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Spangenberg, Shibley & Liber, LLP | Jun 6, 2014

The Payday Industry's No-So-Good Intentions

Categories: Business Litigation

Lisa McGreevy, longtime bank shill and the online payday lending industry’s mouth-piece over the course of the last few years has an opinion piece up over at American Banker. McGreevy “[t]his month…visited with about a dozen consumer groups about the current status of online small-dollar lending. The purpose of the visits was to share information about what we are seeing in the marketplace and to solicit their input on what they thought best for consumers.” Ms. McGreevy’s takeaway was that “it's time to start a new conversation on consumer credit.”

McGreevy purports to mean by this that consumers and their advocates need to stop telling the financial services sector what is wrong with their current products and instead tell them what products and product features they need. But that’s not what she means. For example, McGreevy writes that:

Providing equal access to credit products requires a national solution. State and federal laws have not kept pace with innovation in the financial services industry. A national approach to modernizing our laws and regulations means more innovation, flexibility and pricing structures for consumers.

An environment that allows for this innovation must also include more vigilant protection of consumers. There have been far too many unlicensed, rogue operators that have taken advantage of consumers and tarnished the rest of the companies offering short-term credit products. These entities, created solely for the purpose of defrauding consumers, must be identified, reported and prosecuted.

By claiming the problem with the industry is a small cabal of fraudsters, rather than the fundamental structure and behavior of the industry as a whole, McGreevy intentionally misses the point. And her complaint that state and federal laws “have not kept pace” with innovation is both self-serving and false. Almost all laws addressing payday lending have been put on the books during the past twenty years. And the internet does not and should not negate individual state’s abilities to govern lending to their citizens. Further, the reality is that payday lenders, online or otherwise, have never been the types to let a few laws get in the way of doing what they wanted regardless. So, what McGreevy really means is “what can [the online payday-lending] industry do to get regulators and consumer advocates to stop trying to shut us down OTHER than actually complying with state and federal laws regarding cost of credit?”

The answer from consumer advocates should be: go away.

At the end of the day, the real issue with short-term consumer credit is not procedure, disclosure, association (or non-association) with mainline financial institutions or even collection practices – they are important, but they aren’t the crux of the issue. The issue is the cost of the credit. The payday lending industry is an interesting animal. Even those lenders that are in no way fraudulent are essentially loan sharks masquerading as legitimate businesses. Their entire existence is premised on finding increasing novel ways to end run around state laws and federal regulations designed to prevent them from charging usurious interest rates and fees. Their usual position: that the risk associated with these loans is so significant that they need to be able to charge triple-digit effective APRs in order to survive, is questionable in the first instance and irrelevant in the second.

First, we have no idea what the true “cost” of making payday loans would be in a well-regulated market.

There are numerous factors driving up the cost of short-term credit that have nothing to do with default or carry risk:

  • The one-size-fits-all nature of these products necessarily means that everyone is treated as being a bad credit risk.
  • The reality is that these loans are priced based on demand, not on supply. Lenders know the borrowers are desperate and exploit that fact to the maximum extent possible. The payday lending industry has never competed on price – they compete on ease of access and….
  • Marketing. Online lenders have stated that it can cost as much as $200 to generate one lead that lends to a loan. At that expense, there is no way the loans can be made within the legal limits in effect in most states and still be profitable. No one should be spending that kind of money to promote these products.
  • Banks won’t make these loans on reasonable terms even to decent credit risk customers because it cannibalizes their overdraft fees on checking accounts and over- the-limit fees on credit cards. When banks were until recently offering payday lending products, they were priced comparably to an overdraft fee (from the bank’s POV). Non-financial institutions seem to believe that as long as their rates and fees are cheaper than or comparable to bank overdraft fees, they are doing their customers a favor.

The unnecessary marketing expenditures are incurred in large part because of the lack of legitimate regulatory oversight in the space. These keep barriers to entry incredibly low – you basically need a few million bucks and a website – and keep the potential for operations disappearing overnight very high. Brands and reputations are not built in the online payday lending space – constant direct online marketing reigns.

So, long story short, we simply don’t know at what rate a payday lender would be able to offer short-term credit to consumers were that lender:

1) subject to a meaningful regulatory scheme that created meaningful barriers to entry;

2) not engaged in extensive and costly marketing;

3) tiering the cost of their products based on individual credit risk;

4) not increasing in price or decreasing the availability of their products to avoid cannibalizing other penalty fees and or pinning their rates to those fees; and, relatedly;

5) pricing their products on the supply side – that is, charging rates and fees sufficient to assure a reasonable profit given a market cost of capital and default rate – as opposed to pricing the products based on the instant demand.

And, because the payday industry continues to do anything and everything, inside and outside the law, possible to prevent this hypothetical regulatory market lender from ever existing, we may never know what the real cost of relatively high-risk short-term credit should be.

Second, even if it is true that these loans simply cannot be made profitably within the intended limits on rates and fees set by certain states, that is not an excuse to end run around those limits. It is the reasoned belief of the voters of these states that loans should not be made at triple-digit APRs. If no one is willing to loan to certain borrowers on terms otherwise, so be it. But suggesting that is the known reality based on historical experience in a paradigm where the payday industry hasn’t, since its inception, taken a day off from offering usurious loans is ill-reasoned.

So Ms. McGreevy, here is my suggested new conversation: Start offering loans at rates that comply with most or all state usury statutes as opposed to subverting their application…or just go away.