Consumer Law & Policy Blog

Study Finds That Predatory Lending Regulation Leads to Lower Interest Rates and No Loss of Credit Availability

by Jeff Sovern

Yesterday, I was on a panel at the Annual Meeting of the American Council on Consumer Interests, along with Dr. Yilan Xu, a professor at the University of Illinois in agricultural and consumer economics.  Dr. Xu's talk concerned a natural experiment in Cleveland, Ohio.  Cleveland had enacted an anti-predatory lending ordinance which was later found invalid by the Ohio courts.  Dr. Xu compared mortgage lending in Cleveland before and after the law was invalidated, and also examined similar lending in the Cleveland suburbs that was not subject to the Cleveland law.  She found that after the law was struck down, lenders in Cleveland made more high-price loans, that those loans were 5% more likely to go into foreclosure, and that there was no evidence of credit expansion.  These findings contrast dramatically with claims that credit regulation will increase the price of credit and reduce its availability. Unfortunately, the paper is not yet available on the web, and so I can't link to it, but this study suggests that in at least some circumstances, consumers can have their cake and eat it too, in that they can have consumer protection, lower interest rates, and no loss of credit availability. 

Update: the paper is now available here. 

More on the Proposed Safe Lending Act

by Jeff Sovern

Earlier in the week I linked to a Times editorial, Bleeding the Borrowers Dry, about the practice of online payday lenders of lending to consumers in states that bar the kinds of high-interest rate loans payday lenders provide.  Here is a link to my letter in the Times about the prospects of a bill that would block payday lenders from charging higher rates than allowed in the state the borrower lives in. 

Online Payday Lenders In the Media

Today's Times has an editorial, Bleeding the Borrowers Dry.  Here is the final paragraph:

A bill pending in the Senate, known as the Safe Lending Act, would require all online lenders to comply with state laws that provide stronger consumer protections than the federal statutes. It would establish once and for all that payday loan borrowers have the right to stop lenders from raiding their bank accounts. State and federal regulators also need to prohibit banks from giving payday lenders access to the automatic payment system in states where predatory, high-interest loans are illegal.

Meanwhile, the American Banker ran Payday Lenders Assail Online Competitors. Brick-and-mortar payday lenders are arguing that states, like New York, which ban payday lending are not going to stop it--because consumers will just go online to get the loans--and are losing out on the jobs and taxes payday lending generates. Consumer advocates respond by citing a Pew Study finding that states with legalized payday lending have only slightly more online payday borrowing as states that bar it--but that states where it is legalized have much more storefront payday lending.

More on Payday Loans

On Sunday, Brian posted a link to the Times story, Major Banks Play Key Role in Payday Loans Banned by States.  Yesterday, the Times followed up with a report, Dimon Pledges to Change JPMorgan’s Practices on Payday Loans. The specific practice that has drawn Dimon's ire is of withdrawing money from depositors' accounts to repay payday loans even over the objection of the depositor.   But the original article also noted that the federal government also plays an important role in thwarting applcation of state usury laws by providing that the usury law (or lack thereof) of the state where the lender is located applies to consumer loans, not the law where the consumer lives.  While three years ago duiring consideration of what became the Dodd-Frank Act, the Senate reconsidered that law--called the exportation doctrine because states export their usury laws to other states-- some Democrats joined all nearly all the Republican senators to preseve the exportation doctrine.

Meanwhile, Pew has issued a new study, Payday Lending in America: How Borrowers Choose and Repay Payday Loans.  According to the accompanying press release:

Pew’s survey results reveal that people choose these loans to avoid outcomes like long-term debt, borrowing from family or friends, overdraft fees, and cutting back further on expenses. But the average loan requires a repayment of more than $400 in two weeks, the typical duration, when the average borrower can only afford $50. When borrowers have trouble paying off the loan, they return to the very same choices they initially tried to avoid.

