Payday Lending

Arizona and Ohio Go to the Ballot Box to Reject Payday Lending

Asset Building — Mon, 10 Nov 2008 18:16:00 -0500

By Leslie Parrish, Senior Researcher, Center for Responsible Lending

On Tuesday, Ohio and Arizona voters not only selected leaders to deal with the credit crisis on the national stage, they also roundly rejected ballot initiatives sponsored by the payday lending industry in an effort to curtail high-cost lenders from preying on vulnerable families.

My organization, the Center for Responsible Lending, advocates for reasonable interest rate caps that apply to all small loan products, including payday loans. While these loans are marketed as a quick and easy way to deal with an occasional unexpected expense, their high cost and short two-week term typically cause borrowers to become trapped in a cycle of debt where they must take out a new loan every pay period. The average borrower takes out more than eight loans a year (usually on a consecutive basis) at the cost of around 400% APR. More often than not, borrowers ultimately end up paying more in fees than they actually receive in credit.

Payday lending in Ohio and Arizona grew rapidly once lenders were granted an exemption to their states' small loan interest rate caps which allowed them to charge 400% annual interest. Hearing of problems stemming from the payday lending debt trap, Ohio policymakers overwhelmingly passed bi-partisan legislation to prohibit any small loan lender from charging more than 28% annual interest earlier this year. Similarly, Arizona legislators refused to renew the authorization of payday lending in that state, which is set to expire in July 2010.

Seeking to rebuke policymakers, the payday lending industry took the issue directly to voters through the ballot initiative process in each state. The industry poured over $30 million into their campaign, vastly outspending a broad coalition of grassroots groups in each state concerned about the negative impacts of payday lending. Voters in Ohio and Arizona, however, overwhelmingly rejected these referenda by large margins-with 60% and 63% casting their ballots against the payday lending industry respectively.

We have seen the impacts of predatory subprime mortgage lending reverberate from neighborhoods on Main Street to our larger financial system on Wall Street. At a minimum, this has shown the inadequacy of granting mere "access to credit"-indeed, if this credit crunch has shown us anything, it's that we are drowning in credit...and debt. Instead, Ohio and Arizona have voted for credit to only be offered on reasonable terms, giving struggling families a fighting chance to better secure their financial futures.

Ms. Parrish can be reached at Leslie.Parrish@responsiblelending.org

Who's Missing from the Payday Loan Debate?

Ellen Seidman — Mon, 28 Jul 2008 00:28:00 -0400

Saturday's Washington Post carried an article with the hopeful headline "Credit Unions Slowly Fill Void as Payday Lenders Leave D.C." In January-before Ohio enacted its anti-payday lending law, before the Arkansas Supreme Court interpreted that state's laws to effectively ban payday lending-the District of Columbia capped interest rates on short-term loans at 24%. That meant that traditional payday lending was out of business.

While the article's headline was hopeful, what followed showed the difficulty these bans face. Credit unions are indeed trying to fill the gap, not just in the District, but nationally. And the Federal Deposit Insurance Corporation (FDIC) has a small-dollar loan pilot underway with 31 banks around the country (although none in the District).

But the article reports that whereas in 2006, the two largest payday lenders in the District made 260,000 loans, so far District credit unions have made only "a few hundred." More troubling, two credit union executives interviewed said that the loans are "not something we really make money on," but rather an on-ramp to "traditional banking products," but "it's hard to get persons to talk to our financial counselor so that we can get their financial status in a better position." Officials at the District's Department of Insurance, Securities and Banking added that some District residents are getting their payday loans in Virginia or on the internet.

Going around a payday lending ban is not limited to the District. New York has long prohibited payday lending. Yet, in a recent study of two low-income communities in New York City by the City's Office of Financial Empowerment, 9% of the respondents "reported accessing a formal or informal loan with a term of less than one month provided by a friend or family member, Internet or telephone-based business, loan shark, or local business." As the study's authors noted, this is a rate similar to the access rate in states where payday lending is legal.

All this suggests that while banning payday lending might be a good start, more is needed if lower income consumers are to really be able to rid themselves of high-price short-term debt. The credit union and FDIC programs are small but important steps toward both creating a good alternative product and encouraging-or requiring-users to build savings as part of the product, so that emergency needs can be reduced and, if they occur, satisfied with savings rather than high-priced credit.

