There are more payday loan stores in the U.S. than all the McDonald's and Starbucks stores combined. It's clear that tens of millions of consumers across the nation want and feel they need this product. It's equally clear that government policymakers believe they know what's best for consumers.
Recent actions taken by the federal government to eliminate a variety of short-term loan products suggest a strong bias against all such loans period. If so, regulators need to reconsider before they destroy a critical source of credit for families and the economy as a whole.
I want to make a couple of things clear before proceeding. Until April when I reach mandatory board retirement age, I am chairman of Fifth Third Bancorp, which is one of four large banking companies to recently abandon very popular short-term lending products in response to regulatory pressure. Also, my consulting firm has done regulatory compliance work for one or more payday lending firms. I'm not speaking for those companies.
My motivation is to help millions of unbanked and underbanked individuals gain or maintain access to short-term credit on the best possible terms to meet emergency needs through reputable financial institutions. This is a subject I have written about for over a decade.
Recent actions by the Comptroller of the Currency essentially eliminated unsecured short-term consumer loans at national banks. The Department of Justice's "Operation Choke Point" attempts to prevent banks from lending to certain online lenders. The Consumer Financial Protection Bureau is apparently gearing up to take action against online lenders.
All of this is happening by regulatory fiat against activity that's clearly legal under federal and state laws without any involvement from the legislative branch of government and without explanation of the end game. How will consumers access much needed short-term credit? What are the rules and who will determine them?
Short-term consumer loans to borrowers without good credit histories can now be provided by only nonbank financial institutions. Before regulators go any further, they should open a public dialogue to make sure they don't do a lot more harm by eliminating the few lenders that remain.
Short-term, unsecured consumer loans to borrowers with weak or limited credit histories are necessarily expensive. The millions of people who use these loans are not irrational. To the borrowers, these loans are less expensive than a series of overdrafts. They are less painful than the consequences of defaulting on an auto loan or a mortgage. They are a better deal than having the electricity and heat turned off only later to pay for having them turned on again.
Research at the Federal Reserve Banks of New York and Kansas City both show that states that eliminate payday loans immediately experience a substantial rise in these costly outcomes. Significantly, these studies also find more households file for bankruptcy when payday loans are no longer available.
Are borrowers deceived by the terms of their payday loans? Clearly, guaranteeing transparency to the borrower is critical, but research done at Columbia University indicates that most borrowers understand the terms of payday loans and are pretty realistic about how many months it will take to repay the loans and at what cost.
Payday loans are heavily regulated by the states. Some states ban them. Other states regulate the terms in various ways, including the allowable amounts. It's not clear to me that we have done nearly enough research to determine which model is best and whether borrowers will be better protected by one federal model versus the many models used in the laboratory of states.
There is a role for federal regulators. Online lenders who avoid state law are violating state law, and federal regulators could help enforce those laws. Federal regulators have long had the power to punish false advertising, and they should continue to make the terms of loans transparent and understandable. More competition should keep loans as affordable as possible, and this is something federal bank regulators can and should be promoting.
It's important that government proceed cautiously and not take precipitous actions that will force millions of underbanked consumers into far more costly not to mention unsavory and potentially dangerous means of meeting their emergency financial needs. It's past time for a good, fact-based debate about the best way to satisfy this glaring societal need and then go about encouraging reputable, regulated institutions to deliver the goods at the lowest possible price.
It's easy for government to just say "no" to payday lending. A more responsible course is to encourage reputable bank and nonbank institutions to develop and offer quality services on the best terms possible, coupled with counseling for customers on how to better handle their finances and graduate to less costly, longer-term solutions.
I'm perplexed when I watch the government force banks out of the lawful business of providing short-term unsecured loans to meet emergency needs telling the banks it represents too much "reputational risk" while at the same time encouraging banks to provide services to marijuana dealers whose activities clearly violate federal and nearly all state laws.
"Curiouser and Curiouser!" Alice would proclaim.
William M. Isaac, former chairman of the Federal Deposit Insurance Corp., is global head of Financial Institutions for FTI Consulting, chairman of Fifth Third Bancorp and author of "Senseless Panic: How Washington Failed America." The views expressed are his own.