NEW YORK — In a challenge to what has become conventional wisdom in many quarters, a research report prepared for the Federal Reserve Bank of New York argues payday lending is not necessarily predatory lending.
The report's author, Donald Morgan, begins the report by noting there is no agreed upon definition of predatory lending so he proposes one–and then detailed how payday lending does not meet the criteria. He argued that the question of whether lending is predatory or not should be judged by its effects.
"We define predatory lending as a welfare reducing provision of credit, and we show how a voluntary transaction can make borrowers worse off if lenders contrive to increase loan demand by exaggerating households' income prospects," Morgan wrote. "Predation in our model resembles advertising; advertisers accentuate how much pleasure their product brings, while predators attenuate how much a loan will cost (in terms of future well-being). We show that lenders will prey as long as the extra revenue from larger loans exceeds the cost of fooling households into overborrowing and any associated increase in default risk."
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Morgan argued that his model distinguished predatory lending from the other kind of lending, the kind that helps households maintain consumption even as income fluctuates. While reformers tended to focus on the interest rates charged by alleged predators, Morgan suggested that predatory lenders in his definition would not be those who charged more for their funds, but rather those who pushed borrowers to keep on borrowing to the point of default.
Using this definition, Morgan revealed that delinquency rates were marginally lower for so-called "risky households" in states with unlimited payday loans. Risky households and less educated households were also less likely to report being turned down for credit if their state allowed unlimited payday loans, Morgan said the research found.
"Our findings seem mostly inconsistent with the hypothesis that payday lenders prey on, i.e., lower the welfare of, households with uncertain income or households with less education," the report said.
"Those types of households who happen to live in states that allow unlimited payday loans are less likely to report being turned down for credit, but are not more likely, by and large, to report higher debt levels, contrary to the overborrowing prediction of our model. Nor are such households more likely to have missed a debt payment in the previous year. On the contrary, households with uncertain income who live in states with unlimited payday loans are less likely to have missed a debt payment over the previous year," Morgan added.
Morgan said the research suggested the possibility that payday lending might actually help lower income households manage their money better, though he noted that this required a good deal more research.
The report also suggested that more payday lenders help drive down the prices for payday loans through increased competition.
"Despite their alleged naivet?, payday borrowers appear sophisticated enough to shop for lower prices," Morgan noted. "The problem of high prices may reflect too few payday lenders, rather than too many. If scrutiny and prosecution risk limit entry into payday lending, the lack of competition may drive rates higher. In the end, the simple fact that payday lenders have triumphed over pawnshops suggests that payday lending raises household welfare by providing a preferable alternative."
As might be expected, the payday lending industry trumpeted the report.
"This report gives clear and objective scholarly evidence that payday loans are not predatory," Darrin Andersen, president, Community Financial Services Association of America (CFSA), said. "To the contrary, the report concludes that payday lenders may actually enhance the welfare of households by increasing the supply of credit.
"By demonstrating that payday loans are not predatory, this report refutes the key criticism leveled against payday lenders," Andersen said. "The media and critics of the industry should consider the conclusions made in this important study."
A spokesman for the Center For Responsible Lending, an affiliate of the $262 million Self-Help Credit Union, headquartered in Durham, North Carolina, said that Morgan's definitions were too narrow and the report had been contradicted by other, more thorough, studies.
"While Morgan's attempts to define these murky topics are certainly commendable, the narrow interpretations of family welfare and likely payday borrowers make it impossible to draw broad conclusions regarding the impact of payday lending on the welfare of 'risky' households," the Center said. "The author concedes this point in the Conclusion, in which he states, "…perhaps payday loans help risky households better manage their finances? It will take more data to confirm that particular conjecture…' " –[email protected]
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