Short-Term Lending: Regulation of Exploitation or Stifling of Business?

The Problem

The problem associated with short-term lending that is presently being discussed in Washington’s Legislative Bodies concerns one of the most common forms of these.  The Associated Press best describes what a pay-day loan actually is in an article from OregonLive.com:

Payday loans are small, very short-term loans with extremely high interest rates that are effectively advances on a borrower’s next paycheck. They’re typically obtained when a borrower goes to a check-cashing outlet or an online equivalent, pays a fee and writes a postdated check that the company agrees not to cash until the customer’s payday. (Associated)

In and of itself, this does not sound too bad.  However, what this description does not describe is the fact that annual interest rates can often reach somewhere between 400% and 800%.  ProPublica’s Paul Kiel describes the effects in an article describing reform to the system in Washington State: “borrowers [are] caught in a cycle of debt by taking out loans over and over.”  When this factor is combined with a description from a study by the Consumer Financial Protection Bureau, “No collateral is held for the loan,” the unavoidable conclusion is that this is a distinct mode of exploitation of already marginalized consumers, much in the same way as actions during the sub-prime mortgage crisis.  These extremely high interest rates result in a highly profitable structure, though this shall be discussed below in the context of the impacts of recent Washington State legislation.  Another major component of the role of payday loans as “debt traps” is the idea that “they may rely on ensuring they are one of the first in line to be repaid from a borrower’s income.  For the consumer, this means there may not be sufficient funds after paying off the loan for expenses such as for their rent or groceries – leading them to return to the bank or payday lender for more money” (Washington).  All in all, the greatest issue exists in the fact that, in an excessive number of situations, consumers simply are not aware of the negative impacts of their choices.  This is not to mention the fact that such programs are often the only lifeline these people have.

The Policy

The most Less payday lendingimportant starting place to consider the current state of legislation on payday lenders in Washington State is HR 1214, the Payday Loan Reform Act of 2009.  Considering the chart on the left from The Seattle Times, Jim Brunner makes the following statement: “Washington’s payday lenders have lost three-quarters of their business in the five years since a touch new state law restricting the high-cost loans marketed to poor families took effect.”  On one hand, advocates of anti-poverty measures and their like say that this is excellent.  Given the highly exploitative and dangerous nature of payday loans, any decrease in their presence is a fantastic step towards weaning disadvantaged populations off of the system.  However, from the perspective of Moneytree and other such lending companies, this has quite simply caused them to shut down an enormous number of locations and overall struggle as a company.  Specifically, these reforms outlined that “You may only borrow a total of $700 or 30% of your gross monthly income, whichever is less… Maximum Loan Term: 45 days… Maximum Fee: 15% on the first $500 and 10% above $500… [And that] You may only take 8 payday loans per 12-month period” (Washington).  Finally, it declares that “Payday lenders would be required to establish a statewide database to track all borrowers: their incomes, how many loans they have outstanding, and whether any are on installment plans” (Onstot).  In all, The Olympian’s Editorial Board states that “[these] reforms successfully reduced payday loan debt statewide by 75 percent.”  Aside from enforcement, this does not require significant investment on the state’s part.  As such, economic feasibility is pretty much guaranteed.  Now, of course, this isn’t to say that everything has been fixed.

According to Brunner, “Nearly one in five [loan recipients takes] the maximum eight loans per year.”  Furthermore, according to Chris Thomas, “One in five payday loans is taken out by someone age 55 or older.”  These facts make it apparent that, even if the scale of the problem has somewhat been mended by reform, its outcomes have not.  As such, they have allowed Moneytree to campaign for the passage of a new set of bills, HB 1922 and SB 5899, which would “eliminate traditional two-week payday loans and replace them with ‘installment loans'” (Brunner).  Brunner goes on to describe the specific nuances of this by stating, “Under the installment-loan proposal, contained in House Bill 1922 and Senate Bill 5899, customers could borrow up to $1,000 for up to one year.  A $700 loan under that system would cost borrower $495 in interest and fees if held for six months.  If the loan were paid over a full year, borrowers would pay $879 in interest and fees.”  The most interesting aspect of this was a point made by the CEO of Moneytree in a testimony to a Senate Committee, described by Brunner: “he blasted the limit as ‘paternalistic rationing’ and said it was leading some consumers to seek out illegal online lenders.”  It is with this goal of returning to a more similar system to what existed pre-2009 for the purpose of regenerating a higher level of profits, and, in doing so reduce the supposed problems caused by the reform, that Washington’s Congress is discussing these bills.  Of course, since this is largely driven by corporate incentives, it is fairly hard to agree with backers of the bill that its passage would be a “win-win.”  Even if it introduces greater incentive than simple deadlines to pay loans back early with relatively low fees that are shown based on time as opposed to up front, the larger caps mean that, once again, consumers could move back towards the immense risk of accrued debt.  As such, the equity sponsored by this bill, much less its effectiveness in actually helping Washingtonians, is more or less nil.  If change is actually to be made, the state’s Attorney General Bob Ferguson’s point that the payday-lending system “does not need to be overhauled” (qtd. in Brunner) must be considered seriously, and change actually be made to available educational resources.

