The Consumer Financial Protection Bureau, at a field hearing yesterday in Richmond, Virginia, laid out how to deal with one of the country’s most abusive industries: predatory consumer credit.
The transformation is in its embryonic stages. CFPB described it as an announcement of a consideration of a proposal about payday, installment and auto title loans. If the agency completes its work — and if they get it right, which is at this point an open question — lenders may no longer be able to trap consumers in a cycle of debt. But we should question why so many Americans must resort to 21st Century loan sharking.
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There are more payday loan outlets than McDonald’s and Starbucks combined, and over 12 million Americans use their services annually. This relatively new form of consumer credit can best be described as a debt tornado. Borrowers take out a no-questions-asked loan, and give the lender either a post-dated check, electronic access to their bank account or the rights to take their vehicle (in an auto title loan) to ensure collection. At that point, whether the borrower ever pays back the loan doesn’t matter, as long as the lender can keep them in debt and extract the fees.
Lenders typically charge $10 to $20 in fees per $100 borrowed for each two-week pay period. If the borrower cannot pay off the loan, the lender rolls it over, generating more revenue. CFPB’s 2013 study on payday lending found that over two-thirds of borrowers took out seven loans a year or more. In most cases, the new loans are made the same day the previous loans are closed. The average borrower remains in debt 200 days a year.
The immediate access to bank accounts ensures the lenders make back their investment, even if it totally drains borrowers’ funds and leads to overdraft charges. The auto title loan is even worse: borrowers put up a car they own debt-free as collateral, with the risk of losing their only source of transportation.
By the time most borrowers escape the tornado, they will have paid more in fees than the original loan balance, not to mention hits to their credit rating or the loss of their car. This has enabled payday lenders, often capitalized by Wall Street banks, to become huge, publicly traded companies with massive profits.
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Under the Dodd-Frank Act of 2010, CFPB will supervise this industry at the federal level for the first time, though by statute it cannot cap interest rates. After three years of study, the bureau put out a set of proposals yesterday and invited feedback.
The proposals fall into two separate buckets: prevention and protection. Prevention incorporates the novel idea of requiring the lender to ensure, through third-party financial records, that the borrower can actually repay the loan without defaulting or re-borrowing. Since the payday lender’s best customer is someone without the ability to repay — a borrower who must continually roll over loans and rack up fees — this proposal would attack the current business model. But CFPB added an alternative protection method without an ability-to-repay requirement. “Lenders could choose which set of requirements to follow,” said CFPB Director Richard Cordray in Richmond.
For short-term loans under 45 days, lenders would be allowed to offer an initial loan and two rollovers, followed by a 60-day cooling-off period. They would have to provide an affordable way out of the debt, either through decreasing principal or a no-interest “off-ramp” to finish the payments. On loans over 45 days, CFPB is considering two protection approaches. One would restrain lenders to the same consumer loan terms as the National Credit Union Association. The other would limit monthly payments to less than 5 percent of the borrower’s income.
There are other ideas in the proposal, including a requirement that borrowers by notified before their bank accounts are raided and placing a limit on unsuccessful withdrawal attempts that lead to bank account fees. But the hybrid prevention/protection approach has almost all consumer advocates concerned. Michael Calhoun of the Center for Responsible Lending explained on a briefing call that the protection rules would allow payday lenders to give borrowers six short-term, small-dollar loans a year, creating enough fees in some states that the borrower would owe $1,250 on an initial $500 loan. “This is one place where prevention is better than trying to fix what is already broken,” Calhoun said.
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CFPB had no problem mandating an ability-to-repay standard for mortgage loans, and these consumer groups want it to do the same for low-dollar consumer credit. The protection alternative would not bar lump-sum balloon payments at the end of a loan, which “devastate borrowers,” said Nick Bourke, whose organization, the Pew Charitable Trusts, put out a comprehensive report on auto title loans this week. “The CFPB should require that all loans have affordable payments.”
On a conference call, White House Press Secretary Josh Earnest sidestepped whether President Obama supported a full ability-to-pay requirement. “We would view the rules as a foundation that states could build upon,” Earnest said. But at the state level, lenders often remain one step ahead of regulators. For example, in Ohio, though the legislature prohibited payday loans and voters backed that up in a ballot measure by a 2-1 margin, the lenders returned to the state by reclassifying as mortgage lenders. Bringing the greater resources and enforcement capabilities at the federal level is critical, but the loopholes that have advocates concerned would damage that.
While regulation in the Wild West of low-dollar credit is urgently needed, we also must think about the root causes of why so many Americans perpetually need an extra few hundred dollars. The vast majority of payday and auto title loan consumers use the money for everyday expenses, not emergencies. This rolling desperation drives them toward predatory financiers. That so much of this activity occurs in communities of color should only redouble efforts to snuff it out. Nobody who works full time should really have to contend with high-cost predatory loans just to pay all the bills. Raising wages would hasten their irrelevancy, as could a stronger safety net of transfer programs to fill in the gaps.
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If that doesn’t work, there’s always competition. “We need viable options and alternatives for our communities,” said Wade Henderson, President and CEO of The Leadership Conference on Civil and Human Rights. Some options are already available, like credit union loans or cash advances on credit cards, both far cheaper than payday loans.
But Henderson pointed to a proposal from the U.S. Postal Service Inspector General, to have the post office offer fully underwritten small-dollar loans at a lower cost. If the public has an interest in eliminating predatory lending and giving people a fairer opportunity, then there’s good reason to support a public option, which benefits the postal service and low-income Americans simultaneously, as a complement to regulation.
Essentially the payday loan predators are fulfilling a role government should be doing, and they have no interest — financial or moral — in being kind about it. If full-time workers need additional help, that’s not just a problem for regulators, it’s a problem for all of us.
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