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What payday opponents fail to mention is that nobody rolls over a loan twenty-six times. This brings up an even more important discussion: do consumers even care what the APR of their loan is?  The answer is a resounding “no”.

The Austrian Economist’s Perspective

In his article, “In Defense of Payday Lending”, Dr. Thomas Lehman spells out exactly why APR is meaningless to consumers.

“The effective annual interest rate on the payday loan may not even enter the mind of the borrower. In all likelihood, the borrower cares not what the “effective APR” is on the loan. The real price signal to which the borrower responds is the flat fee that is charged to hold the postdated check. If the value attached by the borrower to the immediate cash advance exceeds the value of the principle plus the fee one or two weeks hence, then the borrower will undertake the transaction, pure and simple.”

Dr. Lehman reminds us that every person values things differently.  With payday loans, the value in question is the time value of money.  To those for whom time is of the essence, known as having a “high time preference”, then they will be willing to pay more to obtain credit than people with low time preferences, all else being equal.  As one might expect, low-income households exhibit higher time preferences.  So the fee is not excessive to these people.  They place a subjective value on the time value of money, and enter into a payday loan transaction voluntarily.

TILA Gets In The Way

So why bother with APR at all?  Because the Truth in Lending Act requires such disclosure.   Back in 2009, a Congressional hearing before the Committee on Financial Services, Subcommittee on Financial Institutions and Consumer Credit, addressed legislation requiring banks and credit unions to calculate overdraft protection fees as an annual percentage rate (APR).

Bank and credit union officials testified that APR was not an accurate measurement of short-term credit.  This is to be expected, because the APR of a $35 overdraft fee on a $25 bounced check is 51,000%.  Nevertheless, the arguments presented also happen to be logical and correct.

The Banker Weighs In

Kenneth Clayton of the American Bankers Association said, “Any time an annual percentage rate is calculated for a term less than a year, the inclusion of a fixed fee, even a modest one, will distort and overstate the APR. The shorter the repayment period, the greater the APR will appear in instances where there is a fixed fee. This means that the sooner the consumer repays, the greater the calculated APR – a difficult concept to explain to consumers, as it appears that paying earlier actually increases the cost of credit.”

He went on to confirm the point I just made about the APR becoming, “greatly inflated to the point of distortion. In these cases, the fee is fixed, the overdraft often small, and the term of repayment short. It is easy to see how triple digit APRs would result. However, it is not at all clear how this would assist consumers. Rather, the inflated and distorted APR will confuse consumers as they attempt to reconcile this APR with other APRs with which they are familiar, such as the APRs for credit card, home, auto, and personal loans. The result will be to dilute the effectiveness of the APR generally, rather than enlighten them with regard to overdrafts. In the overdraft fee context, consumers understand a dollar amount far better than an inflated and meaningless APR.”

The concept of using APR now makes a lot less sense, doesn’t it?

The Credit Union Opinion on APR

It isn’t just banks that have a problem with APR for overdrafts.  So do credit unions.  Douglas Fecher, of the Credit Union National Association (CUNA), testified that, “CUNA opposes treating overdraft programs under the Truth in Lending Act because we do not believe that this service is a lending product.  If this bill were law, it would cause credit unions offering overdraft programs to exceed the usury ceiling prescribed by the Federal Credit Union Act (presently at 18%), since even a modest fee would exceed this threshold. As a result, credit unions subject to the usury ceiling would no longer be able to offer these services, driving members of these credit unions to alternative – and perhaps more expensive – financial services providers.”

Community Banks Agree on APR

So the concept of using APR becomes even sillier.  However, we can’t let this issue go without Linda Echard, of the Independent Community Bankers of America, telling us when APR actually should be used.  She says, “Regulation and disclosure under TILA is appropriate for open-ended accounts, such as credit cards, where a consumer is offered and extended credit and has certain rights and obligations regarding using and repaying it. The disclosures provided under TILA are based on specific principal amounts and defined terms, elements lacking when overdrafts occur since customers are charged a flat fee, not an interest rate.”

