The Politics of Payday Loans

As a former union member and war protester, I’m quite familiar with these kinds of people. This is why we often had a small team of my mercenary stagehand friends, or other assorted biker types, nearby at all times to stand between those being assaulted and those doing the assaulting until the authorities arrived. At 6′ 1″ and 210, I was often part of that team, and was physically assaulted many times.

Every one of them was well worth it.

I got onto BART yesterday and there was some right-wing stooge handing out anti-union propaganda, mostly crab-bucket stuff, attempting to make riders jealous of the union’s benefits. I never understood how people could be so petty. Why not instead organize everyone so we can all have those benefits? Seems silly to try to pull others down instead of pulling ourselves up.

@2 Katherine: Hmm, I’m not having any such trouble with that link in any browser. Those warnings usually mean the site was flagged by Google SafeBrowsing (or one of several similar services, if you’ve installed a browser plugin for them, like Web of Trust)… but as far as I can see, none of those are currently reporting any problem with it. That might mean that someone had snuck a bad script onto the site at some point which has since been found and scrubbed.

Sorry, “. . . to get a payday loan“

The payday loan business is basically non-violent loan sharking. Give poor working people loans you know they can’t repay, and trap them into paying the vig forever. You don’t even have to break their legs.

Interesting piece. Kind of casts a shadow over the whole venerated concept of ‘liberal democracy’, don’t it.

Brett, presumably these are people who have maxed out credit cards (if they have any) and poor enough credit (or high enough debt service relative to income) that they can’t get more.

Or young people with no credit history, and no family/friends with solid enough history to co-sign or give them a personal loan.

I’m somewhat ambivalent about payday lenders and their legality. On the one hand, the tactics described here are execrable and should be illegal. Further, the industry should clearly be regulated to limit their ability to make one bad decision an albatross around a client’s neck for years or until they declare bankruptcy.

OTOH, there’s clearly a demand for these services, and the risk level is such that they cannot be provided profitably at normal rates of interest. One big question I have is whether most of the people who patronize payday lenders actually have any other options for small amounts of credit, and whether they actually need credit just to live/keep their commitments.

If the answers are no and yes, I’m not sure shutting down payday lenders entirely would be good for poor people on balance.

I don’t know if standard operating proceedure is to hook folks on a single loan they can’t repay. They make out like bandits even when the customer pays up as soon as possible. Often they take something like a check with a future valid date, as collateral, so the lender is gonna get paid on time, but the mark has paid a steep rate to get the money a few days early. My vision of the typical customer is the guy who comes in every two weeks (month?) three days before he gets his paycheck and is willing to cough up a substantial fee to get at his money early. Then next month he is further behind on his bills (partly as a result of last months payday fee), and is prepared to do it all over again. All this time he probably thinks of his payday lender as his good buddy getting him out of a jam.

Even more than having lobbyist’s, this industry has media. Payday lender adds are a pretty significant part of broadcast add revenue. And they have several media celebrities doing the adds.

In old time religion, this would have been outlawed as usury. But, we only keep the traditions that help business, not those that help the little guy.

re: “where the hell is the media?”

You mean the corporate media that airs commercials for pay day loans?

And, not to be flippant, but taxing poor people’s poverty seems to be the easiest way to keep them in line. We wouldn’t want poor people to better themselves too quickly, they might actually compete with the lazy sloths already occupying the rickety middle shelf.

From what I hear[1], payday loans aren’t substituting for credit cards; they are substituting for cash. Rent can’t be paid with a credit card; most babysitters can’t be paid with a credit card; court-order payments (child support or fines) can’t be paid with a credit card. Those things–which have to be paid in cash–seem to drive a lot of the payday borrowing.

1) I ride the bus to work when I can’t bike; most of this is from fellow riders.

The incident described is of course terrible and payday loans are generally an abomination. In recent years a number of states and federal agencies have taken steps to limit their activities. Payday lending continues to exist for two reasons: In some instances people who may be confused and desperate sign onto arrangements that make no sense. In other instances it may be the only alternative, or the best available alternative available, as bad as it is. That this may be so is an indictment of our financial system but many cannot obtain credit from banks and sometimes those that do get caught by the system with fees and charges that can be as oppressive as payday loans. Righteous indignation aside, what is needed is not simply action against payday lenders but the creation of financial alternatives that the working poor can in fact access at reasonable cost. I see little sign that that is in the works.

there’s clearly a demand for these services

Well ok then.

Credit cards give cash advances.

Not maxed out they don’t.

