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Polemics on payday loans
Yours truly, vs. Nouriel Roubini.
Posted by Tyler Cowen on May 11, 2007 at 04:18 AM in Economics | Permalink
Comments
To misquote Roubini:
Borrowers (economists) with inadequate financial (economics) education and meager finances (brains) often fail to realize the imprudence of such loans (arguments) until it’s much too late.
Posted by: Edgardo at May 11, 2007 5:20:28 AM
You don't come out of that exchange particularly well in my opinion. It is highly implausible to suggest that people could make rational financial decisions if it weren't for their moral failings (which we have no business getting involved in). People make stupid decisions - always have done and always will do. One rule of thumb people go by is that if a company will lend me money they must think I can afford it or they wouldn't lend it. That's actually quite a reasonable assumption to make and one a lot of educated people make too. Obviously it's false and the regulations should reflect that.
Posted by: Jon Martin at May 11, 2007 9:00:17 AM
"There are two kinds of people in this world" is always a good start ;-), but is this what surveys show?
I'd worry that there is a category of foolish people who, while not "genuinely" needing money immediately, or "desperate" for the necessities, nonetheless fall into a trap. A prepaid cellphone and a Latte now is better than one next week. (That's they way I've seen it happen.)
Some will by now, not doubt, be disdaining my paternalism ... but what is the flip side of paternalism? To use the poor (and foolish) as fodder for whatever scheme you have?
Posted by: odograph at May 11, 2007 9:27:38 AM
One rule of thumb people go by is that if a company will lend me money they must think I can afford it or they wouldn't lend it. That's actually quite a reasonable assumption to make and one a lot of educated people make too. Obviously it's false...
I'm confused by this argument. This seems to imply that you think those who loan money want borrowers unable to repay, no? But why would anyone lend you money if they don't think you can afford to repay it? I can think of some reasons (e.g., if loaners anticipated government bailouts), but not any which seem to mesh well with increased regulation.
Posted by: Steven Vickers at May 11, 2007 10:04:50 AM
How many of these loans are made by lenders who suspect strongly that the applicant may not pay, but are afraid not to make the loan because they may be sued? Isn't government responsible for that? Also, what government action in the history of the world would make anyone think that any government would know how to regulate any form of lending accurately and efficiently? Isn't there massive evidence to the contrary in the government's own student loan program?
Posted by: Robert Speirs at May 11, 2007 10:38:09 AM
"There are two kinds of people in this world".
No, there isn't. I am not willing to accept this claim without proof.
It is incumbent on you to prove that the curve between "need it now" and "no control over temptation" has a jump discontinuity. I skeptically do not believe a jump discontinuity exists and more that I believe it exists in demand curves or utility curves.
Posted by: Nonsequiturboy at May 11, 2007 11:27:36 AM
Professor Cowen,
You accuse those who want to limit loans of snobbery, i.e., they believe only the credit worthy deserve loans.
On the other hand, you, and those who want no limits assume that everyone who enters these loans knows what they are doing. Having assisted a large number of young enisted members of the military and their families, I can assure you this is not true. Many of those who take out payday loans are unsophisticated and unaware of the risks they are taking. And this is because either 1) there is no effective consumer education or 2) they cannot comprehend the mechanics of the loans.
I believe that most, if not all, people on both sides of the debate will agree: if both sides fully understand what is going on, there is no problem. You tell me how to ensure this and I think that you will be well on your way to making your case.
Posted by: Allan at May 11, 2007 11:28:37 AM
That's exactly the point. They want "free trade" which, in this case, means freedom to enter into a transaction where one party is hiding its terms by complex legalese and protected by laws which enable and encourage obfuscation and the other party is thrown to the wolves.
It all sounds eminently 'fair' if one is in the former party or if the latter party has the wherewithal to wade through the byzantine terms. Most aren't in the former and from my experience, very few are in the latter.
That said, there will always be people who, in spite of full comprehension of lending/trading terms, will make poor decisions.
Posted by: fustercluck at May 11, 2007 11:44:58 AM
I'd love to see another article published side by side with tat one, written by someone who searched out and found poor people who were helped by access to loans. That side of the coin is effectively always either ignored or downplayed in this type of article.
If you cut off loans to the poor via regulation, how sure are you that this will be a net positive for them as a group? How sure are you that they won't simply become fodder for illegal loan sharks with their own collection methods?
I'm inclined to think the best remedy, albeit perhaps limited, to so-called predatory lending is to mandate clear disclosure of payments that will be made, including the relevant time frame, as well as any changes in rates that may occur for whatever reason, and finally what the effective annual interest rate is for any payments or penalties.
The problem as I see it is not that there isn't disclosure, it is that the disclosure is in legalese and how many people simply never bother trying to read that opaque crap?
