Ohio lawmakers sought last spring to aid borrowers like Ms. Minda by capping annual interest rates for payday lenders at 28 percent, a sharp reduction from 391 percent. But lenders are fighting back in a novel way, collecting enough signatures, once certified, to force a vote in November on a ballot measure that could overturn legislation that established the rate cap.
"You can't make a payday loan cheaper than the industry does," said Steven Schlein, a spokesman for the Washington-based Community Financial Services Association of America, which represents lenders."
Yet somehow, banks and credit cards remain in business. I wonder how?
By lending to people who are better credit risks. If you have a credit card or a bank willing to lend you money, you don't take out a payday loan (except for an economist of my acquaintance who is researching payday loans). The people who get them are the most financially marginal members of society--i.e., the people least likely to pay them off.
Nonprofits have tried to enter the market in order to offer the loans at lower interest rates. People without other access to credit say they need them to cover emergencies. What those non-profits have found is that in order to cover their default risk, and the transaction costs of manking a lot of small-denomination loans, they need to charge shockingly high interest rates--291% annual, at one non-profit covered by the New York Times.
If that's the interest rate at which payday loans break even, it's pretty obvious that capping the interest rates at 28% will put an end to the industry. Hurrah! Say the credit nannies. Not so fast. If people really need the money, and don't have anywhere else to get it, you've just put them in a nasty fix. Ban payday loans and you'll drive them to even worse alternatives: pawnbrokers, loan sharks, or losing their job because they can't afford to fix the car. Loan sharks didn't used to be just for gambling debts and illegal finance; they used to be staples of poor neighborhoods. And you can't declare bankruptcy against an illegal debt. Especially not with your kneecaps broken.
Payday loans aren't so bad if borrowers pay them off when they get their paychecks. While the interest may be very high on an APR basis, given the relatively small size of the loans and their very short duration, the actual dollar amounts of interest are modest. It's when people keep rolling their loans into new ones, that the charges really start mounting.
The most obvious alternative to a payday loan is simply paying your bills late. But if you take the penalty on some bills and annualize it, you see that it is in fact more financially viable to take out an extremely high-interest loan rather than pay the utility's penalty fee.
Maybe the president should just give them money. Instead of a payday loan the government could just hand out a couple hundred dollars to people when they need it.
I'm asking this because I'm extraordinarily naive and young:
How much do loan sharks charge for interest? I think I remember guys charging each other interest during "The Sopranos", but I don't remember how much.
It probably depends on the loan shark and the person who is borrowing the money.
I have to wonder as a typical white-bread person how one would even go about finding a loan shark, if one happened to need such services. Is there some guide on how to gain entry to the underworld?
Adam writes: "I have to wonder as a typical white-bread person how one would even go about finding a loan shark, if one happened to need such services. Is there some guide on how to gain entry to the underworld?"
All you have to do is know a bookie, or talk to someone you know who is a gambler... they'll generally know a bookie. And every bookie on the planet knows loan sharks or doubles as one himself.
If you've led such a rarified existence that all this seems totally foreign to you, hanging out in a working class bar and asking a few questions might get you somewhere. Or it might get you some loose teeth. But bookies aren't all that hard to find.
So, Moe:
Purely theoretically, of course, how much would a loan shark charge for a $500 loan?
You loan to marginal borrowers at high rates of interest in the U.S. and economically uninformed state legislatures come after you. You do essentially the same thing in Bangladesh and you get a Nobel Prize for it.
I've been doing some work for a non-traditional lender that provides a similar product for small businesses. It's able to do so at much lower rates than payday lenders (although at higher rates than credit cards) because it's able to work nationwide via one location, doing business via phone, Internet, fax, wire, etc. Payday lenders need have a lot of storefronts generally.
I think people should have a choice. These establishments are there to use if you need them. I am not sure why the government is out to get them. They are there to serve a need and a purpose. Not sure why they are compared to loan sharks and banks are not. If you bounced one check with them is cost way more than a pay day loan. If you vote.... VOTE NO ON ISSUE 5 TO PRESERVE THIS RIGHT!... The government should not be taking our options away.
I am curious to know how many posters have taken out pay day loans? I've had to in the past; better to pay the $20 of interest on a two-week loan of $200 than get charged a late payment fee and subsequent overlimit fee on a credit card. Or (more honestly) better to have beer and cigarettes for the week rather than not.
It was a valuable service when I needed it, despite however humiliating / humbling the experience.
Klug writes: "Purely theoretically, of course, how much would a loan shark charge for a $500 loan? "
From what I've heard there's no set rule. You make an agreement and then you make weekly payments. Miss a payment and it gets tacked on to the principle and the weekly payment goes up, too.
So if you start with a $500 loan you might agree to pay, say, $25-50 bucks a week. Miss two $50 payments and you now owe $600 and your weekly payment is $60. And so on. They don't care if you miss a few payments as long as you keep paying more or less regularly.
If you want the debt to go down as you pay it's more expensive. The same $500 loan will cost you $100 a week, and after 6 on-time payments you're done.
There are other wrinkles I've heard of where if you go back and borrow more while you still owe the whole agreement gets redone and you're paying more once again. So if you owe the original $500 and you've been paying $50 per week, and you borrow another $500, then you're told to pay $125 per week total.
And so on and so forth.
Credit card companies also have a second source of income: the N% of each purchase that the merchant gives them. I'm a terrible deal for a credit card vendor, since paying the balance in full every month avoids all interest and late fees, but I'm still constantly offered new ones.
FWIW, in my brief experience as a payday borrower, the vast majority of the customers never fully paid off the loan on time. Instead the loan was just rolled into another loan, so it's not out of the ordinary for people to end up paying the ridiculous APR for many months for some smallish sum of money (the place I went to capped loans at $400).