 

Jim Hawkins, et al. Paper on Title Lending

Vanderbilt Ph.D. student Kathryn Fritzdixon, Jim Hawkins of Houston, & Paige Marta Skiba of Vanderbilt have writtetn Dude, Where's My Car Title?: The Law, Behavior, and Economics of Title Lending Markets. Here's the abstract:

Millions of credit-constrained borrowers turn to title loans to meet their liquidity needs. Legislatures and regulators have debated how to best regulate these transactions, but surprisingly, we still know very little about the customers who use title loans. This Article reports findings from the first large-scale academic study of title lending customers. We surveyed over 400 title lending customers across three states and obtained information about customers’ demographic and behavioral characteristics.

Based on the results of our survey and guided by insights from behavioral economics, this Article seeks to reframe the title lending debate. Instead of focusing on the risks and consequences of borrowers’ cars being repossessed, as the vast bulk of the literature does, we argue that the primary problem that most borrowers face is underestimating the true cost of taking out a title loan. Borrowers’ survey responses demonstrate that many borrowers are overly optimistic and experience self-control problems that affect their ability to make timely loan payments. We argue that these deviations from the assumptions of classical economics do not warrant an outright ban of title lending, but they do provide room for policy interventions. Policymakers can improve efficiency in title lending markets by requiring lenders to disclose to consumers the likely experiences they will have with their title loans rather than merely requiring lenders to communicate pricing information.

Paper Finds Evidence of Mortgage Originators Steering Borrowers to Subprime Loans in 2000s

Sumit Agarwal of the National University of Singapore and Douglas D. Evanoff of the Chicago Fed have written Loan Product Steering in Mortgage Market.  Here's the abstract:

Accusations of unscrupulous lender behavior — e.g., predatory lending — abounded during the housing boom of the 2000s. Such behavior is said to have generated significant social costs as borrowers were misled into accepting loans with inferior characteristics relative to the mortgage products that they should have qualified for. However, there is little hard evidence of such behavior and few estimates of the true effect of such behavior. Much of the research to date is based on anecdotal evidence or analyzes differential loan terms for broad groups of borrowers that are thought to have been targeted for such lending behavior. We employ a more direct methodology and test whether a particular form of this behavior existed during the housing boom: credit steering toward predatory-like loan terms. With this steering, the broker or real estate professional encourages the home buyer to access credit from a particular lender that provides the credit, but at unattractive terms. We find evidence of such behavior. That is, we find evidence consistent with lenders steering higher-quality borrowers to affiliates that provide subprime-like loans. These borrowers were charged 40-60 bps higher APR, and were 2% points less likely to default compared to similar borrowers who were not steered to such loans — consistent with the steered borrowers receiving inferior loans given their qualifications. Delving deeper, we find that the loans with steered borrowers were more likely to be privately securitized and steering was not concentrated solely among the large banks. Our results are, to our knowledge, the first explicit evidence of systematic mortgage lending abuse during the run-up in the housing markets.

More From Creola Johnson on Payday Lending

Creola Johnson of Ohio State has written Congress Protected the Troops: Can the New CFPB Protect Civilians from Payday Lending? 69 Washington & Lee Law Review 649 (2012). Here's the abstract:

In 2007, Congress enacted a law, commonly referred to as the Military Lending Act (MLA), which placed a 36% interest rate cap on several consumer loans, including payday loans, and prohibits lenders from engaging in several practices considered predatory. However, the MLA grants these protections only to active-duty military members and their dependent family members.

In the wake of the mortgage foreclosure crisis, Congress passed and President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd–Frank Act), which creates a new federal agency, the Bureau of Consumer Financial Protection (CFPB), to focus on protecting consumers in the credit market place. In this Article, I assert that the newly-created CFPB should use its authority to afford to ordinary Americans protections similar to those now enjoyed exclusively by military families. To support my assertion, I describe how payday loans entrap civilian Americans in a cycle of indebtedness just like they once ensnared military families and yet both groups are equally lacking in financial sophistication. I further describe how regular payday lenders and now major banks, such as Wells Fargo, are engaged in reckless lending because when issuing a payday loan, they fail to do any assessment of a borrower’s ability to repay, charge triple-digit-interest rates, issue loans frequently in excess of the borrower’s next paycheck, and require loans to be repaid in a single balloon payment usually in fourteen days or less.

