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Robert DeYoung on payday loans | Econbrowser

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I thought this was an interesting editorial in Tuesday’s WSJ.

Robert DeYoung writes:

For those who depend on taking out a loan in advance of a paycheck, life may soon get harder if Congress passes the Payday Loan Reform Act.

The bill’s sponsors, which include Rep. Luis Gutierrez (D., Ill.), say they want to clean up abuse in credit markets by clamping down on the prices lenders charge for payday loans. In reality, the legislation will reduce the supply of these loans and make borrowing more expensive.

The reform is based on the false premise that consumers take out these loans without realizing how much they are paying. True enough, these loans are expensive. A two-week payday advance of $300 typically comes with a $45 finance charge– an implied annual percentage rate (APR) of 391%. Critics say borrowers could not possibly intend to pay that much for an advance on their paychecks, and that the cost alone is evidence of exploitation of the working poor.

But new research suggests that most payday borrowers are more rational and informed than critics believe. A January 2009 study by Gregory Elliehausen at George Washington University found that payday borrowers make informed choices. About half of the 1,173 payday borrowers he surveyed considered other credit alternatives– such as bank, credit card, or personal loans– before taking out a payday loan. Over 80% lacked sufficient funds in their bank accounts to meet their expenses, so by taking out a payday loan they avoided expensive checking account overdraft fees. Nearly 90% said they were either very or somewhat satisfied with the transaction.

A November 2008 FDIC report on overdraft protection provides the context. According to this exhaustive study, the average APR on a two-week checking account overdraft is 1,067%, more than double the rate on the typical payday loan. Worse, a large percentage of banks studied by the FDIC take deliberate measures to increase the frequency of customer overdrafts– such as displaying account balances on ATM screens only after the overdraft has occurred, and increasing the number of insufficient funds checks by clearing large customer checks before small ones. Compared to these overdraft practices, payday loans are transparent.

Nonetheless, the legislation pending before the House would cap payday-loan finance charges, even though government price limits almost always have negative effects. Price controls are especially harmful when competition is robust, as in payday-loan markets.

Ron Phillips of Colorado State University and I examined seven years of payday-loan prices in 117 Colorado neighborhoods. We found that local markets with more payday stores tend to enjoy lower prices, but that the benefits of competition were largely been washed away when Colorado imposed a cap on finance charges. Over time, the longer a price cap remains in place the more borrowers get charges the legal maximum price. Price caps make these loans more expensive and less available.

Details of the proposed legislation can be found here, and the DeYoung Phillips paper is available here.

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This entry was posted on April 19, 2009 by . […]

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House Preparing To Legalize Payday Loans With 391% APRs – The …

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A House subcommittee wants to legalize payday loans with interest rates of up to 391%. Lobbyists from the payday industry bought Congress’ support by showering influential members, including Chairman Luiz Gutierrez, with campaign cash. The Congressman is now playing good cop, bad cop with the payday industry, which is pretending to oppose his generous gift of a bill.

“While they may not be JP Morgan Chase or Bank of America, they’re very powerful. Their influence should not be underestimated,” Gutierrez, the top Democrat on the Financial Services subcommittee in charge of consumer credit issues, said in an interview this week.

Indeed, the payday lending industry is strenuously resisting Gutierrez’s measure, which it says would devastate its business. The measure would cap the annual interest rate for a payday loan at 391 percent, ban so-called “rollovers” – where a borrower who can’t afford to pay off the loan essentially renews it and pays large fees – and prevent lenders from suing borrowers or docking their wages to collect the debt.

A newer player representing Internet payday lenders – a growing segment of the market – also ramped up its lobbying and political giving efforts. The Online Lenders Alliance, formed in 2005, nearly quintupled, to $480,000, its lobbying expenditures from 2007 and 2008. It contributed $108,400 to candidates in advance of the 2008 elections compared to about $2,000 in the 2006 contests. Gutierrez was among the top House recipients, getting $4,600, while the top Senate recipient was Sen. Tim Johnson, D-S.D., a Banking Committee member who got $6,900.

After watching members of the military fall prey to exorbitant payday loans, Congress in 2006 capped the interest rates for military payday loans at 36%. Fifteen states have similar caps or outright bans.

Congressman Gutierrez is competing with Congressman Joe Baca to see who can author the biggest giveaway. Baca’s legislation would allow rollovers, higher fees for online banks, and would pre-empt state laws banning payday loans.

Someone—maybe Carolyn Maloney, who did an excellent job with the Credit Card Bill of Rights—needs to step up and punch the payday lending lobbyists in the face.

THE INFLUENCE GAME: Payday lenders thwart limits [AP]

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