Of course, payday loan opponents aren’t ones to let all these facts get in the way of their arguments.  And those facts are clear — APR is not a proper method for determining or comparing the cost of a payday loan.  The only thing that matters is whether the consumer wants to pay the flat fee, and they do so because the cost is reasonable to them.

The payday loan industry provides customers with small-denomination, short-term, and unsecured cash advances.  The industry developed in the early 1990s in response to changes in the availability of short-term consumer credit alternatives from traditional banking institutions. The high charges associated with having insufficient funds in one’s bank account, as well as overdraft fees and other late/penalty fees charged by financial institutions and merchants, helped create customer demand for cash advance services.

Customers value cash advance services as a simple, quick, and confidential way to meet short-term cash needs between paydays while avoiding the potentially higher costs and negative credit consequences of other alternatives.  Recent demographic trends show the following information concerning payday loan customers:

• Sixty-three percent (63%) have annual household incomes of more than $25,000, with 46% earning $25,000 to $50,000 a year.
• More than half (55%) have attended college, and nearly one in five (19%) has a bachelor’s degree or above.
• Thirty-eight percent (38%) own their own homes.
• Just under half (48%) of households have children under 18.
• Sixty-three percent (63%) of customers are under the age of 45.

People who use payday loans generally do so because they are in need of a short-term lifeline to meet an emergency expense, such as fixing a broken car.  The average borrower takes out six to eight loans each year.  This does not necessarily mean that they take out one loan and then flip it, rather that they take out that many separate loans.

One of the popular misconceptions about payday loan borrowers is that they do not have bank accounts.  This is false.  All payday loan customers must have a bank account, and they must be employed.  Money is lent only because the borrower presents a pay stub, proving that they are employed and that their next paycheck will be used to pay off the loan.  The customer is required to have a bank account because, if they default, the lender must have recourse to recover the money that was loaned.  The borrower secures the loan by writing a post-dated check, which the lender can present to the borrower’s bank for payment.

The maximum fee that can be charged depends on which state the borrower resides in.  Each state has its own laws.  The average fee is $15 per hundred borrowed.  Internet payday loans can cost between $10 and $30 per hundred.

Pretty simple, isn’t it?  Makes you wonder how the media can make so many mistakes when doing stories on this loan product.

But how do payday loans differ from installment loans?

Installment loans have a history stretching back decades.  Many independent finance companies existed in the mid-to-late 20^th century, and borrowers could get a modest line of credit of $5,000 – $10,000 that was often unsecured, or secured with real estate.  Names such as Beneficial, Household Finance, and Avco were the big players.  Over the year, many of these companies were gobbled up by larger banks and finance companies.  Many of them remained in operation as subsidiaries, while companies such as World Acceptance Corporation remained independent.

Installment loan consumer finance companies operate in a highly structured regulatory environment. Consumer loan offices are individually licensed under state laws, which, in many states, establish allowable interest rates, fees and other charges on small loans made to consumers and maximum principal amounts and maturities of these loans. Like payday loans, virtually all participants in the installment-loan consumer finance industry charge the maximum rates permitted under applicable state laws in those states with interest rate limitations.

Installment loan consumer finance companies generally make loans to individuals of up to $1,000 with maturities of one year or less. These companies approve loans on the basis of the personal creditworthiness of their customers and maintain close contact with borrowers to encourage the repayment or refinancing of loans. By contrast, commercial banks, savings and loans and other consumer finance businesses typically make loans of more than $5,000 with maturities of more than one year.

Those financial institutions generally approve consumer loans on the security of qualifying personal property pledged as collateral or impose more stringent credit requirements than those of installment loan consumer finance companies. As a result of their higher credit standards and specific collateral requirements, commercial banks, savings and loans and other consumer finance businesses typically charge lower interest rates and fees and experience lower delinquency and charge-off rates than do installment loan consumer finance companies. Installment loan consumer finance companies generally charge higher interest rates and fees to compensate for the greater credit risk of delinquencies and charge-offs and increased loan administration and collection costs.