So it looks like the most straightforward charge is 20% interest, which is not that different than credit cards. Interesting.
It'd be interesting to see what was cheaper, loansharks or credit cards. I'm guessing it would be close.
Maybe the president should just give them money. Instead of a payday loan the government could just hand out a couple hundred dollars to people when they need it.
Or set up a Pay Day loan GSE that the government will bail out when they can no longer cover their obligations.
My father once owned a small loan business. The state capped the interest he could charge. When the interest rates on what he borrowed skyrocketed in the early 80s, he lost two businesses.
There is no free lunch.
I'm not sure that pawnbrokers are that bad, but yes.
Of course, the state could set up a payday loan facility. The thing about Fannie and Freddie is that it's not obvious that they were a bad idea except that they paid external shareholders, as government can borrow much more cheaply than anyone else, why shouldn't it offer loan facilities to its citizens?
Whether it is payday lenders or sleazy "we tote the note" car dealers, many marginal people would not have cars, gas, money, heat, or beer and cigarettes in time of need.
Now certainly, banks should not make scads of mortgage loans to crap borrowers, especially on overpriced houses. Still, small loans or loans on cheap cars is a more manageable proposition.
Pawnbrokers also fill a useful niche in the market. It is easy to trash people who operate in these margins, but they are helping people who are desperate and might be even more desperate if these choices weren't available.
Because the government bureaucrat that makes the loan has little (or no) incentive to get the money back because they know that the government will bail them out. Therefore they make high risk loans at low interest and lose huge amounts of money. With the example of Fannie and Freddie so fresh in our minds I'm kinda hoping your post was sarcastic. I'm kinda scared it wasn't.
If on the other hand you think the government should loan money to poor people and then not try to get it back, we do this already. It's called welfare (and Medicaid, and the EITC, etc., etc., etc.).
Credit card companies also have a secondary source of income that supports lower APRs- they pick up a fee from the vendor on every purchase. That Hilzoy doesn't know this is pretty unsurprising- that Megan forgot to note this is a bit of a surprise.
Yikes! I see Mike had already noted this.
The problem with payday loans is not necessarily the interest, it's the fine print on many contracts, such as the common one that requires a borrower to inform a lender, sometimes in writing, at least three days (sometimes the days vary) before the loan is due, of the intention to pay the loan in full, or the payday loan is automatically rolled over into a new loan.
So, when you go to pay off the loan, surprise! You owe more than you think. But that's okay, they'll work with you -- by rolling over the fees into a new loan you can pay off next payday.
As long as you give them advance notice in writing of your intent to pay off the loan.
We focus solely on the interest rates. That's not the problem. The problem is the practice many lenders engage in as they roll over these loans.
Megan I'm sure this won't alarm you, but your readers might be interested...
The Atlantic's cover photo for October was taken by an exceptionally partisan Dem who tried to get the worst shot of McCain possible. http://newsbusters.org/blogs/noel-sheppard/2008/09/13/lib-photographer-admits-making-mccain-look-sinister-mag-cover
She describes the picture on the cover thusly "I left his eyes red and his skin looking bad." Greenberg is known for her highly retouched photos.
On her hiring, Greenberg says "I am a pretty hard core Democrat. Some of my artwork has been pretty anti-Bush, so maybe it was somewhat irresponsible for them [The Atlantic] to hire me."
What was the process for the photo she wanted used for the cover? "After getting that shot, Greenberg asked McCain to 'please come over here' for one more set-up before the 15-minute shoot was over. There, she had a beauty dish with a modeling light set up. 'That’s what he thought he was being lit by,' Greenberg says. 'But that wasn’t firing.'
What was firing was a strobe positioned below him, which cast the horror movie shadows across his face and on the wall right behind him. 'He had no idea he was being lit from below,' Greenberg says. And his handlers didn’t seem to notice it either. 'I guess they’re not very sophisticated,' she adds."
Nice ethics of your Magazine.
Klug says: So it looks like the most straightforward charge is 20% interest, which is not that different than credit cards. Interesting.
Firstly, those numbers are pretty damn speculative, so I'm not sure I'd use them to draw any conclusions.
Secondly, if where you are going with this is to say "well, loan sharks can work with marginal borowers at 20%, so payday lenders could too", then not so fast. Your chance of defaulting on a real underworld loan shark is essentially zero. He knows where you live and he'll rob your house and break your teeth to get repaid. A legitimate lender bears a much higher default risk. The best estimate of the minimum interest rate that a legitimate payday lender could charge and still break even is probably the rate charged by a non-profit that Megan cites.
David:
No, that's not where I was going -- there is a clear difference between having your credit rating ruined and meeting Rocky in a dark alley. T
Nevertheless, sounds like to me that Moe has an idea as to what short term interest rates might be on the street -- let's note that in his example, it'd be a 173% annualized rate. (20% for 6 weeks, calculated for 52 weeks)
One thing that I find odd about the example is $400 for school clothes and school supplies. $100 I might buy, $200, sure. Then again, I never got "school clothes" when I was young; must have been deprived.
Banning payday loans is anti free market. So is banning prostitution. Political societies make choices. Libertarians, get over it.
That's actually a good thing to ask: what does "school clothes" mean for an average American family? I grew up here with an immigrant parent, so I'm actually not really familiar with the process.
Is it essentially a new wardrobe (changing out outgrown clothes, etc.) or is it buying a few items here and there?
Another thing I've noted is the growing expansion of what is "required" from parents in terms of school supplies. The lists look longer and longer each year -- are they not aware of their students' SES?
Staash:
FWIW, in my brief experience as a payday borrower, the vast majority of the customers never fully paid off the loan on time.
