Regulators in many states seem to have made up their minds on payday lending. Either through usury limits or full on bans of the practice, payday lending is illegal in at least a dozen places. But are these restrictions really in consumers’ best interests? It’s an important question for many of the estimated 60 million Americans who are underbanked — and for those in the payments industry trying to provide financial services to those Americans.
It’s also a question that’s been studied by Don Morgan, Assistant Vice President at the Federal Reserve Bank of New York. His answer is one typical of a super smart economist working squarely in the public eye: in essence, it’s not that simple, he says.
Morgan says regulators look “askance” at payday lending for three reasons: one, it looks expensive; two, it looks like it might target certain groups of people; and three, consumers who roll over their payday loans might fall into a debt trap.
The first argument is disputable because payday lending is an extremely competitive market, Morgan says. In other words, if payday lenders were making boatloads of profit, in theory a competing firm would come in and undercut the high-profit price, until marginal revenues got fairly close to marginal cost. As for the second point, Morgan collaborated with Kevin Pan on an extensive argument at the NY Fed’s blog.
The third argument is harder to refute. In fact, if it can be shown that payday lending does “overtempt” certain households into sacrificing future financial stability for short-term spending flourishes (Morgan calls this “present bias”), then regulation is warranted.
Unfortunately, hard evidence of “overtemptation” is hard to find. Instead, Morgan’s most recent publication on the subject — “Payday Credit Access, Overdrafts, and Other Outcomes” — looks at one specific way in which payday lending might actually help consumers. Morgan’s research shows that, in states where payday lending bans are put into effect, banks report an increase in overdraft fee revenues.
The paper is available at the New York Federal Reserve’s website.
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