In an attempt to protect consumers, regulatory agencies and city councils sometimes create misguided laws that end up harming the consumers they’re trying to protect.
Many times, the laws end up punishing ethical payday lenders and borrowers who use payday loans responsibly. Some of these laws will drive licensed lenders out of business and push borrowers into the arms of unregulated, illegal loan sharks.
- Moratoriums on New Payday Loan Stores
A moratorium is a temporary ban or halt to a specific activity – in this case, the creation of new payday loan stores. For example, Las Vegas imposed such a moratorium on new payday loan shops.
Such moratoriums are great for existing payday loan shops. They can now charge exorbitant rates without having to worry about cheaper competitors appearing.
Less competition means higher prices, lower levels of service and less innovation in the market so these moratoriums hurt consumers.
- Distance Requirements
Some city ordinances stipulate that payday loan shops must be a certain distance from residential neighborhoods and from each other. The distance can be as little as 200 feet or as much as a quarter of a mile or more.
Like moratoriums, distance requirements stifle competition and hurt consumers through higher prices and lower levels of service.
Distance requirements inconvenience borrowers. They are forced to travel farther to compare shop prices and service. Consumers who don’t have the luxury of time or transportation end up going to the closest lender, even if the rates are much higher or the service is substandard.
- Borrower Databases
Many states have created borrower databases to track the number of payday loans that people take out. Such databases were created to keep irresponsible borrowers from taking out multiple loans but end up hurting responsible borrowers with higher prices and less privacy.
One feature that some borrowers appreciate about payday loans is confidentiality. State databases remove this feature and unnecessarily violate the privacy of responsible borrowers.
Borrower databases also lead to higher prices for consumers. The state transfers the cost of creating and managing the database to lenders by charging a transaction fee. The lender, in turn, passes this transaction fee as well as increased operating costs involved in reporting to a centralized database on to consumers.
Ultimately, responsible borrowers end up holding the short end of the stick with higher prices and less privacy.
- Discriminatory Business Tax Increases (Updated 2008/04/25)
Alexandria City Councilman Justin Wilson wants to increase business licensure taxes for payday lenders to the maximum allowable under Virginia law.
The proposed tax increase would be from 35 cents for every $100 of gross receipts to 58 cents for every $100 of gross receipts. In other words, a payday loan shop paying $16,652 per year in business licensure taxes would now have to pay $27,594 annually. This additional cost would ultimately be passed on to loan consumers.
- uses the taxation system as a weapon
- punishes businesses that are legally licensed
- does the above to achieve political gains
- increases prices for loan consumers
Discriminatory business tax increases would hurt the consumers Wilson was trying to protect.
- Rate Caps
Some politicians seek to protect consumers by limiting the interest rates lenders can charge. An example of this is the 36% APR rate cap on loans to military personnel and their families.
Payday lenders contend that a 36% APR would not even cover their costs on short-term loans. Advance America CEO Kenneth Compton said that his company will stop giving loans to military members and payday lender Dennis Brassford considers closing his outlets near military bases.
A rate cap that makes offering loans unprofitable becomes a de facto ban on payday loans. To see why this is bad, see our next point.
We’ve tried it with alcohol. We’ve tried it with “salary buyers” at the turn of the century.
Back then, payday loans were called “midget loans” and payday lenders were called “salary buyers” or “5 for 6 boys” because you paid back $6 for every $5 that you borrowed. Usually, the loan had to be repaid in one or two weeks.
A qick calculation tells us that a two week loan at that rate works out to 521% APR – comparable to modern payday loans.
In the interest of consumer protection, salary buying was prohibited by law and many borrowers turned to illegal loan sharks.
Does prohibition work?
With regards to the prohibition on alcohol, Albert Einstein said:
“The prestige of government has undoubtedly been lowered considerably by the prohibition law. For nothing is more destructive of respect for the government and the law of the land than passing laws which cannot be enforced. It is an open secret that the dangerous increase of crime in this country is closely connected with this.”
Will payday loan prohibition protect consumers?
History tells us that the prohibition of alcohol and “salary buyers” only led to bootlegging and loan sharking, respectively. Organized criminal organizations profited handsomely from both types prohibition. Consumers suffered because they risked more than just money dealing with dangerous, violent criminals.
While the intentions of regulatory agencies and city council members are usually good, these laws are bad for consumers. Many times, they punish ethical loan shops and responsible consumers by increasing costs, stifling competition and violating privacy.
These laws may not even be effective.
Irresponsible borrowers can always avoid regulations by seeking loans from unlicensed, illegal loan sharks.
One has to wonder about the motivation behind these laws.
Were these laws:
- based on solid data collected from borrowers and payday lenders?
- based on misinformation from self-appointed advocates who have never even taken out a payday loan?
- intended as long-term solutions to protect consumers?
- intended as short-term schemes to gain political advantage?