SEPTEMBER 2007: ECONOMIX
The payday lenders weren’t the problem
BY TOM
POTIOWSKY
|
ON JULY 1, a number of bills directed at short-term lenders
(“payday” and “title” loan companies)
took effect. The purpose of the bills was to stop the
“unfair” interest charges for very short-term
loans. Basically, with fairly strong public support, our
lawmakers felt that these short-term lenders were preying on
the unfortunate who were facing cash-flow shortages. So they
capped the interest rate and fees that could be charged.
But if we look at the economics behind this industry, we may
find a different story as to whether the government has truly
helped those in need.
Private markets are amazingly efficient. When they work
properly, people get the goods and services they desire at the
lowest price. But as great as private markets can be, they
don’t always work as planned and then government
sometimes is needed to do the job.
Back to the short-term lenders. At the end of 2006, there were
346 licensed short-term lenders. For a 14-day loan period, the
Division of Finance and Corporate Securities found that the
average finance charge per $100 was about $18.83. This works
out to an annual percentage rate of around 491%. Would not any
reasonable person call this a market failure?
Not so fast.
For the short-term lender market to be a market failure, one
party has to have more (or less) information about the other
party and the details of the transaction. Short-term lenders
are regulated so the finance charges, duration of loan,
collateral and all the terms of the contract are upfront. But
who is likely to go to a short-term lender? Those who are
strapped for cash for making payments that are due now. How
creditworthy are these people? Not very, or too difficult to
tell on short notice, so the lender charges a higher interest
rate than conventional lenders. Is this a market failure? No,
not in the economic sense. There is a short-term need for cash
by the demanders, and the short-term lenders, the suppliers,
provide a service to meet this demand. The market is working
very efficiently to satisfy people’s wants and
desires.
You really have to stretch logic to claim that this was a
market failure and necessary for government to intervene. The
bills passed by the Oregon Legislature go after the supplier to
supposedly help the demander, and so far cutting the supply
seems to be working. As of late July, 102 licenses had been
surrendered and this number is likely to climb. The remaining
short-term lenders cannot charge more than 36% interest, plus a
10% loan origination fee up to $30.
But has this helped the demanders, those who find themselves
strapped for cash? They have fewer places to go for a loan and
the lenders still in business will be very choosy. The
supply has been affected, but not the demand.
I think the short-term lender market is a society failure, not
a market failure, and that’s why government got involved.
The outrageous interest rates would not have existed if people
were not willing to pay them because of their economic
situation. Markets are nondiscriminatory. They do not care if
one party made bad financial decisions in the past.
Thus going after the short-term lenders will not truly solve
the problem. We have to recognize the role of the consumers
whose tough economic conditions brought them to this market and
ask what we can do to assist them. There are many education
programs available from both government and private agencies.
One that I am very familiar with is the Oregon Council on
Economic Education (I sit on its board). We need to help
families make better decisions concerning their financial
well-being. If we do, short-term lenders charging 491% will
disappear on their own.
No one supplies if no one demands.
Tom Potiowsky is an economics
professor at Portland State University and the former state
economist.
Have an opinion?
E-mail feedback@oregonbusiness.com