But two parties are missing from the scene, the only parties who could take the alternatives to scale. Namely, the large banks and the payday lenders themselves. Unlike credit unions and many of the banks in the FDIC pilot, large banks and large payday lenders are publicly traded corporations. Their shareholders can't be very happy right now-bank shareholders for reasons that are well known, shareholders of payday lenders because state after state is destroying their business model. Maybe it's time for these parties to come to the payday alternative table. With good, scaleable and sustainable alternatives.

On the Outs in Arkansas

Reid Cramer — Thu, 17 Jul 2008 14:13:00 -0400

It looks like the pressure is continuing to rise on payday lenders across the country.

Back in March, the attorney general of Arkansas Dustin McDaniel ruled that all payday lenders must shut down immediately or face lawsuits. The demand was made based on two recent legal rulings by the state Supreme court which found that the high interest rates that payday lenders charge were "unconscionable" and there were widespread deceptive trade practices.

Well, a few months later, reporter Jason Wiest highlights the work of the Arkansans Against Abusive Payday Lending which documents that the total number of payday lenders operating in the state has fallen from 237 in March to 136 in July. That's a pretty big drop.

However, they also report that about one-third of the payday lending operations still up and running were operating illegally. Others have tried to adopted new business models. It will be the job of the attorney general's office to figure out which lenders are conforming to the law and which are not, but it sure looks like pressure is being brought to bare. I'm all for making sure people have access to credit and loans but lenders have to ensure that borrowers know what they are getting into. Seems like Dustin McDaniel agrees.

A Poor Business Model

Reid Cramer — Wed, 04 Jun 2008 15:16:00 -0400

Well, it's now official: Ohio Governor Ted Strickland signed into law a 28% cap on what payday lendings can charge for their unsecured, short-term loans. When lenders have been previously counting on returns of closer to 400%, this law will effectively shut down the payday loan industry in Ohio.

Here's an article from CNN about the growing threats to payday lending business model across the country. The Democratic presumptive nominee Barack Obama has already proposed a national cap of 36%, and it seems pretty clear that there is downward "pressure" on the stock prices of Advance America Cash Advance Centers Inc. and QC Holdings Inc. Perhaps these firms can remake their business models to find innovative ways to offer consumers valuebale services that don't depend on capturing them into a debt trap.

Preying on the Poor or Filling a Niche? Lessons from Payday Lending on Profits in Microfinance

Jamie Zimmerman — Thu, 22 May 2008 20:49:00 -0400

The international microfinance movement - cheered and arguably hyped for its ability to alleviate poverty through access to microcredit - originated based on a social mission to provide financial services such as small loans to the poor and underserved. However, the recent explosion of profit-seeking providers (in some instances, non-profit MFIs going public, such as the now-infamous Compartamos IPO, in other cases, a surge in predatory micro-lenders) has been met with a mix of applause, skepticism and in some cases, disgust. Now, some microfinance leaders are speaking out about the risks industry faces if it loses sight of its social mission, fearing the likelihood of an influx of profit-seeking actors offering credit products that are actually more welfare-harming than welfare-enhancing. My question is: Has anyone else noticed some eerie similarities between these debates over profits from microcredit and the debates within the US over payday lenders?

First, the crux of the current debate in microfinance is over what we could call "ethical" interest rates and hence profits for micro-credit institutions. Mohammad Yunus, winner of the Nobel Peace Prize for his poverty alleviating microcredit model, has "blasted" Mexican MFI Compartamos for charging effective interest rates over 100%. And in a recent Economist article, Poor People, Rich Returns, microfinance expert Chuck Waterfield argues that these rates "little different than what illegal loan sharks demand, and it is deliberately making it difficult for poor borrowers to understand how much they are paying for their loans." Sound familiar? Opponents of payday lending in the United States have argued for years that those who take out such loans typically do not understand them, will unlikely repay within the typical two week repayment deadline, and end up in a debt-trap that pulls them deeper into financial despair and poverty. And to be sure, in the US annual interest rates on some loans (such as those recently "banned" in Ohio) have reached beyond 300% (three times the arguably unjust rates charged by Compartamos). One difference though is that so far the vast majority of the microfinance industry operates under a system that incentives instead of discourages high repayment rates on loans.