Posted by: happyjuggler0 at May 11, 2007 12:44:30 PM
I keep hearing how loan-sharking is a net negative for the poor. Have you *seen* credit card interest rates and concomitant fee structures lately?
At least with a loan shark, the terms are pretty straightforward.
Posted by: fustercluck at May 11, 2007 1:48:11 PM
Happy,
It is very likely, if not certain, that payday loans have done some good. But, then again, some murders have done some good, too.
To me the question is whether the good outweighs the bad, or even come close.
Clear disclosure is impossible. If I told you that a loan was for 1% per day, compounded hourly, you would understand. Someone with less sophistication, however, might think that was a better deal than a loan at 4% per year with simple interest.
In any case, the cost of making sure everyone understood what was happening (assuming we could put a contract in terms that 90% of the population could understand) is prohibitive for payday loans.
Further, without changes in the law (which are pro-consumer and were written because lenders were acting in an unconscionable manner), I don't think we can get clear contracts.
Is there anyone else out there who thinks that even doing ordinary life activities has become too complicated?
Posted by: Allan at May 11, 2007 1:55:19 PM
Allan,
Thanks for your response.
I was thinking in terms of disclosure of interest rates (explicit or implicit such as from penalties) on an annual basis to keep things consistent across lenders.
I think we are seriously overregulated and I'm basically opposed to the vast bulk of regulations, noting that they do add compliance costs, as well as tend to make consumers feel protected when they aren't necessarily so. However I tend to be quite sympathetic to mandatory disclosure in areas subject to abusive behaviour, such as situations like the linked article.
Posted by: happyjuggler0 at May 11, 2007 2:09:48 PM
As with some many other things, The Simpsons show us the way forward.
Canyonero Salesman - "Ok, heres how your lease breaks down... this is your down payment, then here's your monthly, annnnnnnnnd there's your weekly."
Homer - "And that's it, right?"
Canyonero Salesman - "Yup... oh, then after your final monthly payment there's the routine CBP, or (mutters almost inaudibly) Crippling Balloon Payment."
Homer - "But that's not for a while, right?"
Canyonero Salesman - "Right!"
Homer - "Sweet!"
Posted by: David J. Balan at May 11, 2007 4:16:52 PM
When I look at things as an economist I tend to think we are over regulated. But when I look at individual regulations, and the history of how they came into being it is hard to stick with that position. It is extremely rare for a regulation to be written just for the sake of creating a regulation. Essentially every regulation is there because at some point someone was exploited and it was severe enough of a problem that the political system decided the situation needed action.
but that is the problem with real life isn't it, the truth is not always as self evident as simple theories would suggest.
Posted by: spencer at May 11, 2007 4:33:56 PM
I wonder why no one tries doing loans to the poor with clear, lower interest rates as a charity. Would there be legal barriers?
Posted by: Nancy Lebovitz at May 11, 2007 4:35:46 PM
Happy,
Sure, we can peg the interest rates using a common scheme.
But, lenders will not be happy and will seek to get money another way. What about a $100 loan at 4% simple interest for a year (cost $4) and comparing it to a $100 loan at 3% simple interest with a $2 fee (cost $5). Since the cost is $2, are you not really getting a $98 loan at 5% (plus a little) simple interest? Are late fees considered part of the loan, or not? What if you have a balloon payment?
Whatever standards and benchmarks you set, people will try to get around them. One will always be able to figure it out, but it will take time.
You and I could come up with a system, but to do so would result in more regulation than we have now or would result in many fewer options for those who are able to understand the ins and outs of loans.
One last thing. I would agree that there is a tremendous amount of regulation. That is because there are so many people trying to part me from my money. (At the risk of sounding like a Marxist) Many of the regulations came about as a result of those with money taking advantage of those without. The regulations even the playing field in a way the free market was unable to.
Posted by: Allan at May 11, 2007 5:06:23 PM
Let's say you're a part of the working poor. Because of a change in jobs, you're going to miss one weekly paycheck which you desperately need. Your landlord is going to charge you a $75 late fee if your rent isn't in by the 5th, and the power company is going to turn off the electricity. You will not go without electricity for one week, but for two -- because if the power is shut off, the utility wants an extra $200 deposit plus a $150 reconnect fee. You have two days to come up with an extra $500, or else you face $225 in late fees plus a $200 deposit.
But wait! There's a payday loan company willing to loan you $500 with only $50 in fees for one week, or $75 for two weeks! By taking the loan, you can pay your bills, save $150 or more in late fees, preserve your credit, avoid a $200 deposit, and continue living with electricity!
Yup. Outlaw the bastards.
Posted by: SheetWise at May 12, 2007 9:42:04 AM
Surely, SheetWise, you do not think a cunningly designed hypothetical describes the reality as a whole?
I asked above, and missed the answer if there was one, that we look for some survey of who these people are, and the extent to which their actual loans represent "cunning economics."
