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The said Constitution shall be never construed to authorize Congress to infringe the just liberty of the press, or the rights of conscience; or to prevent the people of the United States, who are peaceable citizens, from keeping their own arms.

-Samuel Adams

Regulating Payday Loans

Doug Mataconis tackles an issue at the Liberty Papers that I've been meaning to write about all week. The Virginia General Assembly is considering a repeal of the Payday Loan Act of 2002, which legalized the short-term, high-interest loans commonly known as Payday Loans.

Last November, the University of Virginia School of Law hosted a panel on the topic (sponsored by Family Resource Clinic, the American Constitution Society for Law and Policy, and the Federalist Society). An article in the newspaper UVA Today explains the loans as well as any other source:

Payday loans are generally governed by the states, explained moderator Prof. Daniel Nagin, director of the Law School’s Family Resource Clinic. But the federal government recently got involved when Congress passed legislation placing a 36-percent cap on the annual interest rate of loans taken out by active-duty military personnel.

Obtaining a payday loan in Virginia is as simple as writing a check, Nagin said. Anyone who has a checking account is qualified to take out a loan. The payday lender will charge the borrower $15 for every $100 that is loaned. At the end of the loan period, which can be as short as seven or up to 30 days, the borrower must return to the store to repay the loan, or the company can cash the check that was written at the beginning of the transaction. The maximum a borrower can take out under Virginia law is $500...

The payday loan industry in Virginia has grown from a $165 million business in 2002 to more than $1 billion worth of transactions in 2005, Nagin explained. There are approximately 750 authorized payday loan outlets throughout the state.

750? That sounds like there is quite a demand for these places. But Delegate Jennifer L. McClellan, D-Richmond, has a different take on that number:

There are over two payday lending stores for every McDonalds in Virginia and three for every Starbucks. This is ridiculous.

I am horrified to learn that this is the standard my lawmakers will use to judge the situation. [shudder] And that's clearly become a talking point. I have no idea where it started, but it's constantly repeated on the Richmond radio and in most news articles. My question: why have we allowed this disparity between the number of McDonalds and the number of Starbucks in the first place? What ever happened to equality in this country? And what is the ratio of payday lenders to Taco Bells? I demand an answer!

As Mataconis points out in the post at The Liberty Papers, we can question the wisdom of borrowers to enter into a payday loan, but what right does the state have to prevent it? Not that legislators give a damn about what they have the right to do, of course.

Since we're here, let's take a look at what proposals are on the table. Again from UVA Today,

The Virginia General Assembly is currently reviewing two bills that would affect the Payday Loan Act of 2002, which authorized payday lending companies to set up shop in Virginia and exempted the industry from the prior 36-percent interest rate cap. The first bill repeals the Act; the second bill introduces an amendment calling for a real-time database that would force payday lenders to report the identity of the borrower and the terms of the loan to the state. Lenders would be able to search the database when a prospective borrower wants to take out a loan. The lender would be prohibited from lending money to patrons who had three or more outstanding loans. Finally, lenders could not loan money to anyone who had terminated a loan contract within the previous 48 hours.

(emphasis mine)

I love the comments by Michele Satterlund, an attorney who represented the payday lending industry at the UVA panel:

There are no viable alternatives being presented and there is a market need. We are a product that serves that market.

When I hear [panel member Jay Speer, executive director of the Virginia Poverty Law Center] talk, it’s as if he’s saying people who find themselves in financial hardship are not very smart, that’s the message I get. They’re not very smart, they can’t control their money, let’s control their money for them.

Opponents of Payday lenders point to a lot of alternative sources, but when it comes down to it, they are trying to legislate away one of my options because they think they know what's best for me, and I don't. Doesn't that sound familiar?

For those who think the high interest rates warrant government action, consider a point illustrated in Wikipedia:

Payday loan makers also argue that the interest on a payday loan is less than the costs associated with bounced checks or late credit card payments. For example, bouncing a $100 check may inccur an NSF fee from the bank of $28 and a returned check fee of $25 from the merchant.

In comparison, when expressed as APRs for two-week terms:

$100 pawn loan with 20% service fee= 240% APR;
$100 payday advance with $15 fee= 391% APR;
$100 bounced check with $48 NSF/merchant fees = 1,251% APR;
$100 credit card balance with $26 late fee = 678% APR;
$100 utility bill with $50 late/reconnect fees = 1,304% APR.

I await the logical conclusion - a bipartisan proposal to outlaw usury. For the children.

Posted by Wulf on January 21, 2007 at 10:57 AM

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Wow, the payday people must have worked to get that Wiki to their liking.

The reality is that the payday loans have to be repaid in full, and most of the other items indicated either aren't loans, or are loans that only require the repayment of the fee and a small amount of principal (i.e., cards).

Because of the full-payback requirement, the true interest rate of a payday loan is 20% COMPOUNDED 26 times for each 2-week period within a year (1.2 to the 26th power). That would be 11,448%, and the point is not arguable.

We have an unfortunate chicken-egg problem. Govt schools (and parents too) have failed to educate kids on basic finance. It is thus unfortunately the case that such ignorant people as adults don't understand the cost of what they're getting into.

Because there are unethical people who will exploit the demonstrably ignorant, the govt (yes, which created a large part of the problem by having crappy schools) has to step in and prevent the worst abuses.

I think there's near-universal agreement that "loan sharking" should be illegal, so the idea that there should be no financial regulation of any kind isn't credible. I think that payday lending is a fundamentally dishonest business that labels its interest charges (the opportunity cost of getting money now, vs. later) as "fees," and at a minimum should be required to do Truth in Lending disclosures, so that at least a few people see the TRUE interest rate/opportunity costs in front of their faces before doing a deal.

Posted by: Tom at BizzyBlog at January 22, 2007 6:28 AM

Tom, thanks for the comment. I'll be the first to say that Wikipedia is a useful but not always accurate source - in fact, I say exactly that to my students.

My point is only that the benefits of payday loans are being ignored, as is the issue of letting adults make their own decisions about their own finances. Not everybody has been in the position of needing some cash right now but having to wait 2 weeks till payday. But for those people, this is an option. To deny them that option because some people misuse it and get themselves into trouble is exactly the reasoning that is used for all authoritarian laws - bans on guns, drugs, alcohol, smoking, prostitution, gambling, etc. Things that I am able to use responsibly, but have become regulated/outlawed for my own protection.

And I do think that the logical conclusion will be an attempt to further clamp down on other forms of "abusive" loans, to help the stupid poor.

Posted by: Wulf at January 22, 2007 9:27 AM

Write your comments here, please.

Posted by: firebunny at February 10, 2007 6:30 AM

The said Constitution shall be never construed to authorize Congress to infringe the just liberty of the press, or the rights of conscience; or to prevent the people of the United States, who are peaceable citizens, from keeping their own arms.

-Samuel Adams

Regulating Payday Loans

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