May 12th, 2008 at 6:25 am
The Ohio House recently voted to restrict the amount payday lenders can charge to 28 percent on an annualized basis. The Senate has yet to vote. Currently, one may pay as much as $15 per month per $100 loaned, according to a Plain Dealer editorial.
Payday loans should be avoided as a matter of someone being smart with their money. Yet payday loans may offer a loan of last resort for that person needing to make the payment on their apartment or face eviction.
Payday loans are a risky business. If a customer is demanding a payday loan, the risk that customer may not pay back the money is phenomenally greater than the person who can pay for a car in cash. The payday creditor must make money from other loans to cover the losses on loans that default. The market currently exists because some people can pay those loans at those interest rates. If the interest rate is capped below a point where the creditor makes money, the creditor will have to get funds elsewhere or go out of business.
We cannot forget that payday loans are a voluntary arrangement between creditor and debtor. The creditor cannot be “predatory” if you don’t sign the loan.
We plan our business everyday with a set of assumptions. If we have to take into account the possibility that government is likely to tweak every assumption we make, that will indeed be a trap. Either we will be paralyzed by waiting for the government’s hand to play out, or we will make the wrong business decision and suffer.
May 12th, 2008 at 7:45 am
Yeah, payday loan places are tough to figure out, at least for me. On the one hand, I agree as a general principle that we shouldn’t interfere with the market. On the other hand, it seems likely to me that, because of asymmetric information between creditor and debtor, the situation here approaches something akin to fraud — people who get payday loans typically don’t know enough to meet the pre-conditions for a properly-working market.
Have you ever blogged on Luther’s “economics.” I’d be interested if you have. E.g., in regard to the seventh commandement, Luther includes these comments that seem pertinent (particular the bit about “nimbleness and queer finances,” and “wantonly driving a hard bargain”):
“Furthermore, in the market and in common trade likewise, this practise is in full swing and force to the greatest extent, where one openly defrauds another with bad merchandise, false measures, weights, coins, and by nimbleness and queer finances or dexterous tricks takes advantage of him; likewise, when one overcharges a person in a trade and wantonly drives a hard bargain, skins and distresses him. And who can recount or think of all these things? 228] To sum up, this is the commonest craft and the largest guild on earth, and if we regard the world throughout all conditions of life, it is nothing else than a vast, wide stall, full of great thieves.
. . .
“And indeed, if there were a well-ordered government in the land, such wantonness might soon be checked and prevented, as was the custom in ancient times among the Romans, where such characters were promptly seized by the pate in a way that others took warning.
“No more shall all the rest prosper who change the open free market into a carrion pit of extortion and a den of robbery, where the poor are daily overcharged, new burdens and high prices are imposed, and every one uses the market according to his caprice, and is even defiant and brags as though it were his fair privilege and right to sell his goods for as high a price as he please, and no one had a right to say a word against it. ”
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I read Luther’s comments here and, on the one hand, they seem to me driven by the Medieval notion of a “just price,” something that modern economics eschews almost entirely. At the same time, I wonder whether what Luther is talking about are situations that can be fitted into examples of “market failure,” where government intervention is typically recognized as justified — fraud, asymmetric information, etc.
I haven’t thought a lot about it; that’s why I’d be interested if you posted on it previously.
May 12th, 2008 at 8:03 am
Jim, great notes.
I’ve not blogged on Luther’s economics, but as you can imagine I’m now quite intrigued. Just from the examples you cite, I wonder if a lot of Luther’s complaints wouldn’t be addressed by the quick dissemination of supplier information we have today (e.g. eBay).
Such an analysis would be a fun thing to collaborate on.
May 12th, 2008 at 1:04 pm
I, too, have mixed feelings. Well, I should say, my feelings are quite clear, I hate these places. Payday loan shops are to be found by the dozen immediately out the gate of any major military installation. It kills me to think of all the young soldiers — flush with the first real income of their lives — getting taken advantage of. Certainly some of them have deserved it through sheer foolishness, but there are certainly some who are in genuinely tough financial spots, and these establishments are unlikely to improve the situation. Intellectually, however, I do feel I have to trust in the market, because I simply do not trust a governmental “solution”. If the government absolutely must “do something” about this, I would feel much safer with an educational campaign than with more regulation. But that’s just me.