It’s just very expensive to lend small amounts of money for short periods of time. Expensive in relation to the amounts being lent that is.

Unfortunately this is true – not even so much because of the risk, but because of the administrative overhead. dsquared had a back-of-the-envelope example last time this came up, if I remember: even if you lend out money at zero interest and only ask for a small flat administrative fee to cover the office costs, it still works out as a massive APR if the loan and term are short enough.

It’s funny to me how when someone cites admin costs in the NHS, it’s Baumol, it’s the root of all evil, it’s our money being wasted by socialist government, etc. etc.

But when someone says that the admin costs make payday loans expensive, that’s just the order of the universe…

It’s all the rage in do-gooding these days (or it was a few years ago) to tout micro-credit programs in third world countries. Why couldn’t a non-profit or NGO run the same sort of program in the US or the UK? Is it simply overlooked due to prejudice?

Another big thing that’s worse than payday loans, because it affects anyone who can’t get a bank account, is the new habit of large companies to pay only by direct deposit or money network cards. But of course, there are fees associated with using the money network cards.

Note, I’m not actually suggesting that payday lending services are a good thing. The fact that they exist and can help *anyone* is a huge indictment of our social service system. The fix belongs in the social service system. Basic income, or some kind of automatic credit available against future wages or basic income would make any need for these services moot. My point is only that shutting down payday lenders and doing nothing else probably won’t fix the problem, and could arguably make things worse for some people.

Most poor people are not actually stupid, and use these services only when it’s actually better than some terrible alternative.

Like Collin, I’m puzzled by the suggestion that problem for poor people is a lack of credit, rather than a lack of income. Consumption finance is not a thing that should exist.

shutting down payday lenders and doing nothing else probably won’t fix the problem

Along the same lines, prohibiting poor Irish families from selling their babies for stew-meat and doing nothing else probably didn’t fix the problem of poverty there, either.

It’s funny to me how when someone cites admin costs in the NHS, it’s Baumol, it’s the root of all evil, it’s our money being wasted by socialist government, etc. etc.
But when someone says that the admin costs make payday loans expensive, that’s just the order of the universe…

Whoa, hey, steady on with that strawman there. I said nothing of the kind. (And you’re misusing Baumol. Baumol isn’t “why are NHS costs so high” it’s “why are they getting higher”.)

32: for payday lenders, as indeed for credit cards, the business model rather depends on people rolling over loans – the ideal customer is someone who pays the minimum every week, not someone who takes on debt and promptly pays it off.

SamChevre 36, there are fees yes, but 20-30% APR credit cards charge is nowhere near 3-400% of these paycheck loans. Or am I missing something?

True, but there is no pressure to pay it off next week. Or maybe it’s a bad thing, psychologically, what do I know.

Mao, the fee of a payday loan is generally a fixed sum that is a moderate to large percentage of the loan, somewhere between 8 and 20%. So you get $100, but must pay back $108-120 within 1-3 weeks. The APRs are gigantic because the loan is expected to be paid off very quickly if one is to avoid more fees (and there is no way to roll an unpaid loan into a 20-30% APR the way it would happen on a credit card advance).

A standard credit card advance fee of 3-5%, with the amount paid off in a month or less (to avoid further 20%+ interest charges) would also result in a very large APR, although still quite a bit less than a standard payday loan, if there are no other fees (such as over limit or late fees) involved.

Also, Mpowell is making my own argument better than I am. It’s certainly plausible that an empirical case can be made that payday lending is far more often used to sucker people who have other options into poor choices, than to provide a legitimate service to people who are intelligently choosing the least of evils in a bad situation, in which case simply banning it would make sense.

Such a case may even have already been made by someone somewhere, but I haven’t seen it. I usually see it just assumed that it should *obviously* be banned. And well, so it should under a sane regime, where these problems are solved by some combination of reasonable minimum wage, welfare provision and social service availability. But that is not the regime we live under.

Note also, I am not accusing anyone of hypocrisy. I’m aware that pretty much everyone who wants to shutdown payday lending would also vote for the social safety net improvements needed to make that a good idea if it isn’t already.

College students are offered credit cards because the companies are interested in their probable future income. A marginally employed worker of the same age is not viewed in the same way.

You don’t need a checking account for a payday loan. If you have a checking account it’s easier, you might even be able to get your loan online. If you don’t have a checking account you have to bring in pay stubs to show employment. You might have to put up your car title as collateral for larger loan amounts.