Consider this nugget:
"A 2001 study indicated that only 35% of civilian payday loan users had fewer than four loans." (link)
Can you describe a cunning plan, in which it is advantageous for 65% of users to return for a payday loan more than 4 times? Or is it likely that these people have, thought faulty economics, gotten themselves in a trap?
Posted by: odograph at May 12, 2007 10:22:29 AM
OK, this surprises me:
"Proof of regular employment is required to obtain a payday loan, and lenders
also oblige borrowers to provide a pay stub. Payday borrowers are predom-
inantly middle-income. More than half of borrowers have family incomes of
between $25,000 and $49,999.23
About a quarter of payday loan borrowers earn less than $25,000, whereas
in the general population more than 30% fall into this category. Likewise,
about a quarter of payday borrowers earn more than $50,000, whereas in
the general population nearly 40% are in this category.24"
Payday Lending Fact Book (link to pdf)
Posted by: odograph at May 12, 2007 10:31:48 AM
odograph - Cunningly designed? I don't think so. It's actually quite expensive to be poor. It's close to reality. Are you suggesting that a program which many people find beneficial and which eases their burdens should be eliminated just because some people abuse it? That's the beginning of a pretty long list ...
Why were you hitting the return key in the second post?
Posted by: SheetWise at May 12, 2007 12:48:31 PM
That was a copy and paste from a the linked pdf. Didn't feel the need to reformat.
Now, I think the interesting _question_ is what to do when the poor do things that reinforce their woes. It's an age old question, and usury laws are one solution.
... but you misinterpret me if you think I am an ideologue with a prescription for the world. I'm a moderate looking for balance, and not sure where that is.
One way, without government intervention, to find balance is to call these things what they are - usually stupid - and to caution the vulnerable away from them in 'non-emergencies'. An ideologue who defends a usually stupid practice with a cunningly designed hypothetical isn't really helping on that.
I mean, talk to me about people making $25-50K, and going 4 times plus to the payday loan guy ... sound to you like sensible personal finance?
Posted by: odograph at May 12, 2007 1:46:30 PM
odograph -
No -- it doesn't sound to me like sensible personal finance -- but who am I to judge? I also think it's stupid to spend $100 on a golf game, $50 on a video game, or $20 on a movie and popcorn. So what? The list of dumb things people can do with their money is endless -- why focus your attention on people who profit from it?
How many people blow Fridays paycheck in a tavern before Monday morning? Should we outlaw liquor, drinking, taverns, or bartenders? What about casinos? Have you ever blown a wad of money at an amusement park? Paid $200 for a bottle of wine that was only worth $20? I could go on for days about stupid things people can do with money. There's no mystery to why people are poor -- and making 25-50K or more a year doesn't make you immune to poverty any more than earning minimum wage means you have to live poorly.
I can't go on -- because it's Mothers day, and I must go visit my Mother. But before I do, I'm going to stop at a florist and spend $75-$100 on some fatally wounded, non-edible plant life that will end up in the trash before the end of the week. What a waste -- perhaps we should outlaw florists.
Posted by: SheetWise at May 13, 2007 2:30:08 PM
My Mother told me not to buy into the commercialism, and that the Trader Joe's orchid I gave here a few years ago is blooming just on time. Maybe this frugal perspective runs in the family ;-)
Anyway, I never said "outlaw" in my search for moderation. That's a straw dog. What I'm looking for is balance, and possibly a few limits. (One might note that a tavern and a tavern-goer already face some limits, on age, levels of public intoxication, operation of vehicles, etc.)
I'm askin what will give people many options, but at the same time not contribute too far toward their decline? I think I'm asking something consistent with the history of our democracy.
Posted by: odograph at May 13, 2007 5:00:25 PM
That's no straw man -- it's pretending that there's a difference between "outlaw" and "regulate" that's insincere. You can't "regulate" without "outlawing" some practices.
Nothing -- repeat, *Nothing*, will give people as many options as an unregulated, unrestricted market. Government can do *nothing* but restrict options.
Your search *is* consistent with the history of our democracy -- but I'm surprised that you unabashedly assume that's a good thing.
Posted by: SheetWise at May 13, 2007 9:32:17 PM
I came to this thread already bored this morning ... and the claim that there is an "insincere" difference between "outlaw" and "regulate" bores me the rest of the way out of this thread.
"Nothing -- repeat, *Nothing*, will give people as many options as an unregulated, unrestricted market. Government can do *nothing* but restrict options."
It's now clear that I'm talking to an ideologue who would repeal drinking ages and public intoxication laws ...
You know, recent brain theory says that we all have the capacity to be carried away by an idea. Surely there must be people in a population who feel that too strongly. There must be people who reject reality, and the complexity therein, in favor of a myth, a dream, a purity, of abstract ideology. Have fun with that.
Posted by: odograph at May 14, 2007 9:41:44 AM
