Righting a Flawed Payday Loans Rule
Recently the Consumer Financial Protection Bureau (CFPB) proposed to reexamine the role of payday lenders, which are consistently cast as the villains of the financial industry. Such a depiction makes it easy to forget that these lenders are helping millions of Americans solve very real financial problems each year.
The demand for small-dollar loans won’t disappear even if we close off the legal avenues to access them. That’s why CFPB’s new proposal is a clear win for consumers, as well as for evidence-based policy.
To see why, let’s back up and take a look at the payday lending rule promulgated by the CFPB. If this earlier rule takes effect in August as scheduled, it would harm low-income consumers who need a hand up. It requires lenders to make a reasonable determination that the borrower “would be able to make the loan payments and be able to meet basic living expenses … without needing to re-borrow over the ensuing 30 days.”
Though that may sound sensible, basic living expenses are exactly what many payday loan borrowers seek to cover — meaning the rule denies them the option until their financial situation improves.
The Bureau’s own report predicted that when the 2017 rule takes effect, “Payday loan volume and revenues would decline between 60% and 82%.” It still believed, with little evidence offered, that “short-terms loans would still be available in States that allow them to consumers facing a truly short-term need for credit.”
The 2017 payday rule was based largely on feelings and beliefs rather than a body of replicable, empirical scientific research. Consumers — especially vulnerable ones with few financial options — deserve rules that arise from a thoughtful, deliberative, and objective process.
Among the valid reasons to review the existing rule: Exactly why do we need a federal payday lending rule? Every state has enacted laws regulating small-dollar loans, and they’re updated regularly. Are they somehow failing?
The Bureau never answered this question. Appallingly, it instead acted without a firm basis of empirical evidence by finalizing a rule that will override existing state laws. A good rule should sit atop a pyramid of good research. The Bureau inverted the pyramid.
The rule’s linchpin seems to be the Bureau’s interpretation of a 2014 study by law professor Ronald Mann. Professor Mann surveyed about 1,300 customers in five states, using various locations of one payday lender. No bona fide researcher would claim that the results from one study and one lender can be generalized to the entire market for payday loans. Professor Mann does not believe this misuse of science, yet the Bureau somehow does.
Professor Mann states that his data show “that about 60 percent of borrowers accurately predict how long it will take them finally to repay their payday loans.” Thus the Bureau wrote a sweeping payday rule by focusing on a subset of the borrowers who made an inaccurate prediction.
In a comment letter to the Bureau, Professor Mann vigorously objected to its interpretation of his work. He states, “…it is frustrating that the … discussion of [my] work is so inaccurate and misleading.” The Bureau admits their differences with Professor Mann in footnote 546 in the Federal Register: “The Bureau notes that Professor Mann draws different interpretations from his analysis than does the Bureau in certain instances…”
Going forward, the questions that need answers aren’t really about the lenders, they’re about the borrowers. What will people with little or no access to much-needed credit do if payday loans are no longer an option? Losing access to credit is especially costly for these consumers. When you’re broke, short-term financial decisions like skipping a doctor visit, forgoing school supplies for the kids, or bouncing a check for a utility bill can make life much harder in the long run.
In addition, who are the borrowers who are taking out a series of payday loans over the course of a year? If payday loans are oppressive debt-traps, as the Bureau claims, why do some people choose to roll-over payday loans rather than simply default? (Default is an option — lenders aren’t loan sharks.) Under what circumstances will borrowers walk away? Without knowing all, or even most, of the objective facts, we rely too much on subjective judgments.
Consumers benefit from research that is unfettered by the preferences and whims of policy makers. Economists at the Bureau, as well as independent researchers, can best inform policy makers by following the scientific method: ask questions, gather data, apply widely-accepted research methods to the data gathered, and publish replicable research results.
As the Bureau considers making changes to payday regulations, it needs to incorporate independent, critical economic analysis into the final rule. Too many people rely on access to small dollar loans to get the new rule wrong.
Thomas W. Miller, Jr. is a professor of finance at Mississippi State University and a senior affiliated scholar with the Mercatus Center at George Mason University.