Writing in the latest issue of The Atlantic, Bethany McLean gives a fairly balanced treatment of the oft-whipped payday lending business, and asks the very intelligent question, "If you get rid of it, will anything better replace it?"
After noting that payday lenders serve almost 15% of American households, and that the typical customer is a white woman age 25 to 44, she also points the problems faced by those typical customers, many of whom live paycheck to paycheck, as a result of the typical payday loan.
The entire amount—the fee plus the sum that was borrowed—is generally due all at once, at the end of the term. (Borrowers give the lender access to their bank account when they take out the loan.) But because many borrowers can’t pay it all back at once, they roll the loan into a new one, and end up in what the industry’s many critics call a debt trap, with gargantuan fees piling up.
McLean states "a key truth" about all small, short-term loans: "they are expensive for lenders to make." Payday loan borrowers are not "price sensitive" because "[t]he typical payday-loan consumer is too desperate, too unsophisticated, or too exhausted from being treated with disrespect by traditional lenders to engage in price shopping." With price competition being "inelastic" and with fees being so high, you would expect to see the business "awash in profits," yet studies of the industry show that the profit margin is less than 10%, which is less than one-third of the profit margin of the consumer-financial-services industry as whole. This is because default rates are high. The people who pay high fees for short-term loans don't have access to other alternative sources of credit because they are lousy credit risks, and on a $300 loan, payday lenders can't afford to underwrite them as they do more "conventional loans. An even bigger drag on profitability is overhead. Lots of storefronts, high employee turnover rates, and overall lousy efficiency.
The CFPB's proposed rules for the business would require underwriting to ensure sufficient verified income to ensure repayment (as well as living expenses) without either default or repeated re-borrowing. The latter is the aspect of payday lending that most disturbs its critics, who feel that payday lenders "trap" borrowers in never-ending cycles of re-borrowing. However, McLean supports the payday lending industry's supporters' contention that these requirements would put all payday lenders out of business, and she asks whether or not that's a good thing.
Emergency credit can be a lifeline, after all. And while stories about the payday-lending industry’s individual victims are horrible, the research on its effect at a more macro level is limited and highly ambiguous. One study shows that payday lending makes local communities more resilient; another says it increases personal bankruptcies; and so on.
If most payday-lending customers ultimately need to fall back on financial support from family members, or on bankruptcy, then perhaps the industry should be eliminated, because it merely makes the inevitable more painful. Yet some consumers do use payday loans just as the industry markets them—as a short-term emergency source of cash, one that won’t be there if the payday-lending industry goes away. The argument that payday lending shouldn’t exist would be easy if there were widespread, affordable sources of small-dollar loans. But thus far, there are not.
She discusses the desire of consumer advocates like Sheila Bair and Richard Cordray to strong-arm banks and credit unions into the business, at much lower rates. On the other hand, she rightly observes that Bair's foray in 2007-2008 to entice banks into the mix was a crashing failure because, as even dim bulbs like this blogger noted at the time, you can't make any money on them at 36% (the consumer advocate's favorite annual percentage rate cap). McLean also notes the perversity of the subsequent FDIC and OCC guidelines about the risks of small-dollar lending that drove Wells Fargo and U.S. Bankcorp to drop the business entirely. Even credit unions, which (need we point this out?) DON'T PAY TAXES, can't figure out a way to make payday lending work for them, at least not on a scale that will replace the current payday-loan-office-on-every-corner industry model and service the targeted market.
Although McLean suggests that Colorado has done some "out-of-the-box" thinking about payday lending (thinking apparently done prior to the legalization of recreational marijuana use), it's not likely to satisfy the industry's critics (like Cordray & Co.) because it actually leaves the industry in place. Sure, it's a much smaller industry, one that charges 42% less in fees, and one whose loans default less frequently, but it still actually exists, making all those icky payday loans to people that The Care Bair and King Richard need to protect from themselves because they're all just too dense to do it alone. True believers will never rest until Michael Corleone and his crew step back into the role they were born to play: real-life loan sharks and knee-cappers. If that happens, McLean will not be rooting from the sidelines.
Outrage is easy, and outrage is warranted—but maybe payday lenders shouldn’t be its main target. The problem isn’t just that people who desperately need a $350 loan can’t get it at an affordable rate, but that a growing number of people need that loan in the first place.
That last sentence is especially cogent, but a topic for another day, and a different blog.