NYU Study Questions Link between Payday Loans and Predation
Payday Loan Profits Don’t Automatically Equal Predatory Lending
Even if you’ve never been a customer of a payday loan business, you’ve likely seen or heard about the product. You probably also know that payday loan businesses are fairly easy to find in both the brick-and-mortar world and in cyberspace. With such a proliferation, it seems obvious that there is a demand for such consumer loans. Yet for a product that millions of consumers use each year, it’s interesting that the entirely legal payday loan industry has been affixed with such a negative reputation.
The most common allegation levied against the payday lending industry is that it constitutes predatory lending, exploiting helpless consumers with high rates and other loan shark tactics. On their behalf, those who offer payday loans assert that the rates charged are appropriate to protect against risk, yet much less damaging than what consumers can encounter in fees if they don’t pay their bills or have their utilities shut off. Unfortunately, there is relatively little objective analysis that looks beyond the rhetoric of both sides of the payday lending issue. Critics adopt what they consider to be a moral high ground where they use “payday loans” and “usury” in the same sentence, while lenders defend their practice by illustrating that customers are made aware of costs before a contract is signed and by claiming that current rates are necessary in light of operating costs.
Let’s Take a Balanced Look at the Stats, Shall We?
That’s exactly what Aaron Gold does in his New York University honors thesis “Payday Lending: Grounding the Policy Debate Through Economic Analysis.” His study compares some key metrics between payday lenders (five of the largest chains, representing 25 percent of U.S. stores) and a sampling of “traditional” lenders such as banks and credit unions. In a nutshell, Gold finds that high operating expense does seem to justify the cost of local payday loans. While data supports the notion that payday lenders are more profitable than traditional lenders, their profits in relation to their “break even” point aren’t as outrageous as overheated critics claim.
The Social Forces behind Payday Lending
While people from all walks of life have had the occasion to use payday loan services, averages definitely point in the direction of an upper-middle to lower class demographic. Gold cites the M.S. Barr article “Banking the Poor” in the Yale Journal on Regulation. Barr suggests that an increasing number of Americans are “under-banked” (Barr, 2004, p. 2). “Real or perceived costs and fees of maintaining traditional banking services,” suggests Barr, are simply too much of a hurdle for scores of people to clear. Considering the shenanigans of financial institutions that steered America toward the current recession, such skepticism is no surprise. Douglas McGray writes in an article entitled “Check Cashers, Redeemed” that lower income consumers and (anecdotally) some segments of immigrant communities tend to disdain the system of traditional banking and credit. Furthermore, he alludes to public relations efforts made by payday lenders in their communities (such as employing local, multi-lingual people). Thus, payday loan stores serve as comfortable, convenient one-stop shopping for those in need of quick cash during an emergency.
Payday Loans Are For Consumers with Steady Income
It is simply untrue that payday loan companies prey upon people who don’t have the money to repay. Only those with a verified steady income are eligible, a safety measure for both the consumer and the lender. An analogy Huckstep uses in his important study “Payday Lending: Do Outrageous Prices Necessarily Mean Outrageous Profits?” (See: http://www.checkintocash.com/images/media_center/Fordham-report.pdf) is that payday loans are like a financial taxi: “Expensive for long trips, but perfectly viable for short distances” (Huckstep, 2007, p. 207). Used properly, payday loans can save consumers a great deal of money over more catastrophic alternatives. This is a fact that reputable payday lending businesses stress to consumers through their literature and service counseling.
But Are Payday Loans Too Expensive?
That’s what critics say, and the key defensive position has been that high risk justifies the price. Gold points to the 2005 FDIC study by Flannery and Samolyk “Payday Lending: Do the Costs Justify the Price?” in support of the defense, but Huckstep counters that “while loan losses may be high… that seems to be a trait of the lending industry generally, rather than a unique trait of payday lending institutions” (Huckstep, 2007, p. 230). Looking at said charge-off rates, Gold finds the ratios (dividing yearly charge-offs by the amount of originated loans during that period) between payday lenders and traditional lenders to be rather similar, and very much in keeping with overall Fed averages. In fact, the average for payday loan default is shown in Huckstep’s study to be below those of credit cards. This suggests that consumers are indeed able to handle their payday loans when compared with other kinds of consumer lending.
Do Payday Lenders Reap “Obscene” Profits?
Overall, multiple sources confirm the truth that payday lenders have enjoyed greater profits in recent years than traditional lenders based upon similar products. But Gold would have us understand that from 2006 to 2008, the profit margin above the “break even” point for the major payday loan companies decreased dramatically. There are numerous reasons for this, but Gold intimates that a lack of growth opportunities within the payday lending industry may have something to do with it. Whether this is because the industry has become overgrown and needs pruning or overzealous regulation has hamstrung businesses in too many states is debatable.
From the standpoint of the numbers, loan volume is considered to be the key to payday loan store profitability (rather than exorbitant rates). Growth and competition have a definite impact upon loan volume on a per store basis. Gold believes that consumers are attracted to payday loan locations primarily because of convenience, so expansion of store locations and operating hours are necessary to compete. However, venturing beyond a saturation point may actually decrease profits.
Good Return on Assets and Equity
Payday loan business, according to Gold’s findings, produce a greater return on assets (ROA; the ratio of operating income to average assets), which indicates that they are more efficient at what they do than banks and credit unions that offer similar products. Considering that payday loan companies tend to have a relatively small number of physical assets when compared with big traditional lenders, the payday lenders experience much less loan turnover and require much less operating capital in order to produce positive returns.
Does this mean that shareholders of payday loan companies are making a killing? Relative to traditional lenders, the equity tale of the tape says no. Gold finds that from 2004 through 2006, payday loans originators and traditional lenders were basically dead even. By 2008, however, the subprime mortgage crisis sent traditional lenders plummeting. Payday lenders readily took up the slack of consumer demand and posted a much more positive return on equity.
Scale Down, Payday Lenders?
Gold appears to lean toward the idea that if “store density is a function of price, then a reduction in density would increase loan volume and profit at remaining stores.” In such an instance, payday lenders could conceivably charge less and still collect a decent profit. A reduction in competition would then help consumers.
Payday loans could continue to satisfy consumer demand, provided the constant attack mentality of legislators (who no doubt receive sizable campaign contributions from traditional lenders). Some regulation is beneficial (since there are lenders with room in their profit margins to decrease price), but a 50 to 75 percent reduction in APR will only serve to put legal businesses down and increase unemployment. Cooler heads must prevail. As Gold puts it,
For real progress to be made toward finding an equilibrium that works for all involved in the payday debate, interested parties need to move away from inflammatory rhetoric and legislation that views the industry in binary terms. They must move toward defining acceptable interest rates and profit margins and take cautioned steps to satisfy the credit demand in an economically sustainable way.
Follow the Numbers
In America’s recessionary economy, sustainability is a highly desirable goal. Payday loans are here to stay. When will legislators admit that and work toward economic harmony?