a bank. There were fewer takers than I expected because many of them, being in the military, banked with USAA and, if I recall correctly, USAA allowed them to use other banks’ ATMs without paying fees. Still, there were a few takers.
I pointed out that if they had paid $3 to get, say, $40 (that used to be my typical draw from an ATM) instead of waiting a day to get $40 from their own bank’s ATM, they were paying a daily interest rate of $3/$40, which is 7.5 percent per day. This, I pointed out, was way higher than the 15 percent for two weeks that is typical of payday loans.
I think one of the hardest things to do, but something that is absolutely required if you want to be a good economist is to put yourself in the shoes of someone who differs from you and ask yourself how he or she sees the world. One of my students shook his head in disapproval at the idea of a soldier or sailor using a payday loan to be able to play a game a little earlier. I could imagine the young soldier or sailor shaking his head in disapproval at the officer who pays a fee at an ATM so he can buy a snack or a toy for his kid.
By the way, good for the Consumer Financial Protection Bureau for doing this. Typically a good way to protect consumers is to let them engage in transactions that they see as benefiting them.