Will an Arizona style ban on payday lending happen with the Consumer Financial Reform bill? Image from Wikimedia Commons

The state of Arizona recently allowed the licenses of payday lenders for the entire state to lapse. Payday loan stores are in the process of closing their doors all over the state and are moving on to different pastures. Currently, the financial reform bill is awaiting the president’s signature. Part of the bill will create a new consumer financial protection agency within the Federal Reserve that will regulate consumer lending, and there is concern that a fate similar to Arizona payday lenders’ awaits all payday loan lenders nationwide.

Arizona stores closing up shop

A recent article on azcentral.com highlighted the effects of the new usury cap, or percentage rate cap the state of Arizona has imposed. At 36 percent interest, or rather, 36 percent annualized interest (on a two week loan), any payday lenders in Arizona are having a hard time keeping their doors open. Check’N'Go, one of the largest payday loan, cash advance and check cashing franchises in the country, immediately closed 11 of its 34 locations. The company employs more than 100 employees in Arizona, and all stores will be closed by the end of the summer. The remaining stores in the state will have to either resort to making car title loans or close their doors completely. Studies have shown greater incidents of bankruptcy, bounced checks, and debt collections after bans on payday credit.

Financial reform bill

Part of the financial reform bill is a new Consumer Financial Protection Agency, that will be housed inside the Federal Reserve. The bill, recently passed by the Senate, is awaiting the President’s signature. Payday lending will then fall out of the hands of the states, and into Federal jurisdiction. If the rate cap were to be imposed nationally, the entire industry will fold.

Who will the ban benefit?

It is thought that consumers will no longer be trapped by awful loans and high interest, or at least payday lenders will have to follow the same standards applied to mortgages and credit cards to cash advance loans. The only problem with that is that it costs almost $14 to lend $100 of payday credit, and 36 percent APR only yields a couple dollars per $100 loaned. Since payday customers aren’t accessing first tier credit because they don’t want to or can’t, what is going to take the place of short term loan lenders if they can’t lend and keep their doors open?

Further reading

AZ Central

Consumer Affairs

Peer-to-peer money lending is confounding the standard definitions at the SEC. Image from Flickr.

The Securities and Exchange Commission has been in an extended debate with Prosper, one of the two largest peer to peer lending businesses. A new industry, the peer to peer lending model is a Silicon Valley startup that directly connects investors with borrowers, effectively cutting banks out of the lending equation. The SEC believes that these businesses should fall under their purview of regulations. However, one of the two largest p2p lenders is fighting that ruling.

The basics of p2p lending

Peer to peer lending is a business model that is not entirely unheard of. The basic idea is that investors get the option of investing a lot or a little money directly with the borrower. Borrowers posts their information, including credit score and desired loan amount. Investors can peruse these requests, and decide exactly where they want to put their money — and they can loan as little as $25. The two largest p2p lending facilitators are both Silicon Valley startups – prosper.com and lendingclub.com. These two companies report that, on average, investors get a return of 6 to 16 percent on their investments.

The regulation question for peer to peer lenders

The Securities and Exchange commission currently regulates the lending and investing that occurs on these peer to peer lending websites. The argument the SEC uses is that these online lenders are investment firms selling bonds – and therefore fall under the purview of the SEC. One lender, Prosper, is arguing that the business is instead a lender that should fall under regulation of a different agency — ideally, the new Consumer Financial Protection Agency.

The difference between bonds and loans

A bond, usually known as a corporate bond, is a type of investment usually used by corporations and companies. A bond is basically a promise to pay a certain amount of money later in exchange for an amount of money now. A bond can be traded, exchanged, insured and generally moved around financial markets without much trouble. Because of this liquidity, a bond usually has a very low interest rate – 5 percent or lower. A loan, on the other hand, is a contract between a borrower and a lender that cannot be easily exchanged or traded. Generally, loans are “sold” by individuals to a bank, while bonds are “sold” by corporations to individuals.

Where should p2p lending be categorized?

Peer to peer lending is a difficult industry to categorize. Relatively new in the financial market, these businesses offer loans directly from one individual to another. Because of this, these loans could be seen as bonds, but they could also be viewed as standard loans. Currently, the SEC regulates both the Lending Club and Prosper, though Prosper has chafed under this regulation. The company has spent a significant amount of money on lobbying for p2p lending to be categorized and separately regulated by the possible new Consumer Financial Protection Agency. At the same time, Prosper has spent over $5 million to come into compliance with SEC regulations. Either way, this is an industry that appears to only be growing – and is worth keeping an eye on.

