Opinion
Payday loan industry still preferable to alternatives
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Also by Patrick McEwen:
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In 1995, the Wisconsin state Legislature repealed their restriction capping at 18 percent permissible interest rates in Wisconsin. This act essentially legalized the “payday loan industry.” Here’s how it works: People can get short-term loans from employers, often only for days or weeks, at exorbitant interest rates well above 100 percent when calculated on an annual percentage basis.
State Rep. Gordon Hintz, D-Oshkosh, is now pushing legislation that would recap Wisconsin interest rates at 36 percent. The new rate cap would be higher than the last, but still low enough to functionally eliminate the payday loan industry.
The motivations behind Hintz’s bill are self-explanatory. Proponents want to prevent predatory lending practices that take advantage of unwary consumers. It’s not hard to discern the primary recipients of payday loans: the working poor. The wealthier, oppositely, either have enough savings to cushion themselves from unforeseen expenses or are able to access alternative forms of credit like credit cards or traditional bank loans. Certainly noone in the top income brackets need take refuge in a payday loan. The working poor, for a myriad of reasons — credit history or lack of steady income, notably — are simply unprofitable as borrowers, regardless of interest rate.
Other than reeking of “government knows best” nanny-statism, the proposed legislation has a couple of issues. There are basically two scenarios that could unfold should this legislation pass. Capping permissible interest rates will either provoke some tax break or other incentive for banks to continue to provide short-term loans at rates below the 36 percent cap. Or it won’t. Each scenario has its flaws and needs to be addressed separately.
Without any short term loan incentives, Hintz’s legislation would essentially make it illegal to give short-term loans to anyone whose financial situation, even given interest rates below 36 percent, makes them likelier to default on a loan. The payday loan industry would be eliminated. This would leave these working poor with no choice besides looking elsewhere to find money for unexpected expenses, such as repairing a car that just broke down. It is not hard to imagine such individuals bouncing a check, borrowing from friends or family or — much worse — turning to illegal black market lenders.
Under this hypothetical situation, the only way Hintz’s legislation makes sense is if we assume payday loans to be the worst of the aforementioned “crisis” options — or more sinisterly, if we assume the working poor aren’t capable of discerning their appropriate financial options. Despite the high costs of payday loans, nobody in the state Legislature is qualified to make that judgment about the working poor. Various policy wonks might be able to prove overdraft costs are lower at some banks, but they cannot assess the financial burden of borrowing money from that crazy uncle nobody likes to deal with. And they are not qualified to assess the impact on someone’s personal life of not being able to get their car fixed in time to be able to get their work and keep their job. For some, the payday loan industry really is a lifeline, however imperfect. And compared with the other lifelines which might emerge in its place, I’d favor the payday loan industry in a heartbeat.
The second possible consequence of Hintz’s legislation would involve coupling the interest rate cap with tax incentives or subsidies to lenders, enabling them to continue providing short-term loans at legal rates to those in sudden financial trouble. While this solves the problem of illicit or even more-problematic financial recourses, it brings about an entirely new set of issues.
Forget for the moment about the interest rate cap and just consider the idea of our government subsidizing loans to the working poor. Do you see a problem here? If there is one universal principle of economics, it’s that whenever you offer money to enable something, more people will always emerge to do that “something.” In this case, giving banks incentives to make payday loans will ensure heavily-increased demand for such loans by the working poor — who will realize, not illogically, that less costly interest rates make payday loans more lucrative for them.
If the goal of Hintz’s legislation is to stop unwary consumers from taking out loans on which they’re sure to default, then providing incentives for people to go into debt in the first place would be incredibly counterproductive. Those who don’t see the inherent flaws in a plan to encourage people to take on unnecessary debt really have not learned anything from the economy of the last two years. Does the term “sub-prime mortgage” sound familiar to anyone?
Patrick McEwen (mcewen@wisc.edu) is a junior majoring in nuclear engineering.
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Preferable to living within your means? How stupid do you have to be to pay 36% interest?
Live within your means. If you’re poor, own it.
At least the Payday Loan people don’t use beatings or cut off body parts as a late payment penalty.
The moral of the story is spend less so you can save a bit for emergencies, or else maintain good credit so you can borrow at reasonable rates.
Government rules forcing banks to make a certain percentage of their loans to non-traditional borrowers (i.e. people with bad credit) is a big reason for current problems. Then the big brains on Wall Street figured out a way to chop/flake/form those loans to make part of them look like good stuff! But no matter how much offal you start with, what looks like steak will stink sooner or later.
Couldn’t agree more! Let’s be careful about adding more legislation and regulation about personal finance.
Did anyone else notice how the author’s main argument against regulating payday loans is that it would hurt the credit market for those likely to default and then he turns around and says we shouldn’t be extending credit to them anyway?
Someone needs an editor
It must be nice to let Rush Limbaugh and other conservatives think for you. Any interest rate over 36% is unconscionable. Its plain simple greed. There is a reason it used to be illegal. And it only became legal when banks figured out that they could make a killing by taking money from poor people. I don’t know how it can be defended.
And why would it be okay to subsidize banks and credit unions to get them to offer a shortterm loan product while driving existing payday lenders out of business?
Kudos to the author for pointing out some of the major flaws with this proposed legislation!
The reality is that bank overdrafts on average (according to a 2008 study by the FDIC) run $27 in fees on $36 transactions. A minimum cost of $0.75 per $1 to the consumer. By contrast, payday loans have fees of $0.15-$0.25 per $1. Consumers are saving 66% to 80% by accessing payday loans.
“I don’t know how it can be defended.”
It’s very simple.
If many of the borrowers default on their loans, then the lender has to charge a much higher interest rate to all in order to stay in business.
Loan sharks are willing to take these risks because they employ more aggressive loan collection tactics than are available to payday lenders.
Makes the payday loan fees look positively reasonable!
So he was stunned when his bank charged him seven $34 fees to cover seven purchases when there was not enough cash in his account, notifying him only afterward. He paid $4.14 for a coffee at Starbucks — and a $34 fee. He got the $6.50 student discount at the movie theater — but no discount on the $34 fee. He paid $6.76 at Lowe’s for screws — and yet another $34 fee. All told, he owed $238 in extra charges for just a day’s worth of activity.
http://www.nytimes.com/2009/09/09/your-money/credit-and-debit-cards/09debit.html?_r=1&ref=business
A rate cap on payday loans will not only drive lenders out of business and out of the state, but will literally take away credit options for sub prime consumers.
In this state of economic recession, we should be offering MORE responsible lending solutions, not less. The key is to fairly regulate all financial institutions - not just payday lenders, but banks as well - to ensure that they can be successful, while also serving their customers responsibly.
Might as well bring back debtors prisons.
Aye, it should be off to the sponging house for the deadbeats, just like in jolly old England.
Sponging house (Eng. Law), a bailiff’s or other house in which debtors are put before being taken to jail, or until they compromise with their creditors. At these houses extortionate charges are commonly made for food, lodging, etc.
Before the 20th century, rules and practices concerning bankruptcy generally favored the creditor and were very harsh toward the bankrupt. The focus was on recovering the investments of the creditors and almost all bankruptcies at this time were involuntary. In England, the first official laws concerning bankruptcy were passed in 1542, under Henry VIII. A bankrupt individual was considered a criminal and was subject to criminal punishment. Potential punishments ranged from incarceration in debtors prison to the death penalty.