By Karen Shaw Petrou
It is a truth known to all who seek consumer protection from predatory lending that payday lending is a scourge. However, it is also a truth among business analysts that financial institutions will not willingly go broke. Regulated companies will exit a business which cannot generate profit regardless of unmet demand. It is also a truth among business analysts that unregulated companies then rise to meet this demand, often undeterred by the social-welfare scruples that underpin the consumer-protection rules.
The challenge in calibrating financial policy, especially for retail financial services, is to design a regulatory system that recognizes the investor-driven reality of for-profit companies and then defines terms and conditions in which profit comports with purpose. If this cannot be done, then a market need can be met in only one of two ways: the unregulated or unscrupulous offer the service or the government must step in to ensure prudent finance without ill-gained profit.
The CFPB’s payday-lending rule is a perfect example of regulatory sanction divorced from profit realities. The Bureau’s conviction that payday lending is bad for poor people may well be right, but poor people need payday lending. Despite this rule, they will get it, likely at still greater harm. This is a prime case in which either rules must change to accommodate the profit needs of scrupulous, regulated providers or the government – in this case the Postal Service – must step in to ensure that prudent products are provided independent of profit motives.
Even the language in the Bureau’s own payday rule makes it clear that the products the rule sanctions will be replaced by loans that put borrowers at acute risk. Stunningly, the payday standards condemn one popular form of short-term lending – the aforementioned payday products– and praise another – pawn shops – reviled if not by this federal regulator, then by all forced to use it until payday lending came along.
You don’t believe that anyone could love a pawn shop? Here’s what the CFPB has to say about its advantages over short-term lending secured by future income:
The Bureau believes that non-recourse pawn loans do not pose the same risks to consumers as covered loans because consumers are more likely to understand and appreciate the risks associated with non- recourse pawn loans, and the loss of a pawned item that the lender has physical possession of is less likely to affect the consumer’s other finances. In addition, a consumer who cannot afford to repay a non-recourse pawn loan at the end of the loan term has the option not to return for the previously-surrendered household item, thus ending his indebtedness to the lender without defaulting, re-borrowing, or impacting his ability to meet other financial obligations.
As I said when similar text was included in the CFPB’s payday proposal, anyone who thinks so well of pawn shops has never seen a set of dentures on display. Will pawn shops supplant payday lenders? The Bureau notes that pawn-shop lending increases when payday lending is curtailed:
A study described in the Section 1022(b)(2) Analysis [of the final rule] found that non-recourse pawn lending increased in States that banned payday lending; a similar substitution effect may occur to some degree for consumers who are unable to obtain additional covered loans.
The False Choice between Predatory Payday and Desperation Pawns
The CFPB may not be troubled by its beneficial effect on pawnbrokers and, should these be wanting, loan sharks. I am.
It is the height of paternalism to assume that barring a source of urgently-needed lending will instill new thrifty virtue in the under-class. The rule makes it clear that the Bureau knows how desperately needed these loans can be and how few options borrowers have:
Covered short-term loans are typically used by consumers who are living paycheck to paycheck, have little to no access to other credit products, and seek funds to meet recurring or one-time expenses. The Bureau has conducted extensive research on these products, in addition to several years of outreach and review of the available literature.
The Bureau goes on to say:
[C]onsumers who use online payday and payday installment loans tend to be in economically precarious positions. They have low to moderate incomes, live paycheck to paycheck, and generally have no savings to fall back on. They are particularly susceptible to having cash shortfalls when payments are due and can ill afford additional fees on top of the high cost of these loans.
The Private-Sector Option
Even the CFPB’s own rule thus makes it clear that borrowers will get short-term loans even if companies regulated to the Bureau’s liking can no longer offer them. The first solution to this problem isn’t pawnshops – rather, it’s to re-examine the rules. Congress is poised to review them under the brunt of heavy lobbying from the payday-lending industry, but wholesale revocation of the Bureau’s standards would put the payday problem right back where it was before this well-intentioned effort, leaving borrowers vulnerable. As the CFPB’s rule itself makes clear, these borrowers will be at risk from predatory short-term lenders reinvigorated by the general absence of sanction in an area rife with risk for borrowers often too deep in the red to stop to read the fine print many would ill-understand even if they paused to do so.
Prudent, balanced regulation is key to payday-lending availability without payday-lending problems. Indeed, payday customers know this – a recent study shows that more than 80% of payday borrowers would rather deal with a bank. One reason unregulated payday lending grew so fast is the unmet demand resulting from 2013 rules banning bank short-term installment loans from the Office of the Comptroller of the Currency and FDIC. When the CFPB’s rule was finalized, Acting Comptroller Noreika simply withdrew the OCC’s standards. Still the FDIC’s rule remains and the ability of banks regulated by the Federal Reserve is in as much limbo as it was before the other federal agencies stepped in and out of this complex arena. Still, new short-term installment loan products are being developed that offer considerable promise.
Are banks the only lenders who can be trusted to make prudent, non-predatory payday loans? Of course not, nor can banks of their own accord be trusted. The reason to put banks back into this business is that they are uniquely subject to an array of regulatory standards and day-to-day supervision designed to ensure that higher-risk consumer needs are met at reasonable return without deception, abuse, or impoverishment of vulnerable borrowers. State-regulated payday lenders and banks offering prudent products may be able to meet market needs for short-term funding and thus protect borrowers from still worse ways to handle unexpected bills or compensate for ill-considered consumption.
The Public-Sector Backstop
Banks want to get into deposit-advance and other short-term lending products. That’s why they protested so vehemently when the 2013 rules were finalized. It does, though, remain to be seen if a sound model of payday lending is consistent with all the capital and prudential rules that have only grown tougher since bank payday products were banned. It is thus possible that ambitious bank plans will provide little real competition to unregulated payday providers or the pawn shops and other lenders that take their place should the CFPB rule remain as is.
Should this prove the case – and it’s too early to know – then the U.S. faces a dilemma: meet borrower need for short-term loans in a prudent way or expose the vulnerable to still greater financial risk that makes them still less economically equal.
The federal government has long provided social services – think food stamps – when markets cannot. Indeed, the U.S. Post Office once offered basic financial services, getting out of the business only when the U.S. banking business changed in the 1960s to better meet the needs of low-and-moderate income depositors and borrowers. If the private sector cannot continue prudently to meet these needs, then it’s time for the Post Office again to do so.
We don’t know if we need the Post Office to provide payday lending because we don’t know whether ongoing demand can be prudently met. The CFPB’s own analysis is, as shown above, woefully inadequate. Although legislation to bring in the Postal Service has been proposed, we need to know first if the private sector can meet borrower needs. Banks think they can and some bank regulators believe this can be prudently done. Let’s quickly find out and, if profit doesn’t comport here with purpose, then call in the Post Office.