Earlier this month, the Consumer Financial Protection Bureau proposed rules that would eliminate 80 percent of payday loans — that is, loans with extremely high interest rates that allow cash-strapped people to borrow in a pinch and pay back the loans with their next paycheck. In doing so, the CFPB sided with critics who say payday lending is predatory and leads to “debt traps” where borrowers must take on new loans to pay off their outstanding debt.
Free market advocates have decried the proposals as government overreach, arguing that payday lending — while undesirable — fulfills the demand of people who are strapped for cash. But in the midst of the debate, there’s a broader question that’s getting less attention: Are there other easy credit alternatives available?
There’s a near universal consensus that payday lending is, financially speaking, a terrible way to finance debt. With average annual interest rates floating around 320 percent of original loans, an estimated 45 percent of payday borrowers end up taking out four loans or more. Momentum has been growing to try to halt the industry, both on the state government level and in the private sphere. Indeed, Google announced last month that it will ban advertisements for payday lending on its site.
Still, there remains that question of “what’s next.” Without access to credit, people in dire poverty may be unable to afford basic needs, like car payments or groceries. That’s why many people argue that the CFPB rules — which would require lenders to make sure borrowers can afford the loans and would limit how many consecutive payday loans people can take out — would be reckless without a contingency plan in place to help those in need. Without these lenders in place, what’s to keep borrowers from turning to other, worse alternatives?
Without a viable solution, opponents of the CFPB proposals have defaulted to defending the status quo or more moderate regulation, suggesting that high interest rates are simply the price for doing business with risky borrowers. Under this banner, the solution to the problem is innovation: Use the markets to seek out more trustworthy borrowers or experiment with technology that can reduce the cost of lending.
But others argue that there’s room for the government to step in. A number of outlets, for example, have recently discovered that the Post Office used to serve as a bank for communities and argue that the United States should return the agency to that function (and solve its financial problems in the process).
Of course, as critics of this proposal like to point out, the Post Office’s banking programs existed mostly as a basic form of government-insured banking, offering a place for communities to deposit their money without the fear of panics shutting down banks unexpectedly. As such, postal banking fell out of relevance once the Federal Deposit Insurance Corp. offered protection to all commercial banks. If we truly wanted the Post Office to serve as a point of access to credit for poor people, it would have to depend on some form of government subsidy to make it less risky to offer services and loan out money to impoverished borrowers.
As the CFPB moves its proposed rules through the public review process, the debate for further action around payday loans will continue. Is federal regulation the answer? Or should government take a greater role in offering emergency finance for the poor?
Over the next few days, we’ll hear from:
Mehrsa Baradaran, professor at University of Georgia Law School
Mike Calhoun, president of the Center for Responsible Lending
Tim Worstall, senior fellow at the Adam Smith Institute
Nathan Fiala, assistant professor at the University of Connecticut
Valerie Wilson, director of the Economic Policy Institute’s Program on Race, Ethnicity and the Economy