The Legislative Assault on Payday Lending Harms the Poorest Consumers
by Marc Levin

A proposal by Georgia’s State Superintendent to strip the word “evolution” from the school curriculum has attracted national attention. While criticism led the Superintendent to abandon the proposal, another battle of biblical proportions has erupted in Georgia concerning usury.

The Georgia State Senate recently made capitalism an endangered species by approving a ban on payday lenders. These lenders, who have been derided as usurious sinners, would be sent to prison for up to ten years. Democrat presidential candidate Sen. John Edwards has also attacked payday lenders, accusing them of “predatory” practices and vowing to push federal legislation against them.

Yet, payday lending is increasingly popular throughout America with 15,000 locations nationwide that process $27 billion a year in transactions. For people living on a tight budget who have bills due before their paycheck arrives, they can obtain an instant cash advance from a payday lender in return for tendering a personal check that the payday lender does not deposit for several weeks.

Borrowers need only show proof of their identity and residence, a paycheck stub, and bank statement. Of course, payday lenders charge a fee, usually around $15 on a $100 advance. Given the two week duration of most of these loans, this amounts to an astronomical interest rate when computed on an annual basis. However, $15 is considerably less than the $60 that a bounced check typically costs, or the interest and late fees on most credit card accounts. Therefore, payday lenders fill a niche that larger financial institutions have either overlooked or declined to fill because they have bigger fish to fry.

The Georgia House is now debating the ban on payday lending passed by the State Senate. In 35 states, payday lenders are regulated by law. The Community Financial Services Association of America (CFSA), the trade association for payday lenders, supports the existing regulations that most states have adopted.

These regulatory schemes require full disclosure of fees and ban or restrict “rollover.” A rollover occurs when the borrower cannot repay the loan and fee within the two week period and therefore pays only the fee. As a result, the borrower incurs additional fees to extend the term of the loan. The CFSA also supports regulations that license payday lenders, prohibit abusive collections practices, and mandate that lenders not loan consumers more than their paycheck indicates they could payback.

While such regulations are reasonable, politicians who vilify payday lenders may be proposing solutions in search of a problem. A 2001 Georgetown University study on pay day lenders found that 96 percent of payday advance customers understood the service and the fees involved and that almost 92 percent believe payday advance is a useful service.

Ultimately, like the debate over teaching evolution in the classroom, whether to outlaw payday lenders is an ethical question. So long as there is no fraud or deception, we must ask whether a transaction should be illegal simply because the rate of interest seems high or one of the parties appears desperate. One might be forgiven for thinking this question had long been answered, as pawn shops dot every state in America, but apparently some politicians need a quick primer on economics.

Given that the payday lending industry is highly competitive, the basic principles of economics dictate that the fee charged will be reduced by competition to the lowest rate at which a profit could still be made. While the fees charged by payday lenders may seem exorbitant when they are annualized, this overlooks two important factors.

First, the type of consumer who seeks a payday loan is in a tight financial position, which means there is a relatively high risk that borrowers, who need not give any collateral, may skip town, leaving the lender holding the bag. The cost of defaults must be reflected in the fee.

Second, there are transaction costs associated with making payday loans, including building and maintaining physical locations and paying employees. Such flat costs are inevitably a larger percentage of small loans.

Whether it is on civil rights or evolution, Georgia has long been branded as backward. By banning payday lending, politicians in Georgia and Congress would truly be regressing to life before the modern theory of free market economics. Consumers will not profit from such a prehistoric policy.

–From the May 2004 Austin Review