In your experience as a payday borrower, wouldn't the vast majority of customers have been you? How do you know what other customers did?
So is banning prostitution.
So, what is wrong with prostitution? Societies do make moral choices that are written into law.
But surely anyone who thinks it is OK to ban pay day loans could not object to banning abortions.
Because the government bureaucrat that makes the loan has little (or no) incentive to get the money back because they know that the government will bail them out. Therefore they make high risk loans at low interest and lose huge amounts of money. With the example of Fannie and Freddie so fresh in our minds I'm kinda hoping your post was sarcastic.
Fannie and Freddie were private companies. So was Countrywide. And Bear Stearns. And Lehman. Tell us again about how private firms can be trusted to lend money sensibly.
hey isn't very bright: "What was the process for the photo she wanted used for the cover? "After getting that shot, Greenberg asked McCain to 'please come over here' for one more set-up before the 15-minute shoot was over. There, she had a beauty dish with a modeling light set up. 'That’s what he thought he was being lit by,' Greenberg says. 'But that wasn’t firing.'
What was firing was a strobe positioned below him, which cast the horror movie shadows across his face and on the wall right behind him. 'He had no idea he was being lit from below,' Greenberg says. And his handlers didn’t seem to notice it either. 'I guess they’re not very sophisticated,' she adds."
Nice ethics of your Magazine."
Since they didn't use that shot for the cover, genius, what difference does it make?
You cons nominated an elderly liar, so stop pretending you care about ethics, anyway.
Here's the passage you evidently missed:
"The Atlantic didn’t select the diabolical looking McCain for its cover. Greenberg is hoping to license that image to some other magazine (she negotiated a two-week embargo with The Atlantic so she could re-license images from the shoot before the election)."
Brandon,
Payday lending "banks" aren't particularly private or well-staffed. If you go there at a busy time (Friday near close is the worst) you will become intimately acquainted with the financial situations of the customers queued ahead of you, whether you are interested or not.
It wasn't all that long ago, no more than 25 years or so, that companies such as Beneficial and Household Finance and Seaboard made small unsecured loans to borrowers of modest means. Over the years they got out of that business, in favor of home equity loans and other forms of secured financing, mostly because changes in bankruptcy law made the business too risky.
Klug writes: "Nevertheless, sounds like to me that Moe has an idea as to what short term interest rates might be on the street -- let's note that in his example, it'd be a 173% annualized rate. (20% for 6 weeks, calculated for 52 weeks)"
The "rates" can be lower than that for repeat borrowers with good records of repayment. Since these are almost always non-amortizing loans the rate doesn't matter as much to the sharks - if there's someone they think will pay the principle back fast a lower rate still gives them easy cash.
Todos los personas Michael o Mike. Soy Senor Guapo!
1) You could probably pay off a $500 "loan" with around $550 or $600 the next payday, so the interest is 10 or 20 percent for the two weeks, which annualized is, a hell of a lot.
2) the interest actually isn't called interest, but "the vig" or "viggorish"
3) the principal isn't called "principal", its called "the nut"
4) as long as you pay the vig every two weeks, you can have the nut as long as you want.
So, payday loans are probably cheaper than loansharks, but with loansharks you don't have to fill out any forms.
ChuckC writes: "3) the principal isn't called "principal", its called "the nut""
Depends. More genteel sharks will talk about "your obligation" and so forth. Same with "vig" - you'll hear "your weekly" and so forth. I guess there's some generalized fear of wires and so forth out there, or maybe they just think it's all sort of funny.
Despite the movies, there's very little violence involved in this sort of thing. I have more respect for loan sharks than I do for credit card execs.
How 'bout that? MoeLarryAndJesus and I totally agree on something!
I'm just wondering where these guys are getting all their info on loan sharks? (haha, that's a joke, fellas!)
I once worked for the most incompetent illegal pawn broker ever. Frankly, I loved the guy.
Yeah, he'd actually make them deliver the broken 10-year-old stereo before he'd give them $100. He didn't want to humiliate a man by just giving him something.
He had a used car lot and financed them himself. He made a little profit on every car with just the down payment. He never went into the deal expecting a payment. The ones he got were gravy to finance his charitable pawn-broking scheme.
Believe it or not, he hired me to inventory all the junk he'd taken in over 25 years. He'd sold almost none of it. He had two legitimate businesses that helped keep him going.
He'd be a great recurring character in somebody's books somewhere.
"Six for five" a week is the rate for "shylocking" in literary tradition; it's supposedly based on actual historic rates for high-risk debtors in places with a violence-enforced monopoly on loansharking by organized crime.
Agreed that Hilzoy is almost comically wrong; the comparison to loans good borrowers can get is foolish. But the kind of responsible use of the payday loan you suggest -- that doesn't happen much. Many, many times I saw the morning crowds outside payday loan places in Oakland and thought, wow, this has become an amazing tool for people to screw themselves.
Some kind of regulations, please. Maybe not on the industry so much as on the borrowers -- keep track of who's borrowing, maybe people can be routed to some kind of counseling or something, especially say people whose checks come from AFDC or Social Security? And whatever you come up with, you'll know it works if it will grossly curtail the business of those lenders. Not that that itself should be the goal.
"Fannie and Freddie were private companies."
"Private" companies created by government and run by well-connected Democratic pols such as Franklin Raines and James Johnson, who was the head of Obama's VP selection committee until he was implicated in the Countrywide payola scandal.
I'm just wondering where these guys are getting all their info on loan sharks?
Elmore Leonard novels.
Mike quotes and palins: "I'm just wondering where these guys are getting all their info on loan sharks?
Elmore Leonard novels."
I've never read one. If you have information to the contrary, present it. If you don't, you're doing a Palin.
