Trust Payday Loan Borrowers to Make Decisions for Themselves

Editor’s note: A previous version of this article included incorrect figures from a 2012 Pew Charitable Trusts survey. The article has been updated with the corrected figures. 

The Consumer Financial Protection Bureau’s proposed rules governing payday loans would effectively outlaw the industry. In an economy with a daunting array of financial products, what motivates the CFPB to single out this industry for eradication? The answer is clear: the Bureau believes that borrowers who repeatedly take out payday loans are victims of involuntary or "forced" borrowing.

It is odd to characterize businesses as "forcing" products upon their customers. But the Bureau’s approach rests on the idea promoted by Sen. Elizabeth Warren and her co-author Oren Bar-Gill in their 2008 article "Making Credit Safer." Warren and Bar-Gill claim that payday loan borrowers become trapped in debt cycles because they are optimistic about their future cash flows but unexpectedly run out of cash before they receive their next check. They are then "forced" to re-borrow money to repay their loans.

Given that Congress denied the Bureau authority over capping interest rates, it makes sense that the Bureau would embrace the narrative of payday loans as an elaborate trick. The storyline of "optimism" is attractive because it supports regulation that does not attack interest rates directly.

However ingenious, the obvious problem is that payday loan re-borrowing is not forced in the least. Surprisingly for such a data-based agency, the Bureau offers no evidence that lenders "force" their customers to re-borrow. Indeed, the empirical evidence suggests that borrowers understand the consequences of their actions more accurately than the Bureau’s paternalistic mindset implies.

A recent paper of mine discusses a 2012 survey administered to 1,374 new payday loan customers. The survey asked borrowers when they expected to repay their debt and be free of payday loans for an entire month.

The borrowers were realistic about their prospects. About 60% predicted how long it would take them to become debt-free within a single pay period of accuracy. The Bureau’s posited "optimism bias" did not appear; just as many borrowers were out of debt sooner than they had expected as later.

Those results match 2012 research by Center for Financial Services Innovation that shows 68% of borrowers reported repaying their payday loans no later than they had expected. A 2013 Harris Interactive survey funded by the Community Financial Services Association of America, an industry trade association, also shows that 94% of borrowers report understanding "well" or "very well" how long repaying their loans would take.

Not all parties agree with this assessment. For example, Pew Charitable Trusts in 2012 surveyed 703 borrowers who had received a payday loan in the preceding five years. Only 42% said they could afford to repay more than $100 a month, or $50 per two weeks. But the typical borrower takes out a loan of $375 and owes an additional $55 fee, meaning that he or she will owe $430 in two weeks, according to the survey’s analysis of 2011 data from payday lender Advance America.

Pew uses that finding to argue that payday loans are deceptive. The organization suggests that borrowers must be deceived when they borrow several hundred dollars from a payday lender with no expectation that they will be able to repay the funds at the end of their pay period. But in fact, Pew’s findings match my own research. Borrowers know even before they borrow that they will need loans for more than two weeks.

In truth, borrowers whose repayment schedules are consistent with their expectations before they take out loans have not been duped into protracted indebtedness. Yet the Bureau moves toward eradication of payday loans — a move that will inconvenience the large share of borrowers who use this form of credit with their eyes wide open.

People face innumerable choices every day. They must weigh employment opportunities, competing health plans, cell phone contracts and college admissions offers. All of this requires a dizzying array of multi-factor comparisons. No doubt some of us make choices that go against our best interests at least some of the time. But even if we occasionally err, the solution is not to take our options off the table.

Perhaps there are borrowers who will rejoice when they learn that the Bureau has forced the closure of the short-term lenders in their local communities. But thousands of families will be frustrated as they find they lack access to funds that would allow them to repair their cars, pay for medical care or keep up with their utility bills. The Bureau’s mandate to prevent "deception" and "abuse" hardly justifies depriving those still struggling to recover from the Great Recession from access to a tool that allows them to mitigate crises in their daily lives.

Ronald Mann is the Albert E. Cinelli Enterprise Professor of Law at Columbia Law School.