Also, there is the common fear of uncontrollable industry growth rates. Today there are thousands more payday lenders and check cashers than there are McDonald's in the US. Similarly we've seen growth in microfinance institutions within just a handful of years from just a few hundred to close to four thousand, according to the microcredit summit report. Some say the increase in predatory "loan sharking" in the US is a product of a breakdown of Federal Usury laws since the 1970s. In microfinance, leaders argue not a breakdown of laws but an explosion of practice where such regulations and protections simply don't yet exist.

Then there are even similarities on the flip-side of this debate. Some argue that clients of both U.S. payday lenders and MFIs are consciously and willingly entering into these arrangements. They counter that the high interest rates are more a reflection of limited supply meeting great demand. Indeed, Compartamos is reaching vast, unmet demand for microcredit in Mexico (60 thousands to 900,000 loans in eight years), and US payday lenders operate where historically banks couldn't be bothered to. This is a valid argument, but does not take into account the information asymmetries, lack of disclosure or understanding of such products that might lead some to make "less rational" decisions than they otherwise might. Finally, both in the US and abroad, it's argued that if you take away the very limited financing options available to these individuals (an unregulated MFI in a remote area or a check casher in an impoverished neighborhood, let's say), then these clients will turn to even more risky and potentially dangerous options.

Finally, there are also similarities in efforts to expose and address such. Groups like Self-Help (and the subsequent, policy-focused Center for Responsible Lending) have been working to expose and eliminate welfare-harming lending practices in the US for over a decade. They have argued for interest rate caps, increased transparency and more and better financial services options for targeted communities. While such efforts are relatively new within microfinance, recently leaders within the microfinance movement have addressed concerns over lack of transparency, indebtedness of clients and extraordinary profits of micro-lenders "in advance of adequate competition" that seem to mirror those expressed by CRL and others. See the Poncantico Declaration signed just one month ago by a high level group of MF leaders. One difference is the call from the Declaration for a code of conduct and ethics to guide microfinance practices around the world, though this is a reflection of the fact that microcredit abroad was born out of a social mission. On the other hand, payday lending in the US was born solely out of a desire to fill an extremely lucrative market niche within disadvantaged and underserved areas.

To be clear, I'm not anti-profit and I do believe in the power of creative capitalism. However, I also believe that the trends in microfinance and their similarities to pay day lenders in the US possibly foreshadow the very real problems that will arise if creative capitalism to help the poor escape poverty succumbs to creative capitalism to maximize profits above all else.

Payday Lending Cap Springs the Trap

Reid Cramer — Tue, 20 May 2008 21:21:00 -0400

I heard from a few payday lenders following my last blog post lauding the Ohio legislature for their passage of a 28% interest rate cap on payday loans. They thought I was being callous to the job loss that would be brought on by the new law. They gave me momentary pause. But then I considered the work of my former colleague Leslie Parrish, who has moved on to work at the Center for Reposnsible Lending. She argues convincingly that measures short of an interest rate cap fail to fix the problem.

The Ohio Coalition for Responsible Lending has the CEO of Cash America on record as describing the business model as one that strives to transform customers into a "repetitive, long-term customer, because that's really where the profitiability is." Well, that may be so but it creates a debt trap that can be difficult for people to get out of.

The action of the Ohio legislature is getting pretty high marks all around the state. Here is the Cleveland Plain Dealer's editorial of support. More importanlty, it is serving as a model for others aound the country who seek to limit the debt trap.

Way to Go Ohio!

Reid Cramer — Fri, 16 May 2008 15:00:00 -0400

One unfortunate growth industry in recent years has been the rise of alternative financial institutions. These are the payday lenders, auto title companies, and check cashers who offer access to cash to virtually anyone that walks through their doors but on horrific terms. I mean really bad.

Payday lenders often charge about $15 for every $100 borrowed on a two-week loan. This would be equivalent to an annual interest rate is approaches 400%. It is an outlandish deal that many people take because they feel like they dont have other options. The problem is that many people in America don't have basic bank accounts, so they conduct their everyday financial transactions with these stores just move their money around. Our colleagues at the Center for Responsible Lending have been committed to ending these abusive practices and are working with people all across the country to change the state laws that govern these transactions. The need for the service is real but the terms are criminal. There ought to be a law...