Touchy, touchy, Moe. I think he was joking.
Let's be clear.
Usury laws are not about protecting consumers from unscrupulous lenders. Usury laws are about deciding, as a society, that some people are just to irresponsible to have credit. To pretend otherwise is disingenuous.
By lending to people who are better credit risks.
Like, for instance, college students with no reliable income.
Oh, wait.
I've never read [Elmore Leonard]
I was speaking for myself, Moe. By the way, I highly recommend Get Shorty and Out of Sight.
Usury laws are not about protecting consumers from unscrupulous lenders. Usury laws are about deciding, as a society, that some people are just to irresponsible to have credit.
And anti-slavery laws are about deciding, as a society, that some people are just too dumb to negotiate employment contracts.
Mike- And anti-slavery laws are about deciding, as a society, that some people are just too dumb to negotiate employment contracts
You'd have a better case if you changed that to simply "indentured servitude." We outlawed slavery in the US long after we outlawed indentured servitude (ironically).
Sanjay: I don't know about California but in New York the recipients of welfare and food stamps don't get paper anymore. They get a debit card like benefits card. If you are on welfare you can use the card to withdraw cash from cash machines. The food stamps portion, using the same card, is used at grocery stores. I think WIC vouchers are still paper. Social Security is done as a direct deposit so are unemployment benefits. The people in payday loan offices are getting paychecks from employers.
Fannie and Freddie had private profits and government backed risk -- quite possibly the worst of all possible worlds. And who in the government is going to lose their job because they had to sink billions into them? Anyone? Not so at Countrywide and Bear Sterns.
So called usury laws were universal in the US until at least the 1970's, They capped interest rates. That didn't seem to stop America from becoming an economic powerhouse. So 200 years of history suggests such laws don't inhibit systematic growth.
On the other hand such laws are an affront to Libertarian ideology so that settles it. Americans must bow to ideology, for the Libertarian ideology is the font of all truth.
JPM got a low interest $29 billion dollar loan from the Treaury in the Bear Stearns takeover which nobody pretends they will have to pay back. Some libertarians did grouse about that for a few days. Yet we will hear wailing and gnashing from them about usury laws till the end of time.
How much do loan sharks charge for interest?
I don't know for a fact, but I would expect less than payday loan shops precisely because loan-sharks do use threats of violence and because the illegal debt cannot be discharged by bankruptcy. For a given poor-credit-risk borrower, the loan-shark has a higher probability of being able to collect than the legal payday loan shop, so the shark can make money charging lower interest.
Newsflash: Megan "Pangloss" McCardle once more defends the best of all possible economic status quos.
Perhaps she might explain why she finds pawnbrokers a worse alternative. The article in question made reference to interest rates lower than those she indicates are offered by pay-day lenders and philanthropic microcrediteurs.
Hillaire Belloc produced an essay on usury some decades back in which he offered the observation that in the realm of credit transactions, one is faced in a certain number of circumstances with a choice of destroying the debt or destroying the debtor. It is that dilemma that puts a certain boundary on the proper range of the market and contractual obligations in allocating credit.
The Federal Reserve Bank of New York Staff did a study and concluded that compared with households in states where payday lending is permitted, households in states where payday loans are prohibited have bounced more checks, complained more to the Federal Trade Commission about approved lenders and debt collectors, and filed for Chapter 7 bankruptcy protection at a higher rate.
FRBNY focused on quality of life issues and not simplistic APR explanations. People suffer when the credit nannies determine what is best for them.
If they had capped it at .25 percent, it would have damaged economic growth.
These 291% interest rates--- and it can go as high as 487% from what I've seen, are on two week loans. So you borrow 400 bucks till the next payday, pay back 440. Which isn't a really unreasonable fee, IF you can pay it back in two weeks.
It's when you have to refresh the loans that it gets bad. Sure, it's pretty much legal loansharking, but hey, at least now they are bound by the law.
FRBNY focused on quality of life issues and not simplistic APR explanations. People suffer when the credit nannies determine what is best for them.
The study in question is 49 pages long. I have yet to read it and I am not sure I could critically engage this sort of literature anymore. I would like to know why they compare a three or four year period of time in Georgia and North Carolina (subsequent to the prohibition of pay-day loans) to the situation in other states which permit such loans rather than make a general comparison between states that prohibit and states that permit such practices.
Has anyone done any empirical analysis of Megan's claims or are we all just assuming Econ 101 must be right?
Interest rate is simply not the right measurement for very low dollar loans. Although the default rate is an element of the high rates, the largest factor in payday lending is simply the small size of the loan. Megan's reference to transaction costs was brief but accurate. A $75 dollar loan outstanding for a year, at 20% interest, would earn only $15. No loan, regardless of size or length of time outstanding, can be made for such a low cost.
Islam, so I understand, really does ban collecting interest as usury. Islamic finance works, and is increasingly present in some financial markets. How does itprovide the eqivalent of payday loans? Anyone know?
One way Islamic finance works is by using what we would call a "repo" structure. So you "sell" your TV or whatever to the pawnbroker, but agree to "buy it back" in two weeks for $120.
Mind you, the Islamic finance transactions that I have been worked on have been a little larger than this. In general, however, most shariah-compliant structures have Western analogues, i.e., repos, sale-leasebacks, etc.
Payday lending is a scourge on our families, our communities and our economy. There are just too many Ohioans negatively impacted by payday loans for the new legislation to be upheld. There are alternatives for borrowers at Ohio's credit unions and a link deposit program will be created as a result of House Bill 545. It's imperative that the legislation be upheld and that the payday lobby is unable to hijack Ohio's electoral process. The payday lobby is dead set on lying to voters in order to protect their ability to charge 391% interest on payday loans. 391% APR interest serves only as a debt trap.