Why target minnows and ignore the sharks? Image from Wikimedia Commons

Part of the Wall Street reform legislation is provisions governing the practices of payday lenders. An amendment to the recently passed Senate version of the bill, introduced by Senator Kay Hagan (D – NC) would limit any and all consumers to no more than six loans per year and limit interest to 36 percent interest, or 391 percent interest depending on how you do your math.  The amendment was killed.  Though many consumer advocates are calling for the outright abolition of payday lending as an industry, perhaps they are gunning for the wrong targets.

The Hagan amendment on payday lenders fails

According to the Washington Independent, Senator Kay Hagan, a Democrat from North Carolina, introduced an amendment to the financial reform bill that would have placed serious restrictions on payday lenders.  It was killed on the Senate floor.  There have been numerous attempts to corral the industry, though few have been successful at all. Regardless of the Hagan amendment failing, payday loans could be placed under the jurisdiction of the proposed Consumer Financial Protection Agency, which will likely be an office of the Federal Reserve.  The senate bill will still need to be reconciled with the house version.

Why such a small target?

Payday loans are seen as marketing to the poor. But all credit is marketed to people who don’t have a certain amount of money laying around at any given time. The only people who don’t have financial products marketed to them are the people who run the companies that sell them. Though some attempts have been made to shore up credit cards, such as the CARD Act, you’ll notice that same vitriol is not leveled at VISA or MasterCard. You know why? Simple: they have status as institutions.  The average American has more than five credit cards and carries $10,000 in credit card debt.

Did everyone skip Econ?

The reason payday lenders and payday loans exist is supply and demand. Obviously, demand exists, and supply has risen to meet it. Like anything else, if you don’t do anything about demand, supply will remain.  If costs of good and services increase above the rate of inflation, and wages don’t rise accordingly, what did people think was going to happen? That money would trickle down?

Are we all destined to be under a consumer protection agencies' wings? Image from Wikimedia Commons.

In the wake of the Wall Street collapse and the ongoing investigation of Goldman Sachs, there are calls for a consumer protection agency, or multiple ones. There seems to be a real need for some financial reform, but which consumer protection laws should be put forth are a point of contention.  Part of the proposed new agency would create national regulation of credit cards, payday lenders, possibly even car dealers.  Where this potential agency and the financial reform bill will go are yet to be determined.

Consumer protection agency proposals

A recent post on the NASDAQ website reported some of the proposals and arguments pursuing a consumer protection agency in Congress.  Currently, the proposed consumer financial protection agency would be an entirely new agency.  An amendment is being put forth by Senator Chris Dodd (D-CT) that would change it to a bureau within the Federal Reserve.  Senate Republicans are looking to scale back the scope and power of the proposed agency, while some Senate Democrats wish to see the agency as an entity all its own. The bill is opposed by the U.S. Chamber of Commerce.

What would be the powers?

The proposed agency would not regulate what any business or retailer that does not offer financial services may do.  In other words, if you’re on a payment plan with a doctor or lawyer for services rendered, it doesn’t cover that if you feel you’ve been bilked.  Another amendment is being sought by Sen. Sam Brownback (R – KS) that would exclude auto dealers from any regulation by the proposed consumer financial protection.

Senator Hagan goes after payday lenders

Senator Kay Hagan (D-NC) plans to offer an amendment that would place new federal regulation on payday lenders.  The amendment, which is co sponsored by Sen. Dick Durbin (D-IL) and Sen. Charles Schumer (D-NY), would limit payday lenders to making six loans a year to any one person.  She countered criticism by stating that the Federal Deposit Insurance Corporation already imposes that restriction on banks.

Other concerns

From a New York Times article, Senator Mitch McConnell (R-KY) said that the language was too ambiguous to determine just who would be caught in the net. “Financial services” is a far reaching term.  That could easily include car dealers, and restrictions could make it harder to purchase cars.   Many jewelers offer financing, and many businesses like furniture stores, guitar stores, etc.  offer layaway plans. Many other businesses, many of which are the small businesses of Main Street, could be negatively affected. Those businesses deserve freedom to thrive rather than being protected into extinction.

Senator. Chris Dodd (Photo: Wikipedia.org)

The people of American are looking for debt relief any way they can find it these days, and it appears that the only way true gains in this area are going to be made is if major restructuring of America’s financial regulatory agencies occurs. Along those lines, controversial Connecticut Sen. Chris Dodd (who some consider to have turned a blind eye to the financial shenanigans that greased the way for the mortgage industry collapse) is hard at work. He wants to push through a new financial reform plan that would completely change the way the government would control banking oversight and debt relief.

