H.R. 1909 — Unfinished Free-Market Business to Lift Barriers to Lending

They said it couldn’t be done. That Congress couldn’t pass a bipartisan bill in an election year to help the economy. Particularly one that lessens the burdens of government on consumers and entrepreneurs. The parties’ ideological positions were just too different. And besides, no one had an interest in the other side getting credit for a legislative accomplishment as campaign season was approaching.

Yet Congress and President Obama proved them wrong last month when both houses passed and Obama signed the Jumpstart Our Business Startups (JOBS) Act, which broadens exemptions for small and young firm from some of the most onerous regulations fr0m the Sarbanes-Oxley and Dodd-Frank financial acts. As I noted last week here and in the Daily Caller, the JOBS Act is already paying dividends as there has been a noticeable uptick in smaller firms raising capital through initial public offerings.

With the JOBS Act, both sides realized it was in the interest to take to voters at least some bipartisan legislation offering the “little guy” some relief from the burdens of government. But there is still a bit more that can be done — deregulatory bills that already have bipartisan sponsorship. This is particularly true on barriers to lending. There has been talk of floor action in the Senate of the Small Business Lending Enhancement Act to ease barriers to small business lending by credit unions, a move supported by CEI and a coalition of center-right groups.

But Congress should not forget the non-bank sector that throughout American history has gone where banks failed to go and provided desperately needed loans to countless entrepreneurs and consumers. There is a bill in that regard that introduces the competitive forces of optional federal chartering to one of the most important areas of financial services: the small loan market. H.R. 1909, the FFSCC Charter Act of 2011, would create an optional charter from the Comptroller of the Currency for non-bank lenders who choose to be designated as “Federal Financial Services and Credit Companies.” It is sponsored by Rep. Joe Baca (D-Calif.), with cosponsors including liberal Democrats such as Reps. Gregory Meeks (D-N.Y.) and Albio Sires (D-N.J.), and conservative Republicans such as Rep. David Schweikert (R-Ariz.), who was a major force behind the JOBS Act.

The bill addresses a vital need for access to credit for both lower and middle-income Americans. “Microfinance” is a hot topic in the academic and policy world. Muhammad Yunus of Bangladesh won a well-deserved Nobel Prize a few years back with his innovative approach to non-bank neighborhood lending in Bangladesh.

Yet providers of microcredit in America — payday lenders, pawn shops, etc. — are looked on by many policy elites with scorn. And even when these lenders are subject to legitimate criticism, frequently no one details how to remove barriers to creating an alternative in the lending market.

And the need for quick access to small amounts of credit couldn’t be more pressing in an economy with 9 percent unemployment. Unexpected circumstances like a car breaking down or the need for emergency travel can hit responsible individuals who could pay back the loan in a few months, or even a few weeks.

If they find themselves in these circumstances, however, their options are limited. A bank typically won’t process a consumer loan of a few hundred dollars. Sometimes folks in a pinch can borrow money from relatives, but even when they can, for many this is a blow to their pride.

These individuals can also be late in paying their bills and credit card debt, bounce a check, or overdraw on their debit card. But these options not only result in lowering their credit scores, which affect their ability to better their lives through a new job or starting a business, they are often more costly than a payday loan would be.

This is where, as I note in a recent CEI paper, the typical charge that payday lenders charge a 400 percent annual percentage rate, which has served as the basis for several state interest caps enacted in the past few years, is so misleading. If common “fees” for overdrafts, bounced checks and late payments were counted as interest, they would well exceed the APR for payday loans.

Kelly Edmiston, senior economist at the Federal Reserve Bank of Kansas City, points out in his study published in that Fed branch’s Economic Review, that the “median interest rate” for bounced check fees — if they were measured as interest payments — would be  “well in excess of 4,000 percent, or up to 20 times that of payday loans.”

In short, annual percentage rate is an inappropriate measure for loans that have a duration of weeks and months. This is something that H.R. 1909 recognizes in directing the federal regulator to measure “the true cost of the loan in terms of actual finance charge per dollar of credit extended to such person instead of the annual percentage rate.”

Under competitive regulation, alternatives to payday lending could also flourish. A somewhat legitimate criticism of a payday loan is that it must be folded into another loan if it can’t be paid in the two-week duration, rather than modified.

But much of the reason for the way this works is that many states severely restrict non-bank lenders from making installment loans. However, installment loans would be explicitly allowed under H.R. 1909’s federal charter.

This Congress may not be able to topple the regulatory state in its remaining days. But there’s no reason why it can’t call back a few more government commandments.