The CFPB needs to act to protect civilians because, despite attempts by several states to curb payday lending, payday lenders exploit loopholes in state laws or use scams to skirt consumer protection laws. The CFPB also needs to protect civilians because they are more vulnerable to ensnarement by payday loans than the active-duty military members. Military families enjoy a strong social safety net, which is comprised of numerous benefits, including complete health care coverage, educational assistance and subsidized housing. In contrast, average low-to-moderate-income civilian families face financial difficulties due to high unemployment rates and ever-shrinking compensation and benefits packages. If military families, who enjoy strong social safety nets, need protection from payday loans, then unquestionably civilian Americans, who are largely left to fend for themselves, deserve protection from payday loans.

Under Title X of the Dodd–Frank Act, the CFPB has the authority to issue rules as well as guidelines to prevent a covered financial institution from committing an unlawful practice in connection with any consumer financial product or service. Because the rulemaking process could take as long as ten years, I propose that the CFPB issue immediately guidelines and a policy statement to get lenders to voluntarily cease predatory lending practices. The guidelines would give notice to all lenders about which common payday lending practices the CFPB considers unfair, abusive and deceptive and, therefore, unlawful. The CFPB’s policy statement would identify responsible lending practices, such as applying reasonable criteria to assess a consumer’s ability to pay and avoiding any practice that extends the loan’s due date for the primary purpose of generating fees for the lender. While the guidelines would warn lenders that they may be subject to enforcement actions for committing unlawful practices, the policy statement would provide a safe harbor, exempting from enforcement actions lenders who follow practices that comport with responsible lending standards. In addition to using the guidelines and policy statement to decrease the supply of payday loans, the CFPB should use its educational mandate to increase the demand for safe affordable loans. To accomplish this mandate, the CFPB needs to employ a multi-faceted strategy that harnesses the power of social media and uses a national public service announcement campaign to make it easy for consumers to access safe affordable loans from lenders with a demonstrated commitment to responsible lending practices.

 

 

Creola Johnson on the CFPB and Payday Lending

Creola Johnson of Ohio State has written America's First Consumer Financial Watchdog Is on a Leash: Can the CFPB Use Its Authority to Declare Payday-Loan Practices Unfair, Abusive, and Deceptive? 61 Catholic University Law Review (2012). Here's the abstract:

To stop payday lenders from skirting state laws, this Article asserts that the CFPB should exercise its rulemaking authority to declare many payday loan practices as unfair, deceptive, abusive, and, consequently, unlawful.

The CFPB's imposition of restrictions on payday loans will not end short-term, small-dollar loans in America, but will cause an increased prevalence of responsible lending practices. The results of a recent pilot program implemented by the Federal Deposit Insurance Corporation (FDIC) demonstrate that lenders can issue small-dollar loans subject to the types of restrictions proposed above and still achieve long-term profitability. Therefore, the CFPB's regulatory intervention will correct the continuing market failure by promoting profitable, yet fair loans by responsible lenders.

Victor Stango: Are Payday Lending Markets Competitive?

Victor Stango of UC Davis Graduate School of Management has written Are Payday Lending Markets Competitive? Regulation (Fall 2012) at 26.  Here's the abstract:

The rapid and widespread growth of the payday loan market has sparked considerable controversy, in part regarding the “high” prices charged for these loans. This article presents several new pieces of evidence addressing this issue. Specifically, it finds that credit unions — who frequently are payday lenders’ sharpest critics — do not (and apparently cannot) offer functionally identical products at lower prices. It concludes that the claim that other lenders can serve this market at lower prices does not seem justified.

Obama vs. Romney on Consumer Protection Issues

Here.