June 17, 2016 | Commentary on Economic Analysis, Financial Regulation

CFPB's Payday Lender Rules: Markets Exploit, Government Saves

Radical change may soon come to the short-term lending business. And we’re not talking about the good kind of change.

New rules proposed by the Consumer Financial Protection Bureau (CFPB) are bad news for consumers, those who work for short-term lenders, and the people who supply the capital to make these loans.

Topping out at more than 1,300 pages, the proposal is a testament to government micromanagement grounded in the notion that a handful of super-smart bureaucrats know exactly what’s best for everyone else. It’s a mindset that frightens anyone who recognizes that free markets provide the best way for people to improve their lives.

By the CFPB’s own admission, these rules could effectively destroy the payday lending industry, eliminating up to 85% of the loans made. Supposedly, that’s acceptable because, as CFPB director Richard Cordray puts it, “There’s [sic] some ugly kinds of credit out there that we have seen that are quite predatory.”

Terms like “ugly” and “predatory” have no objective meaning in regards to private contracts, even if a third party thinks the interest rate on a loan is “too high.” That’s a value judgment; it has no place in federal regulation.

Sure, some consumers make decisions that look bad from an outsider’s point of view, but only the consumers themselves can grasp the single “right” way to look at those decisions. It’s also clear that some people make decisions which they later learn were, indeed, bad – an ugly, but important learning process.

Federal policies that prevent people from learning from their mistakes, on the other hand, can be even uglier.

Part of the problem here is that the CFPB regulators don’t believe in the power of free markets. Admirers of markets see the payday lending industry as the success story it really is.

There was a need for credit in certain markets, and these companies figured out a way to fill that need. The result: voluntary, mutually beneficial exchanges.

Yet fans of the CFPB hold a fundamentally different view.

They see most private transactions as a form of exploitation, where consumers buy goods and services because they have no choice. Through this distorted lens, they see payday lenders as greedy financiers charging exorbitant prices to consumers who have no other option.

Worse, they perceive them as actively seeking out people who can’t possibly repay, all the better to trap them into a state of perpetual debt.

Given that horrible scenario, the only solution is to get the government to step in with extensive regulation and even provide the lending service itself. In their minds, only the government can know what the “right” set of loan terms should be; the people can’t be trusted to know what’s good for them.

From any other perspective, the CFPB’s own complaint numbers don’t support the Bureau’s case. From July 2011 to August 2015, consumers lodged approximately 10,000 complaints against payday lenders. Even if we ignore the fact that these are unverified complaints, and these consumers could be complaining about all sorts of issues (or possibly taking advantage of the system to lower their debt), the number fails to impress.

More than 12 million people per year are using payday loan services. So the average number of (unverified) complaints represents barely one of every 5,000 payday transactions.

Blinded by the assumption of exploitation, proponents of the CFPB’s rules also fail to recognize that it costs more to provide small-dollar consumer loans than typical bank loans. They insist that someone else – perhaps the post office, or maybe online lenders backed by Google or some government-funded nonprofit – can magically provide these loans at a lower cost.

As for the notion of consumers being caught in debt traps, it is contradicted by rigorous research. Columbia’s Ronald Mann found evidence that payday loan customers clearly understand that they’ll be rolling over a payday loan before becoming debt-free. But they still see an advantage in taking out the loan.

Indeed, many payday loan customers openly acknowledge how beneficial these short-term loans are to them.

As for the “predatory lending” argument, the entire concept defies logic. Why would lenders—or any business—literally seek out customers they know won’t be able to pay back their debts?

But none of this seems to matter to the CFPB, which seeks to put so many restrictions and legal requirements on small-dollar lenders that many will have no choice but to stop providing loans. That will put their employees out of work and their customers out of luck. The people who have the toughest time getting credit will have nowhere to turn other than to loan sharks.

The tragedy here is that none of this is necessary. We don’t need a national nanny.

Small-dollar lenders have served a niche—and a purpose—for generations. They are willing and able to provide a product that people are demonstrably willing and able to buy. The CFPB should stop second-guessing consumers’ needs and decision-making: Butt out and let the market work.

About the Author

Norbert J. Michel, Ph.D. Research Fellow in Financial Regulations
Thomas A. Roe Institute for Economic Policy Studies

Originally published in Forbes