I also strongly believe that the market should determine the pricing of loans products. The Federal Reserve’s Report on the Economic Well-Being of U.S. Households shows 47 percent of Americans cannot afford an unexpected $400 expense without resorting to some sort of borrowing or selling. We agree the need is there, and this should be a large market, where supply, demand, and risk factors determine a fair market price.
We also agree bank regulators have artificially constrained the supply. It would be wonderful if someone could go down to their local bank, and take a small loan to cover unexpected expenses. Most banks simply do not offer this service. This forces people to the only other available option- payday lenders.
I don’t have empirical data to research, or the banking expertise to argue the law, I am offering the perspective of personal experience, and that of friends who have resorted to these lending options, and those employed by payday lenders. Most of their profit is derived from converting these lump sum payday loans into installment loans. This is why I cited APR, as these loans tend to be stretched for several months instead of a week or two. If the loan is repaid at the next pay period, everything would be fine, the rate is understandable and acceptable. But this is where the problem is- the customers can’t afford to use their entire next paycheck to pay it back, they are already living paycheck to paycheck. Therefore, these fees are allowed under the guise of one time loans at a high rate, but turn into an installment loan at a rate that no other industry would be allowed to charge. This is the problem that needs to be addressed. Yes, the customer entered into the agreement understanding the cost, but I argue, what other option did they have?
If the free market were allowed to work, with competition driving prices down to an equilibrium, or even a diversification of pricing in the market, regulation would be unneeded. This isn’t happening. There are nearly 60 payday lenders in my town of around 100,000 people, their rates are nearly identical. I don’t believe this is because a market-driven equilibrium has been reached. It is because a niche market has been created by artificially constricting supply, driving out both entrepreneurs and traditional banks from offering their capitol at lower, true market rates.
As always, the best answer is not more regulation. However, until massive deregulation opens this field to true market forces, I feel consumers do need some level of additional protection. They are not in a position to walk away, a prerequisite to the open market. Bringing these “refinance” or “loan extension” costs more in line with installment loans through law is the only realistic answer for now. It may slow the opening of some new branches for all these payday lenders, but it isn’t going to drive people to “informal” lending. We should work toward ending the laws that have created this beast to begin with. For now, the only way to tame it may be additional regulation.