A recent study published in the Journal of Banking and Finance by Dartmouth professor Jonathan Zinman revealed that banning payday loans ended up hurting Oregon households, not helping them.
“Restricting access (to payday loans) caused deterioration in the overall financial condition of Oregon households,” Zinman wrote. “Overall the results are consistent with restricted access harming, not helping, consumers on average.”
Economists agree: Eliminating payday loans as an option for consumers has disastrous consequences for those who utilize them. We’ve already seen what happens when other states outlaw these short-term infusions of cash. It remains to be seen whether Colorado will fall into the same trap.
Comparing Oregon, which has placed a rate cap on payday loan that drove three-quarters of the lenders out of business, to Washington, which has no cap, Zinman measured both subjective assessments (i.e., how people felt) and more objective measures like employment status. He found that people fared worse in both regards.
Think of it this way: You’re living paycheck to paycheck but have a steady job. One morning, the radiator in your car goes kaput, putting you in a bind. With no savings it will be impossible to get the car repaired. For most Americans, no car means no transportation and no job.
A short-term payday loan, however, gives you access to instant cash allowing you to repair your car and keep commuting to work. Removing that source of credit cuts a lifeline that many families rely upon in crises, a lifeline that, in many cases, keeps them out of the unemployment line.
That isn’t the only way in which eliminating payday lenders from the menu of available credit options damages customers, however. The Gerson Lehman Group showed that households with checking accounts pay up to 13% less in overdraft and insufficient funds fees than in states that prohibit payday loans than states that allow them.
This shouldn’t be all that surprising. Critics of payday loans act as though banning them will eliminate the underlying economic problems facing Americans. But stripping away short term loans as an option won’t keep that radiator from blowing up, and the car will still need to be fixed. To cover the expenses, consumers are more likely to resort to a bounced check or a debit card overdraft fee. These options can be far more expensive than payday loans, and can even lead to legal trouble.
According to the FDIC, the average bounced check was made out for only $66. After the “returned check fee” and “merchant insufficient funds fee” are added up, that $66 check ends up costing another $59.58 in fees. Plus, writing a check you know will bounce is illegal – try it in Nevada and you could spend 6 months in jail. In contrast, a payday lender that charges $15 per $100 borrowed collects only $10.56 on that $66.
And busybody regulators argue that consumers need to be protected from payday lenders and delivered into the hands of banks?
In the complex ecosystem of the banking sector, competition is the surest way to keep prices for financial services low. This is Econ 101 – a crowded marketplace forces prices downward. What enemies of consumer choice don’t seem to understand is that short term payday lenders are an important piece of that competitive marketplace.
Banking services aren’t one-size-fits-all products, and customers should be allowed to choose the option that best fits their needs. Payday lending became a popular source of short term loans because many people were unhappy with the credit services provided by their bank (payday loan companies require you to have a checking account at a bank). Unreadable loan agreements filled with legalese and hidden fees have soured a lot of consumers on traditional banks.
It’s no secret that payday loans are expensive sources of credit, and it is noble of watchdog groups and community activists to think they need to protect consumers from themselves.
Unfortunately, the unintended consequences of restricting the freedom those consumers enjoy will outweigh any benefit they see, as Oregon has shown us. Their misguided quest will only end up hurting the most vulnerable amongst us.
Sarah Longwell is the Director of Communications at the Center for Consumer Freedom. EDITOR’S NOTE: This is an online-only column and has not been edited.
