NY Federal Reserve Bank staff decide payday loans are NOT predatory

Sounds like you think people of moderate means shouldn’t have credit made available to them.
Not everyone has bank accounts and credit cards; many in our society live paycheck to paycheck, and when an unexpected expense (car repair, medical bill) comes along, they have nothing to fall back on. The average person is more intelligent than he is assumed to be, and when hard times come, he knows what he has to do. More than 90% of payday loans are paid when due, and 85% of users report they were “highly satisfied” with their payday loan experience. Banks can’t afford to offer these small, unsecured loans (payday lenders earn only 99 cents on a $100 loan!) so where is a person with no options to turn? Responsible lenders who support regulation are a far better choice than eliminating the option so that borrowers are forced to go to the unregulated Internet or “underground” where the fraud really is.

Greetings,

The URL above takes you to my staff study “Defining and Detecting Predatory Lending.” Please note that Sam Hanson is not a co-author.

Sincerely,
Don Morgan

Greetings,

My staff study “Defining and Detecting Predatory Lending” is at
http://resnet.re.ny.frb.org/applications/pubs/cgi-bin/pubcoding1.cgi?id=1966

N.B. 1) Sam Hanson is not a co-author. 2) Staff Studies do not necessarily represent the views of the Federal Reserve System

Sincerely,
Don Morgan

Don: The URL in my post goes to an article entitled “Predatory Lending?” from 9.9.2005, with Samuel G. Hanson and Donald P. Morgan listed as authors. The link you posted was dead when I tried it, but I assume it goes to the article I referenced in my first paragraph. If I wasn’t clear, the two are different articles, but appeared to me to be related in reasoning and thrust, from what I could tell from the ABI blurb I read.

Thank you for your clarifications.

Jay: I think you are jumping from my comments to a conclusion I didn’t intend. Yes, people of all means should have access to credit. But the fact that credit is available to them does not enhance their welfare. It increases their options, in some cases, but also their risk, which is especially dangerous if they are not aware of the risk.

I am also in favor of regulation. If 90% of payday loans are paid when due, then how do payday lenders justify APRs of 300% to over 1000%? If a lender makes only $.99 on a $100 loan, where does the rest of the fee go? I’ve never heard of a fee that low for a payday loan!

The report seems to have placed little or no value on the cost of the credit, which is the source of complaints with payday loans. We do not live in a financial world free of transaction costs.

PayDay One, for example, charges $1/$100 borrowed/day, or a 365% APR. That’s $14 on a $100 loan for 14 days. How can the lender make only $.99 on that, especially given the likelihood that borrower will roll over the loan for another 14 days for another $14? Those numbers aren’t too far off of what brick-and-mortar payday lenders charge in many states.

Here is what appears to be the study’s answer, taken from RTOonline.com (I have not been able to find a copy of the full study):

Price does not make payday loans “predatory”: limiting access raises prices

“Higher prices are neither necessary nor sufficient to conclude that a certain class of credit is predatory.”

“We find somewhat lower payday prices in cities with more payday stores per capita, consistent with the hypothesis that competition limits payday loan prices…The problem of high prices may reflect too few payday lenders, rather than too many.”

“Before payday lending…very small, short-term loans may not have been worthwhile for banks. Payday lending technology may have lowered those fixed costs, thus increasing the supply of credit…That suggests the payday innovation was welfare improving, not predatory.”

Unfortunately, that does not satisfactorily address the problem. Even “low cost” payday loans have exorbitant costs. Maybe the market will right itself, but it wouldn’t hurt to give payday lenders a push in the form of regulated interest rates.

Sam,

My staff study “Defining and Detecting Predatory Lending” is at
http://www.newyorkfed.org/research/staff_reports/sr273.html

N.B. 1) Sam Hanson is not a co-author. 2) Staff Studies do not necessarily represent the views of the Federal Reserve System

Sincerely,
Don Morgan

p.s. the link in your post is to an earlier version of the article.

http://www.newyorkfed.org/research/staff_reports/sr273.html

I think I have it right now; thanks for the corrections!

[...] Last week we blogged about the Fed staff article “Defining and Detecting Predatory Lending”, by Donald P. Morgan. At the time, however, we did not have an actual copy of the article in our hot little hands Now we do. As we said before, the article posits that the availability of credit is welfare enhancing, and that, since payday loans increase the availability of credit to consumers of modest means, the payday lending industry is welfare enhancing. [...]

Sam, I think the point of the article was determining predatory pricing. The results of Mr. Morgan’s study showed that predatory pricing equalled wealfare reduction and that in the insuing markets he studied, payday loans did not create welfare reduction. The conclusion drawn is that since payday loans do not meet the criteria of welfare reduction they are not guilty of predatory pricing - his conclusion being the higher costs are more a natural affect of less competion rather than an unfair system. Rightfully so, if there was only one grocery store in a town of 250,000 then you would, naturally, pay a higher price for goods.
I believe the conclusion Mr. Morgan comes to is that payday loans are not welfare reducing - your argument that they are not welfare increasing is correct as well. They just create more available credit options.