Speaking of educational campaigns, are our churches doing their part to minister in such a way? I would think most churches might have plenty of members with the financial savvy to connect struggling families with less “predatory” assistance. Just a thought.
May 12th, 2008 at 1:06 pm
Hey Dan,
I don’t know where else, other than in his treatment of the Seventh Commandment in the Larger Catechism, that Luther treats this question. (Who knows, I’d suspect that there’s already a book written on the subject.)
Clearly, a large part of what Luther treats in his teaching in this commandment is out-and-out fraud. So prohibiting that is not a problem for modern economic theory (or libertarian principles).
Then there’s a second set of cases that would seem to stem from asymmetric information. My sense is that this is where “payday” lenders would fall. Now, to be sure, private information services might be created (think of Underwriters Laboratories, who certify lots of electrical equipment, or Edmunds.com for cars), but is there a big problem of the government requiring the sharing of information, particularly if, say, the provision of information was an alternative to direct regulation?
For example, in the case of the “payday” lenders, what if instead of setting a maximum interest rate, the state legislature instead passed a law that only required the lenders to report in big letters the annualized interest rate for the loan, or something that would insure that the putative debtors truly understood the cost of what they were getting into?
(On the other hand, what about the prohibition in the OT on charging interest to poor folk? Is that entirely passed away in the transition from OT to NT. And, if so, why? Can we think of “welfare” as discharing the obligation, with a secondary safety net of high-interst payday lenders that “penalizes” the most spendthrift individuals, much as indentured servitude for debt did in the OT? Would we want to argue that God’s law is defective in really helping the poor by prohibiting interest being charged of them? I have many more questions than answers!)
But there seems to be a third category that Luther treats: those people who sell for the highest price that they can get. That’s obviously the toughest category in terms of market theory. Adam Smith assumes that both sellers and buyers will seek to sell at the highest (resp. lowest) price possible. Is Luther thinking of personalized markets with heterogenous goods (his example of skilled labor would seem to suggest that) as opposed to the mass-produced set of homogenous goods that we often have today, where if you don’t like what one seller is asking, you can find the identical good (almost) at another seller?
Anyway, lots of questions. As I said in my first post, I’ve been aware of Luther’s teaching via the seventh commandment on these matters, but I’ve never attempted to think through them systematically. Any suggestions?
May 12th, 2008 at 2:07 pm
Snake:
Thanks for coming to NR.
I am curious how much repeat business payday lenders get. If these guys take too much advantage of their customers, either the customer finds a friendlier agent or learns his lesson and gets out of that racket. Generally speaking your feeling about legislation has a proven record in unintended consequences.
Jim:
Regarding asymmetric information: Government requiring the provision of information isn’t as bad as requiring specific action, and I nearly always prefer the provision over the proscription.
Private organizations that collect and disseminate that information have incentive to maintain the integrity of their information and maximize the integrity of their brand. Government organizations only have incentive to follow the laws that govern them. The American Petroleum Institute is a good example in my industry of a private standards and information-providing organization.
To your example, the best solution would be a web site or phone number where lenders self-report their interest rates, and the manager of that information could also report feedback from debtors. The web site could charge lenders a nominal fee to maintain service, and they could also promote their brand of trustworthy lenders. In a way people do this with the Christian fish, but that’s another post.
Mosaic usury: Christ fulfilled the law instead of abolishing it, I seem to recall. We have the Christian freedom to disregard interest to any debtor we want, even cancel the debt and call it a gift if the debtor has no ability to pay it back. I would handle that from a Gospel perspective rather than Law. If you find the loaning of money to the person too much of a risk to your own financial well-being, perhaps barter services or something. Better that you decide what you can handle than your state or national government.
And obviously, I’d have to ask a theologian about what Luther thinks of personalized markets.
I have blogged a couple of times about how much of God’s Law should be codified in man’s law. You’re welcome to search further: Legislate What Society Will Bear and Citizen as Vocation come to mind.
I am so glad I enabled Live Comment Preview. Love the discussion: thank you both.
