Monday, May 21, 2007

Legal Loan Sharks

What is the right thing to do when it comes to payday lenders in Utah? Payday lending outlets have proliferated like crazy in Utah over the last few years. And that’s not just my imagination. As explained in this D-News article, “The first store appeared in Utah in 1984. In 1994, 17 were in the Salt Lake area. Now, state-license lists show Utah has 381 payday loan stores and online lenders licensed here.” That’s 1.6 payday lending outlets per 10,000 residents.

Payday lenders claim to serve a valid market. They also claim to already be one of the most highly regulated industries in Utah. However, D-News points out that part of the reason for the proliferation of the payday lending industry in Utah is that Utah has among the least restrictive laws in the nation with respect to the industry. There is also a burgeoning target market that includes Hispanics, Air Force troops, and college students. Some payday lenders offer (in Spanish) candy from Mexico.

The pure libertarian argument would be to eliminate government interference and allow the market to do its own thing. The idea is that the market would regulate itself. But most Utahns countenance legislation to restrict all kinds of moral ills. For example, Utah is one of two states that permit no forms of gambling. A market certainly exists for gambling, but the general consensus is that it is a moral ill that has enough societal drawbacks as to warrant its restriction. There is certainly a worthy argument that the payday lending industry generates enough societal ills to warrant its restriction as well.

An interesting discussion of various opinions about regulation of the payday lending industry in Utah can be found at this Utah Politicopia site.

Industry and free market proponents say that payday lenders provide services that customers are unable to find elsewhere, but others counter that the industry simply preys on the ignorant. An argument made by Rep. Steve Urquhart (R-St. George) is that state regulation of this industry is valid because the industry’s basic business plan involves the state as an unwitting partner. How so? Urquhart says that the business strategy is based on a high default rate. This leads to escalating debt as interest accrues at incredibly high rates along with steep penalties. This finally leads to prosecution in Utah’s court system, which then becomes the enforcer of obscene contracts that are structured from the outset to victimize the client party.

Urquhart says:
“Anyone who thinks the victims of these loans are well-informed needs to go to district court and watch them get run through like cattle. The payday lenders always have polished attorneys. The borrowers rarely have any representation; they are left on their own, often with poor language abilities or life skills. They get loans for meager amounts, but owe fortunes after the loans churn hundreds of percentage points. It is sad to watch.”

As far as customers having no alternatives Tom Gregory suggests, “Credit card cash advances, or credit card use. Loans from family members. Government welfare options, including Medicaid. Religious welfare offerings, including fast offering assistance. Bank overdraft protection. Equity loans. Or, gasp, going without.”

KCPW reports that payday lenders gave Utah legislators $10,500 in 2006: $7000 to Democrats and $3500 to Republicans. Although Rep. Urquhart garnered $500 from the industry, it does not seem to have limited his criticism of the industry.

As far as whether the industry is moving toward self regulation, consider the claim of Don Hester of Debt Free Consumer, that the number “of people trapped by payday loans increases about 400 percent per year.” And any bankruptcy lawyer can tell you that almost all bankruptcy filers have at least one outstanding payday loan.

The payday lending industry is based on predation and entrapment. Yes, the prey is willing until the trap is sprung. And then the citizens of Utah, through the state’s court system become partners in these predatory practices. The government is only an extension of its citizens. Is it right to allow this industry to use Utah’s citizens to enrich some people unimpeded while financially destroying some of the most vulnerable among us?

Critics of payday lending regulation claim that government has no business protecting people from their own stupidity. Still, we do it on a regular basis. For example, we have certain seatbelt laws because we are unwilling to bear the emotional and economic cost of people not wearing seatbelts. Libertarian minded folks will tell you that we have no business regulating seatbelt compliance, but that is not what most Utahns believe.

The fact is that we are willing to violate the principles of laizzes faire when a greater moral good is achieved by doing so. We do not always agree on what constitutes a greater moral good, and that is why we have a legislative system that includes public debates.

Some of the proposed restrictions on payday lending include Dollar limits on single loan amounts, combined loan Dollar limits, limits on number of outstanding loans, various APR caps, elimination of automatic loan rollovers, restriction of predatory penalty practices (that amount to $4.2 billion annually nationwide – see here), and requiring lenders to register with the state.