The working poor use payday loan businesses for more than loans. These businesses act like banks; they cash checks and sell money orders. Some will arrange to pay bills (utility, telephone, rent). Renters who have ever bounced a rent check are sometimes required to make future payments in cash or by money order. This is the all cash economy for people with no credit history.

Why don’t their customers get banks accounts? Partly, it’s cultural. There is (in the US, I have no experience anywhere else) a whole social strata without experience with mainstream banking. They aren’t aware of the availability of low or no fee accounts. Psychological factors come into play. Banks are seen as unfriendly, formal, and likely to be a place of humiliation. Fear of rejection is a huge factor. Payday loan businesses know this and work at being customer friendly and understanding. Their advertising is all about “we know you’re a good person fallen on hard times.” Banks are not enthusiastic about small deposits and customers who require basic financial education.

Related to payday loans are used car dealers who specialize in poor to no-credit customers. Here in Seattle there is Pierre Money Mart. If you watch one of their TV ads (and they blanket late-night local programming) you might not realize they sell cars. The ads sound more like testimonials for a self-help program. Customers gush about how well they were treated, how the salespeople understood their problems, how PMM helped them rebuild their lives and self esteem. This business has tapped into the insecurities of the poor and apparently does very well. Whether the terms of their sales are fair I can’t say but they clearly understand how to market to this population.

Payday loan businesses also buy bad debt. Bounced checks are purchased for pennies on the dollar. Aggressive collectors, who work on commission, go after the debtor even when the debt is too old to be legally collectible any longer. Abusive collection practices are common. I can only speculate about harassed debtors taking out payday loans to make abusive collectors go away. A grand business model.

maidhc – Putting your money into a bank account is a bad idea. When you’re living on the edge, you need to be able to control your money.

Yes. Speaking only of the situation in the UK, payday lenders use the highly ‘creditor’-friendly way in which bank accounts now operate to bypass the account holder’s control over what they pay out:

http://www.parliament.uk/Templates/BriefingPapers/Pages/BPPdfDownload.aspx?bp-id=SN06253

Payday loans are usually secured on the borrower‟s next pay cheque. The loan maturity date coincides with the next pay day (on average 30 days). On this day the lender debit‟s the borrower‟s account (or presents a post-dated cheque), and receives the loan principal amount, plus the accrued interest (which varies as between lender).
Direct debit facilities are used by some payday lenders to give them greater control over the repayment of the short-term loan. This means that if a borrower defaults on the loan, the lender can make multiple attempts to take money from the borrower‟s account without agreeing specific amounts or dates with the consumer. The OFT has criticised some payday lenders for using this „continuous authority‟ as a way to bypass proper checks on a borrower‟s ability to repay. Indeed, on 14 February 2011, the OFT warned payday lenders that they must not misuse direct debit facilities to vary the amount or date of a loan repayment.

1. This is just one way in which banks (who aren’t blamed for this at all) bypass their responsibilities as agents and thus fiduciaries (under English common law at least, as declared in the 20s IIRC) with respect to payments out of accounts. Another is by unilaterally extracting charges from their own customer’s accounts without any mandate, giving such payments priority – see below).

2. These mechanisms are automated, and the model requires no credit checking or human intervention. I suspect that the supposedly high variable costs (as well as the ratio of overheads to revenue) are being grossly exaggerated to justify huge profits and parasitism (also cf. below) not that limiting profits to some notional ‘market’ rate equal, say, to interest rates, would make the practice acceptable.

3. Plaintive ‘warnings’ from the OFT (office of fair trading) are not the kind of thing to worry large businesses much (and again see below).

The high street banks offer something very similar to payday loans by means of ‘unarranged’ overdrafts. These were previously called ‘unauthorised’ because back in the day of the cheque guarantee they actually often were, and because subsequently this gave additional moral leverage to justify big fees – penalties – for anyone who might have been inclined to challenge them. The people paying the charges, and at one point hugely inflated interest rates too, were led to believe they’d got away with something. The criminal law having been brought into play to protect the cheque guarantee in a couple of highly-publicised cases in the early 80s also helped to keep people furtive and guilty even as their meagre pay packets were milked by these parasites.

The fees for these ‘unarranged’ overdrafts – which are not always even entered into intentionally – provide a huge net income for the banks (subsidising ‘free’ banking for everyone else) and they even had the audacity to argue on that basis when they were challenged in court. because they got so much money from them, they must be a core part of the contract, and not penalties or similar.