Installment lenders require payments of equal amounts each month, with interest front-loaded under the “Rule of 78’s”.  The first month of a 12-month loan is assigned interest equal to 12/78 of total interest due, in the second month it is 11/78 and so on.  This reduces the overall risk to the installment lender by collecting more of the interest early I the loan.  These days, installment loans are generally unsecured as lenders have little utility for seizing collateral such as furniture or televisions.  Defaults are easily covered by cash flow.

Borrowers for this product are in need of larger amounts than they obtain via a payday loan and for a longer period.  It is also much easier for the borrower to refinance the loan with a smaller principal and extend the maturity.  Installment borrowers do not necessarily have to be employed or have a bank account, although generally at least one of these is required.

These products are easy to understand for consumers, so one must eye the media askance for so easily botching basic facts about them.  It is this very ineptitude that should help legislators realize that if the public knows more than the media, perhaps the public should be allowed to choose among credit products, rather than eliminate them “for consumer protection”.

It’s time to examine what the word “usury” really means, and why it does not apply to payday loans.

Here’s the definition of usury from a random Google search:

An exorbitant or unlawful rate of interest.

Let’s take “unlawful” first.  States that permit payday loans specify the maximum allowable fee and/or interest by statute.  As long as a payday lender makes a loan within those amounts, the loans are lawful and therefore not usurious.

Let’s define “exorbitant,” per the same dictionary:

Greatly exceeding bounds of reason or moderation.

We must ask what “reasonable” means in the world of short-term unsecured credit.

If a lender charges a price he deems reasonable that the borrower thinks is unreasonable, the borrower will not take out the loan.  If the borrower wants a price he deems reasonable that the lender thinks is unreasonable, the lender will not make the loan

So what is “reasonable”?

It’s obvious. Ready? Here’s the earth-shaking news: we define “reasonable” to mean “that price that both the lender and borrower agree upon so that a transaction occurs.” Most call this “the free market.”  Since hundreds of millions of transactions have occurred in payday loan stores across the nation, both sides must obviously think the transaction is reasonably priced, or they wouldn’t undertake it, per the analysis above.

Therefore, the interest rate is reasonable, and therefore not exorbitant.

Thus, we see that payday loan rates are not usurious because the rate of interest is both lawful and not exorbitant.

And so, we see that the secular (and even legal) definition of usury does not describe payday loans.

Let’s move on to the Bible.  Setting aside the irony that many payday loan opponents are themselves part of “interfaith organizations”, I’ve always been shocked at their faulty interpretation of a text they allegedly know so well.

We look to the Book of Nehemiah for a Scriptural definition of usury.

In this section of the Bible, Nehemiah is the Governor of Judah.  He had compassion for the Hebrew people who had returned to Jerusalem from Babylonian captivity. They were a crushed people. Nehemiah defended and protected them. After learning they were forced to borrow money on their fields and vineyards to pay the King’s tax, he was outraged. He brought charges against the nobles, saying, “The thing that you are doing is not good,” (5:9). “Let us stop this taking of interest,” (5:10), He persuaded them to restore all that they had exacted from their people

The myopic and incorrect interpretation of Nehemiah 5, as provided by payday loan opponents, is that it fails to place blame where it is due – on the King. The Jews were oppressed due to the taxes they had to pay the King, not due to the interest they were being charged!

The parable of the Book of Nehemiah is that the Jews were truly powerless and starving, while being charged interest on loans for the fields where they worked their food. In this particular scenario, I’d say (as Nehemiah did), that this practice did indeed take advantage of the poor.

However, much as payday loan opponents wish an analogy exists between the parable of Nehemiah and payday loans, there is no such analogy. Payday loans, when used and offered responsibly, don’t take advantage of anyone. They help people bridge financial gaps.