If the referendum makes it to the ballot, vote yes on issue 5!
http://www.yesonissue5.com
Islamic finance works, and is increasingly present in some financial markets.
Can you give some examples of this? I ask that question in all seriousness and honesty.
Justin:
Has anyone done any empirical analysis of Megan's claims or are we all just assuming Econ 101 must be right?
First, are you qualified to use the term "Econ 101" in a pejorative sense?
Second, it's not Econ 101; it's Math 101. At a 28% APR, your revenues on a two-week, $400 loan are about $3.80. If one loan in 100 isn't repaid, that eats up all your revenues and then some. Let's say one loan in 200 isn't repaid. You now have $1.80 per two-week, $400 loan with which to pay for rent, utilities, employees, and taxes, and after that make enough profit to make it worth your time. It can't be done.
It can't be done.
So?
Something I've heard on the radio (from a personal finance show) is that payday loan places routinely threaten late debtors with prosecution for having written hot checks when that's actually the business model. That's highly unethical on the part of payday lenders, and I think that would be a good place to start with prosecutions. I've also heard a number of high-income callers on the radio who got entangled in payday loans who could have gotten regular credit--it's not exclusively an underclass phenomenon.
Pawnshops are actually the least bad form of credit, in my opinion. At least if you are unable to redeem an item from a pawnshop, you don't owe anybody money.
From what I hear, use of the FICO score has far exceeded its actual usefulness. I think the world of credit is going to look entirely different in 2-3 years. Lenders are going to have to start looking (again) at income and savings, rather than just assuming that because a borrower has been able to pay credit cards on time, she will be able to carry a mortgage that's half of take-home.
y81
As you say, the equivalent of pawnbroking works in Islam; I still do not see the equivalent of payday loans.
TW Andrews
Wikipedia - with some strong backing from the IMF etc. - puts the total of larger scale islamic finacing at US $500 billion and growing fast.
"So?"
Chet, why do you persist in parading your ignorance? If it can't be done, it won't be done, and then risky borrowers will have to go to loan sharks or lose their jobs and resort to crime. Payday loans are a better option.
TW Andrews, I am not aware of a Shariah-compliant loan structure that can be used for unsecured loans for personal purposes. Most of the structures I have seen are either for secured loans (some Western analogues would be repos and sale-leasebacks) or for unsecured business loans (the Western analogues would be debt disguised as preferred equity).
But I am hardly the world's greatest expert.
Something I've heard on the radio (from a personal finance show) is that payday loan places routinely threaten late debtors with prosecution for having written hot checks when that's actually the business model.
There's a decent chance that violates the Fair Debt Collection Practices Act and state-level versions of debt collection law. See, e.g., 15 USC 1692e.
If it can't be done, it won't be done
It was being done; it just wasn't awesomely profitable under the old usury laws.
And that's really at the heart of it. The explanation that these absurd interest rates - not just on payday loans but across the finance industry - are necessary to "cover risk" are so much flim-flam. The finance industry is one of the most profitable in the world. Credit card companies and payday loan offices are making money hand-over-fist.
Why? Because they've drastically overestimated the risks, thus inflating interest rates and making windfall profits when the "expected" level of defaults fail to materialize. And, hey, if you don't like it, you can go over to the other place - except they're using the exact same formulas, based on the exact same credit bureau information, so the rates are exactly the same.
You know, in any other industry, we'd call that "price-fixing." Just another anti-competitive failure of the free market, brought to you by your friends, the libertarians.
"Credit card companies and payday loan offices are making money hand-over-fist."
But they operate in a number of fields. Just because they make money from credit-cards and car loands doesn't mean they will take losses in payday loans.
"they've drastically overestimated the risks, thus inflating interest rates and making windfall profits when the "expected" level of defaults fail to materialize"
Did you genius, by any chance, read something about the mortgage industry as of late? Do you think these guys also overestimated their risks, and anticipated defaults that never came?
How come Wells Fargo and BofA are still in business, while WaMu and others might go under? Must be libertarian-induced price-fixing.
Any more brilliance form you today?
Megan takes the time to pick on Hilzoy's sarcasm, but rolls along with this trope:
This, of course, ignores one of the more potent actual points that Hilzoy makes: that 96% of the recipients of these loans gets 5 or more payday loans a year. Now, there are two possible reasons for this: either the vast, vast majority don't actually represent some unlikely crisis, but are a much more mundane sort of mismanagement; or the loans are structured so unfairly that people really are getting 'trapped.' (Or quite possibly both).
Don't get me wrong, anyone that wants to make a nanny-state argument about protecting people from themselves has my sympathy (I've never much appreciated laws against gambling, prostitution, or even suicide, for that matter). But this is a philosophical argument that we can have honestly, instead of pretending that it's a common occurence for payday lenders to come to the aid of otherwise responsible folks, and helping them save their jobs. That particular characterization is as silly as it is misleading. We would never try to justify legal gambling by acting like people might win enough to pay for their truck when they are in crisis.
The basic case against these loans is that payday loans are inherently self-destructive, so you should either show that they aren't (parse the facts), or make the case that it just doesn't matter, and people should be allowed to do whatever they want to themselves as long as they aren't hurting others.
[As to the question of what would happen to someone who is cutting it close, but experiences a particular short-term crisis:
I'm with the person above, that wonders whether a trip to the pawnshop is really "worse." I also think Megan omits community-based ways to handle a crisis: going to relatives, friends, neighbors, church, etc. It's a little humbling to ask for help, and I suspect a large number of people put their pride ahead of their wallet. And, in the case of the overmentioned and overwrought "car crisis," I suspect public transport might even factor in.]
But if we outlaw payday loans, where will poor people get the capital to invest in lottery tickets?