That was after they had previously argued that the fees charged were merely cost-covering: a claim which was absurd on its face to anyone who knows how these things actually work, since in fact the banks credit-check all account holders and derive an overdraft limit by means of computerised systems (at one point the banks were arguing as though some Bob Cratchit figure was involved in painstakingly ‘assessing’ whether to extend overdrafts). This limit is then discounted by a certain amount to render a ‘notified’ limit – i.e. the one they tell you about – while the actual ‘non-notified’ limit, and indeed its existence, is kept secret from the customer. Anything that falls between these two is subject to swingeing fees.

The banks ran rings around the OFT in court – the latter put up a miserably inadequate fight, due I suspect not only to the gross disparity in spending power for legal services but also to a lack of real enthusiasm (to put it mildly).

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And yes, as others suggest, the ‘voluntary’ nature of payday loans is based on the usual neoliberal economist’s conception, which not only ignores the background conditions in which a certain course of action becomes the least bad option but also studiedly overlooks the psychological methods of ‘marketing’, which run the gamut from euphemism to outright misrepresentation and take in bait-and-switch, engineered dependency and all the other techniques available to a single-mindedly profit-seeking entity whose only real constraint is the criminal law – or more specifically, avoiding the prosecution of senior execs, which is laughably easy.

A payday loan is a stopgap and in the vast majority of cases works as the name suggests – by postponing financial problems and payingf for the privilege. This is no doubt irresistibly tempting when one’s living from hand to mouth and can’t make ends meet. It may even be rational given a sufficiently high level of uncertainty about the future (I haven’t tried to model how this would work). But that’s largely beside the point. Rather than adopting some neoclassical/rationalist/Laddite conception of the rational agent and the incorrigibility of first-person judgements of self-interest, one needs to take a lead from the parasites themselves, whose business model is based on a more realistic understanding of human beings as manipulable, only very boundedly rational animals – especially when in extremis.

Michael Sullivan @43:

A standard credit card advance fee of 3-5%, with the amount paid off in a month or less (to avoid further 20%+ interest charges) would also result in a very large APR, although still quite a bit less than a standard payday loan, if there are no other fees (such as over limit or late fees) involved.

Minor quibble: Most credit cardholder agreements I’ve seen specify that there is no grace period for cash advances, so even if you pay off the card in less than a month, you’re paying interest (often at a higher-than-usual rate) on top of the 3-5% advance fee.

Dr. Hilarius @45:

There is (in the US, I have no experience anywhere else) a whole social strata without experience with mainstream banking. They aren’t aware of the availability of low or no fee accounts.

“No-fee” doesn’t include “Not Sufficient Funds” charges. If you’re living paycheck to paycheck and have limited experience with the banking system, it’s probably pretty hard to avoid bouncing a check once in a while. With fees that seem to hover around $25-$35 per transaction, you don’t need to screw up that many times before Bank of America is taking more of your money than Friendly Moe’s Money Mart would’ve. Plus you’ve got your landlord angry at you because your rent check didn’t clear.

In the UK at least, that’s why the (pretty tightly cartelised) high street banking sector introduced ‘free’ banking. Free to those who can afford it, very expensive to those who can’t, to quote Withnail (see above and CT comments passim.). Lobbying for bankerisation of the building societies (US: mutuals?) helped too, of course. Just another privatisation of what should be a public utility, in other words. Another quote, from Walter White in Breaking Bad: ‘corner the market, then raise the price – that’s simple economics’.

52: yes, the UK does have Post Office banking which provides basically all the benefits of a normal bank account ( it’s actually whitelabelled from the Bank of Ireland). Don’t think it does cheque cashing.

(the BoI don’t charge overdraft fees nor a penal rate for the supposedly unarranged overdrafts – the standard rate that they do charge is 15% EAR though, I should add.)

Thanks to both ajay and Tim.

I’d also add that most payday loan customers in the US lack checking accounts or credit cards, and have to either pay to cash their pay check or get fee-laden debit cards.

@50
“In general, I’d be really interested to know how much these institutions are functioning as an alternative payments system for the poor, as opposed to a source of credit, as various people here have suggested. ”

Most all of them offer some services to facilitate paying utility type bills like cell-phone, power etc. But that’s not really the bread and butter business. Its really just another couple of bucks they can nick while they have the customer in the store and arguably its a convenience for the customer who doesn’t then have to pay such bills in person or buy a money order to send it in since they likely don’t have a checking account.

The loan business as thoroughly discussed is the backbone of the whole thing and where the best total returns are.