Policy

  • The first essential step is to reduce the frequency of loans being provided to individuals who are demonstrably unable to pay them. Though basic identity checks are currently offered, this could easily be achieved through rapid credit checks upon application for a loan.  Infrastructure could be put in place to prevent costs from this becoming unreasonable for companies like Moneytree.
  • However, the key here is not to refuse them the loan, as in the case of most sorts of loans. This will simply drive them towards illegal methods, such as loan sharks.  Rather, it is necessary to still offer the loans, but with the addition of some form of education.
  • Of course, financial education as a whole is necessary. Aside from this particular example, it is vital addition to high school curriculum, such that future generations are more aware of the conscious choices that lead to problematic financial situations, like the excessive debt of many recipients of payday loans.
  • The more direct method of education implementation, though, would be through an education system focused on the sort of applicants who would not ordinarily be granted them. The goal here would be to introduce them to essential financial skills and habits, like budgeting and saving, that can discourage excessive debt and better guarantee prompt paybacks to the company (though considering profit is largely due to late fees, this may not be their preferred method).  Of course, this would take funding that could perhaps come from a cut of lending company profits.  Perhaps it could be privately operated, and thus most easily privately funded, albeit legally required.

 

 

Works Cited

The Associated Press. “Payday Loan Law Takes Effect in Washington State.” OregonLive.com. OregonLive LLC, 1 Jan. 2010. Web. 05 Mar. 2015.

Brunner, Jim. “Moneytree Leads Push to Loosen State’s Payday-lending Law.” The Seattle Times. The Seattle Times, 04 Mar. 2015. Web. 05 Mar. 2015.

Consumer Financial Protection Bureau. “The CFPB Finds Payday and Deposit Advance Loans Can Trap Consumers in Debt Newsroom Consumer Financial Protection Bureau.” Consumer Financial Protection Bureau. Consumer Financial Protection Bureau, 24 Apr. 2013. Web. 04 Mar. 2015.

Editorial Board. “Payday Loan Bill Hurts the Vulnerable, Helps the Lenders.” The Olympian. The Olympian, 21 Mar. 2013. Web. 05 Mar. 2015.

Kiel, Paul. “How One State Succeeded in Restricting Payday Loans.” ProPublica. Pro Publica Inc., 06 Aug. 2013. Web. 05 Mar. 2015.

Onstot, Laura. “The Secret to Passing a Payday-Loan Reform Bill.” Seattle Weekly News. Sound Publishing, Inc., 24 Mar. 2009. Web. 5 Mar. 2015.

Thomas, Chris. “Payday Lenders Back New Loan Type for WA Borrowers.” Public News Service: News in the Public Interest. Public News Service, 4 Mar. 2015. Web. 04 Mar. 2015.

Washington State Department of Financial Institutions. “Payday Loans.” Washington State Department of Financial Institutions Financial Education Clearinghouse. Washington State Department of Financial Institutions, 2014. Web. 05 Mar. 2015.

WashingtonWatch.com. “H.R. 1214, The Payday Loan Reform Act of 2009.” Washington Watch. WashingtonWatch.com, 1 May 2009. Web. 05 Mar. 2015.

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One response to “Short-Term Lending: Regulation of Exploitation or Stifling of Business?

  1. Pingback: Case Study: Merrill Lynch and Washington Mutual Bank | Exploring Distances 2.0·

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