'Saving' borrowers from payday loans

Right about now, Arizonans are receiving mailings urging them to vote "yes" on Prop. 16, the Payday Loan Reform Act (PDF). All ballot propositions are sponsored by somebody, and this one is backed by Arizonans for Financial Reform, a group the Arizona Republic reports "has received nearly $2 million in contributions from payday lenders." It's a payday-loan industry group backing a "reform" bill that would impose regulations on the industry and -- oh yeah -- incidentally repeal a state measure that would essentially abolish the industry in 2010.

So that has critics screaming that Arizonans for Financial Reform is an astroturf group defending its evil, exploitative, industry through the appearance of a reform measure -- which it is, except for the "evil, exploitative" part.

If you don't know, a payday loan is a short-term loan people take out, borrowing against their next paycheck at a fee that works out to a very high rate of interest. Not surprisingly, it's the sort of loan people with limited financial alternatives take out -- stereotypically (though not always accurately), the working poor. That makes lenders open to vilification for preying on the needy.

Except that nobody makes people take these loans; they choose to do so, and for a reason. In fact, as Reason magazine reported six years ago, there has always been a market for short-term loans for people who see value in giving up a little money in a few weeks for cash right now.

Today's thriving industry of payday lending looks a lot like the "salary lenders," later renamed "salary buyers," that thrived in the late 19th and early 20th centuries. "In current dollars, they would buy $650 worth of salary by writing a check for $500," says Lendol Calder, a professor of history at Augustana College and author of the 1999 book Financing the American Dream: A Cultural History of Consumer Credit.

These days, if a person wants to borrow $200 on the first of the month, he'll write a check for $234 dated the 15th. When the 15th rolls around, either he pays off the loan in cash or the lender cashes the check. If he can't afford to pay off the entire amount, the lender will roll over the loan for an additional fee.

One hundred years ago, the leading critic of "salary loan lending" called such people "sharks, leeches and remorseless extortioners." Today's consumer advocates call payday lenders "predatory" and "legal loan sharks."

Are borrowers right to seek these loans? Well, you either leave the choice to them, or you substitute the judgment of legislators, do-gooders and government officials who have no idea of the specific needs of the people patronizing payday lenders.

It's not as if the alternatives are so much more reasonable. Bank overdraft fees are now drawing the wrath of the same folks (PDF) who vilify payday lenders. And Tom Lehman, a professor of economics at Indiana Wesleyan University, says bounced-check fees can actually be significantly higher than the fees charged by payday lenders.

Not surprisingly, given that people have long sought out payday lenders and their predecessors, "protecting" people from short-term loans can have serious consequences. In research (PDF) done for the Federal Reserve Bank of New York, Donald P. Morgan and Michael R. Strain found:

Compared with households in states where payday lending is permitted, households in Georgia have bounced more checks, complained more to the Federal Trade Commission about lenders and debt collectors, and filed for Chapter 7 bankruptcy protection at a higher rate. North Carolina households have fared about the same. This negative correlation—reduced payday credit supply, increased credit problems—contradicts the debt trap critique of payday lending, but is consistent with the hypothesis that payday credit is preferable to substitutes such as the bounced-check “protection” sold by credit unions and banks or loans from pawnshops.

Is your blood pressure rising? Are you thinking that, perhaps, all short-term loans are nothing more than legalized loan-sharking that should be abolished for the good of would-be borrowers, whether or not those borrowers appreciate the gesture?

Then let me point out that the logical, final alternative to legalized loan-sharking is illegal loan-sharking, with all that implies. If you think a triple-digit rate of interest is harsh, consider that real loan sharks are known for inflicting broken bones and occasional fatalities on deadbeats.

Franchised payday lenders, no matter how much you hate them, don't do that.

So, it's our choice. We can either leave people free to borrow money at rates of interest that make us shudder, or, to give ourselves warm-and-fuzzy feelings, we can outlaw the practice, hurt some people financially, and drive others to borrow money at rates of interest that make us shudder -- from criminals.