Obama Praised Dodd’s Consumer Protection Agency Work

It appeared that Dodd was preparing to take banking regulation and debt relief in an exciting new direction much in tune with the president’s plans. However, recent signs indicate that Dodd’s plan will be significantly different that what was previously expected by the current administration. Specifically, Dodd wants nearly all bank-supervising powers to be removed from the Federal Reserve and FDIC (where they currently reside). An entirely new agency would pick up the reins. They would be responsible for all national finance institutions as sole regulator and guide toward debt relief on both the institutional and consumer level. It would replace the four federal regulatory agencies that exist.

Enter the Watchdog

Watching out for potential risks to the country’s banking and finance industries would become the responsibility of a new kind of watchdog council that would be a chaired by a single White House official. What this would accomplish is to take the teeth out of the Fed’s ability to conceive of consumer protection and debt relief measures on its own. America’s 12 Federal Reserve Banks would also potentially be in jeopardy or closing, according to the Wall Street Journal.

And guess what? In a time when President Obama constantly extols the virtues of bipartisan support, Senator Dodd’s actions could be seen as somewhat extreme. That’s because Dodd is going after his version of the finance reform/debt relief bill on his own. Sheila Bair of the FDIC is against Dodd’s ideas, and the Journal predicts that Senate Republicans will be as well.

The Frank-Man Commeth

Rep. Barney Frank (Photo: Wikipedia.org)

Rep. Barney Frank and the House Financial Services Committee is currently working on its own debt relief and regulation program. According to the Washington Post, Frank’s bill would take a much more conservative approach to regulatory reform. It would get rid of just the Office of Thrift Supervision. At the same time, rather than stripping the Fed of power, it would give them even more power to step in and control the actions of America’s banks.

Consumer Debt Relief Appears to Be Covered

That’s where the Consumer Financial Protection Agency the House has already concocted comes in. Mortgages, credit cards and various consumer loans will fall under that agency’s jurisdiction. Dodd and Frank are battling for a solution to the problems in the banking industry as a whole. Frank estimates the House will vote on his plan by the end of 2009, but Dodd is attempting to push his plan through even sooner than that, perhaps as early as next week if the Washington Post‘s sources are accurate. Get ready for some major debt relief debate, America.

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President Obama's plans for the Consumer Financial Protection Agency could mean that debt relief is closer than ever for the downtrodden. (Photo: flickr.com)

The recession has forced America to face some of its most deep-seated systematic financial troubles. One thing that has become clear is that unscrupulous mortgage lenders and credit card agencies have dined for far too long upon consumers who largely didn’t understand that they could hold out for something better. Foreclosure and bankruptcy have amplified the burden on consumers, courts and the economy as a whole tenfold, which makes the question of how debt relief should be handled a more pressing issue that it has been in decades.

Cornell and George Washington Law School Economics lecturer and former professor Dr. Neil Buchanan ponders in a recent FindLaw column entitled “Should Federal Agencies or Courts Protect Consumers in Financial Markets?” which side of the regulatory coin America needs most. Existing regulatory agencies are being given more extensive duties by the Obama administration in order to help make America’s financial markets safe and sound. At the same time, new agencies like the newly minted Consumer Financial Protection Agency appears to be on its way to receiving unprecedented powers. In theory, it will have the power to police how mortgage lenders, banks, credit card companies, payday lenders or any other consumer finance company interacts with consumers. It is Buchanan’s opinion that allowing regulatory agencies to protect consumers is the best route, as relying solely upon the courts wouldn’t be enough of a deterrent to keep suspect lenders from indulging in bad behavior. The ideal system would have both in place as a regulatory enforcement clearing house.

But Isn’t This Big Government Clogging the Market?

Some will surely feel that way. What I have seen from state governments is an overzealousness to regulate payday lending, to the point where it is impossible for such legitimate businesses to operate in some states. Mortgage lenders and credit card company supporters would likely have similar complaints, although the path of destruction their industries have carved is rather hard to ignore. Buchanan begins his argument by considering the “courts only” option. If it were possible t regulating a market in need of deep repair like the mortgage industry through simple enforcement of the law, that would be ideal. However, Buchanan doesn’t see that as being enough. Sometimes the courts might work in favor of the consumer and debt relief, but not often enough. Extreme circumstances would be required to convince most judges to see cause to invalidate a contract. The “non-elite” consumers, as Buchanan calls those most in need of debt relief, would not receive the help they need.

There is precedent here, but it could be a one in a million kind of thing. Buchanan points to a New York Times story where a judge ruled that a homeowner’s mortgage debt could be completely discharged during bankruptcy. This loop in legal convention happened due to a technicality: the mortgage company couldn’t prove it had the legal right to collect payments on the homeowner’s mortgage due to the fact that their mortgage had been repackaged and resold so many times that the paper trail had been lost. The mortgage company claimed this was “standard procedure” now, but the judge wouldn’t accept such shenanigans. Since the judge wasn’t exactly sure who was due the money, he decided he couldn’t compel the consumer to make mortgage payments to any one party.

“Saved by a Technicality” Won’t Work for Everyone

Buchanan rightly points out that not all judges will be as determined to call mortgage lenders’ bluff in such situations. “Standard procedure” should hold in most cases, meaning that homeowners would still be legally obligated to follow the terms of their mortgage contract. And mortgage lenders have certainly learned something from that case and are making sure all paperwork is in order. Once again, the deck will be stacked against consumers.

Don’t Depend Upon Courts for Debt Relief

Courts enforce the law. When a consumer enters into any legal contract with a lender, the terms of that contract are in most case subject to enforcement by law. Buchanan considers the vast majority of consumers to be “grossly mismatched” against mortgage and credit card companies. Mandatory arbitration clauses, hidden interest spike triggers and means of computing interest are always written in the best interests of the creditor. Consumers often agree to such contracts because they feel they don’t have any other choice. New regulatory agencies may be able to curtail abusive practices that are currently considered legal, but until that time officially arrives, there is too little hope that the average consumer will be able to fight back through the court system.

Courts Have Been Friendlier to Finance Companies

Families can go to court to attempt to prove that they shouldn’t have to pay under the terms of less than legal contract. However, Buchanan believes most judges will stick to enforcing contract language. In turn, the lending companies themselves are effectively using the court system to compel consumers to pay, even if it is through wage garnishment.

What about “Equitable Doctrines” for Debt Relief?

Hoping that lenders lose their paperwork isn’t a good strategy. That’s where “equitable doctrines” come into play. These can create situations where courts might be willing to set aside otherwise valid contracts because they feel that it there were unconscionable circumstances that placed the consumer under duress or undue influence to sign. Buchanan draws our attention to the “doctrine of unconscionability” itself, claiming that it works in two ways. First, in terms of procedure, there is the scenario where a contract was formed under suspicious circumstances. Second, there is the scenario where the substance of a contract is deemed grossly unfair. If both conditions are met, a contract like a mortgage, credit card agreement, etc, will not be enforced.

Too Good to Be True?

Perhaps it is. It all looks great on paper, says Buchanan, but debt relief is hard to come by via equitable doctrines. Only the most extreme cases are considered by courts, and for most people, having trouble paying a mortgage or credit card they signed up for won’t be enough to sway a judge. This raises the question in Buchanan’s mind as to whether courts should be compelled by stronger legislation to accept equitable doctrine arguments based on things like unconscionability. But as with any other action fought through courts, the cost would likely be prohibitive. Moreover, lenders would still be favored because “losing a contracts case legally cannot result in a company paying punitive damages,” writes Buchanan. “If you lose a contracts case, you merely pay what you would have paid anyway; and if you win, you are ahead. Thus, from the standpoint of repeat players, there is no reason not to abuse your customers (except to maintain goodwill, which many of the companies at issue here have already forfeited).” Then there are plenty of consumers who simply will not have the stomach to sue or be willing to accept a lesser settlement.

Calling on the Government for Debt Relief

Traditionally, the government has remained behind the scenes while consumers have pursued their right to take debt relief matters before the court system. As Buchanan suggests, however, this route has not often proved itself to be effective for the average consumer. In situations where genuine signs of abusive practices and unconscionable contracts are involved, new government agencies could take up the baton and make financial regulation more consumer-friendly.

“An agency can be empowered by Congress to order changes in behavior, changing business practices broadly and generally in order to level the playing field on which financial institutions and their customers do business,” says Buchanan. There could even be scenarios where lenders themselves could support agency regulation over the courts. “Out of control lawsuits” that financial institutions claim burden them unnecessarily would certainly be something lenders would be willing to leave behind so that a regulating agency can rule on matters. “But that hypothetical,” Buchanan writes, “ignores the financial industry’s real agenda, which is to fight to maintain both weak legal rules (allowing them to win in court) and weak-to-nonexistent agency regulation.”

Congress, Act Now

New agencies are about to spring forth from the executive branch to regulate the financial abuse of consumers through deceptive practices. Congress is in a perfect position to arm these agencies with more consumer-friendly laws that will make reasonable debt relief easier to attain. It’s that kind of consumer protection that Neil Buchanan and most concerned consumers are in search of as America looks to emerge from the darkness of the recession into the light of a stronger domestic America.