Sunday, August 10, 2008

"Reining In" the Interest Rates of Payday Lenders

In the aftermath of the problems related to subprime lending, some states are moving in to limit what companies can charge for making loans (WSJ). Ironically some civil rights groups are coming to the defense of "predatory lenders" (as described by left-wing rag Mother Jones).

Of course the results will be predictable. According to the WSJ: "Indeed, payday lenders have withered away in several states that have passed rate caps. Since the Oregon legislature passed a 36% payday loan cap last year, about three-quarters of the state's 330 or so payday lenders have closed." In the rush to protect people from themselves, Reason Online points out the flaw: markets are more rational than politicans think: America's check cashers don't exploit the poor; they serve them (via Instapundit). To beat this point home even further, this applies as much to the real poor in places like Africa as it does to the relative poor as pointed out earlier. From the WSJ on a credit experiment in South Africa:

The lender charged its normal rate: 200% APR. The remaining, just-below-the-normal-approval-bar applicants (the "control group") were rejected in line with the lender's normal credit policy.

We then tracked both groups over the next six to 27 months, measuring their well-being based on a range of economic, social, health and mental health measures. Applicants who were randomly approved for a loan had higher incomes, less hunger, better credit scores and more positive outlooks than their control group counterparts -- even after paying the high interest rate. Though they had higher than normal default rates, the borderline loans were also profitable for the lender.
This should serve as a reminder that, as the US drags others into an economic slowdown, political responses often have the perverse effect of prolonging hardship rather than alleviating it. Of course politicians and policy makers tend to forget that it was their interference in markets (add to the CRA, the role of the Federal Reserve with cheap credit not to mention Fannie and Freddie) that got us into this mess to begin with.

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