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.