I'm with the person above, that wonders whether a trip to the pawnshop is really "worse."
Pawnshops only work for people with sufficient collateral. AIUI, they loan only a small fraction of an item's value, so to get a loan of, say, $500, it would be necessary to have pawn-able property worth several thousand dollars.
Pawnshops only work for people with sufficient collateral. AIUI, they loan only a small fraction of an item's value, so to get a loan of, say, $500, it would be necessary to have pawn-able property worth several thousand dollars
Cannot say what is accurate, but the article referenced claims 50% of the value is the norm.
What Brad L. said.
I agree with Brad L here. I doubt that society, or even individuals who use them, would be much worse off if payday lenders were prohibited. We could all find cases where people would go to a loan shark, and on the other side we would also find people who would have been tempted by payday lenders that instead chose a better route if they were banned.
So again, we go back to the real argument. What is the role of government in telling people how to live their lives? Those who wish to ban payday lenders are saying, as others have put it it here, that there are some people who are not capable of making the decision to take out a loan like this.
I find this sort of thinking a little bit scary. There's a ton of things that we could find out there that some part of society seems to have a problem with, but we don't ban it across the board. Lots of people can't handle booze; we certainly shouldn't ban its sale. There are a lot of people that take rap lyrics a little too literally, but we don't ban DMX. And there are a _ton_ of people who are not capable of being parents, but we don't force them into abortions or adoptions. Are we really going to ban Coca-Cola?
One of the things that makes society here great is that we assume that people will act in their best interest, but we accept that sometimes people do dumb things. Trying to anticipate the dumb things that they will do is a recipe for massive government intrusion. Isn't that why we all struggle with the Patriot Act? Isn't it just a massive program to try to predict the dumb and bad things people will do?
Finally, if I lend my friend 50 bucks, and in a couple weeks he pays me back 60, will I go to jail?
Art Deco -
Yes 50% could be the norm, but that's depreciated value. As anyone has noticed with insurance, there's a rather huge difference between replacement cost and the value that an insurance adjuster will place on your stuff. Your $4,000 bike is worth maybe 400 used, so the pawn shop gives you $200. You'll get another 15 for your 42 inch plasma.
Consumer goods depreciate in value extremely rapidly, much more than the IRS assumes. It's the difference between useful life and the risk of buying someone else's abused or defective piece of crap. Unless you have jewels, the only people for whom pawnbrokers make sense are thieves. For everyone else, there are payday lenders and loan sharks.
Did you genius, by any chance, read something about the mortgage industry as of late? Do you think these guys also overestimated their risks, and anticipated defaults that never came?
Completely different industry, and it really proves my point - interest rates have noting, in practice, to do with "assessing risk." Rather, it's about assessing the absolute maximum the consumer can be soaked for, before he decides to simply do without whatever he wanted the load for.
it's about assessing the absolute maximum the consumer can be soaked for
You're assuming that the payday lending market is uncompetitive - either there are few players or heavy collusion. There seem to be a fairly large number of companies in the business, so the assertion is that they are colluding and have artificially high profits. But the barriers to entry into this market seem fairly low; if profits are so great, there should be lots of people joining the market offering slightly lower prices. Why isn't this happening?
"and it really proves my point - interest rates have noting, in practice, to do with "assessing risk." Rather, it's about assessing the absolute maximum the consumer can be soaked for"
I'm guessing that if no bank ever had to deal with bad loans, you would see that as proof that interest rates are too high. And that makes sense. But now since some banks do have to deal with that I fail to see how that too can be proof of your point. Unless, of course, your point is that nobody knows in advance the correct interest rate to neutralize the risk of default. In which case, how do YOU know what the appropriate interest rate on payday loans should be?
As an aside, I don't know if it's the Mafia or some other outfit that runs Cleveland's underworld, but whoever it is, re-instituting usury laws makes them very happy, I would think.
(Now, we can argue that the mere fact one is living paycheck-to-paycheck is "a mundane sort of mismanagement," but I suspect you meant something more by that term.)
You're assuming that the payday lending market is uncompetitive - either there are few players or heavy collusion.
Uh, I think I proved it already, actually. For the first part, lending agencies follow each other nearly lockstep in terms of the calculations they use to determine interest rates for a given credit score.
Secondly I doubt that any consumer of payday credit compares interest rates or fee structures; rather, since the business is opportunistic in nature - seizing on the calamities in people's lives that lead them to need a sudden advance on a paycheck - its obvious that it is immediate expediency that determines which business the customer will get a loan from. Probably most people in need of a payday loan stop at the first place they see.
Everybody knows that you can tell how poor a neighborhood is by how many payday loan offices you see. Obviously, it's a predatory business, and they've moved into position to strike.
But the barriers to entry into this market seem fairly low
Aside from "having a ton of money to loan around." You know, no barriers, though.
if profits are so great, there should be lots of people joining the market offering slightly lower prices.
Why bother to lower prices when they make more money at higher interest rates?
But now since some banks do have to deal with that I fail to see how that too can be proof of your point.
My point is that interest rates aren't, in practice, determined by risk. If they were determined by risk in the credit card and payday loan areas, they'd be lower. If they had been determined by risk in the mortgage area, they would have been much higher.
But ultimately CC's and payday loan interest is determined by what the market can absolutely bear. In the mortgage area they were determined by what would get people to sign the document and make the loan officer a huge commission.
Everybody knows that you can tell how poor a neighborhood is by how many payday loan offices you see. Obviously, it's a predatory business, and they've moved into position to strike.
I also see a bunch of coffee houses in rich areas, but I wouldn't consider them a predatory business. Businesses locate themselves in the areas where they are most needed. It makes complete sense to locate yourself where your customers are. The richer areas command higher rents, and there are far fewer customers.