Critics of these proposals claim that those desperate for easy loans will simply resort to getting loans from far less scrupulous purveyors, such as illegal loan sharks. It’s the old coat-hangers-in-back-alleys ploy, which is a sleight of hand trick. Just as we exchanged less than 200 illegal and unsafe abortions annually for 1.4 million legal abortions annually, we now have a proliferation of people taking advantage of legal loan sharks who employ the argument that it would be worse if the practice were restricted.

We need to think clearly about what course of action would result in the greatest moral good. And I simply do not believe from the evidence I have seen that allowing the payday lending industry to continue on its current course will constitute much good at all. We should seriously consider restrictions on the payday lending industry that will prevent predation of the vulnerable.


Anonymous said...

As a general rule, I am all for the free market. However, this just seems to be such a predominant problem. However, I wonder if it wouldn't be better controlled at the city or county level by limiting the number each city can have. Or having a city that eliminates the service in their city. However, I don't know that I would be opposed to stronger state regulation on the industry either. Even though it goes against my general rule in favor of the free market.

Jesse Harris said...

It's amazing how some industries can be perfectly fine with a minimum of controls (i.e. Internet service providers and computer manufacturers) whereas others end up either establishing a de facto or de jure monopoly or engage, willingly or unwittingly, in industry-wide collusion (telecommunications, payday loans, etc.). When an industry falls into the latter category, it works to suppress the free market and ends up being rightly subjected to regulation to correct that course.

The payday loan industry has reach a point of massive collusion, albeit intentional. They all sell the same product for more-or-less the same rate and an increase in the number of businesses in the industry has increased prices instead of decreasing them. Indeed, more entrants into the market has resulted in less favorable conditions for the consumer.

That's what I've never figured out about most free market die-hards: they never want to talk about what to do when it is a company rather than the government doing the suppression of market forces.

Democracy Lover said...

I heartily agree that government regulation of industry is vital to the interests of the citizenry.

In this case, we have an industry whose raison d'etre is dubious at best. The market for their services is caused by the combination of low wages, high housing costs, and the constant pressure to buy things one does not need with money one does not have (advertising). Perhaps if we had stronger government regulation in other areas, the market for exploitation of the poor by usurers would dry up.

Tom said...

Good article. (Thanks for the link. ;)

In another DesNews article in the same series as you linked to, the paper found annualized interest rates ranging from 365% to 912%, with a median of 521%. Horrific, in my mind.

The part your missing though (and it's been missing from most discussions): What specific regulations would make a difference? Interest rate/fee caps? Required informational pamphlets in multiple languages, suggesting other options, and showing where to direct complaints? (Payday lenders cite the extremely low number of complaints to government oversight. Perhaps those uninformed enough to use a payday lender are similarly uninformed regarding government channels?)

The same DesNews series suggested that existing rules weren't being followed. Would additional enforcement help?

Asking for additional oversight is well and good--I agree with you. How, specifically, should it be accomplished?

Reach Upward said...

Tom, you are right that we need to make sure that any step we take is calculated to produce the desired result while minimizing negative side effects, since there are negative side effects anytime government intervenes.

In that respect, I suggest that the task force that is studying this needs to get information on the effects of the payday lending regulatory practices of other states to get an idea of what works, what doesn't, and the negative impacts of each type of restriction. Only armed with that kind of information can a decent proposal be structured.

Also, if we are failing to enforce existing laws and regs, we need to determine why that is. Are they unenforceable? Is the agency tasked with enforcement understaffed or is this simply a low priority for them? This falls in the Governor's court. He ought to remedy enforcement problems and demonstrate bad policy to legislators so it can be changed.

Steve Urquhart (among others) has blasted the industry's contention that low complaint rates mean that they are doing a fair job. Most of these people feel trapped. They don't see how complaining is going to help them, since they would have to demonstrate that rules have been violated. Many are ill equipped to do that. Also, see my quote of Urquhart's comments about the nature of the victims he has seen come through the state courts. Lack of complaints is not necessarily a stamp of approval.

Tom said...

Two replies: per the DesNews article, the reason they found more violations than government oversight was (according to the DesNews) that their queries were done anonymously whereas government regulators would identify themselves as such at the start of the interaction. It seems to suggest a simple solution.

Second, I too am not convinced that low complain levels is, in this instance, a sign of satisfied customers.