The Free Market Ignored: How the CFPB Intends to Destroy the Payday Loan Industry

The basic concept of a free market is that consumers are free to decide on the price they are willing to pay for a service or product, sellers are free to set their prices — and the government does not dictate prices to either buyers or sellers. When the demand for a service at a given price is roughly equivalent to the supply of the service, the market is said to have achieved economic equilibrium. Although a limited amount of government intervention is often necessary to eliminate individuals using illegal practices, intervention is normally kept to the minimum in a free market. Intervention is typically confined to a case-by-case basis to target the lawbreakers while leaving legitimate sellers alone. However, the regulations proposed by the Consumer Financial Protection Bureau that target payday lenders ignore the basic principles of a free market, and the new rules could well destroy the entire payday loan industry.

The Link Between Ignoring the Free Market and the Destruction of the Payday Loan Industry

The Pew Charitable Trusts reports that 5.5 percent of all American adults use payday loans annually, but when analyzed by state, usage rates can be as high as 13 percent in certain states. In numbers, this equates to between 10 and 12 million people and indicates a demand for payday loans.

In a free market, demand drives supply. With so many people seeking payday loans, lenders have founded businesses to supply these loans. As businesses, lenders expect to make a profit. At the same time, they understand that their rates cannot exceed the price that borrowers are willing to pay to obtain the loans. Lenders must also keep their rates in line with what competitors are charging as they could lose customers if the competition’s rates are considerably lower.

This is how the free market is supposed to work. Sellers decide on a price they must charge to make a profit, and buyers decide whether they are willing to pay the seller’s asking price. The fact that an estimated 12 million Americans annually are willing to pay the fees to obtain a payday loan is an example of the free market in action.

To illustrate how the pending regulations could kill the payday loan industry, suppose the government decided to regulate the sale of bread. Under the regulations, grocery stores were told how much they could charge for a loaf of bread. Before the store could sell a loaf, it must first determine whether the customer could afford to purchase the bread. The store must also verify that the customer has not purchased more than a set number of loaves within a certain time period. Customers who need the bread may have to be turned away if they cannot show that they can afford it or if they have purchased too much bread.

Before long, the grocery store will discover that the increased operating expenses related to verifying customers’ finances and purchases have reduced the profit that the store makes on a loaf of bread. With a price cap in place, the store cannot simply raise the price to offset the costs. When the total costs exceed the price that the store can legally charge for a loaf of bread, the store will simply stop selling bread, and no one will be able to buy a loaf.

In essence, this is what will happen under the proposed regulations. Payday loans will no longer be profitable, and since lenders are not in business to lose money, they will simply stop making the loans.

Does the CFPB Have the Power to Destroy an Entire Industry?

The CFPB expects that the new regulations will curtail payday loans by at least 84 percent. Payday lenders will shutter their doors, and no alternative lenders seem ready to fill the demand for small-dollar, short-term loans.

However, although the actions of the CFPB have the potential to kill the payday loan industry, there are those who question whether the agency has the authority. In an article appearing on JDSupra.com, attorney Richard Eckman states that litigation may occur to challenge the regulations. He states that the CFPB is relying on the unfair, deceptive or abusive acts and practices, referred to as UDAAP, authority. The payday loan industry is the first instance of the CFPB invoking its UDAAP authority to pass regulations affecting an entire industry.

Furthermore, the CFPB does not have the authority to establish a national usury rate. However, the CFPB has already stated that payday loans to members of the military cannot exceed an annual percentage rate of 36 percent, which is in essence a usury cap. Individual lenders with interest rates exceeding 36 percent could be found guilty of abusive practices by the CFPB.

With so many people questioning whether the CFPB is overstepping its authority, the issue will likely be debated for many years to come. In the meantime, however, the payday loan industry will be devastated. Lenders will cease operations and find other investment opportunities. Therefore, even if the regulations are revoked at some future date, lenders may be slow to return, and the industry will likely never make a complete recovery.

If you would like to explore the issue of payday loans in greater detail, you can find many educational articles at the Personal Money Store.

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