This isn't like emergency surgery where you need to be treated this instant, and you are incapacitated. The person must have at least an evening to figure something out, so I highly doubt it's all that difficult to shop around.
It also happens that these people are all adults, and I'm sick and tired of a government that feels the need to tell adults "you can't do that, because you might hurt yourself" That's not for the government to decide. I don't want a government that feels like we're all a bunch of dumb children that need to be protected from ourselves.
Aside from "having a ton of money to loan around." You know, no barriers, though.
If you have good credit, you could take out a loan at low interest. Many people do that to start a business in this country, it's not all the uncommon.
I also see a bunch of coffee houses in rich areas, but I wouldn't consider them a predatory business.
You don't think selling a drug to addicts constitutes predatory? I wonder then if you would consider any business predatory.
It makes complete sense to locate yourself where your customers are.
If consumers were shopping around for better rates it wouldn't matter where they are, and they would surely relocate their offices - filled, as they are, with cash money - to someplace with a little less crime.
But, they don't. Because they know that interest rates have nothing to do with their clientele, most of whom wouldn't even be able to calculate compound interest.
I don't want a government that feels like we're all a bunch of dumb children that need to be protected from ourselves.
I'd like a government that recognizes that private companies aren't always economic equals acting in good faith, but rather, and fairly often, self-interested, powerful accumulations of influence and wealth for whom my personal freedom and access to information represent direct threats to their profit base.
And it's clear that the vast majority of Americans agree, which is why we have things like mandated overtime after 40 hours, weekends, occupational safety regulations, public schools, the Post Office, Social Security, and other liberal success stories. Perhaps you'd find another country more to your liking. Why don't you try that libertarian paradise called Iraq?
Chet,
Are you really that stupid....what you say doesn't even make any logical sense...
I also see a bunch of coffee houses in rich areas, but I wouldn't consider them a predatory business.
You don't think selling a drug to addicts constitutes predatory? I wonder then if you would consider any business predatory.
Wait... coffee shops are predatory? OK, I'm done. Clearly, you consider all business predatory.
Because they know that interest rates have nothing to do with their clientele, most of whom wouldn't even be able to calculate compound interest.
Most people don't have any understanding of basic economics, international relations, law, or sociology; be we still trust them to vote in a presidential election, because we decided long ago that we ought to have the same rights and opportunities, and that none of us are smart enough to decide what the criteria is to make such a decision.
The Supreme Court has decided that governments can't intrude on the right of privacy to ban abortion. Why is this different?
"interest rates have noting, in practice, to do with "assessing risk." Rather, it's about assessing the absolute maximum the consumer can be soaked fo"
Chet,
The higher the interest rate a lender charges, the higher the default rate he can accept, and, consequently, the riskier the borrowers he can lend to. The client of mine I alluded to above charges business borrowers a third of what his competitors charge, but he also has higher underwriting standards and a default rate a third of that of his competitors.
Chet,
You keep saying that the rates charged by payday lenders are excessive. How do you know that? What is, then, the correct rate? Megan had some data to the effect that a non-profit had to charge some 290% APR to stay even. That's not much lower than figures quoted to justify government crackdown.
Even if you were right, and the customers are desperate people who are ripped off by the lenders, what good will closing down legal shops do? Cleveland's Tony Soprano, we can safely assume, will still be open to business. Will the borrowers be better off dealing with him?
Everybody knows that you can tell how poor a neighborhood is by how many payday loan offices you see. Obviously, it's a predatory business, and they've moved into position to strike.
This is because a payday loan office would shut down in a wealthy neighborhood. People who have good credit don't use payday loans to pay for emergency expenses; they use credit cards. There aren't payday loan offices in wealthier neighborhoods for the same reason that you can't find a grocery store that sells bacon in the middle of the orthodox Jewish neighborhood. It's not predatory for stores to only go where they would have customers.
You don't think selling a drug to addicts constitutes predatory? I wonder then if you would consider any business predatory.
I find that illegal businesses are the most predatory, and laws that force legitimate businesses to be illegal isn't going to help a thing. Would I prefer to live in a country where the poor don't need to resort to high interest payday loans? Of course, but we have to acknowledge the reality of the world.
Two points:
1. My town (Staunton, VA) has a lot of neighborhoods with boarded-up buildings and a lot of payday and title loan places, but most of the latter are in strip malls near fast-food places, not in the run-down neighborhoods themselves.
2. Even leaving out the illegal options, there are worse ways to get money than paying 20% interest on a one- or two-week loan. People in need (particularly college students) have been known to sell books to used bookstores for 10% or 20% of what they paid for them, sell CDs or DVDs to used-media dealers for similar markdowns, and sell furniture or appliances on Craigslist huge losses. If these are things you can't do without in the long run, buying a book (or CD or DVD or air conditioner or toaster) twice because you had to sell it to buy food or avoid eviction is a far worse deal than a payday loan.
People have been known to sell their blood or plasma, or volunteer for medical experiments, too.
Thirty years ago, banks didn't check my balance for anything under $40, so I more than once wrote a bad check for $35 to 'Cash', knowing it would cost me $7 in bounce charges. (Prices have roughly quadrupled since then.) I had no other way to buy food or bus fare, and needed both to keep the job that allowed me to repay the bank. I'm told this is illegal now, but the bank didn't seem to care then, as long as they got their $35 + 7 back within a week or two. It was just like a payday loan, but without the paperwork. No doubt it affected my credit rating, but I imagine a payday loan doesn't exactly look good on a credit report, either.
Cash advance on a credit card is 3% fee (min of $10) plus about 20% annual interest (if you're a good credit risk). Suppose you borrow $200 for 1 month. You pay $10 fixed fee, plus approximately $3 in interest. That's $14 for one month on $200. What is that annualized? I would venture close to payday lender rates.
