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The CFPB Is Not Regulating Payday Loans, It Is Abolishing Them

This article is more than 7 years old.

This is not quite what the Consumer Financial Protection Bureau is actually saying, of course, that it is intending to abolish payday lending. But that is the practical effect of the new regulations they intend upon issuing. It is not immediately obvious that this is a good idea as the Federal Reserve has pointed out. People use payday loans because they perceive that payday loans are valuable to them. Quite why regulation should be used to stop people doing as they wish, as long as that causes no harm to others, is one of those things no one is really explaining. But since Senator Elizabeth Warren and others seem to think that people should not borrow small amounts of money for short periods of time it looks like people will not be able to borrow small amounts of money for short periods of time.

The news is that they are issuing regulations:

The Obama administration will announce Thursday the federal government’s first move to regulate high-interest, low-dollar “payday loans,” a $38.5 billion market currently left to the states.

The crackdown on the payday industry—largely storefront lenders extending credit to 12 million lower-income households paycheck to paycheck—follows a series of actions by President Barack Obama and his aides to cement a change in the balance of power between consumers and financial institutions during their last year in office.

This is all to be done by regulation, not by properly considering the issue and crafting a law about it of course:

Under the guidelines from the Consumer Financial Protection Bureau — the watchdog agency set up in the wake of 2010 banking legislation — lenders will be required in many cases to verify their customers’ income and to confirm that they can afford to repay the money they borrow. The number of times that people could roll over their loans into newer and pricier ones would be curtailed.

The new guidelines do not need congressional or other approval to take effect, which could happen as soon as next year.

The Federal Reserve has had something to say on this point:

Except for the ten to twelve million people who use them every year, just about everybody hates payday loans. Their detractors include many law professors, consumer advocates, members of the clergy, journalists, policymakers, and even the President! But is all the enmity justified? We show that many elements of the payday lending critique—their “unconscionable” and “spiraling” fees and their “targeting” of minorities—don’t hold up under scrutiny and the weight of evidence. After dispensing with those wrong reasons to object to payday lenders, we focus on a possible right reason: the tendency for some borrowers to roll over loans repeatedly. The key question here is whether the borrowers prone to rollovers are systematically overoptimistic about how quickly they will repay their loan. After reviewing the limited and mixed evidence on that point, we conclude that more research on the causes and consequences of rollovers should come before any wholesale reforms of payday credit.

The people who take out payday loans take them out because payday loans benefit those people. Why should they be stopped from doing that? Of course, the CFPB doesn't say that they are going to stop it: they are instead just saying that there will be regulations. Which can be found here.

And here's the part that tells me that they're banning, not just regulating, payday loans.

“The very economics of the payday lending business model depend on a substantial percentage of borrowers being unable to repay the loan and borrowing again and again at high interest rates,” said Richard Cordray, the consumer agency’s director.

The economics of a business is what makes a business work. Destroy that economics and you destroy that business. And they really are very clear in their own mind that the economics here depend upon re-lending again and again. So, what are these "regulations" then? They are to ban re-lending again and again.

By their own analysis they are killing off the economics of the business: and thus they are killing off the business. As the Federal Reserve points out:

Even though payday loan fees seem competitive, many reformers have advocated price caps. The Center for Responsible Lending (CRL), a nonprofit created by a credit union and a staunch foe of payday lending, has recommended capping annual rates at 36 percent “to spring the (debt) trap.” The CRL is technically correct, but only because a 36 percent cap eliminates payday loans altogether. If payday lenders earn normal profits when they charge $15 per $100 per two weeks, as the evidence suggests, they must surely lose money at $1.38 per $100 (equivalent to a 36 percent APR.) In fact, Pew Charitable Trusts (p. 20) notes that storefront payday lenders “are not found” in states with a 36 percent cap, and researchers treat a 36 percent cap as an outright ban. In view of this, “36 percenters” may want to reconsider their position, unless of course their goal is to eliminate payday loans altogether.

Or, as we might put it, kill the economics of a business and you kill that business.

The sad thing is here that there is in fact no solution. The publicly traded payday lenders don't make better returns on their capital (the useful measure of "profit" here) than other lending businesses. Thus they're not in fact charging over the odds for their loans. Sure, those interest rates look expensive as an APR but there's a harsh truth that must be acknowledged here. Short terms loans of small amounts of money are expensive: thus short term small loans will be expensive. Goodwill found this out some time ago when running them as a not for profit activity:

But alternative payday loans have also drawn criticism from some consumer advocates, who say the programs are too similar to for-profit payday loans, especially when they call for the principal to be repaid in two weeks. At GoodMoney, for example, borrowers pay $9.90 for every $100 they borrow, which translates to an annual rate of 252 percent.

The reason is there's simply overhead associated with actually making a loan. Someone, somewhere, has to review the documents and make a decision. That human time must be paid for. The cost of that human time will be a smaller portion of a $5,000 loan than a $100 one. Thus, expressed as an interest rate, the cost will be larger for the smaller loan. Given this basic economics this means that making the loans cheaper means that we should be doing less analysis of who should be getting a loan. The CFPB has decided to insist upon more analysis: making the loans more expensive to issue. They're really not helping matters very much there: unless, as the Fed indicates about usury rates, them aim is to close down the business altogether.

And that, in my opinion, is what they are doing. The CFPB says that the core economics of the business is repeat fees and rollovers. They are going to ban that: and thus they are gutting the economics of the business. They are not trying to regulate here, they are attempting to ban payday loans.