Payday Loans: Leave this Industry Alone

“Bunch of do gooders shutting down the last chance these people had.”

This sentence is a rare moment of truth concerning the coming regulation (or shutdown) or the payday loan industry. It appeared in the comment box on the New York Times story. Otherwise, most comments were out for blood. Regulate them! Limit interest! Make them all suffer for their usurous ways!

But, pretty much, the commentator I quoted has it right. The effort by the Consumer Financial Protection Bureau to regulate payday lending on a national level, backed by President Obama, cannot lead to good things, either for the industry or the people it serves. It’s another case in which intellectual and financial elites who do not use or need the service will crack down and thereby hurt the very people they are claiming to help.

Let’s establish some priors. This industry is big, employing some 70,000 people. It’s been growing for decades, and now spans the country. There is probably a payday lender in your community, or maybe even dozens. It’s also very profitable because these institutions provide a service that regular banks do not provide: quick cash to those without bank accounts, credit history, or credit cards.

Who uses them? New immigrants, migrant workers, poor people, the socially marginalized, the unemployed, people faced with unexpected financial liabilities, and others with serious needs. Very often, these are people without power, influence, or connections. What the poor and marginalized sometimes do have are small assets such as cars and paychecks that can serve as collateral for loans to meet temporary cash needs.

It’s pretty odd that the same crowd that howls about the evils of payday lending meanwhile toasts the innovators of microcredit in the developing world, showering their founders and managers with prizes and foundation grants. Do these people not understand that payday lending is the U.S. version of microloans, a form of credit that operates outside regular banking? Apparently not.

Are the loans expensive? Absolutely. There are fees, such a $25 for a quick advance of $200 over a two week period. That’s often cheaper than overdrafts. And it is much cheaper than the government itself charges for late payment of tickets. Regardless, is anyone forced at the point of a gun to take them? Absolutely not. For most everyone, they are a last resort, something you do when cash on hand is absolutely necessary, right then. For whatever reason.

As with every market exchange, it is mutually beneficial because both sides win. If this were not true, this rarified loan market would not exist. The business is profitable because it provides a service that people need. Maybe that seems so ridiculously obvious that it would not need to be pointed out. And yet, it seems like the one point that is completely lost on those who believe that the industry is exploitative and evil.

What is it that the regulators propose to do? They want to limit the number of loans a person can take out in the course of some period of time. They want to limit the amount of interest that can be charged and the amount of the loan. They want to put some stop on the time in which collection for the loan can take place. They would further require more extensive credit checks to make sure that people really can pay back the loans in the future.

All of these measures would seriously compromise the functioning of these institutions and the markets they serve. Requiring more extensive credit checks would, quite simply, rule many people out for getting loans. The “do gooders” might think that is a great idea. But those denied access to fast cash would certainly have another opinion.

The limits on collection would further disincentivize making loans, as would restrictions on the interest that can be charged on loans. As for limiting the number of times the service can be used, it’s a very strange measure that only punishes the consumer who found the service beneficial in the past and desires to use it again.

Of all the measures, perhaps the one that seems most intuitively correct is that which limits the amount of interest charged. Instead of 100%, why not limit interest to 25%? That would certainly seem to lighten the load on the poor. Right? Well, perhaps, provided that credit could still be extended under those conditions.

But think about this just a bit. Let’s say that all conditions remain the same, so that there are just as many loans available to the same people, but one thing changes: the interest owed is much lower. What do you suppose the effect will be? Interest is the price of credit, so what happens to the quantity demanded at a lower price? It goes up.

In other words, the poor would actually be encouraged to borrow more rather than less under a mandatory lower interest. Regulators surely understand this given that the Fed has a zero interest policy right now precisely encourage a greater rate of borrowing. The same would be true in the payday loan industry.

Is this what we want from regulations, for new rules to encourage more borrowing, more indebtedness, more reason to avoid saving and financial responsibility? Probably not. In fact, if your concern is for the values of the poor, you should actually favor higher and not lower rates of interest. Higher interest discourages profligate borrowing. If the “do gooders” don’t want the poor constantly to avail themselves to debt-based financial management, they should be pushing for even higher rates.

All this basic economics aside, this really is a moral issue. Regulations like these cut off opportunities for the most vulnerable people. Let’s say you are living paycheck to paycheck, using your car to get to work, and suddenly you need a fix on your car that costs $500. You have no money, no credit, no family. The payday loan people can get you on your feet again, right away. Yes, you pay but that’s better than losing your job.

In the regulated world that Obama is proposing, this person is sunk, all due to government controls.

There is a social-psychological point here that I find particularly intriguing. None of the people proposing these new rules use these services. Still, they imagine themselves competent to use force to override the voluntary choices of entrepreneurs and the clients they serve. They imagine that they know more than those who are directly involved in the markets themselves, which is to say that they are elitists who wildly exaggerate their own intelligence while looking down on the mental functioning of the poor and the marginalized, while accusing the rest of us of not caring.

It’s time we realize that those who push for government regulation of markets are fundamentally dangerous to social progress.

“Bunch of do gooders shutting down the last chance these people had.”

Downvote that comment all you want, readers of The New York Times, but it is absolutely true.