Usuary laws are mostly about restraint of trade. If the "mouse houses" [consumer finance licensees] and banks can legislatively forbid unlicensed competition [private individuals] from making loans at more than 12% [Oregon Revised Statutes 82.010], under the guise of "protecting" the borrower from usuary, while they are free to make the identical loan at "usurious" rates, guess who has just eliminated their competition?
ORS 82.025 exempts from the usuary statute: Banks, trust companies, consumer finance licensees and pawnbrokers, HUD approved mortgate lenders, FHA and VA loans, SEC registered broker dealers and dealers in commercial paper.
A lobbyist wrapping herself in the mantle of "consumer protection", whilst wiping out competition legislatively, deserves a bonus!
Good point Jennymoose. Its "Bootleggers and Baptists...". Its even better for the "bootleggers" in this case because they get to have their activity remain legal, just outlawing some of the competition rather than the whole trade.
Wait... coffee shops are predatory? OK, I'm done.
Does caffeine addiction exist, or doesn't it? You don't have to be a biochemist to know that caffeine is more dangerous, in terms of LD50, than marijuana.
So, you tell me. Is it predatory to charge ridiculous high prices - Starbucks, I'm looking at you - for substances that their customers have become addicted to? That seems to me to be the very definition of "predatory."
Does that mean I don't enjoy the occasional cuppa? Of course not. But let's call a spade a spade, here.
Why is this different?
Because "freedom" is meaningless if it includes the freedom of others, through force of arms, or force of wealth, to put you in a position of duress. That's why there's no freedom at all in a situation of anarchy; that's why freedom requires considerable regulation of those entities with great power, force, or wealth.
The greatest threats to free living often are not from any government, but from your own neighbor.
The higher the interest rate a lender charges, the higher the default rate he can accept, and, consequently, the riskier the borrowers he can lend to.
Yes, thank you, I'm aware how it's supposed to work in theory.
Not just in theory Chet, in reality. If you force the interest rate down, then fewer borrowers will qualify, as lending to the riskier borrowers at the new lower rate will be unlikely to be profitable.
Okay, all, I am rather ignorant about this. But it seems to me, from these posts, that payday loan places
-serve a function that people want sometimes and
-probably need to charge high interest rates in order to persist.
And some of them also use deceptive lending practices, charge higher interest rates than they could, threaten their customers, and use flesh as collateral (kidding).
So it seems to me that the legislation to consider would be not one banning payday loans, but one prohibiting usurious rates IN CONTEXT- as in, limit payday loan interest to 500% annualized (just making up a figure), and prohibit dodgy tactics like needing to notify in writing when you pay it off and so on. A little regulation of abusive practices, and letting the industry continue, legally.
If you're really worried about those who use the loans too much, one could prohibit more than a certain number of loans in a year to an individual, or prohibit the rolling over of the loan past 9 months or 3 years or whatever. That doesn't strike me on the face of it as a great scheme, but better than the ban.
Doesn't limited, wise regulation of an industry that serves a particularly vulnerable population make sense?
There comes a point when a person hits rock bottom. When he simply can't make things work. If you're tottering at the brink of financial ruin, it's probably not because of a series of misfortunes that you could bounce back from, if Only you could get a loneshark to tide you over for the week.
Instead of acknowledging that some major readjustments need to be made in a life where there are probably long term cash flow issues, the Loanshark offers people a temporary escape. You don't have to face reality just yet, come to Loanshark Inc.!
If you can't make things work now, how are you going to manage with a loanshark on your back? The cost of 'free' money this week is permanent servitude to the loanshark.
But shouldn't a person always be allowed to make their own choices? Hells Bells NO! I don't believe in absolute freedom. I think you should be able to sell your organs if you want. But if you're under the influence of a drug, or in the case of a loanshark, great fear and anxiety, you are not making, nor are you in a position to make, rational decisions. Your judgment is compromised.
Yes, this is a slippery slope, but I think we can make exceptions where the negative consequences are the rule, major, and where there is profound emotional vulnerability.
It's illegal for kids to do a lot of things because they lack the capacity to consistently make wise decisions. We hope this changes by the time they're 18.
But if we can acknowledge that children's judgment is inadequate, by Observing their Behavior when unrestrained, then how can we not easily determine if a person has a dangerous lack of judgment by evaluating unambiguously bad decisions made as adults?
If you think you need crack, you've demonstrated that you lack the qualities necessary to make a sane decision on the matter. Like children, you should be banned from exercising free will in this case.
You're probably making a whole bunch of other bad decisions, but they're open to interpretation—meth isn't.
If you think that postponing your problems for a week is worth a lifetime of debt, you've demonstrated you lack the capacity to make a good decision in the matter. The choice is unambiguously insane.
(The people who could get away with using these loansharks don't use them, and the people who can't do.)
But what about the people who Can use drugs responsibly (recreationally on occasion) or who use the loansharks only if the benefits outweigh the costs? Bully for you!
But the other 95 percent are Going to have a negative impact on society. Why should we subsidize your behavior by paying for their predictable messes?
The Libertarian replies, “Justitia fiat, ruat coelum.” The little l libertarian says, “bugger that”.
Or so sayeth Quoth
Quoth - Yes kids under 18 have a lot of their decisions constrained by their parents and the law backs them up, on that. The kids can't sign contracts etc.
But adults are no longer kids, and the government shouldn't try to act as their parents.
It's important to remember that payday loans are just one aspect of the credit market. The industry is facing defacto bans in several states, which doesn't help or protect the people who need the loans. If payday loans are banned, what is the person who has an emergency expense today, but poor credit to do?