Quarrels can happen anywhere, and the public policy research world is no exception. Since 2010, Pew Charitable Trusts had been conducting research on consumer finance. This research has led Pew Charitable Trusts to dislike payday loans. For those who are unfamiliar, a payday loans is a small, short-term, high-interest, unsecured loan. Normally, they are paid on the next day, hence the name "payday loan." Per the consumer finance research from Pew Charitable Trusts, affordable small loans are preferable to the payday loans Pew considers to be suboptimal.
What is wrong with payday loans? According to Pew, "single-payment payday loans are unaffordable and harmful for most borrowers. The repayment periods are too short, the required payments are too large, and the annual percentage rates are 10 times higher than traditional interest rate limits set by states." Most pay short-term loans within six weeks, which is why using an annual percentage rate (APR) is a misleading metric. Plus, the average APR for an average checking overdraft fee is over 1,000 percent, but I digress.
The libertarian-leaning Southwest Public Policy Institute (SPPI) did not accept Pew's general premise about payday loans and fought back. Earlier this year, Pew released research about most major banks providing small installment loans that have better terms than payday loans.SPPI rebutted Pew with two reports: No Loan for You and No Loan for You, Too. SPPI points out that in response, Pew archived the Consumer Finance project and reassigned the project manager, Alexander Horowitz, to Pew's Housing Policy Initiative, although he has not published any housing research to date. I am going to cover at least some of this quarrel, but I independently want to ask whether these loans should be legal.
According to Federal Reserve data, 81 percent of Americans are "fully banked," which means that they have a bank account and did not use an alternative financial service (payday loans being one of those services) in the past 12 months. That leaves nearly one in five Americans that partially or fully rely on non-conventional financial services.
It leads me to ask why people are not banked. The Cleveland Federal Reserve Bank conducted research last year on why people are underbanked or unbanked (Boel and Zimmerman, 2022). The most common reasons were inability to meet minimum balance requirements, lack of trust in banks, desire for privacy, and high bank account fees. There is a significant minority of Americans that either do not have access or do not want to have access to conventional banking services. These survey data indicate that there is a demand for such alternative financial services as payday loans. Given that the payday loans are taken out to deal with short-term shocks to their income or expenses, this would imply that the demand for such loans is inelastic. To quote the Journal of Law and Economics (Bhutta et al., 2016), "the fact that consumers switch to other forms of high-interest credit when payday loans become unavailable suggests that the demand for such loans is fueled by a general desire for short-term credit (rather than a decision-making bias that is unique to the design of payday loans)."
As for the impacts on consumer welfare, the findings in the academic literature are more ambiguous. One study suggests that payday loans increase likelihood of bankruptcy (Skiba and Tobacman, 2011), whereas another one suggests that payday loans increase financial distress (Meltzer, 2011). There are other studies that show that it does not harm or that improves one's financial situation. A study of U.S. Army members using payday loan services found that payday loan access has "few adverse effects" on credit and labor market outcomes (Carter and Skimmyhorn, 2017). One study found that payday loans have helped in times of natural disasters (Morse, 2011). Another study shows that they result in fewer bounced checks (Morgan et al., 2012). A study from Kennesaw University goes as far to suggest that payday loans improve overall consumer welfare (Priestley, 2014).
Does this warrant payday loans to be banned? Given the high interest rates, a payday loan would personally not be my first choice. I also acknowledge that my financial situation is not the same as that of other people and that some people do not care for dealing with banks. People should be allowed to make the best choice based on their circumstances, regardless of whether I think it is a sound financial decision for me or for them.
For some people, a payday loan might be their best option, which is similar to a response I had with regards to sweatshops. Sure, I have moral qualms with sweatshops. However, for someone working in a developing country, a sweatshop might be the best option and are certainly better than the options of back-breaking agricultural labor or prostitution. The same concept of "beats the alternative" applies with payday loans. Here are some alternative options if payday loans are not available. One is to go to the underground market and ask a loan shark for the money, which is even more expensive than a payday loan and could come with getting your kneecaps busted. Another option is to simply not borrow, which could be bad if the emergency was acquiring medical care or avoiding eviction from your apartment.
In 2019, I criticized Bernie Sanders for wanting to cap consumer loan interest rates to illustrate some examples of how payday loan restrictions played out in practice. What happened when Ohio tried to de facto make payday loans illegal? A proliferation of pawn shops and second-mortgage lending (Ramirez, 2018). In Oregon, payday loan restrictions led to bank overdrafts and late bill payment (Zinman, 2010), the former of which has an even higher APR than payday loans. And what happened with Arkansas in the 20th century when it tried to limit payday loans? Not only was there a surge in pawn shops, but many consumer finance companies simply stopped operating in Arkansas (Peterson and Falls, 1981).
The fact of the matter is that there is a demand for alternative financial services, especially for those who are underbanked or unbanked. Banks are typically unwilling to give a consumer loan for an amount as small as the average payday loan of $375. Payday loans are fast cash to help those cover an emergency situation, pay expenses, or avoid bankruptcy when conventional lending institutions fail to help. Even though payday loans are not perfect, depriving underbanked or unbanked individuals of such a lifeline and driving them towards more unsavory options is another example of harming the people that a policy was meant to help. If there is a need for a better product, lending institutions should create such a product. In the meantime, we should continue to allow for payday loans.
No comments:
Post a Comment