Wednesday, July 1, 2009

Payday Lending...

The Payday Loan business has quietly grown into big business, without much fanfare. That is beginning to change, and people are beginning to question some of the business practices, and whether or not they are a burden on the communities they serve.

Devona Walker on The Loop makes a compelling case that Payday Lenders's practices are wildly unfair in her article: "Payday loan sharks feed on the black community." Her argument is that this industry is ripe for regulation, and that even with heavy regulation, the industry would still be profitable. She takes on the Wall Street Journal's take directly, and her comments on customer satisfaction are absolutely priceless.

The Wall Street Journal's view is that price controls will make things more difficult for borrowers.

It is awfully hard to stomach the idea of a structured loan with interest and fees that annualize to 390%.

At the same time I do tend to agree with the Journal's assertion (based on recent research research by GWU professor Gregory Elliehausen) that borrowers are rational, and fully informed on the costs of the loan. Honestly, a large percentage of Payday borrowers are repeat customers, so it would make sense that they are aware of the true cost.

With an average APR on a two-week checking account overdraft at 1,067% (from a WSJ analysis of a 2008 FDIC study of Overdraft protection), payday loans don't look like such a bad option, but I am not sure that is a reasonable comparison.

The larger issue that this comparison ignores is that for a significant section of our population payday lenders are the only option. When banks and credit cards are out of reach for living paycheck to paycheck, what choices do they have.

On the other side of the coin, market economics teaches that prices are not set in a vacuum. If the prices for payday loans were too high, people would stop using them, and similarly if they were too debilitating to individuals and the community the lenders would loose customers and fail.

Is better regulation the answer? Maybe so, but like fire and government in general, regulation is a very dangerous tool, and should only be used as a last resort.

I wonder if the new availability of micro lending here in the US will offer competition to the payday lending market. Apparently there is enough of a market to support at least 2 micro lenders in the US so far -- check your Google listings for additions to the list...

Is competition from micro lenders enough to bring down payday loans? Probably not, but it can't hurt.