In a comment published on June 6, Neal W. makes a reasonable and powerful point with regard to my blog post of June 3. I believe that experience should carry significant weight in financial policy discussions. His experience demonstrates to us that the need for small dollar/short-term credit is very real. The issue is how is that need to be met, and can it be met by reducing the number of lenders and restricting the availability of credit?
I do not make the case, nor does Neal, that small dollar/short-term loans should not be regulated. The issue is, who should do the regulating? I would give first place in that role to the markets. For example, if, as Neal avers, these lenders were earning way above what the risks and costs were for these loans, then that would draw more lenders into this market. More lenders would mean more competition, and market pressures would tend to move prices closer to real risks and costs.
Which takes us to the key point in Neal’s argument: the pricing of these loan products. I do not know what the correct price is, neither does Neal, and the Consumer Bureau certainly does not. There is little evidence that the borrowers are unaware of the pricing for these loan products. If that pricing is not clear or is somehow deceptive, then there are existing laws that can address such deception. If the pricing is clear, then the best person to know whether the service is worth the price is the borrower. Millions seem to decide that it is worth it. Would they like a lower price? Most likely. I wish that the products and services that I use were cheaper. And when they are too expensive, I walk away. But when they are really worth it to me, no matter how high, I will engage in the transaction. Apparently, that is the same decision made by the borrowers, and who am I to second guess them? I am very confident that bureaucrats in Washington do not know these borrowers’ situation better than these borrowers do.
Also with regard to pricing is this canard of annual percentage rate (APR) being applied to credit that has a maturity of weeks or at most months. A one-year cost measure for a 30-day loan? Why would we apply a percentage measure of one year to a credit that is designed for a far briefer period? If we are going to measure the cost by a term totally unrelated to the term of the loan, why not apply a five-year percentage rate? That would be similarly arbitrary and unrelated to the actual transaction. I rented a car not long ago for one day at the astronomical rate of $18,250 per year. Fortunately, I only paid $50 for the one day. Even more astonishing, I stayed at a hotel recently for one night at the annual rate of $45,625. Again, I only paid $125, since I only stayed one night. Or perhaps more accurately said, in all of these cases, quoting an annual rate for a much shorter service would be clearly misleading, providing me with no useful information for a product or service lasting for a much briefer period.
Bottom line, let us do what we can to allow the customers in the market place to decide what they want and what they are willing to pay for it, and let the market do the regulating. If the prices are way too high in relation to the risks involved, other lenders will jump in and prices will be brought more in line with risk.
Of course, there is the possibility—or shall I say the reality—that bank regulators have constricted the supply, restraining banks from offering competing small dollar products. Maybe a better approach is to encourage more competition, not regulate more lenders out of the market.
When people need these funds, as Neal did, lack of supply can make them desperate. If the regulations make the supply less available, where will people go? We already know that answer: to the “informal” lenders. You can imagine who those are, and you will not likely be wrong.