Payday loans are a form of small-dollar, short-term credit used by lower- and middle-income consumers, principally to enable them to withstand expense shocks and to smooth consumption when their income is “lumpy.”
In a report published today by Competitive Enterprise Institute, I explain how the payday-lending policy debate has largely moved on from earlier squabbles over whether lenders earn abnormally high profits, target minorities or, on balance, harm consumers; economic literature now substantially resolves these issues in lenders’ favor.
But one key issue remains unresolved, at least to the satisfaction of the CFPB: whether borrowers’ propensity to refinance, or “roll over,” their loans is harmful in itself, and what to do about it. On June 2, the CFPB published a notice of proposed rulemaking which would bring payday lending in general, and rollovers in particular, to a screeching halt. The bulk of the proposed rule is aimed at ensuring that consumers don’t roll over; i.e., remain indebted for protracted periods.
There are a few problems with the proposed rule. Like all regulation, its purpose—and effect—is to prevent willing parties from entering into bargains that they choose for themselves. In this case, there are about 12,000,000 Americans who use payday loans, on average about eight times a year. Nearly all—more than 90%, according to a former CFPB assistant director—of those transactions will be precluded by the proposed rule.
Whether that’s a good thing or a bad thing depends on whether those loans themselves would be harmful. And that’s just the problem. The CFPB’s empirics just don’t support either the need for an intervention at all or that this particular intervention will enhance consumer welfare.
First, CFPB presumes that most borrowers engage in rollovers by inadvertence, not expecting to be, or being surprised by being, short of funds at the maturity of their original loans. The CFPB has conducted no research on this issue. The only evidence-based conclusions about this issue are to the contrary: consumers know, ex ante, how long they are going to be in debt.
Second, the CFPB assumes that rollovers must be harmful, because consumers pay more interest to have their loans outstanding longer (so, by the way, do credit card holders who revolve, and homeowners who use 30-, rather than 15-year mortgages). But once again, the CFPB has not conducted any research of its own on this issue. And again, the only actual empirical evidence is to the contrary. Economics-laboratory data also support consumer choice in determining borrowing duration. It turns out that consumers who are permitted to determine for themselves how long to remain in debt have better outcomes than those whose borrowing term is limited by law.
Third, this rule might make sense if the CFPB had tested its proposed intervention in a controlled field experiment and found that the intervention somehow improved consumers’ lot. That’s the gold standard for pharmaceuticals and in economic science, too. But the CFPB has not done so. And the intervention is so draconian that it will certainly preclude millions of welfare-enhancing transactions along with some of the targeted rolled-over-too-often loans. Where to draw the line? We have science for that. The CFPB simply has not employed that science.
Payday loans, though expensive, are frequently a borrowing source of last resort for constrained consumers who have used up their credit card lines and tapped out mom and dad, and who desperately need to fix a car, pay for a funeral, buy school supplies or prevent a much larger default on a mainstream credit obligation. By making these loans impossible, the CFPB will drive consumers to inferior substitute sources of credit, including overdrafts, late bill payments, and loan sharks.
Consumers overwhelmingly want a lawful form of short-term credit, and eliminating supply will not eliminate demand. Basic principles of economics dictate that consumers are not made better off when their choices are eliminated. The CFPB’s intervention, while comprehensive, was not evidence-based or narrowly targeted at high-rollover borrowers. A more thorough rethink is required.
The full report is here.