The common complaint about payday loans from pseudo-reputable special interest organizations like the Center For Responsible Lending (CRL) is that it traps borrowers in a “cycle of debt” that leads toward inevitable bankruptcy. Clearly the subprime mortgage-backed organization did little actual research (their few “studies” are done largely in-house, reflecting complete bias), because numerous independent studies exist that show that their claim against the payday loan industry is without merit.

The most recent of such independent studies disproving the CRL’s claims is a study by Petru Stoianovici (from The Brattle Group) and Professor Michael Maloney of Clemson University. “Restrictions on Credit: A Public Policy Analysis of Payday Lending” proves that there is “no empirical evidence that payday lending leads to more bankruptcy filings; this finding casts doubt on the ‘cycle of debt’ argument against payday lending.” In addition to their own findings, Stoianovici and Maloney review a large sampling of current academic literature that supports their findings and further suggests that payday loan critics consistently operate in the realm of hearsay, rather than presenting supported arguments of any consequence.

Good customers and competition

Stoianovici and Maloney use state-level data collected between 1990 and 2006 in their study, with a particular focus on areas with faxless payday loan storefronts. From state to state, payday loan regulation varied greatly, from states like Delaware with no restrictions to those where the loans are banned completely (Georgia).

One common thread from state to state in their study is that lenders screened their applicants. Whether or not traditional credit reporting avenues were used, past financial behavior was taken into account. According to Skiba and Tobacman’s 2007 payday loan study, about 20 percent of applicants are rejected, and the rate of loan default is small (65 percent of what is found with credit cards, per Chessin’s 2005 study that the authors cite). Thus, the argument that lenders prey on helpless consumers is in doubt. These are people who can repay their debts. Borrowers who (according to the study authors) have relatively low probabilities to default are also harmed by payday loan restrictions, due to higher charges. In general, the authors find that restrictions harm the average loan customer.

Further, Stoianovici, Maloney and numerous researchers make the claim that restricting no fax payday loans makes it much more difficult for consumers to handle emergency expenses. Adair Morse argues in a 2007 study that the unnecessary restrictions against the loan product presents a barrier for consumers, in the sense that competition is eliminated in the short-term credit market. Prices for what remains are exceedingly high. Where payday loans remain, according to Morse, consumers benefit.

Easy to understand, easy to repay

Much has been said of regulating payday loans so that consumers can easily see and understand what they’re signing up for. However, these regulations are already being followed. It is as if impressionable government regulators take the CRL’s word without proof. If they looked at the industry, they’d see that consumer protections are already in place. Stoianovici and Maloney find the argument that payday loan terms are difficult to understand without merit; the loans are, in fact, very simple. Costs are listed up front, and if the borrower keeps up his end of the bargain to repay when the loan is due (typically after two weeks), all they repay is the principal balance and the typical $15 per $100 loaned. That’s it. If a “cycle of debt” culture were the norm, how could the supposedly resulting bankruptcies lead to payday loans being a profitable business?

As borrowers enter into payday loan contracts voluntarily and with full knowledge of how the loans work, it seems ridiculous to base an anti-loan argument on the grounds that people are victimized against their will or beyond their control. Paying interest and principal is agreed upon, and payday loan employees are more than willing to explain anything customers do not understand. Stoianovici, Maloney and others make a point of stating that people are not being forced into bankruptcy or any kind of financial distress by the loan product. If they are dishonest in their intentions of repaying a loan when it comes due, that is not the lender’s fault.

Profit and expense – too high?

But critics continue to make the bankruptcy connection. Regarding profitability, most critics claim that the faxless payday loan business is parasitic, that it depends upon hooking in the same “weak-willed” borrowers again and again. However, this is simply not the case. In multiple studies, such as the one by Flannery and Samolyk, payday loan store profitability depends on total volume, just as any other type of business would. Frequent borrowers are not a significant income source, which in turn suggests that rollovers are not as common as critics insist.

Regarding whether payday loans are too expensive, the authors point to studies like those by Huckstep. The loans are not too expensive. The high number of stores and significant operating costs, says Huckstep, are

relative to other lenders… payday loans are a product chosen mostly for convenience. Because of this, payday lenders compete in a local area and have a high density of stores, and keep those stores open beyond normal business hours (p. 210-1).

As demand for the product increases, the need to increase the number of stores and workers to meet the demand increases.  Stoianovici and Maloney find this to be consistent with collected data. For instance, Ace Cash Express “opened a store in Augusta, GA less than 1.8 miles away from another of its stores.” This was in response to the pre-ban need. Yet Georgia banned the loans anyway, despite the fact that doing so harms consumers. And if that doesn’t convince you, here’s another example for good measure.

Not as profitable as critics think

Stoianovici and Maloney continue on by citing more from Huckstep’s study. Specifically, he compares the profitability of payday loan stores versus large commercial lenders and the retail giant Starbucks (which has a similar business model to short-term lenders). Analyzing profit margin, Huckstep finds that payday lenders make less (7.63 percent) than both the commercial lenders (13.04 percent) and Starbucks (nine percent).

So how can it be argued that payday loans are predatory? According to Donald Morgan of the Federal Reserve, there is no logical argument that fits. Morgan does not find evidence that the presence of payday loan stores damages the financial well-being of consumers; default rates remain low. Stoianovici and Maloney clearly agree that this does not suggest that predatory lending is taking place.

Payday loans – the consumer’s choice

Authors Stoianovici and Maloney find no empirical evidence that payday loans lead to an increase in bankruptcy filings. The loans do not perpetuate a “cycle of debt.” Admittedly, despite full disclosure of terms and counseling available to customers before signing payday loan agreements, some will borrow beyond their means. This does result in higher finance charges, but this is an uncommon symptom of bad spending habits, not a factor that is inherent in the payday loan industry. It is clear that over-regulation that causes lenders to shut their doors not only puts people out of work, but harms the financial well-being of consumers. These consumers typically look to sources like checking overdraft to protect them when financial emergencies threaten their budget, yet it is unfortunate that this exceedingly profitable device is not in their best interests. Banks profit, consumers lose.