Altes Elliott-Wellen-Forum - Payday Lending: Serving the Unbanked / Artikel mises.org

- Elli -

10.02.2004, 16:01

Payday Lending: Serving the Unbanked / Artikel mises.org

Thread gesperrt

--><div>
http://www.mises.org/fullstory.asp?control=1441
</div>
<div>
 
</div>
<div>
Payday Lending: Serving the Unbanked
</div>

 
By
Mike Foley

[Posted
February 10, 2004]

<img alt src="http://www.mises.org/images3/payday.jpg" align="right" border="0" NOSEND="1" width="150" height="212">The
last few decades have witnessed many innovations in the consumer finance
industry. Consumers enjoy a myriad of credit programs tailored to their
particular needs: credit cards, home equity lines of credit, payday cash
advances, etc. Unfortunately, all these options create problems too, as the
attendant responsibility of money management has left many individuals
struggling to service their debt. Nevertheless those who do not avail
themselves of these services find themselves marginalized in an economy
structured around the use of financial assets.

Enter the Center for Responsible
Lending, a government think-tank dedicated to preventing consumers from making
unwise choices concerning their finances. Of particular concern to the Center
is a segment of society dubbed the"unbanked." Roughly 7% of
families hold absolutely no financial assets (bank accounts, retirement
accounts, life insurance, etc.).<a id="_ftnref1" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftn1" name="_ftnref1">[1]</a>
The unbanked are primarily comprised of the poor (51% earn under $10,000), and
of ethnic minorities (53% are Black or Hispanic).<a id="_ftnref2" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftn2" name="_ftnref2">[2]</a>
By not participating in the financial mainstream, the unbanked miss out on the
convenience, security, efficiency and wealth-building opportunities that
financial institutions offer. Organizations like the Center for Responsible
Lending seek ways to improve the position of the unbanked by forcing them into
the financial mainstream.

In a recent study,<a id="_ftnref3" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftn3" name="_ftnref3">[3]</a>
the Center took to task an industry that offers services to the unbanked, the
so-called"payday lenders." Payday lending refers to short-term
loans designed to tide borrowers over until their next paycheck. The Center
argues that payday lending companies charge"predatory" fees that
ensnare the unwary borrower into a debt trap of repeated loans—each loan
used to pay off the previous loan. The payday lenders are analogous to drug
dealers, addicting their clients, then bleeding them dry, and ultimately
leaving behind blighted communities. Payday lending, which sprang up more or
less naturally from the free-market process, may thus be an example of market
failure needing the remedy of government abolition or regulation.

<h2>What Payday Lending Is</h2>
Payday lending is a relatively new
development in consumer finance. Payday lenders market their service as a
credit instrument to bridge the borrower until the next paycheck. Popular
examples are companies"Check into Cash" and"Check ‘n
Go." A typical payday loan works like this: the borrower writes a
post-dated check to the payday lending company. In return, the borrower
receives cash, minus lending fees. For a $250 loan, the lending fee might be
$50 and the loan term 30 days. That works out to a 240% APR<a id="_ftnref4" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftn4" name="_ftnref4">[4]</a>
—a hefty rate!

<h2>Exploitive?</h2>
The Center for Responsible Lending
concludes payday lending is a predatory business in that it lures borrowers
into a"debt trap." The problem, the Center says, is this: borrowers
take out short-term loans with high interest rates and transaction costs. The
costs are so burdensome that borrowers soon find they need additional loans.
This cycle traps borrowers in a situation of revolving high-priced, short-term
credit. The Center’s study estimates conservatively that borrowers spend
$3.4 billion dollars annually in lending fees.<a id="_ftnref5" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftn5" name="_ftnref5">[5]</a>

Is there a solution? Short of
banning payday lending altogether, the Center advocates that payday lending
companies be permitted to advance no more than 4 loans per customer per year
and that these loans have 90-day terms (instead of 14-30 day terms). In this
way, spendthrift borrowers are prevented from abusing the service and falling
into the trap of revolving credit.

<h2>The Benefits of Payday Lending</h2>
At first blush, the situation
appears exploitive. Here we have masses of lower income people transferring
their meager wealth via outrageous interest rates to unscrupulous moneylenders.
However, despite the sizeable APRs, the lenders may not making be out as well
as one might suppose. As the outstanding growth rate of the payday lending
industry suggests, potential borrowers aren't exactly running in terror.
Indeed, it may be the Center for Responsible Lending that is to be feared most.

Consider first the outrageous APRs
(240% compared to, say, 6% for a typical home loan). The high APR in part
reflects the relative size of transaction costs to the small loan amount
(<$300). The lending company must run credit checks, process paperwork,
etc., regardless of whether the loan is $100,000 or $100. In this way, a
reasonable $50 transaction fee translates into an APR that appears
unreasonable. Even if transaction fees were removed from the picture, one
would still expect large APRs for payday loans because of the relative credit
risk of payday borrowers. A North Carolina government report (sited by the
Center's study) reveals that over 25% of check assets held by payday lending
companies in the state were in the form of bounced checks! Not surprisingly,
high APR’s also reflect the high risk of borrower default.

