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Why DOJ's 'Operation Choke Point' Is Necessary

During a recent conference in Birmingham, England, I spoke with a self-described high-cost credit seller.

"Price is not important to customers anymore," he told me. "We offer what banks don't: money, as few questions as possible and speed".

His conclusion: "That's what the business should be based on".

Pundits have long debated whether the payday lending industry competes less on price – the rather standard rule of competition – and more on speed. The distinction is important when it comes to discussing the Department of Justice’s much-maligned "Operation Choke Point," which aims to prevent online fraudsters from accessing consumer bank accounts by choking off their access to the payments system. Online short-term credit providers, or, as they are often referred to, payday lenders, have come under scrutiny as a result of the operation. 

Former Federal Deposit Insurance Corp. chairman William Isaac recently called the investigation "an attack on market economy." But, before drawing this line the sand, one must consider: do these businesses – and payday lenders particularly – work in a way typical to the market economy?

Unfortunately in the U.S., there has been little research looking at payday loan price variation. One of the few attempts was carried out by Robert DeYoung and Ronnie J. Phillips at the Federal Reserve Bank of Kansas City back in 2009. Noting the lack of evidence that preceded their analysis, DeYoung and Phillips found, rather counter-intuitively, that lenders begin by charging lower prices to first-time customers and raise prices to repeat borrowers. (So much for the notion that upfront high costs are related to risk.)

Another part of the study found loan prices gravitated towards the rate ceiling, if not initially, then over time. Given that there are more than two payday lending storefronts for every Starbucks, one would imagine that, under usual circumstances, price would be determined by competition. But it is not: payday lending from the outset is contrary to usual rules.

This complicates things for the Consumer Financial Protection Bureau, which was created to ensure the consumer benefits from a healthy and competitive financial sector. The CFPB may well wish to see uniform laws on payday or online lending widened in the future, but right now it operates without jeopardizing state laws.

A CFPB researcher also told me recently that, much to their relief, tribal lending – another recurring source of concern among regulators – is out of their purview.  The expression of relief was not surprising. Issues around tribal lenders and tribal sovereignty are clearly sensitive.

But the differences in state laws and the complications surrounding tribal lending regulation illustrate why Operation Choke Point (Yes, I hate the name, too) is necessary. It serves as a means to see that federal and state laws are not circumvented by predatory lenders.

Critics have said that by aggressively targeting the online payday lending business, the DOJ has forgotten the original purpose of its operation. But that’s not true. Its initiative is not about viewing all online payday lenders negatively, as Mark Pearce at the Federal Deposit Insurance Corp. recently said, but about preventing banks that are equipping online lenders, whether knowingly or not, with finance to lend to people in states where such lending is prohibited.

A central issue here is that, clearly, banks don't know enough about their customers.

In another recent BankThink, Barry Brandon of the Native American Financial Services Association, argued that the "behind-the-scenes attempt to shut down legal tribal businesses, by the DOJ, has disrupted our long-held tribal-federal partnership." But I would counter that it is the tribal lenders providing high-cost finance to households in states outlawing such loans that have disrupted this relationship.

Earlier this month, a U.S. District Judge upheld a ruling that Federal Trade Commission consumer protection laws apply to businesses affiliated with tribes. This means any predatory lenders associated with tribes cannot use sovereignty as a get-out – and that is a good thing.

These lenders may be legal in so far as they operate from a sovereignty that allows them to do so. But what happens when these lenders run afoul of rules and restrictions in the states or jurisdictions they are not based in? New York’s chief financial regulator Benjamin Lawsky’s crackdown on online lenders via ACH access, for instance, makes more sense when you consider his state prohibits payday lending.    

Without using the banks as middlemen here, as with Operation Choke Point, we would stand little chance of repairing the very broken payday loan industry.

Carl Packman is a writer, researcher and blogger. His book, "Loan Sharks: The Rise and Rise of Payday Lending," was published in 2012 by Searching Finance. 