Selling prepaid cards and check to card services is #2 by volume. In these cases a guy comes in with say, his $200 paycheck from a job. For one fee, they will hand the guy cash, for a different, smaller fee, they will hand the guy a prepaid card visa card that’s preloaded with the net amount – say $195. Basically they earn $5 for making your check usable to you and earn fees from visa/mc/amex for issuing prepaid cards on which they can earn interchange fees.

The #1 by per transaction profitability is tax services. Most Americans get a tax refund – so you walk into the payday lender with your tax return, or even just your W-2 (annual pay stmt) they charge you to prepare the return first and then they advance you the refund less a discount. So if the person is due $300, they might get $195 (on a prepaid card as above) which includes $75 for the tax prep and a $30 for the the discount. The shop then e-files the return and gets the refund directly in about 7-10 days, so $30 10% discount is a massive APR for a money that is 100% good money coming from a state or federal return. Others might charge $100 for the prep (in this example) and “take no discount” but it amounts to the same thing.

In my observation of this, the customer walks out of the shop “happy” about having $195 and their taxes done and doesn’t really realize that they’ve just been dunned at about a 2000% APR .

Dr Hilarius @ 62

There is nothing, however, keeping a low-income bank customer from buying a money order at their bank rather than a payday loan outfit.

My bank (one of the more reputable ones) charges $8 to cash a check drawn on them if you do not have an account with them. Walmart is cheaper.

And I disagree strongly with Marc @ 58. Payday loans are expensive, but the terms are very clear; that’s a key selling point for the users. “I had a bank account/credit card, but they screwed me over, charged me fees that I couldn’t figure out…” is a common complaint; I’ve never heard it about payday loans.

“I’ve never heard it about payday loans.”
Really? I have heard many complaints about the behaviour of these legal loan sharks!

Dr. Hilarius @62: Having a bank account is significantly less convenient if you have to keep moving it around all the time. Plus banks usually make it difficult to open an account with a low balance. There tend to be lots of fees involved.

No argument about BofA, though. A.P. Giannini would be horrified.

Marc and MPAVictoria

I did not say and did not mean that the terms weren’t abusive; I think that they are far clearer than the terms on a traditional bank account or credit card, and have the anecdata to support it. (Clear and clearly abusive is a possibility.)

John Quiggin @ 68

Australian small loans seem as expensive as American ones (20% setup fee and 4% per month, default fees up to 100% of loan amount.) The key difference I see is the restriction related to “responsible lending”; do you have any idea how that works in practice?

JQ wow, that account really does seem to be fee free. I wonder if they get any subsidy, or have they actually been forced to make do with the wider spread they derive from paying no interest?

The equivalent account terms in the UK – all the banks have much the same terms, in the dynamic, entrepreneurial spirit of cutthroat competition – will allow the bank to charge £10 for rejecting payments (over £10), despite the fact that this has just about 0 marginal cost, and (also AFAICT – these things are kept very obscure, with contract terms distributed among various ‘guides’ and brochures) the bank retains the right to permit a customer to go into ‘unarranged’ overdraft – attempting to make the payment is deemed always to be an overdraft request – at which point a Byzantine regime of charges kicks in. (Excuse the long sentence, as the judge didn’t say to the banker.)

There is also at least one deterrent measure attached to basic accounts in the UK, besides the standard practice of colour coding bank cards solely for status display purposes (cf. gold, black etc credit cards). The ability to use cashpoints from other banks is withheld from basic account holders, even though the only marginal benefit to the bank is presumably the saving in ink or electrons that comes from having slightly smaller figures in whatever inter-bank settling-up process goes on.

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A technical question for econ/accounting types – overdrafts in the UK are repayable on demand; supposedly ‘unarranged’ overdrafts are due immediately. Do either of these features mean they can be kept off the balance sheet, or otherwise provide some benefit over normal instalment loans? I’m thinking that they may not be counted for the purposes of reserve ratios, or something.

@SamChevre
The ASIC page says

All credit providers are required by law to lend you money responsibly. This means they must not lend you money if they think the credit is unsuitable for you.

For example, it would NOT be responsible for the credit provider to:

Give you many small amount loans over a short period of time as your debts could get unmanageable
Give you credit when you are spending all of your money each pay and are unable to meet your other expenses

@ John Quiggin

I saw the information on the ASIC page; my curiosity had to do with how well it seemed to work in practice–is it enforced such that irresponsible loans are rare, or is it one of those “every payday lender knows an audit will find that 10% of their loans are irresponsible and the penalties are just a cost of doing business”?