May 12th, 2008 at 2:22 pm
I put up a post on the same topic of consumer credit. I think a few things are clear:
1) There are few clearer warrants in Biblical ethics than for the government to prohibit fraudulent market dealings. Use of corrupt weights and measures is universally reprobated as wicked, and it is never suggested that “caveat emptor” should apply. I would go further and say that any lending in which the creditor believes that the debtor has a high chance of foreclosing or not being able to liquidate the debt in a reasonable length of time, IS predatory debt, and is both immoral and should be illegal. The Ninth commandment means, loans should be given to help people establish their own property, not strip them of it. Some of this (like some of the fifth through eighth commandments) can and should be legislated.
2) I think it is also crystal clear that people NEED capital, precisely to establish themselves under their own “vine and fig tree”, and some people aren’t very good credit risks, and so a higher rate of interest is necessary to protect the lender. In other words, I have no problem saying that a modern economy has made much of the Biblical (and Luther’s) wariness about interest as such, and charged at differing rates depending on risk, no longer relevant. Capital is, over all, incredibly cheap today, and I am glad the people who created the capitalist economy didn’t listen to Luther and try to abolish interest. But the aim should be, an economy in which property is made available to more and more people who don’t have it, not stripped away from people who have it.
3) I would also say, based on the article I posted snippets from in my blog, that LOTS of sub-prime mortgages and especially credit card debt contracts contain conditions that may be legal, but are essentially fraudulent. (A 47 page text that contains, buried near the end, the line “the company can charge whatever rate it wants” — that’s fraud, but it’s a real case, and it SHOULD be illegal).
So I would say, a free market regulated to make credit terms clear and understandable, and not excessively risky (and I know that’s a difficult judgment to make) — and then, no bail-out for defaulters.
Another interesting question is should regulation be state or federal? It used to be state-based, but since the 1980s, federal regulation has nullified a lot of the state regulations. Both on general economic facts (the US is in fact a single market, for financial products as well as for consumer products), as well as on constitutional principles (the Federalist Papers clearly show economics as something to be regulated nationally, and morals to be regulated locally), I’d say that the feds should be doing the regulation, but should be doing a better job.
May 12th, 2008 at 4:08 pm
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May 13th, 2008 at 9:47 am
Payday loans are usery. Limiting the % to 28 is still usery. Except for the fact that it is a voluntary agreement, the long term benefit is mostly with the lender who is generally taking advantage of people who can least afford to be taken advantage of. The ethical dilemma of usery is clearly understood, and when Jesus found these types of people taking advantage of others in the temple He threw them out.
I understand the argument that some people need cash immediately, but just like prescription drugs, people come to depend on them if not controlled and come to abuse those benefits to their ultimate destruction.
Payday loans don’t help you out of your financial hole, they just help you dig a little bit deeper, so when you finally do hit rock-bottom you have just that much farther to dig yourself out.
May 14th, 2008 at 7:55 am
If we applied Biblical definitions to all major forms of credit today, usury would be the description. The banks don’t have to abide by the Truth in Lending Law, as payday lenders do, therefore they don’t have to disclose interest rates on overdraft transactions or ATM fees. Take the guy who overdraws his account by 50 cents and gets charged a $37 fee!
Payday lenders are an easy scapegoat for a financial situation in America that involves greed as its motivation…on the part of borrowers and lenders! But the truth is that payday lending wouldn’t exist if there weren’t such a big market for it, along with millions of satisfied customers. And did you know that profits of many large credit unions are greater than those of payday lending companies? Get the facts, then make an informed decision on the subject.
May 14th, 2008 at 8:52 am
Payday advances play a necessary role, providing hard-working people with a reasonable, well-regulated option for meeting unexpected or unbudgeted expenses and other short-term financial needs. They might not be the right solution for every person or every financial situation, but they are a useful tool for millions of our customers. Customers use payday advances to cover small, unexpected expenses between paydays. They are people who have a bill to pay today and choose between bouncing a check or paying overdraft fees, late bill payment penalties or credit card late fees, often asking family for money or pledging personal possessions as collateral. Payday loans are fee based, in most states $15 - $17 per $100 borrowed, and to echo jaymore’s comment, a better deal than $37 for a $0.50 overdraft! The Community Financial Services Association promotes responsible use of payday loans as well as laws and regulations that protect consumers while preserving their access to credit options.