(10) Comments



Comments (10)
The part of the article that should catch the attention of anyone trying to fairly understand this issue is the fact that there are "two payday lending storefronts for every Starbucks". The enormous demand for this product is clear proof that there is a lot of need and the payday lenders are the ones taking care of those customers for now. Anyone with a better idea of how to serve these customers has a tremendous opportunity and should jump into the market without delay. As for the states, they no longer regulate the vast majority of credit used by their citizens and the credit markets would collapse if they did. The credit card system could not function if it were subject to 50 non uniform state laws plus the federal and international laws that apply. Avoiding state regulation is not wrong or even a fringe activity, it is a functional necessity and the norm in this nation.
Posted by gsutton | Thursday, April 10 2014 at 8:16PM ET
Completely agree with MikeDP. This guy is a clown and you shouldn't let him write for your pub.
ChokePoint is illegal. Its caused serious harm to companies and individuals. I run a bank, I know. At it won't stop with payday, as MikeDP points out.
Short term or payday lending is very necessary. Ask a borrower. He's happy to borrow $400 on the 1st and pay back $500 on the 30th. It allows him to fix his transmission and get to work to keep his job.
Posted by Mr Drysdale123 | Wednesday, April 09 2014 at 11:43AM ET
"@Pola: ...payday lending is lifeline for lower income groups..." - I've never met a financially literate person who would describe the payday lending as a lifeline. More like a noose. I have issues with the DOJ on this subject but let's be real the growth of payday lending, title loan services, pawn shops and "Rent to Own" operations are symptoms of a much larger economic disease. Namely, real earnings of an ever increasing number of citizens are not sufficient to cover the cost of participating in the mainstream marketplace.
Posted by JamesHenry | Monday, April 07 2014 at 11:11AM ET
Carl Packman is the dictionary definition of a "useful idiot". I am sure he is sincere, but his bias is off the charts. Unfortunately, some agencies use people like Packman to justify outrageous actions.
Commo Banker
Posted by commobanker | Friday, April 04 2014 at 4:51PM ET
MikeDP: I am reminded of a quote from John Stuart Mill. "He who knows only his own side of the case knows little of that." BankThink publishes a wide variety of viewpoints on industry issues, sometimes from people outside the industry, to foster a healthy debate.

For the record, we have also run opinion pieces highly critical of Operation Choke point by Bill Isaacand Peter Weinstock , among others.

And personally, I share your concern about government officials using the financial industry to surreptitiously smother disfavored but legal industries. There is always the chance, however slim, that you and I may be wrong. The truth will out in a free marketplace of ideas. Regards, MH
Posted by Marc Hochstein, Editor in Chief, American Banker | Friday, April 04 2014 at 4:06PM ET
One of the reasons that payday lenders tend to gravitate to the state-imposed price cap, is because of the price cap itself. Economists have long known that rate-setting can serve as an unconscious form of "signaling," whereby firms can unwittingly collude with one another without any actual collusion. Even though it might make more sense for firms to compete based on cost, because of the price cap, they fail to do so. You see it wherever rates or prices are set by the government. That's one reason why economists generally do not believe in setting rates or imposing price controls.
Posted by XYZ1 | Friday, April 04 2014 at 3:58PM ET
AmericanBanker, why would you let someone who is a self-admitted Marxist and has no real knowledge or experience in consumer finance much less finance in general contribute to your site? He is openly biased and routinely distorts facts and numbers to his favor. This completely takes away from your credibility as a knowledgeable and reputable financial publication.

Operation Choke Point was a back door way for the administration to try and kill industries they don't like, including gun manufacturers, ammunition manufacturers, payday loans, some installment loans, some pre-paid debit cards, etc.
Posted by MikeDP | Friday, April 04 2014 at 3:39PM ET
Whatever the merits of payday lending (and I offer no opinion on the subject), Operation Choke Point is not merely about that one industry. Remember, the "choke point" in Operation Choke Point is not the payday lender, nor is it any other merchant. Rather, the choke point is the bank or payments company that provides merchants the ability to accept payment from their customers. The bank or payments company is a choke point because, in the view of DOJ and other regulatory agencies, if they can "choke" off access to financial networks, they can stamp out whole categories of merchants. Today it may be payday lenders, but what merchant category will it be tomorrow? If Congress wants to outlaw a particular product or service, it can pass a law to do so. And if law enforcement wants to pursue a fraudulent merchant, we will support that wholeheartedly. But where Congress hasn't made offering a particular category of product or service against the law, it is troubling to see federal agencies pursue enforcement actions against banks and payments companies for providing lawful service to those merchants.

Jason Oxman
Electronic Transactions Association
Posted by Joxman | Friday, April 04 2014 at 3:34PM ET
Kinda missing the point. There is no objection to enforcing the law. The objection arises when the law enforcement folks DO NOT enforce the law but expect banks to do that job for them. That is inappropriate. It gets even worse when no law has been broken and authorities want to pressure banks to throttle activities that the authorities just do not like. Where does that ever end?
Posted by WayneAbernathy | Friday, April 04 2014 at 3:34PM ET
What you fail to understand is that this "crackdown" is not based on any laws or regulations but only on guidance. What you have a problem with is the high-interest rates associated with online payday lending. What you do not realize is that payday lending is lifeline for lower income groups (which banks do not cater to). In a similar article I read, it was suggested those who use payday lending should suck up their pride and ask friends or family for the money instead... not realizing that friends and family are often within the same economic bracket and do not have the money to spare. This article demonstrate a lack of understanding of the current legal and financial regulatory environment - you should be calling out the government to regulate interest rates (not just of payday lenders but of banks as well). The government knows that such regulations will never happen, because such laws would never get passed because they do infringe on a market economy. And that's why the government is using Operation Choke Point as their back door to suggest that certain actions be taken against certain merchants and industries.
Posted by Pola | Friday, April 04 2014 at 1:54PM ET
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