The Wandering Heretic

In my last post, I discussed how area pastors are preaching for legislation to limit interest earned by Payday Lending business. Using images of greedy businesses that prey on the poor, the congregations are urged to write their State congressmen to support HB 333, the Responsible Lending Bill. As shown previously, the government’s own research shows that these same lenders, despite getting interest rates of up to 391% are not “racking in the dough” as would be anticipated. The costs of keeping the business open during evenings and securing their locations in the poorer neighborhoods pretty much keep their net income lower than that of a Starbucks chain in the suburbs.

Yet the drive moves on, despite these facts. Again, I do not decry pastors getting involved in political issues. However, I do regret it when they dive in without checking out the full consequences of their actions. As Douglas Wilson has said in another context, “So complexity is not a good reason for inactivity or apathy. But it is a good reason for studying the issue thoroughly, and getting your proposed solutions right before insisting on them in the name of Christ.”

On its own, HB 333 sounds sounds good. Who wants to be subject to 391% interest rates? Obviously the poor only go to these lenders because… because…. That’s when the warning bells went off. They obviously go to these lenders and put themselves under those rates because they have no alternatives. After all, banks don’t make a business of lending to the poor. If you have a good credit rating, you won’t be going to the Payroll Lenders. You’ll have alternatives and you will take them.

The poor use the payroll lenders because those are the only ones who will lend to them. If you mess with the free market, then you cause consequences unintended, but disastrous none the less. Adam Smith’s “invisible hand” can reach back and slap you in the face if you are not careful. And the sad part is that it is the poor that will pay; not the pastors nor even the majority of the congregations that will vote on this issue the way they are urged.

My first observation in unraveling the “complexity” is that this “payday loan” situation is nothing new. I remember my father discussing it when I was a child. It was called “four for five.” It meant “if you give me four hundred dollars today, I will give you five hundred back next payday.” This was normally done in “unofficial” connection with the Union. Work it out: that comes to a 20% interest rate for a week or less of time, or about 1,040% APR. Not only that, the potential for bodily bruising, if not breaking if the loan were not repaid was much higher up the rung than would be the case of a current Payday Lender.

In short, the demand for high interest loans for high credit risk people will always be there. The issue is how will this demand be met? It can be through the government controlled, legally restricted, and relatively gentler auspices of Payday Lenders, or it can come from another less official source.

The proposed Law in Ohio limits these institutions to 36%. This is the biggest reduction of rate in any state. Indiana limited the rate to 72% in 2002. As a result, according to Ohio’s own study on the issue, “After this, the number of entities licensed and the number of branch locations decreased. According to Indiana Department of Financial Institutions (IDFI) annual reports, at the end of CY 2000, Indiana had 119 payday lender companies registered with 463 branch locations. By the end of CY 2003, there were 44 companies registered with 313 branch locations, amounting to a reduction in the number of companies and branch locations of 63.0% and 32.4%, respectively”

More germane was Oregon’s 2007 effort. There they reduced the rate to the same 36% proposed in Ohio. The results were again predictable, per the same report:

Another more recent example comes from Oregon, which, effective July 1, 2007, changed its payday lending laws to limit origination fees to $10 per $100 advanced (in other words, a 10% origination fee) and interest to 36% APR. The minimum loan term is 31 days. Including the origination fees yields an APR of 153% for a 31-day loan. An LSC review of recent SEC filings by the publicly traded payday lending companies indicated that, in some cases, these firms cited the new law’s origination fee and interest caps as reasons for closing some or all of their payday loan outlets in Oregon. For instance, Advance America, the country’s largest payday cash advance company, is closing all 45 of its stores in Oregon. QC Holdings has already closed all eight of its stores, and First Cash Financial Services has closed two of its seven stores in the state.

So the reduction in the number of payday stores in Oregon almost dropped to the elimination point. This would be expected if, as per my last post, with the current “high” interest rates such stores barely earned enough to qualify as coffee shop profits; and that after an average of four years of losses. Cutting it to less than 10% of that rate guarantees such stores will have will have to close or lose vast amounts of money.

Businesses are rarely charity organizations, and even charities have to break even. This enforced reduction on interest rates means that the payday lenders will not end up reducing their rates at all. Instead, it they will just close up shop and disappear entirely.

So the poor will therefore not have access to lower interest loans. Instead, they will not have access to funds at all.

However, markets, like nature, abhor a vacuum. My fear is not so much as to what will happen to the Payday Lenders as much as to what will replace them. Like my father’s day of “four for five” someone will be providing the funds to the people who perceive that they need them. If the poor can no longer have access to official sources then the risk is that they will entangle themselves in “unofficial” ones. By eliminating legally controlled and restricted sources you may very subject them to uncontrolled, unrestricted, and illegal ones.

Should the Payday Lenders disappear, I imagine with the drug money that flows through the cities that unofficial ones will appear. In those cases, the 391% rate may not only appear generous by comparison, the percentage of “bad loans” incurred by Payday Lenders (25%) will also drop considerably. In those cases, you may also return to the days of “four for five” where the collection process can escalate to bruises, breakage, and death. In short, the efforts to “fix” the situation can make it far worse than it is now.

Edmund Burke was only partly correct. Sometimes all that is necessary for the triumph of evil is for good men to do the wrong thing, or even the right thing the wrong way or at the wrong time.

Next: Are High Interest Rates Immoral?

This entry was posted on Thursday, April 17th, 2008 at 7:00 am and is filed under Culture, Rants. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site. Or, if you wish, you can find all the posts Caine