But the great news out of Ohio is pretty soon it looks like there will be! Just this week, a bill cleared both houses of the state legislature which will put a 28% cap on payday loans. This cap is effectively a ban because it blows up the business model of these firms. Governor Strickland is expected to sign the bill and Cash America has already announced plans to close its 139 stores. Way to go Ohio!

The New Thrift

Reid Cramer — Tue, 13 May 2008 16:50:00 -0400

In true blogger fashion, I've brought my laptop along to a conference we are co-hosting today on Confronting the Debt Culture.

It is a pretty compelling gathering for a couple of reasons. First off, the idea behind the conference is to raise the profile of the concept of thrift and all of the anti-thrift institutions that now prevade our culture. Secondly, the conference is sponsored by a really diverse set of organizations. It has been spreaheaded by the Institute for American Values, a group lead by David Blackenhorn which has mainly been known for its work promoting marriage. In recent years David has become a champion of thrift and has teamed up with other groups such as Demos, Consumer Federation of America, Public Agenda, and others.

It is being filmed and I supsect the keynotes will be posted. I highly recommend the presentation of Christopher Peterson, a law professor at the University of Utah who has focused his research on usury laws. It turns out that it is an ancient concept. Chris showed a slide of the babalonian stone that stated a 33% cap on loans of grain. He went on to describe the legal framework which governs payday lending across the country today and the wide range of abusive practices that are completely legal in many states. Recently, Congress capped payday loans at 36% APR but in many places it can exceed 450%! This is an area that needs alot more sunlight. He had a couple of great charts which showed how the proliferation of payday lending stores has vastly outpaced Starbucks shops and McDonalds Restaurants. And they dont add value, they strip assets from households that can not afford the hit.

Direct Deposit: Fix it Carefully

Ellen Seidman — Tue, 22 Apr 2008 18:41:00 -0400

Direct deposit of wages and benefits is one of the great financial innovations of the last 30 years. It saves employers and benefits providers millions of dollars in both the purely administrative costs of writing checks and the hassle of replacing checks that are lost or stolen; it provides workers and benefits recipients with quick, safe and reliable access to their funds; it encourages those who are unbanked to move into the financial services mainstream; and, when the payors use their market power to cut good deals, it can mean higher quality financial services at lower prices for lower-income recipients.

In 1996, Congress told the Treasury Department to pay all recurring payments to individuals, such as Social Security and military and civilian retirement benefits, electronically. This mandate has been modified and scaled back, and the transition was not always successful. Nevertheless, Treasury's experience during Hurricane Katrina, when those with direct deposit got their funds, even if with a short delay until they could access their bank account, whereas those relying on checks often went months without funds, convinced the Department to make a new push to move everyone to electronic transfer, through direct deposit to either a bank account or to a well-designed, consumer friendly prepaid card.

But no good deed goes unpunished in the financial services world. High cost lenders noticed that the income stream of Social Security recipients could now be tapped into reliably, notwithstanding the federal prohibition against assignment of such benefits, by directing the recipient to direct deposit the check into an account the lender could tap first. When lenders engaged in similar behavior in South Africa, taking entire government paychecks to repay high-cost loans, the government responded with a major overhaul of the regulation of credit, complete with limits on interest and fees. Here, the Social Security Administration is attempting a more nuanced approach, asking for information about a specific type of arrangement, the master/sub account, which has facilitated high-cost lending and other abuses. As SSA noted in its request for comments, "by obtaining information about these arrangements . . . we can revise our payment procedures to help beneficiaries avoid some of the unfortunate outcomes that may result when they enter into agreements with some payday lenders."

So far, the payday lending industry is not commenting. It will be important that SSA, as well as Treasury and others interested in direct deposit, keep their eye firmly on the difference between direct deposit and the ability of some to abuse it. The abuses need to be stopped. A direct deposit system that cannot be hijacked is better for payors and recipients. But as SSA recognizes, the process of preventing abuse must also preserve the functionality of a very effective system.