Payday Loans in Oregon: An Update

I received an e-mail from a group called the Consumer Credit Research Foundation. This is a non-profit group, funded by payday lenders, that sponsors research on credit markets. They were touting a new study by Jonathan Zinman of Dartmouth College that looks that the effect of the restriction on payday loans in Oregon.

I have posted before with a typical economist's take on the issue: I believe that restricting access to credit (expensive or not) is misguided. If there is a problem with access to credit then do things to enhance access not cut it off. The idea that you are 'helping' people avoid their own bad decisions is government regulation at it worse. What you are really doing, in my view, is punishing the already economically stressed by giving them less flexibility to weather economic turmoil.

So I was really excited that we may have good evidence that these assumptions are correct. Zinman is a young economist with an already stellar research record - he is no hack. Unfortunately Zinman's paper does not provide what I had hoped for. It is not a bad paper, there is no academically dishonest statements, but there are a number of vague and misleading statements that appear to be clearly designed to give the impression to a lay audience that positive evidence is found when it is not.

The study compares pre- and post-restriction surveys in Oregon and Washington of payday loan users. Oregon imposed restrictions while Washington did not. The similarities among the states suggest that these two populations are reasonable for use as treatment and control groups. He finds that payday lending went down significantly in Oregon compared to Washington, which is not a big surprise. Then he finds that former payday loan users shifted:

partially into plausibly inferior substitutes. Additional evidence suggests that restricting access caused deterioration in the overall financial condition of the Oregon households. The results suggest that restricting access to expensive credit harms consumers on average.

First notice the academic-speak: "plausibly inferior," "evidence suggests," "results suggest." Why does he use these terms? Because none of his statistical tests of these effects turn out to be significant. I am quite ready personally to believe that these suggestive results are actually revealing an underlying fact because I believe theoretically that this is likely the case, but it does nobody any good to read ones prior assumptions into a set of results that are not statistically significant - and not just statistically insignificant but with tiny point estimates that are not plausibly different from zero.

Overall there are four serious problems with this study:

1. The data are a set of surveys conducted by the payday loan funded non-profit. This naturally leads to questions about explicit or implicit bias. The questionnaire is not reproduced in the paper and it should be.

2. Respondents to such a survey (especially the ones now excluded from the payday loan market) are likely to be predisposed to suggest that it has adverse effects on their financial situation. Thus the results would be biased toward findings that suggest restrictions lead to financial hardship.

3. The author finds, it turns out, that Oregon and Washington payday borrowers are not good treatment and control groups - the people that utilize payday loans in the two states turn out to be quite different. Efforts to control for these differences are unconvincing, which leads to biased results. [Note, however, that it is not clear in which way the bias would work and may in fact be a cause of the insignificant point estimates]

4. All statements about the adverse consequences of the decline in payday loans in Oregon are not supported by the evidence - they are suppositional.

I believe that restricting access to payday loans is bad policy, but I am still looking for good objective evidence to bolster my theoretical argument. This is a provocative start, but in my view, falls well short.

Payday Loans Redux

A new staff report by the Federal Reserve Bank of New York seems to confirm my fears about the regulation of payday lenders. As an economist, I believe that things like payday loan businesses arise due to some missing market, and to simply shut down that market does not address the original lacuna that caused it to arise. As payday borrowers are mostly lower income individuals, eliminating payday loans could end up making them worse off. Payday loans, as much as they seem usurious to us, seemed to be providing essential liquidity to a population that has a limited access to credit. Preliminary results are that credit troubles have worsened in areas where payday lenders were prohibited.

Payday Loans

Here is a topic which is a good example of the occasional enormous chasm that divides economists from non-economists and makes 'normal' people think that we just don't 'get it.' The argument for the regulation of the payday loan industry in Oregon (which, among other things, limits the amount of interest that can be charged at 36%) seems overwhelming: these businesses are praying on the poor and vulnerable and indenturing them into debt servitude, furthering their misery and contributing to their poverty. Yet, I don't buy it and I worry that the poor and vulnerable will be made worse off with such regulation, not better.

Let's begin the analysis with the root problem: access to credit for the poor and/or those with poor or no credit histories. This is a considerable hardship because credit provides flexibility when dealing with limited and often transitory income. Access to credit can also be a key to escaping poverty by allowing investments in productive assets (like education) that can increase future incomes. This is what I would call the disease.

Here is a symptom: Because credit at (for lack of a better term) mainstream financial institutions is inaccessible, a host of businesses have cropped up to provide credit to this population. They have been criticised for having exorbitantly high interest rates and short repayment periods. The subtext to this critique is that they are abnormally profiting from other's misfortune. Given as evidence of the scale of the problem are the vast numbers of payday loan shops. But these critiques strike me as completely misguided. The fact that there are many payday loan shops suggests to me that the industry is highly competitive, and therefore that the interest rates they charge are reflective mostly of the costs of doing business in small-scale loans and high delinquency rates. So the proposed cure will cause firms to exit the industry - worsening the disease by further limiting access to credit to the poor. For those that remain and are limited to 36% interest, they will impose more stringent requirements to limit their credit to only the least risky of their clients - again limiting access to credit for the poor.

So I find this a totally misguided policy. I think that payday loans are a problem, but that the problem is with access to credit for this population. What government could do that would be more appropriate perhaps is to mandate that banks, credit unions and thrifts extend credit to this population. To do so these institutions would end up charging more for credit for all and thus this would be a type of transfer from the relatively well to do to the relatively less fortunate. But it would be aimed at the disease and not the symptom.

Finally, one argument that really bothers me (and I am perhaps typical of economists) is that these payday lenders are predatory because borrowers are naive and don't understand what they are getting into when they borrow money. I find this incredibly patronizing - basically "the poor are dumb." While it is true that education and socio-economic status are highly correlated, intelligence is not. And even if people (in general) are not too savvy about understanding the implications of these loans, they tend to be very small and short and one experience is likely enough for borrowers to learn (unlike, say, sub-prime mortgages). It would be one thing if these lenders were accused of fraud (like, say, some sub-prime lenders) and I would be in favor of any sanction against such practices, but the argument is not fraud, but the failure to comprehend. But you don't have to just take my word for it, the issue of whether payday loans are really predatory has been studied very carefully by economists at the fed who find that, in fact, the population of payday loan customers looks very similar to customers of mainstream financial institutions in their delinquency rates and that the payday loan industry appears to be quite competitive.

So, in my view, here is a policy that just gets it wrong - it attacks a symptom, not a disease and is likely to hurt the very people it intends to help.