When used irresponsibly, the fault lies with the borrower, unless the loan was made irresponsibly. In that case, the lender bears responsibility as well, but not all of it.

Any lender who makes a loan to someone truly poverty-stricken, who already owes other lenders and/or does not have any chance to repay the loan, is being irresponsible.

But since 94% of all payday loans are paid back on time, I’d say the aforementioned situation rarely exists in the payday lending space. What lender wants to make a loan to someone if they don’t have a reasonable expectation of getting their principle back?

To level the charge of usury against payday lenders is to demonstrate a lack of knowledge concerning credit, legal and Scriptural definitions of the term, and is a typical tactic of payday loan opponents.  The fact that a consumer enters into the contract willingly should be the tip-off, but payday loan opponents are more interested in generating emotion than being distracted by the facts.

Overhead covers rent, utilities, one or two employees, signage, advertising, payroll taxes, software, computers, office supplies, and a few other items.

Understand that these owners don’t just fling open their doors and start making $120,000 in loans each month.  It takes almost 15 months to reach that.  In other words, the store does not generate any profit during this period. The owners have gambled all they have on their business.

So if a store manages to build up to a $60,000 loan portfolio, at the end of their first year, they will break even in month 15.

But industry opponents — who have no clue how these businesses truly operate — never mention this, do they?

So let’s look at the store operator once he’s managed to break even.  He will extend about $1.5 million in loans to customers each year.  Let’s say he’s in a state that permits a fee of $15 per hundred borrowed.

Opponents ignore the fact that, on average, 6% of these loans will never be repaid despite collections efforts.  That means $90,000 of that $1.5 million loaned is never returned. Thus, the lender will only earn money on $1.5 million of loans.

$1.5 million x 15% = $225,000 in total fees

An average store costs $8,000 a month to run. Thus, total store costs for a year will be $96,000.

$225,000 total fees – $96,000 expenses = $129,000 in store profit.

But remember, that operator had to borrow from a lot of people to fund his losses for a year in order to have money to lend out.  That requires about $150,000 in total capital.  Now, maybe they got lucky and got these loans before the credit crisis and are averaging a 10% APR interest rate, which costs them $15,000 in annual interest payments.

$129,000 store profit – $15,000 interest = $114,000 in net profit

Say this owner contributes $14,000 to his 401 (k) for retirement.

$114,000 net profit – $14,000 retirement = $100,000 in taxable income

Now he must pay federal and state income taxes. If this operator has a 4-person family to support, their federal and state taxes will be $16,000.

$100,000 taxable income – $16,000 = $84,000 in take home pay

In the final tally, $84,000 for a small business owner of one payday advance store is a very nice annual income, but hardly the level of wealth opponents claim that payday lenders achieve each year.

This, however, doesn’t even reflect the real truth of what happens to that money.  Chances are he takes home a lot less than $84,000.  He takes home just enough to provide for his family, doesn’t contribute to his retirement plan, but instead he’ll start saving it to open another store.

So next time a payday loan opponent screams over how wealthy a payday loan operator is, ask how much they think an operator makes.  Then surprise him with the truth.

The data is astonishing, and unequivocally demonstrated that as consumer activists and grandstanding politicians decry payday lenders, they ignore the bloodsucking that occurs every time a consumer bounces a check.

Finally, instead of the usual assortment if lies and misleading information spewed by corrupt charities, ideologues, ignorant activists, and uneducated legislators, these same people have been confronted with facts.

So here are those facts.  In 2007, storefront payday lenders provided 154 million loan transactions and collected $6.8 billion in fees. Meanwhile, Bretton Woods Inc, a bank strategy consulting firm, estimated that consumers will overdraw their accounts 1.22 BILLION times in 2008, allowing banks and credit unions to collect more than $35 billion in fees.

So right there, let opponents take note.  Overdraft programs cost people five times more than payday loans did in 2008.

