Thursday, October 23, 2008

Credit Part II: An Economist's Take on Ohio Issue 5 To Cap Pay Day Loan Interest

Sorry about the lack of blog posts, I’m learning how to advise students this week. So back to the credit market. This November Ohioans will be voting on a cap of interest payments for loans. As I noted in a blog post over a year (one of my first at Towson), interest rates at payday loan locations can approach 400% per year, the cap on the ballot is 28% a yea.

The Toledo Blade argues that voters should vote against the cap because “Opponents would have voters believe that 6,000 jobs will be lost if H.B. 545 goes into effect because payday lenders can't keep their doors open charging "only" 28 percent interest. They say the issues at stake are financial freedom, privacy, and not limiting lending options.”

As I noted in my previous pay day loan post, there are more payday loan operations than McDonalds in Ohio. In my home town of Delaware, OH its 4 McDs compared to 6 check cash/ pay day loan locations. Economic theory would dedicate that if one of them could still make money by charging 50% interest they would and could likely garner all the business by advertising lower prices.

Since there are many payday loan companies and anyone can start one, it is likely few loans will get made at a 28% interest rate.

I’m reasonably sure these payday loan jobs will be lost, people will no longer be able to get loans. From a pure economic theory stand point, we must believe that either people would be better off having the option of a payday loan or that people are not very good at making their own decisions so eliminating payday loan operations would be a net improvement.

I no longer live in Ohio, but I spent the first 18 years of my life there. I’m not sure how I would vote, because I see both beliefs.

Next post (hopefully tomorrow), I will compare payday loans with microcredit in developing countries. Why is that small loans in developing countries have lower interest rates (100% per year) and why are these loans more likely to be repaid.

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Steve said...

Thank you for your post on payday lending in Ohio. You're absolutely right that interest rates approach 400% APR - 391% APR to be exact. I disagree with you, however, that these places would choose to charge only 50% APR. The fact is that there are over 1,600 payday loan shops in Ohio and they ALL charge 391% APR. They won't charge less than that unless they are forced to - currently they are the only small loan lenders exempted from Ohio's usury rate of 25% APR. These loans are meant to trap borrowers in debt, not build wealth. I think that will be the biggest difference between the micro lending you may describe in your next post. Those are meant to extend credit to potential entrepreneurs who will build their wealth and grow their businesses. Payday loans however, are based on one purpose: trap someone in debt who has a paycheck coming every two weeks. I think this business model is fundamentally flawed and it's success is dependent upon the necessity of borrowers to keep coming back for months on end. That's morally reprehensible. I'm voting YES on issue 5!

Dan said...

As a pimp and sometime loan-shark, I'm voting YES on issue 5! Since I make my living off of prostitution -- something that's banned by law but has shockingly not gone away -- it's clear that the more we can push things out of transparent, regulated markets where participants in a contract have access to legal remedies if things go wrong, the more money I can make.

My brother the pot dealer agrees with me 100%.

Once small loan places are closed down, I look forward to servicing their customers, who will have no less of a need for short term loans. Of course, I'll charge even higher interest rates than the legal shops, and if they don't pay up, we have ways of getting our money back. They involve crowbars and car batteries. I anticipate a high level of success in my collections.

I'm also thinking about opening up a used car lot. Because as we've seen in other states that pass similar bans, when people need a short-term loan and can't get it through legal means and don't want to go to what some might call the "underworld of organized crime and street thugs," they're likely to sell their cars at fire sale prices.

So in short, as a criminal who preys on the weak, I look forward to the additional business that the well-intended but economically-illiterate backers of this ban will give me.

Esther said...

Thanks for covering this, Seth. If you have time, I'd love to hear your thoughts on Ohio's (most recent) casino issue:

Trista said...
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Dollars & Sense said...

Dan's satirical post is funny, but the only thing that it shows is that it wouldn't be a good idea to shut down usurious payday loan outfits without making sure there is a good alternative for people who need short-term loans (e.g. establishing limits to the interest on loans, as the Ohio bill proposes, or encouraging community-based lending institutions like credit unions). The bigger point is about why we have an economy that puts people in such dire straits that they need payday loans, check-cashing services, etc. etc. Answer: stagnant wages, underemployment, etc.

YesOn said...

We need to regulate the pay day industry. They prey on people who can't afford their ridiculous interest rates - no one would choose to pay 400% interest if there was another option. This was a good law when the legislature passed it and we should leave it in place.

Eriq @ OWU said...

I believe that everyone is focusing this matter way too heavily on the effects the passage of the issue will have on the lenders and not enough on the borrowers. It is true that there are people out there who truly need these payday loans, but then there are people who use them to live beyond their means as well, and that’s what gets people into trouble.

Maybe the disappearance of payday lenders will be for the best because people will be without these high APR loans to bury themselves in debt to buy a brand new hi-def flat screen television. The issue with payday lenders, in my opinion, isn’t the interest rate on the loans but the irresponsible use of the lending service. If you do the math of a $500 loan over 14 days at 391% and it works out to be about $75 in interest. That is high, but it’s not unmanageable if the borrower is responsible.

I personally am voting yes on the issue because I believe that there will still be at least a handful of payday lenders that will serve the market, but I also believe that the lack of lenders will force people to be more responsible with their money and not be investing frivolously in items they don’t need with those loans.

Mike F said...

I am voting no on issue 5, I don’t view this as a market failure and therefore I do not believe that the government has the responsibly to step in and interfere with the market in this case. The borrowers for these payday loans write post-dated check where they know exactly how much they will owe in a week or two weeks. There is no fine print that the borrowers can claim that they did not know what they would have to owe. If you believe that the government should protect people from themselves than that is your belief but I personally believe that the public is better off with the option of payday loans than not having the option.

Esther said...

Thought you might want to read this piece from the Northeast Ohio Coalition for the Homeless on Issue 5:

They support it.

Kara said...

I am so sick and tired of the government trying to regulate everything Americans do!!! What is next? Are they going to tell me how many pairs of shoes I can own, or how many credit cards I can have. They are already trying to put the payday loans business out of business. At least my local payday lender has cash on hand, which is more than can be said about banks these days.

Steve said...

Have you heard? The grand total of jobs lost has reached only 225! Not exactly the 6,000 jobs the industry was claiming. Just goes to show you that you can't trust ANYTHING the payday lending industry tells you. What Issue 5 has done is protected hundreds of thousands of Ohioans from the abusive and predatory practices of the industry and prevented them from getting trapped in debt!

I'm glad Ohio voters saw through the lies and deceptive advertisements of the payday lending industry and voted overwhelmingly (2 to 1) to pass issue 5! This is a very positive development for Ohio's families, communities and our economy. Ohioans realized that payday lending is a defective and predatory product designed to trap people in debt. Voters strongly repudiated over a decade of predatory payday lending! This is a great victory for Ohio's consumers.