The fraying of the fringe economy.
And rightly so. A payday loan is a small, supposedly short-term loan secured by a borrower's personal check, but it usually amounts to serious long-term debt. The typical two-week loan is costly, with lenders nationwide charging rates as high as 800 percent APR. In California and elsewhere in the United States, Blacks and Latinos make up a disproportionate share of payday loan borrowers. While these loans are advertised as a quick and easy way to deal with an unexpected expense before payday, borrowers typically have a hard time retiring the debt, taking out one loan after the other and becoming caught in financial quicksand. The payday lending industry depends on this cycle of repeat borrowing for the bulk of its revenues, with 90 percent of business generated by borrowers with at least five loans per year, and over 60 percent of business generated by borrowers with at least twelve loans per year.
Welcome to the neighborhood
Twenty years ago, payday lending was fresh on the scene, the darling of the dark corner of unscrupulous financial services. And it hasn't taken long for the payday industry to be more profitable each year than the last (though the tanking of the economy may now be making a dent in their profits). In many states, payday lenders now outnumber McDonalds or Starbucks. In California, they outnumber both of them combined. As documented in Predatory Profiling, the Center for Responsible Lending's recent report on the impact of race and ethnicity on payday lender location in California, these storefronts overwhelmingly locate in Black and Latino neighborhoods, and the disparity exists even after accounting for nearly a dozen other factors that could impact why a payday lender chooses a particular location--including income, educational attainment and available retail space.
The location of payday storefronts is critical because many borrowers report that they took out that first payday loan because they simply saw a store and went in. What happens to Black and Latino kids growing up in neighborhoods dotted with payday stores? Triple-digit interest rates become the norm. Black civic leaders opposed to payday lending often hammer home the message that in an era of such social and economic progress, we have traded the denial of good credit for the availability of detrimental credit. Just ask Harold Dees, a social-service agency manager in Oakland, Calif., who took out a payday loan which ultimately took him more than six months to retire. "They are like fast-food restaurants--everywhere in our neighborhoods, and just as bad."
The problem and solution
The District of Columbia and the Department of Defense currently cap interest rates on small-dollar loans at two-digits, as well as 15 states: Arkansas, Connecticut, Georgia, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oregon, Pennsylvania, Vermont, and West Virginia. So nearly one-third of Americans are protected from the abuses of the payday industry, but that still leaves two-thirds of a nation exposed to their faulty products. It is the very nature of payday loans that has drawn fire from lawmakers.
Payday loans are marketed as small-dollar loans that are intended to tide borrowers over until their next payday, usually two weeks away. Theoretically this may appear to be sound. The problem is that most borrowers are unable to both repay the loan in one lump sum in two weeks as well as pay for their other household expenses, such as food, transportation costs and child care. When there's not enough cash available to repay the loan two weeks later, the borrower must take out another loan immediately or within a few days. This is the debt trap, and the payday business model is dependent on it. Despite what the industry claims in PR materials and before legislators--that loans are for infrequent, emergency use and are not intended to be a long-term solution to financial shortfalls--the private reality is something else. According to Dan Feehan, CEO of Cash America: "... you've got to get that customer in, work to turn him into a repetitive customer, long-term customer, because that's really where the profitability is" (Remarks made at the Jefferies Financial Services Conference, June 20, 2007).
In response to the dangers of the payday lending-induced debt trap, and after significant analysis and debate, Congress passed and President Bush signed into law legislation in 2006 that would prohibit making high-cost payday loans to members of the military and their families. The Department of Defense understood first-hand the impact of payday lending debt on security clearances and military readiness of its service-members. Since the only proven solution to the debt trap caused by payday loans is a two-digit interest rate, the Talent-Nelson legislation that addressed military members and payday loans implemented a 36 percent cap on all small-dollar loans made to members of the armed forces.
North Carolina, a long-time leader in protecting consumers from predatory lending in both the mortgage and payday lending arenas, banned payday lending after seeing the effects of allowing the practice for a few years. Because industry and sympathetic lawmakers often express concern about what borrowers will do without these high-cost products, the North Carolina Commissioner of Banks conducted a survey of former payday borrowers after payday lenders had to leave the state.
Not surprisingly, North Carolina payday borrowers didn't even miss payday lenders after they fled the state. Nine out of ten thought that payday lending was a "bad thing," and two-thirds felt they were actually better off without access to payday loans. This reflects a recent survey that found that 75 percent of Americans favor a two-digit interest rate cap on payday loans, as well as the electoral response of voters in Ohio and Arizona who rejected outrageous interest rates on payday loans last November.
The payday industry spent more than $30 million in those battleground states in an attempt to maintain the status quo, but when the status quo is 400 percent APR, pricey campaigns will only go so far with the voters.
But the industry probably hopes that their money can pull more weight with lawmakers than with voters. As all industries that profit from a lack of regulation are wont to do, when payday lending began to come under fire by individual states, the federal government and consumers in recent years, the industry responded by spending lots of that money made at 400 percent annual interest to influence lawmakers in Congress and in legislatures nationwide.
Indeed, Citizens for Responsibility and Ethics in Washington (CREW) released a report just last month which found that the payday industry doubled its lobbying expenditures from the 109th Congress to the 110th, and doubled its political donations over the last three election cycles. And it wasn't double-from-nothing: according to the CREW report, industry lobbying receipts jumped from $2 million to $4 million between those sessions.
Perhaps it has worked. The Payday Loan Reform Act of 2009 was introduced earlier this year by Rep. Luis Gutierrez (D-IL). Contrary to its name, this legislation would instead codify the ability to charge triple-digit interest rates, stymie state efforts to provide better consumer protection, and it is limited to loans of 91 days or less, which means that lenders need only make their loans for more than 91 days to skirt the law. Rep. Joe Baca (D-CA) introduced a payday bill this session as well. His bill would be disastrous, as it would pre-empt the rate caps in D.C. and the 15 states that have them.
Cap interest rates to benefit the economy
Despite all the attention being paid to payday loans and proposed bills--both in Congress and in legislatures across the country--to regulate them, only one solution is proven to spring the payday debt trap, and that is a comprehensive interest rate cap of around 36% APR on all small consumer loans. The Congressional bills authored by Sen. Richard Durbin (D-IL) and Rep. Jackie Speier (D-CA) would implement this cap. All other prescriptions, including bans on rolling over or refinancing loans; caps on loan amounts; limits on loans outstanding; payment plans and databases that supposedly enforce these ineffective provisions, simply do nothing to diminish the debt trap.
If we have learned anything from the economic meltdown spurred by the crisis in the subprime mortgage market, it's that the terms on which credit is offered are as important as access to the credit itself. There should be no shelf in the marketplace for abusive products that trap households in long-term debt, particularly in an era of stagnating wages, rising costs and disappearing jobs.
Payday lending costs Americans $4.2 billion annually in abusive fees. The US unemployment rate exceeds 10 percent and the savings rate is near zero. If ever there was a time to help Americans hold on to more of their hard-earned cash, this is it. The only solution to the drain of payday loans is a responsible, comprehensive rate cap. It's that simple. Anything else--and any reform that payday lenders would support--will fail to be any reform at all.
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|Date:||Jun 22, 2009|
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