Tim Worstall is a senior fellow at the Adam Smith Institute in London and a regular contributor to Forbes.
As the Federal Reserve Bank of New York has taken the pains to point out, everyone hates payday loans except the 10 million people a year who take them out. It’s no surprise, then, that the Consumer Financial Protection Bureau has taken up arms against the payday lending industry.
Banning things simply because we disapprove of other people’s choices is not a mark of a free society. We might do so if we consider that people are being ripped off, and we might if we think the activity is harmful to those not making the actual choice themselves. Thus, laws banning pollution are fine, and laws restricting the capitalists’ ability to gouge the worker are fine too.
If we are to ban — or gut, given the CFPB’s proposed rule making — payday loans, then we’ve got to work out which of those justifications meets this case. We have no evidence that people are being ripped off by what most assuredly look like eye-popping interest rates. Goodwill tried out some nonprofit experiments, working out of their own storefronts too, and had to charge interest at 252 percent APR to make even a no-return system work. Similarly, the listed companies (that is, the ones we can see the accounts for) that indulge in this form of lending make no greater return on their capital than other companies in the consumer financial market.
We, therefore, have something that is expensive to produce but also desired by many. And our absence of excess profits tells us that loans of small amounts for short periods of time are simply something expensive to do. In this sense such credit is like Aston Martin luxury vehicles. So they cost a lot. And? People want them, and they’re expensive to provide. We might well think that someone’s an idiot for purchasing one, but we don’t actually go and ban it.
We should allow competition to deal with the matter — possibly even with a little bit of help from the government. I seem to recall GM getting a bit of aid in providing wheeled transportation that costs less than an Aston. That would be the correct manner of dealing with payday loans.
We could also investigate alternative methods of delivering the same results, such as small short-term loans designed to meet the needs of poor people. These 10 million payday borrowers are by definition banked, as most payday loans require a bank account. We could imagine all sorts of possibilities: Offer banks or credit unions that provide small credit lines breaks on the capital they must put aside to service them. We could also imagine direct subsidy, or special and specific laws to ease being able to garnish paychecks.
Perhaps the Post Office could get involved, as Sen. Elizabeth Warren (D-Mass.) proposed: It would be interesting to find something that they’re useful for in this modern world. Or we could ask the clever people in Silicon Valley to have a look at this. My native Britain has recently seen explosive growth in recent years in a lender called Wonga. By doing everything over the Internet and using algorithms to decide who gets a loan and to figure out who was in particularly dire straits, the company used efficiency to find a way to make actual returns from 2008 to 2012 on the capital they used for small loans (although, they have since reported losses amid stricter lending regulation in the U.K.).
If we were to go the route of technological innovation, the biggest aid we could give the U.S. industry would be to create one simple, national licence that allows this sort of lending, rather than the grossly expensive current system we have where lenders must apply state by state, each with different rules.
Henry Ford brought cars to the masses not by banning the Aston Martins of his day but by making transport vastly cheaper through technological innovation. If we want short-term credit to the poor to follow the same route, we’re going to have to do the same: invent a new way of providing it and out-competing the current providers.
Perhaps no such technology exists, in which case we’ll be stuck with something expensive and somewhat dangerous that 10 million people want each year. It’s a bit like drinkable wine, and we should recall what happened when we tried to ban that: prohibition of the best credit we have to offer will inevitably lead to Fat Tony and his friends running amok again.