After two years of study, the Consumer Financial Protection Bureau is moving closer to writing new rules for payday and small-dollar loans. At the Country Music Hall of Fame in in Nashville, Tennessee, last week, bureau leaders heard from a roundtable of authorities and a packed house of citizens – people with strong opinions and, in many cases, personal stories to tell. A day later, on Capitol Hill, a panel of experts answered senators’ questions about some of the same loan categories and concerns.
Witnesses at both events cited a new bureau analysis of data from more than 12 million storefront payday loans issued over a 12-month period. The report confirms the two major findings of earlier research. First, these triple-digit interest loans, promoted by lenders as a way of dealing with a short-term crisis, consistently lead borrowers into a cycle of unmanageable debt. And second, as Consumer Protection Bureau Director Richard Cordray noted, “The business model of the payday loan industry depends on people becoming stuck in these loans for the long term.” Most of the industry’s revenue, in other words, comes from keeping borrowers on the hook and getting them to pay fees that very often dwarf the amount of the original loan.
The latest data should bolster the bureau’s resolve to act. But, as the evidence makes increasingly clear, the bureau will have to resist the temptation to focus exclusively on the traditional two-to-four week loan with a lump-sum repayment. To keep pace with a fast-moving market, rulemaking must also address the payday-like problems of an array of longer-term loan products developed by an industry that is playing all the angles to get around the rules – the anticipated as well as existing ones.
Payday lending took root in the early 1990s, after the big banks and their credit-card divisions laid waste to state usury laws that had been the norm across the country. Twenty-five years later, payday lending is a huge and highly profitable industry, but a badly failed experiment when it comes to its supposed purpose of helping people in a jam.
In the Consumer Protection Bureau’s tracking, four out of five payday loans were rolled over or renewed within two weeks, and more than one in five initial loans led to a sequence of at least seven loans altogether. Among borrowers with monthly paychecks (a group that includes recipients of Social Security retirement and disability benefits), one out of five took out a loan in every month of the year!
Molly Fleming-Pierre came to Nashville from Kansas City, where she works on economic justice issues for a faith-based partnership of more than 200 Missouri congregations. Fleming-Pierre told the story of a disabled Vietnam veteran who had borrowed to help with mortgage payments and his wife’s medical expenses after she broke her ankle. The vet wound up, she testified, with “five payday loans that he spiraled in for three years,” eventually costing him $30,000 in payments and contributing to the loss of his home.
In Nashville and in Washington, the witness lists included industry representatives pleading the cause of individual liberty and professing to speak for their customers as well as themselves. But when the Pew Charitable Trusts conducted a national survey of payday borrowers, the great majority, according to Pew’s Nick Bourke, supported stronger regulation of payday lenders, with eight in 10 favoring a rule to limit payments to a small fraction of any one paycheck.
One reason for that attitude, Bourke and others suggested, is that borrowers frequently go into these loans with only a vague understanding of the costs. Stephen Reeves of the Cooperative Baptist Fellowship in Decatur, Ga., has been working on payday and small-dollar lending issues for five years. In that time, Reeves said, he has heard “again and again” from borrowers who say they have been making steady payments for months with “no idea … that they were not reducing what they owed.”
At the state level, voters and elected officials are wising up to these realities. Twenty-two states have passed laws establishing interest-rate caps or other restrictions on payday lending. But while some of these efforts have made a positive difference, the results show that the states can't do it alone.
In response to the new regulations, the industry has been moving toward installment loans, auto-title loans and other products that often turn out to have the same key problems: high fees or rates, often camouflaged and hard to figure out, and automatic repayment mechanisms that allow lenders to extract money from borrowers’ bank accounts even if that means leaving them unable to pay rent, utilities and other basic living expenses.
The typical storefront payday loan has an effective annual interest rate of nearly 400 percent, according to Nathalie Martin of the University of New Mexico law school, who testified at Wednesday’s Senate hearing. Auto-title loan interest tends to be a little lower – in the 300-percent range, she said. But Martin added that the interest rates on installment loans, especially the types that payday lenders have developed to get around state regulation, can be far higher. “One consumer I know borrowed $100 and paid back a thousand dollars in 12 months’ time,” Martin said. “That’s 1100 percent interest.”
In some of the states most in need of new laws, moreover, legislators have had trouble summoning the will to act. Rev. Robert Bushey Jr., a pastor in Kankakee, Ill., came to Washington late last year to plead for a national response. Like other members of a delegation organized by National People’s Action, Bushey had participated in unsuccessful campaigns for legislation at the state level. “The payday lobby is very strong in the states where payday exists,” was how he summed up the obstacles.
State regulators now face the fresh challenge of responding to the rapid growth of online lending. Many of the online players operate across international as well as state borders, and some claim legal immunity on the basis of tribal relationships they have forged expressly for that purpose.
Effective regulation, then, must come from Washington. And the Consumer Protection Bureau will need to act broadly as well as decisively. An overly narrow rule would only set the stage for another era of innovation in abuse and exploitation (rather than in serving the real needs of consumers).
The industry is hoping for rules that focus on short-term loans and the “rollover” issue. But the weight of accumulating evidence points to two key problematic features that can be found in a far wider class of loans. One is the reliance on postdated checks and other mechanisms that allow the lender to take control of a borrower’s bank account. The other is the practice of issuing loans without seriously assessing a borrower’s ability to repay – to repay out of income, that is, rather than out of money needed for food, rent, fuel and other urgent priorities.
That fatal combination of loan features frames the challenge that faces Consumer Protection Bureau leaders. As they have already done in the mortgage market, to their great credit, they must now require consumer lenders to verify borrowers’ real ability to repay, and not just the lenders’ own ability to collect. Just as important, they must make it possible for borrowers to retake control of their bank accounts. Without the second requirement, lenders will never take the first one seriously.
Corrected on April 3, 2014:
The original version of
this article incorrectly identified the Pew Charitable Trusts.