Tuesday, January 31, 2012

Louie's Looking for You

Interesting editorial this morning in the Wall Street Journal. In its role as the defender of free markets, the Journal's editorial board usually fires back in eloquent defense of financial institutions, hedge funds and the mortgage industry. This morning the editorial board put on their jeans and tee shirts and went down market to show some love to the storefront payday lending industry.

A payday loan is a short term loan meant to tide the borrower over until his next paycheck. It is a service targeted primarily to low and moderate income households, known as LMI households. According to a payroll industry survey more than three-quarters of households now live paycheck-to-paycheck.

Payday lenders are often accused of charging usurious interest rates, being an unregulated industry, and preying on the poor. Apparently that's all the mandate the new Consumer Financial Protection Bureau needs to jump into the payday lending wars. The Bureau held it first field hearing last week in Birmingham, Alabama to discuss the small loan industry, of which payday lending is a big part.

But the CFBP needs to consider the accuracy of the charges against the these businesses. Typically opponents of the industry will accuse payday lenders of charging 391 percent annually on a $100 loan. But that's misleading. Payday loans aren't annual contracts. They're short term loans. In reality most lenders charge $15 for that $100 loan. That's 15 percent, not 391 percent. The only way you get to 391 percent is by rolling over a two-week $100 loan 26 times.

As to the charge that payday lending is largely unregulated, the fact is that over 60 percent of the states regulate the practice already. The industry's position is that payday lenders would like to see regulation in all 50 states. In the interest of fairness, I should point out that regulation of this type often becomes a barrier of entry to new, potential competitors entering a market. So when storefront lenders cry "Regulate me!"they may be motivated less from a consumer standpoint and more from a desire for territorial protection.

As to the charge that payday lenders prey on the poor, the Journal cites a Federal Reserve study that found nearly all payday loan customers knew the terms of their loan agreements and were satisfied with the loan product.

So you have to ask the question: What does the CFPB hope to accomplish by regulating payday lenders? They provide a valuable service in the communities in which they operate. Where else could a laborer bringing home $190 a week borrow $100 to fix a 15-year old Econoline van? Payday lenders are already regulated at the state level, where the regulators are closer to the businesses and can probably protect consumers better. And the customers themselves seem satisfied with the deal they get.

Payday lending is part of what the Treasury Department terms "money services businesses, " or MSBs.  These include check cashing businesses, money transfer businesses, pawn shops, gold and silver dealers in and payday lenders. These are businesses that don't prey on the poor; they offer products no one else will. The problem in regulating MSBs like payday lenders is that you can regulate them out of existence but you can't regulate the need they meet out of existence. LMI households have the same need for credit as higher income households. The only difference is that LMI households have limited options. The next rung down from MSBs on the credit ladder is some guy named Louie with a real bad temper.

Overregulating, or squeezing might be a better word, payday lenders out of business only hurts LMI households because it further limits their credit options.

I know about MSBs because I worked with this industry for ten years. I know about the Louies of the world because my father had to borrow money from him once to make the rent. Didn't end well.

This is the world in which LMI households reside. They don't live in a federal office building and they don't live in a field hearing. They live in twilight zone between almost-made-it and never-will. And always waiting for them at never-will is Louie.

I have found over the years that regulatory agencies have some of the best and brightest stars in federal service. People who really know how to get their arms around a problem. Quick studies. And good analysts. But I wish next time this comes up, as it does periodically, some regulatory agency, whether it be the CFPB or someone else, would put assets on a case that have actually borrowed money from someplace other than a bank. Have actually cashed a check without having access to a bank. Or pawned a guitar in college to pay the rent. I think those folks would inform the debate more than a photo-op road show.

That's my opinion. What's yours?


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