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									                                               Commentary     June 16, 2010 • Vol. 6, No. 18

                                         Restrictions on Payday Lending Result
                                         in Worse Financial Outcomes
                                          By John Payne
                                                 In April, I attended a hearing of the House Committee on
                                         Financial Institutions in Jefferson City. Three different matters were
                                         under discussion that evening, but I traveled there to watch a
                                         presentation on payday lending — the practice of making mostly
                                         small, short-term loans at what many consider to be unreasonably high
             Summary                     interest rates, which, if annualized, often reach more than 400 percent.
                                         Such seemingly outrageous rates have led some states to cap the level
Payday loans are far from a              of interest, usually at 36 percent, and a bill to do just that was proposed
perfect source of credit, and the        in the Missouri House of Representatives during this year’s legislative
desire to protect people from the        session. However, such interest rate caps drive lenders out of business,
high interest rates that typically       leaving the people that lawmakers intended to help with even worse
accompany such loans is well-            credit options.
intentioned. However, studies
show that banning or imposing                    Payday loans are far from a perfect source of credit, and the
caps on high interest rates leads        desire to protect people from the high interest rates that typically
former payday loan borrowers             accompany such loans is certainly well-intentioned. However, good
to rely on even more damaging            intentions do not necessarily lead to good public policy. We must look
options, like utility shutdowns          at the concrete outcomes that would likely result from a law capping
and overdrafts.                          interest on payday loans.

Main text word count: 747             An article in the October 2009 issue of Reason magazine
                              explored the consequences in some detail and cited studies showing
                              that interest rate caps are detrimental to those who most need help. For
Payday loans are far from a instance, Dartmouth University economist Jonathan Zinman examined
perfect source of credit, and the effects of Oregon’s cap on payday loan interest rates in a 2008
the desire to protect people study. The most predictable consequence was that most payday
from the high interest rates lending institutions closed, but Zinman also found that people who had
that typically accompany      once used payday loans subsequently relied on even more damaging
such loans is certainly well- options, like utility shutdowns and overdrafts. Overall, Zinman
                              concluded, “restricting access caused deterioration in the overall
intentioned. However, good financial condition of the Oregon households,” and “restricting access
intentions do not necessarily to expensive credit harms consumers.”
lead to good public policy.
                                                 The Federal Reserve Bank of New York found much the same
    Show-Me Institute Mission:           thing in a 2008 study. After Georgia banned payday loans in 2004,
 Advancing liberty with responsibility   research economists Donald P. Morgan and Michael R. Strain found
   by promoting market solutions
     for Missouri public policy
                                         that, “Compared with households in states where payday lending is

                                                                                                       continued on back
permitted, households in Georgia have bounced more checks, complained             Sometimes people
more to the Federal Trade Commission about lenders and debt collectors, and
                                                                                  require money on short
filed for Chapter 7 bankruptcy protection at a higher rate.”
                                                                                  notice with no cheap
        North Carolina followed Georgia’s lead and banned payday loans in         and easy way to obtain
2005, after which Morgan and Strain found the same set of problems: “This         it. Eliminating their
negative correlation—reduced payday credit supply, increased credit               least bad credit
problems—contradicts the debt trap critique of payday lending, but is             alternative is no way to
consistent with the hypothesis that payday credit is preferable to substitutes
                                                                                  help people in such dire
such as the bounced-check ‘protection’ sold by credit unions and banks or
loans from pawnshops.”                                                            straits, and could send
                                                                                  them to truly ruthless
        The annualized percentage rates (APR) paid on the relevant                loan sharks who operate
alternatives to payday loans are frequently so large as to make the cost of a     outside the scope of the
short-term loan seem minute by comparison. According to information               law.
provided by QC Holdings — owner of more than 500 payday lending
locations across the country — the APR for a $100 credit card bill with a $37         Attention Editors and
late fee is 965 percent, and the combination of $46 in reconnection and late               Publishers
fees on a $100 utility bill represents an APR of 1,203 percent. Moreover,
thinking about any of these charges in terms of APR is somewhat misleading,       Show-Me Institute commentaries
because very few people incur such fees repeatedly over the course of a year.     are designed to be reprinted in
                                                                                  newspapers and other publications.
                                                                                  Reprint permission is hereby
        In an ideal world, no one would ever need a payday loan. But this is      granted, provided that proper credit
not an ideal world. Sometimes people require money on short notice with no        is given to the author. Electronic
cheap and easy way to obtain it. Eliminating their least bad credit alternative   versions are available at the Show-
is no way to help people in such dire straits, and could send them to truly       Me Institute website,
ruthless loan sharks who operate outside the scope of the law.          

                                                                                  We request, but do not require, that
         Before attending the hearing in April, I coincidentally checked out an   those who reprint one or more of
audio recording of Shakespeare’s The Merchant of Venice to listen to during       our commentaries notify us of
the drive. The plot of the play revolves around a moneylender named Shylock       publication, for our records:
who loans a large sum to the merchant Antonio with the contract specifying
that if the debt is not repaid on time, Shylock will be allowed to cut out the    The author of this commentary is
pound of flesh nearest Antonio’s heart, which amounts to a death sentence.        available for interviews. To speak
                                                                                  with the author or other Show-Me
        Although payday loans are far from inexpensive, no payday lender has      Institute scholars, please contact:
ever attempted to exact repayment through death or grave bodily injury.
                                                                             The Show-Me Institute
However, if we force short-term, high-risk borrowers to seek out loans from  4512 West Pine Blvd.
the criminal world, we should not be surprised if Shylock’s method of        Saint Louis, MO 63108
contract enforcement gains renewed popularity.
                                                                                  Phone: 314-454-0647
      John Payne is a research assistant at the Show-Me Institute, a              Fax: 314-454-0667
Missouri-based think tank.                                              

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