Moving on to the average transaction size for overdraft fees, we discover it was only $60. The average overdraft fee was $27 on that $60 overdraft.

Meanwhile, you can get a $60 payday loan in most states for $9.

Which sounds like the better deal?

But wait, there’s more. In states where payday loans were forced to shut down by legislators swayed by opponent’s arguments, the average annual amount of NSF fees charged to consumers was just under $541.  In states where payday loans are permitted, that amount is only $240.  The data reveals another truth: that payday loans are not only an effective form of short-term credit, but removing them makes things worse for consumers because it forces them to more expensive forms of credit.

Let’s take this one step further.  If someone needs $300 to fix their car, they can take out a payday loan for $45.  If they can’t get a payday loan, and they bounce a check, it may trigger overdraft fees on many other checks.  $300 worth of bounced $60 checks may generate as much as $135 in overdraft fees.

In addition, the payday loan industry has long argued, correctly, that attaching an APR to a two-week loan is a misleading and inaccurate way for consumers to assess the product’s relative cost. It’s been proven time and again that the consumer doesn’t care what the APR is for a payday loan. They make their decision based on the absolute dollar amount of the loan.

Nevertheless, in order to conform with TILA, they agree to post APR’s. These run between 391% and 520%. Since they’re being forced to disclose that useless APR, then let’s do the same with NSF Fees. A $60 transaction that results in a $27 NSF fee translates to a 16,425% APR.

No matter how you choose to interpret the data, the conclusions cannot be denied.  Bank overdraft fees are far more onerous way of handling credit for the average consumer.

A number of bills got traction in the state Assembly, and eventually the chamber settled on one. The state capitol received tens of thousands of letters from borrowers asking that the bill be killed, because they all knew that it would make payday loans more expensive. On top of this, the Finance Committee heard testimony from mom and pop store owners and experts in economics pleading with the Committee to kill the bill. All of these pleas were ignored. The bill passed both chambers and was signed by Governor Strickland.

This bill was championed by Bill Faith, the executive director of the Coalition on Housing and Homelessness in Ohio. If this sounds like a strange person to take up this cause, you’d be right. Payday loans have nothing to do with what the Coalition on Housing and Homelessness in Ohio actually does. What happened was the Center for Responsible Lending recruited Bill Faith to take up the cause. Since Mr. Faith has never opened up his books to the media to see if he was paid off to do this, we have no idea if this was motivated by a misguided need to “protect” consumers, or if there was a mercenary reason behind it. What we did find out was that Mr. Faith is paid more than $100,000 in annual salary to run this “non-profit”.

The payday loan industry tried to kill the law by putting up a ballot initiative, but the initiative was confusing to people, and those who had never used a payday loan were swayed by the misleading argument concerning high APRs.

The good news, however, was that the Legislature was as clumsy as they were stupid. This is always the case with government. The Legislature demanded that payday lenders find other ways to make loans, and they did. They opted to offer loans under another statute that were less expensive for consumers, but didn’t make lenders enough money. So lenders offered loans in the form of a check, and gave customers the option of cashing the check elsewhere or cashing it in the payday loan store for a check-cashing fee. Those fees were not limited by law. So payday lenders were able to stay in business earning what they earned before.

In 2010, politicians attempted to make further political hay out of the situation by passing a bill in the Assembly designed to “close the check cashing fee loophole”. Never mind that they TOLD payday lenders to find other ways to lend money and that was what happened. The good news was that the Senate apparently had reached their limit on the issue and declined to take up the bill.

What is the outlook for payday loans in Ohio? They are probably safe. The new governor is a Republican. The GOP controls the Legislature. Unless there is another overtly political reason to take on this issue, payday lenders and their customers should be able to breathe easy.

Nevertheless, some customers do get caught up in this cycle. It raises a central question concerning not just payday loans, but of all consumer products. That is, should consumers be capped as to the number of loans they may take out in a given period, for their own protection?

The argument of the payday loan opponents and those who believe in the Nanny State, is that consumers cannot take care of themselves. This elitist position is centered around the concept that people are too stupid or unsophisticated or uneducated to know whether or not to take out a loan. The problem with this idea from a philosophical perspective is that it also must, by nature, assume that consumers are also too stupid or unsophisticated to determine what is best for them regarding anything. The moment an artificial cap is put into place, it restricts consumer choice. This is tantamount to a price control, and history has shown this doesn’t work. Banning alcohol during Prohibition didn’t dampen demand, and created an expensive black market with decreased product quality.

By reducing credit supply without a change in demand, the loss of payday lenders forces consumers to seek other forms of credit, which usually means vastly more expensive bank overdraft fees. You cannot legislate behavior. Just as during Prohibition, demand will continue to exist for credit.

Government cannot artificially limit the number of loans someone takes out. First, the rule is arbitrary. How many loans is “too many’, and what period is “too short”? Why do consumers need government to tell them what they can and can’t do? Restricting credit access in the name of “protection” runs contrary to the very concept of individual liberty that America was founded on.

The legendary Milton Freidman, in his landmark book Free to Choose, wrote that people can take care of themselves. They know what’s best for them. If they make a mistake, then they will learn from it and not do it again. With payday loans, if someone does end up in a cycle of debt, they’ll learn not to do it again. Since the legitimate payday lenders also offer extended payment plans for those who borrow irresponsibly, then what’s the problem?

An arbitrary government restriction also creates an unintended consequence. There are plenty of people, especially during these hard economic times, who need repeated access to short-term credit. The government’s attempt to protect people in fact makes things much worse. If someone can’t get another payday loan, then they’ll find a way to do it anyway. Or they’ll find a more expensive source for credit.

Government should not limit the number of loans or rollover a customer uses for payday loans. It’s not government’s business. People are capable of making their own decisions.

So what exactly does the CRL do? It is the PR front for the Self-Help Credit Union. CRL was founded in 2002. Under CEO Martin Eakes, the CRL has created a massive lobbying and PR machine purportedly to expose unethical financial industry practices on behalf of its parent company, the Self-Help Foundation.

CRL’s approach is to try to get payday loans banned. One strategy they use is to publish bogus studies to sway public opinion and legislators. One of the most infamous of these studies was “Race Matters”. CRL’s study claimed that cash advance stores target minority neighborhoods – the implication that payday lenders were racists taking advantage of minorities. The study not only plays the race card, it does so by assuming another falsehood to be true – that payday loans are predatory when they are not. Dr. Thomas Lehman, who conducted several scientific studies on payday lending, said that the research “contains severe weaknesses and presents conclusions that are overstated at best, and misleading at worst…the tone of the study suggests a lack of objectivity motivated by an ideological bias against the payday lending industry”.

But the CRL doesn’t always rely on the race card. It usually just uses sloppy research and methodology. In the study “Financial Quicksand”, it concocted 20 questionable assumptions and 50 estimates, all from data that did not represent the actual demographics of the U.S. population. The study also authoritatively states that taking out five or more loans a year is “flipping” them back-to-back. Not only is this a false assumption, it denies the fact that many states prohibit loan flipping.

Once CRL gins up legislators with bogus research and inflammatory rhetoric, they try to get loans passed that effectively ban payday loans, such as instituting a 36% APR rate cap. CRL was behind legislation that killed payday loans in North Carolina, insisting all along the way that its credit union would take the place of payday loans.

What developed instead was the opposite. With the payday loan option removed, consumers were forced into more expensive overdraft fees. A study by Donald Morgan from the New York Federal Reserve concluded that, “Compared with households in states where payday lending is permitted, households in Georgia have bounced more checks, complained more to the Federal Trade Commission about lenders and debt collectors, and filed for Chapter 7 bankruptcy protection at a higher rate. North Carolina households have fared about the same. This negative correlation—reduced payday credit supply, increased credit problems—contradicts the debt trap critique of payday lending, but is consistent with the hypothesis that payday credit is preferable to substitutes such as the bounced-check “protection” sold by credit unions and banks or loans from pawnshops.

The Institute for Liberty concluded that “under the CRL’s lending reforms, North Carolina leads the U.S. in foreclosures. In a year-over-year comparison, the state’s foreclosure rate outpaced the nation with a whopping 146% increase vs. 94% nationwide.” And what a shock – the Self-Help Credit Union benefited from these increased borrowing costs. I guess that’s what they meant that they would fill the borrowing gap in North Carolina.

Other studies have come to the same conclusions about what happens when payday loans are banned. A 2008 study from George Mason University announced that such bans reduced consumers’ likelihood of surviving financial crises. They concluded that having the payday lender option increased a borrower’s probability of “financial survival” – paying for necessities like housing, groceries, utilities and other bills without facing economic collapse – by 31 percent.

Of course, this is all in service of Self-Help’s own agenda of getting customers into its own credit union.

CRL had succeeded in pushing through short-term payday loan bans or interest rate “caps” in New Hampshire, Montana, Ohio, Oregon, Virginia, Arkansas, Georgia, and North Carolina.
 Meanwhile, Despite its legal status as a nonprofit, CRL’s has increased its assets from $900,000 to $4.5 million, and its annual revenue rose from $1.95 to $6.1 million. In addition, CRL spent $1.7 million lobbying for bankruptcy and finance laws from 2004 to 2007, and more than that in subsequent years. It’s curious behavior for a “non-profit”.

Curiously, Self Help has some predatory practices of its own. Its credit union’s loan delinquency rate is 6 times that of its peers. Meanwhile, while pretending to advocate on behalf of its low-income clients, it drags them into court if they are late on loans as small as $100.

But that’s small potatoes. The billionaire founders of the CRL, Herb and Marion Sandler, pioneered the exotic mortgages that caused the financial meltdown. They made $2.3 billion on the sale of their company to Wachovia in 2006. One of CRL’s largest donors also made a fortune off Americans’ mortgage woes: billion-dollar hedge fund manager John Paulson. He shorted the subprime market – the market that the Sandlers helped create.

While the CRL was attacking “predatory” mortgage lenders, the Sandlers were purveying their option-ARM, or “pick-a-payment,” mortgages, at the heart of their Golden West Financial/World Savings Bank empire. These mortgages allowed thousands of Americans to acquire more debt than they could afford by making monthly mortgage payments smaller than their interest charges.

We know what happened to those folks. They defaulted on their mortgages and the financial meltdown began. But as the housing bubble burst, the Sandlers managed to fob off $120 billion of these garbage loans to Wachovia, and then sold their company for $2.3 billion. It may not have been a Ponzi scheme, but just as many people got screwed.

With all the information about CRL available, it is amazing that legislators still try to make political hay on the backs of Americans who need short-term credit. Instead of listening to an obviously corrupt organization, politicians should listen to the people who matter – borrowers who are smart enough to make their own choices.

So what’s going to happen? This article will try to advance some possibilities – both optimistic and pessimistic.

It’s impossible to say right now how it will all turn out. It’s even possible that the new Republican-controlled House will try and pass legislation to restrict the new Bureau’s powers. However, with a Democratic Senate and President, it seems unlikely the new Bureau will be restricted or defunded. Nevertheless, American Banker magazine said “Senate Democrats, who remained in control despite a narrow majority, acknowledged the vote was a call for more moderation and consensus, but warned their House colleagues not to re-fight unwinnable battles.” One interpretation is that a call for moderation will give payday loan lobbyists the opportunity to be heard. By presenting their honest and convincing case for payday loans, the CFPB may rein in any attempt to over-regulate the industry.

The other positive aspect to the creation of a whole new bureau is that it will take time to implement any new regulations. Furthermore, the call for moderation buttresses the interpretation that any bureau will act cautiously and make certain that what they do isn’t overly-restrictive. American Banker points out that, “The CFPB will have to acquire real-world data on a variety of financial products and their impact. Examining credit cards alone will need data elements ranging from credit card products, terms, fees, outstanding debt, average percentage of debt per household, demographics of households and so on. Another large data segment comprises the list of “covered persons.” The bureau needs to manage master data elements, such as covered entities and products, to fully understand relationships, hierarchies and exposures. In addition, the research department in the CFPB could have potentially more wide-ranging data acquisition needs.”

This suggests that it may take a long time to really learn the details of payday loans before any regulation is presented.

The final optimistic angle is that The Baltimore Sun’s blog stated that Warren’s top three priorities will be to, “Make it easier for families to see the costs and risks of mortgages they are considering. Cut down on the fine print of credit card agreements. Use technology to tap into the experience of millions of consumers so the bureau can develop a rapid response to problems.”

There’s no mention of payday loans in there.

But there is a pessimistic side to the equation. We have to look to the words of Elizabeth Warren, who was hired to be the architect of this new Bureau. Warren has been outspoken about payday loans in the past.

““From subprime mortgage loans to small dollar loans, [non-banks] showed how to wring high fees and staggering interest rates out of consumer lending. Their fine-print contracts, and new tricks and traps, transformed the market.”
I presume she refers here to payday loans. Clearly, Ms. Warren has not set foot into a payday loan store. If she had, she would first learn that all fees on payday loans are disclosed in large text per TILA requirements. I and others have written many times about the false characterization of payday loan fees as “high” or “staggering’, and won’t reiterate that here. In addition, payday loans have no “tricks and traps”. You take a loan, it’s due on your next payday. It’s that simple, and everyone who uses a loan knows that.

This again speaks to the need for research prior to regulation.

But I digress.

On the pessimistic side, the Bureau may not have the power to cap interest rates, but it can do just about everything else, including limit the number of loans a person can take out – even down to one per year. The language of the Dodd-Frank bill, which created the CFPB, gives the bureau broad powers.

This exhaustive list of the CFPB’s power can be interpreted many different ways. The CFPB may be able to create all kinds of unpalatable requirements for payday lenders. While Ms. Warren is not the official director of the CFPB, it isn’t a huge leap to suggest that the architect of the bureau could very well get nominated and confirmed as its chief. Worse, she has stated disdain for non-banks. If she wants payday loans dead, they’re dead.
Here’s one example: The CFPB can call payday lending businesses abusive if they “takesunreasonable advantage of (a) the lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service; (b) the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service.”
It can call payday lenders “unfair” if “the practice causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers and … is not outweighed by countervailing benefits to consumers.”
Imagine the most restrictive interpretation of these phrases!

A lot of what happens may ultimately depend on who actually runs the CFPB. As I said, I’m concerned that Warren will be the obvious choice. The Credit Union Times feels the same way – and when credit unions are worried about regulation, you know there’s a lot to be concerned about.

“Putting aside her unorthodox selection process, having Warren molding the powerful new agency that has the authority to prohibit financial product offerings and control prices confirms my worst big government nightmares. Like many other financial services industry executives who have been following the CFPB saga, I had hoped that the unwanted agency’s leader would not be a partisan activist, but rather someone who would work effectively with all constituencies – including the industry and the other regulatory agencies. With her frequent accusations of financial services providers’ “tricks and traps” and her punitive crusade against traditional banking “bullies,” she is expected to act more like a rogue cop with a chip on her shoulder than as an even-handed and fair referee in a complicated marketplace.”

The bottom line is that tremendous uncertainty exists in the payday loan sector. One thing is very likely, however. Online payday lenders may be able to escape regulation. Many of them are now located offshore. This means they are not subject to U.S. regulations. In the worst case scenario, consumers in need of a payday loan should always be able to get one on the internet.