The Consumer Financial Protection Bureau (CFPB) has proposed new regulations for payday lenders limiting lending to persons unable to repay a loan when due. Governor Robert Bentley recently formed a task force to review Alabama’s lenders.
Opinion on the proposed CFPB regulation is divided. Critics allege that the regulations will put payday lenders out of business. Proponents claim that they will keep borrowers out of recurring debt at high interest rates. But before examining payday lending, I first want you to answer this:
If a product, service or activity harms some users, does this justify prohibition for all?
Payday lending benefits most borrowers, but some customers cannot repay the loans, roll them over, and consequently pay a decent portion of their modest incomes in interest. Many products and activities present a similar tradeoff across society, making the prohibition question highly relevant. Many Americans take on excessive debt through credit cards, student loans, or other borrowing. The problem arises outside of finance as well. Around 35,000 Americans die every year in auto accidents, with driver error often the main cause. About 40 deaths occur annually on the ski slopes. Millions of Americans enjoy gambling even though some ruin themselves with losses they cannot afford.
I would oppose prohibitions, but reasonable people could disagree. Some readers might want to balance the harm and benefit in different cases. They might reasonably want to weigh the proportion of users harmed, the extent of the harm (loss of life or a small financial loss), and the size of the benefits. However one decides, we should know our answer to the prohibition question before addressing specific policies.
Turning to payday lending, some might doubt whether any borrowers actually benefit from a 400% annual interest loan. But lenders do not force customers to take out loans, so borrowers must see some value to the loans. To understand why, we could always just ask them. Troy University economics student Christy Bronson surveyed Wiregrass residents who had used payday lending for a research project.
Ms. Bronson found that 78% of respondents were very or extremely satisfied with their experience. The majority of respondents reported using payday lending occasionally or very infrequently, and to cover unexpected expenses for which they lacked adequate savings. None of Ms. Bronson’s survey respondents thought that the government should ban payday lending, and would delay paying bills (and incur late fees), sell their belongings, or use credit cards if payday lending were not available.
Other surveys report similar results to Ms. Bronson’s. Most payday borrowers are working Americans with modest incomes, limited savings, and no wealthy family members to help them out. They are managing life’s obstacles as best they can, and payday lenders help.
My prohibition question might seem to artificially limit options. What about limiting the harm via restrictions? Arguably this is the intent of the CFPB’s proposed regulation.
Harm reduction is an important goal, and can be accomplished through either markets or government regulation. For example, members of the Community Financial Services Association of America, an industry group, adhere to a Customer Bill of Rights. Markets also limit harm through competition. There are more than 20 payday lenders just in Troy. Lenders who overcharge or deceive customers will lose out to those who do not.
Opening the door to government regulation to limit harm creates an unavoidable risk of prohibition. If states can cap the interest rate lenders can charge, it is virtually impossible to prevent the setting of a cap that makes payday lending totally unprofitable. More than a dozen states have regulated payday lenders out of business without official prohibition. Market regulation is more attractive if we do not want to risk prohibition. This is why I wanted to address the prohibition question first.
We can and should try to limit the harm from payday lending or other activities in the economy. But in deciding between markets and regulation for harm reduction, it helps to be clear about whether harm to some ever justifies prohibition for all.
Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision