How the Free Market Can Reform the Pay Day Loan Industry
The pay day loan industry has been under attack for many years, but the latest broadside fired by the Consumer Financial Protection Bureau has the potential to sink the industry. The new regulations are so burdensome that even many credit unions and small banks say that they would lose money on small-dollar loans if forced to comply. In their attempt to reform certain aspects about payday advance loans, the CFPB and other agencies have decided that the solution is additional government interference — even if such interference results in the total destruction of a legitimate industry. What these reformers overlook or refuse to accept is that the free market has the ability to change the pay day loan industry.
The Connection Between the Free Market and the Pay Day Loan Industry
To understand why the free market has the power to alter the pay day loan industry, it might be helpful to discuss what a free market is and how it works. A free market is one in which individuals — not the government — control the production, distribution and sales of goods, retaining any profits and absorbing any losses. The free market is a cornerstone of capitalism, which relies on private ownership of property, competitive markets and free trade. The opposite of capitalism is the type of communism made famous during the Cold War; the government owned the factories, dictated the goods to be produced, controlled the distribution and collected the profits.
Many people are surprised to learn that the United States does not have a completely free market. In a true free market, there would be no labor laws, no tariffs, no requirements for companies to comply with environmental protection laws and no regulations. In short, the government would take a completely hands-off approach to business; this is sometimes referred to as laissez faire, a French term that can be roughly translated as “let go” or “let them do.”
True laissez faire economies have existed. The most famous example is an instance of laissez faire that occurred in France during the late 1700s. King Louis XV was persuaded to abolish all controls on the selling and transportation of grain. The program worked well for over 10 years, but when an exceptionally poor harvest occurred, merchants chose to export or stockpile grain to maximize profits, causing the cost of bread to skyrocket. Starvation was rampant, and many historians believe that laissez faire contributed significantly to the social unrest that led to the French Revolution.
Although too little government interference can be disastrous, too much interference can be worse. In the early 1800s, Britain enacted the Corn Laws to protect landowners from price erosion caused by imported grain. The result was the artificial inflation of bread prices, and although rioting occurred in London, the most serious damage occurred in Ireland during the famine of 1845. The famine caused many deaths and forced many Irish to relocate before the Corn Laws were repealed.
Obviously, the population fares better when there is some government control over the market. No one wants to be faced with price-gouging, see young children working in mines or other hazardous environments, have their inventions purloined or find that a local manufacturer has made the town’s drinking water unsafe. On the other hand, no one wants to be told what products they must manufacture, to whom they may sell, what price they must charge or how many of each product they are permitted to sell — which is essentially what the CFPB is attempting to do with its new regulations on payday loan companies.
Why Letting the Free Market Control Payday Advance Loans Is the Best Solution
The heart of a free market economy is the concept that individuals have the right to decide which goods or services they will buy or sell, including payday advance loans. Exchanges are voluntary; the government is not coercing either party to enter into the transaction. Both parties benefit from the transaction; the buyer is not being forced to purchase an unwanted product, and the seller is not being forced to sell the product at a loss. As an article on Heritage.org points out, the problem arises when a third party is allowed to make a judgment on the value of the transaction. To someone who has never been in a dire financial situation, the fee for a payday cash advance may seem excessive. To someone forced to decide whether to pay the rent or feed their children, the loan may be a lifeline and the fee more than reasonable. By inserting its own value judgments into the debate, the CFPB is basically denying adult Americans the right to choose a transaction that they find desirable.
The simple truth is that millions of Americans would not be choosing to take out a payday installment loans if the product was not of value to them. Consumer groups and government agencies claiming that these borrowers only sought these loans because they were somehow coerced, manipulated, deceived or otherwise unfairly treated ignore the results of numerous surveys that contradict these claims. Furthermore, the claims insult the borrowers by implying that people who patronize pay day loan companies are incapable of making their own financial decisions, so the government must make the decisions for them.
The answer is not to reduce the options available to borrowers but to increase them. Laws banning monopolies exist because the beneficial effects of competition have long been recognized. Competition leads to declining prices, better customer service and innovative products.
For example, suppose you have an idea for a new smartphone that features superior functionality. If you know that you will be allowed to retain all profits from your sales, you will be more willing to invest your own money and time to see your idea brought to the market. However, you cannot force anyone to buy your smartphone. Since many companies manufacture smartphones, you must be prepared to compete for your share of the market. You may do this by emphasizing your product’s superior functionality, guaranteeing the purchaser’s satisfaction, highlighting your company’s exceptional customer service or promoting your company’s commitment to environmental or social issues. In short, you are emphasizing the differences between you and your competitors.
For the first year or two, your sales are exceptional. However, a new company develops a similar product and begins to claim part of your market. Do you respond by raising your prices? As Tim Worstall notes in an article on Forbes.com, you would have a virtually impossible task ahead of you if you were asked to find an instance in which prices rose due to an increase in the number of suppliers. Instead of trying to regulate the pay day loan industry out of existence, the CFPB should be looking for ways to encourage more lenders to offer payday advance loans.
Legitimate Competition Can Reshape the Pay Day Loan Landscape
The regulations proposed by the CFPB will devastate pay day loan companies and potentially force 75 percent of the current pay day loan stores to close. What will the 12 million people who take out payday advance loans every year do when they lose this option? Many critics of the pay day loan industry blithely claim that borrowers will simply need to reduce their spending, borrow from relatives or use a credit card to meet an unexpected expense. These ideas show a major disconnect between those who use pay day loan companies and those who are campaigning to abolish these lenders.
The idea that borrowers can simply reduce their spending and carry on with their lives borders on the famous quote attributed to Marie Antoinette when she was told that the peasants were starving. Although most historians doubt that she ever said, “Let them eat cake,” the quote serves as a valuable reminder that offering solutions without any understanding of the problems that others are facing is a dangerous practice. Most people who use payday cash advances can barely cover normal expenses. When an unexpected expense arises, where should they reduce their spending? Should they not pay their rent, force their children to survive on ramen noodles for two weeks or allow the electricity to be disconnected?
Borrowing from relatives sounds like a feasible idea, especially to those whose parents and siblings are financially secure. However, many borrowers applying for payday advance loans have relatives with financial difficulties as bad as — or worse than — their own. Furthermore, not everyone wants their relatives to know that they are having financial difficulties. In addition, there is an old saying that borrowing money is the quickest way to turn a relative into a stranger; negative feelings can be generated and relationships strained.
Using a credit card is another good idea, but it is impossible to execute unless the borrower actually has a credit card that is not already at its limit. In an article posted at FEE.org, Paige Marta Skiba states that her research shows that the mean credit score for pay day loan borrowers at the time of their application was below 520, far too low to obtain an unsecured credit card and possibly too low for some banks offering secured credit cards. For comparison, in 2017, the average FICO score was almost 700. Anything above 720 is considered an excellent score, while anyone with a score below 620 is considered to have bad credit.
Misguided opponents of pay day loan companies offer solutions that are simply not feasible. The typical borrower is already faced with limited options. Borrowers do not need to have alternatives eliminated; they need to have more alternatives available to them. Encouraging a free market when lenders compete for business is the best way to lower the cost of small-dollar loans and help borrowers pay off their loans in a timely manner.
Onerous Regulations Undermine the Value of a Free Market Economy
Between federal, state and local regulations, entrepreneurs are finding it increasingly difficult to launch a new business. Regardless of how innovative the product might be or the benefits that the product could offer the average citizen, if it is impossible to navigate the red tape, the product may never make it to the market. In the meantime, a company producing a similar product that is inferior and more expensive could be reaping substantial rewards due to the lack of competition.
If you are wondering just how bizarre some regulations are, consider the following examples found at CNBC.com.
• In Iowa, operators of B&B establishments can bake goods for their guests. However, if customers want to purchase extras, operators can be jailed unless the goods are baked in a licensed commercial kitchen costing up to $50,000. To complicate matters, operators can make and sell maple syrup, cider, canned items or other food products that are not baked without violating the law.
• A woman in Charleston, South Carolina, wanted to open a business to provide guided tours of the city. To do so, she needed to pass the city’s exam, which features 200 questions drawn from a book containing almost 500 pages that the would-be guide was told she needed to memorize. An oral exam was also part of the licensing procedure. The woman was interested in providing tours of the historical sites in Charleston. Strangely, the exam included some questions testing her knowledge of modern celebrities such as Darius Rucker, a member of Hootie and the Blowfish who was born in Charleston.
• Entrepreneurs in Milwaukee face a number of challenges to open a business, but the city also makes it incredibly difficult to close a business. First, you will need to purchase a costly license to inform the public of your planned closure. You will need to complete a stack of paperwork about your inventory and have the information certified by a CPA. If you plan to hold a going-out-of-business sale, you will pay a fee that is based on the sale’s duration. In addition, you must remit a fee based on the value of the inventory you plan to sell.
Onerous regulations erode the free market system by limiting competition. Although no one denies that pay day loan companies, banks and other financial organizations should receive some oversight, burying them under a pile of regulations is not the answer. Increasing the competition — whether it is in the form of more payday lenders, new loan products that are beneficial to both lenders and borrowers, easing the regulations so that neighborhood banks can earn a profit on small-dollar loans or a combination of methods — can resolve the issues that critics of payday advance loans find so disturbing. In other words, the government should let the free market do its job without unnecessary interference instead of attempting to eliminate a lifeline that millions of Americans desperately need.
Where to Learn More
Economic topics can be complex, but the more you know about them, the better your decisions will be. The Personal Money Store has many informative articles that can help you make wise financial decisions.