This is no easy question. In any other context, the interest rates charged for payday lending would be considered usurious, even loan-sharking — minus the knee-capping, of course. But payday lenders operate in a high-risk market with essentially unsecured loans of such short duration that anything less in terms of interest would put them out of business. That appears to be the intent of the new consumer-protection regulation passed by Congress and hailed by Barack Obama as the most comprehensive protections for consumers ever passed. But without payday lending, will the new regulations wind up hurting the people Obama and Congress brag about protecting? Reason TV’s Nick Gillespie and Ted Balaker look at the implications of the new regulation:
Few industries are more reviled than payday lending, which primarily services the working poor by offering short-term loans at high interest rates. Payday customers borrow an average of $350 for a period of two weeks, or until their next paycheck comes in. The money is handed over on the spot, once the payday store can verify that the customer has a job, earns enough to afford the loan, and hasn’t recently defaulted with another vendor. Payday loans are in high demand: There are 22,000 payday storefronts in the United States and in 2009 they loaned a combined $35 billion.
And yet the industry is fighting for its survival. Montana just voted to make it illegal for the payday-loan industry to operate profitably, so lenders are loading their wagons and wheeling out of “The Land of the Shining Mountains.” They’ve already moved on from Oregon, New Hampshire, North Carolina, Arizona, Georgia, and Washington, D.C, because of similar regulations. The annualized interest on payday loans runs about 400 percent, but the reality is that payday firms see returns closer to 10 percent, or about the same as other less-demonized financial service providers.
Now there’s a danger the federal government will quash the rest of the U.S. payday industry. The Frank-Dodd Financial Reform bill, passed in July, created the Consumer Financial Protection Bureau (CFPB), which posseses the power to regulate paydays at the national level for the first time. The vaguely written law doesn’t allow the CFPB to cap interest rates, but regulators have the latitude to enact other rules that would obliterate profits, such as limiting the number of payday loans a customer can take out over a set period of time.
The business model is basically a float — a way for so-called “wage slaves” to meet pressing obligations in advance of the next paycheck. That often means the difference between eating and starvation, having the power on, or even keeping a roof over one’s head. But it comes at a stiff price, at least in terms of the short-term transaction. The consumer pays a significant amount of interest in the short-term loan, which regulators see as exploitation.
However, as Reason TV reports, the actual bottom line for payday lenders is rather modest: the average profit margin is around ten percent, or about half of what is seen for computer sales, for one example. Payday lenders have to maintain storefronts, and they also have to absorb large amounts of losses, much higher than what it seen in credit-card debt. The high interest rates charged typically amount to modest fees in practice of around $40-50 for each transaction. The industry obviously fills a niche that serves significant demand.
Lending regulations prior to this year would have covered issues of fraud and exploitation. The additional regulation goes far beyond the responsible role of government in preventing that kind of violation from a neutral position to actively seeking a desired outcome from market activity, namely the destruction of a $35 billion a year industry. It seems, at least from this report, that the government has once again failed to learn about an industry before attempting to regulate it out of existence, in the same manner ObamaCare threatens private health insurance.