The Payday Loan Debate

There's a short but sweet debate over at Business Week today between two prominent econobloggers, Nouriel Roubini and Tyler Cowen. The question is whether the US government should place greater restrictions on car sellers, pay-day lenders, and tax preparers who offer the working poor cash or credit with high fees and interest rates. Roubini says yes, it should. Cowen says no, it shouldn't. Roubini is right.

Roubini, a famous housing bear, concentrates, as is his wont, on subprime mortgages. I'm happy to see those restricted, but I don't think it would make the slightest bit of difference – because few if any of them were written at usurious interest rates. The problem was that people were buying houses they couldn't afford, not that banks were charging them exorbitant interest. (In fact, the banks are losing money on those loans, which means they're not exactly profiteering.)

The real scandal is not with subprime lenders but with payday lenders. Many of these are geniunely predatory and should be curtailed.

Cowen approaches the debate from the standpoint of a theoretical economist. "There are hundreds or thousands of lenders competing to give borrowers the best deal possible," he says, setting up a utopian world which simply does not exist in reality. Insofar as paday lenders compete, they don't compete on price: they compete in terms of having convenient locations which are open very late and very early, and which don't ask nosy questions about the borrower's income or immigration status.

In any case, the number of payday lenders in any given location is hardly in the triple digits, let alone the quadruple digits: indeed, I'd be most surprised if it was even in the double digits. Payday lenders tend to have tiny little hyperlocal monopolies, a bit like corner delis in New York: you just go to your nearest one.

As a board member of my local community development credit union, I feel obliged here to point out that CDCUs nearly all offer vastly superior alternatives to payday loans – at least as far as their financial terms are concerned. Tyler's wrong that the interest rates charged by payday lenders are necessary because the borrowers are bad or unknown credit risks – he just needs to look at his local credit union to work that one out. The problem, of course, is that credit unions find it very hard to compete in terms of having convenient locations and long opening hours. But they are, always, a much better way to go.