Payday lending is capitalism at its unloveliest. It’s a business that wouldn’t even exist if the market were providing everyone with enough income to meet their needs — yet 12 million adults, the vast majority of them low-income, resorted to short-term, high-interest loans to cover cash shortages in 2010. According to the Pew Charitable Trusts, a typical borrower takes out eight payday loans a year totaling $3,000, paying about $520 in interest. Not infrequently, borrowers pay off old payday loans with new ones, creating a pyramid of debt that ends in default.
Still, payday loans undeniably meet a market need: They’re far quicker and easier (no credit check or collateral) to get than credit cards or loans from banks or credit unions. And, crucially for many borrowers, taking out a payday loan doesn’t show up on your credit report. Yes, they cost a lot, in percentage terms, but that’s because they’re high-risk; heavy fees and high interest for borrowers who can keep up with the payments compensate lenders for the fact that a significant percentage do not.
In short, how you feel about this business depends on how free you think both borrowers and lenders ought to be to assume very high risks in a situation where the former are more than ordinarily desperate and the latter are seeking — well, let’s just call it above-market rates of return. Is this something consenting adults should be allowed to do, or is it an inherently exploitative transaction?
President Barack Obama and the Consumer Financial Protection Bureau say it’s the latter, and therefore high time for government to tip the balance in favor of the payday borrower. Citing many households trapped by unpayable debt, the bureau rolled out a regulatory proposal whose essential feature is a requirement that payday lenders ascertain their customers’ ability to pay before lending; the plan would also curtail the practice of repeated loans to cash-strapped borrowers. “As Americans, we don’t mind folks making a profit,” Obama said. “But if you’re making that profit by trapping hardworking Americans in a vicious cycle of debt, then you need to find a new business model.”
And, indeed, what the bureau proposes would be a new way of doing business: Basically, it mandates the kind of underwriting that payday lending characteristically avoids. This could go a long way toward ending, or at least reducing, payday-lending horror stories. But this benefit will probably come at the cost of precluding some mutually advantageous transactions that would otherwise have occurred. Lenders will exit the business. Here and there families will curtail consumption — which is a plus, insofar as it encourages them to live within their means, or a minus, if they have to skip meals. Just as inevitably some high-interest, short-term lending that now occurs legally will be driven into the underground economy.
The proposed regulation now enters a review period, where, we hope, its true costs and benefits will get a thorough discussion.