Now consider the situation from
the borrower’s perspective. Most who turn to payday lending have poor or
limited credit history. Although their situations may be dire, they naturally
find few people stepping up to extend them a loan. Credit is a measure of the
reliability of a borrower to live up to a loan contract. As economist Henry
Hazlitt pointed out, credit is not"something a banker gives to a man.
Credit, on the contrary is something a man already has."<a id="_ftnref6" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftn6" name="_ftnref6">[6]</a>
For a borrower with bad credit, payday lenders offer an invaluable service few
banks will offer. Not only do they provide liquidity when it is most needed,
payday lenders provide the borrower an opportunity to establish a positive
credit history. In short, payday lenders provide a means for the unbanked to
join the financial mainstream.

Finally, consider the hazardous
option of government regulation via loan-amount and frequency restrictions.
Regulation creates market distortions that are often the source of more
problems. First, limits on loan amount and frequency, no matter how sensible
they may seem to an enlightened advocacy group, necessarily ignore the nuances
of individual situations. Each side in the loan transaction considers its
opportunity costs by weighing price, convenience, and urgency. Loans are taken
for critical needs like paying an electric bill, and for less critical needs
like buying Christmas presents. Who is to draw the line between necessary and
frivolous? Ultimately, the decision to take a loan reflects the subjective
value and time preferences of consumers (which is more valuable to me: $250
today or $300 in 30 days?). On the margin, it is the borrower and lender who
are most fit to decide the appropriateness of any transaction—not the Center
for Responsible Lending, or a congressman.

Payday lending was an innovation
created to serve an underrepresented market segment. To the extent that this
market result is undesirable (high costs to borrower), it leaves open the
possibility for other market players to create better solutions. Government
regulations stifle innovation by reducing the potential for profits or by
outlawing such innovation. One example of a recent development that
ameliorates the need for regulation is"payroll cards".<a id="_ftnref7" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftn7" name="_ftnref7">[7]</a>
These are plastic cards that act like debit cards, but do not require the
holder to hold any bank account. Many companies now pay employees by crediting
their payroll cards instead of issuing a paper check. As the market evolves,
expect other innovations that seek to tap into the unbanked consumer segment.

Finally, the question of whether
such a thing as a"debt trap" even exists is debatable. The Center
for Responsible Lending sites the high frequency of repeat business (2/3 of
borrowers incur 5 or more loans per year). But the transaction frequency may
simply reflect the lack of credit alternatives. And to the extent that
borrowers feel pinched by the high costs of borrowing, those costs may still
be preferable to the alternate cost of resorting to the underground economy.
Whereas a payday loan borrower always has the protection of declaring
bankruptcy, he has no such option in the face of a surly loan shark.

<h2>Conclusion</h2>
Julian Bond, chairman of the Board
of the NAACP, says"Visits to payday lending stores—which open their
doors in low-income neighborhoods at a rate equal to Starbucks openings in
affluent ones—are threatening the livelihoods of hard-working families and
stripping equity from entire communities. The NAACP is dedicated to
eliminating payday [lending], because wealth-building and saving for the
future are vital to the economic success of communities of color."
Observers like Bond are attempting to alleviate a symptom of poverty by
hampering the freedoms that enable people to exit it. If the government steps
aside, a free market will continue to reach out and draw the unbanked into the
financial mainstream.

<div>

<hr align="left" width="33%" SIZE="1">

</div>
Michael Foley studies economics at George
Mason University. mpfoley73@hotmail.com.
The author thanks Professor Mark Bender, George Mason University, for helpful
comments on an earlier draft. Of course, the author holds ultimate
responsibility for the facts and ideas expressed. See also Tom Lehman"In
Defense of Payday Lending."

<div class="MsoBodyText">

<hr align="left" width="33%" SIZE="1">

<div class="MsoBodyText" id="ftn1">
<a id="_ftn1" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftnref1" name="_ftn1">[1]</a>
http://www.federalreserve.gov/pubs/oss/oss2/2001/bull0103.pdf

</div>
<div class="MsoBodyText" id="ftn2">
<a id="_ftn2" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftnref2" name="_ftn2">[2]</a>
http://www.federalreserve.gov/dcca/newsletter/2001/spring01/unbank.htm.

</div>
<div class="MsoBodyText" id="ftn3">
<a id="_ftn3" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftnref3" name="_ftn3">[3]</a>
http://www.predatorylending.org/pdfs/CRLpaydaylendingstudy121803.pdf.

</div>
<div class="MsoBodyText" id="ftn4">
<a id="_ftn4" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftnref4" name="_ftn4">[4]</a>
http://www.efunda.com/formulae/finance/apr_solver.cfm.

</div>
<div class="MsoBodyText" id="ftn5">
<a id="_ftn5" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftnref5" name="_ftn5">[5]</a>
http://www.predatorylending.org/pdfs/CRLpaydaylendingstudy121803.pdf.

</div>
<div class="MsoBodyText" id="ftn6">
<a id="_ftn6" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftnref6" name="_ftn6">[6]</a>
Economics in One Lesson. Henry Hazlitt. P. 43.

</div>
<div class="MsoBodyText" id="ftn7">
<a id="_ftn7" title href="http://www.mises.org/fullstory.asp?control=1441&R=Payday+Lending%3A+Serving+the+Unbanked&rng=00947#_ftnref7" name="_ftn7">[7]</a>
http://www.washingtonpost.com/wp-dyn/articles/A57322-2004Jan5.html.


</div>
</div>