In 1995, the Wisconsin state Legislature repealed their restriction capping at 18 percent permissible interest rates in Wisconsin.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 ([email protected]) is a junior majoring in nuclear engineering.
