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What Payday Lenders Can Tell You About The Current Crisis
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This seems like an odd point to make since nobody is complaining that payday lenders have anything to do with the current crisis. And they don't. Not in a cause-and-effect relationship.
But let's ask for a moment, what payday lenders do.
Most of us have a dim view of them -- we think of them as loan sharks with a logo, minus the muscle and pliers.
Commonly, they're called predatory lenders for the way they allegedly treat their customers: poor folks in need of emergency assistance. No doubt, some of that is true. But it's not comprehensively true.
Do yourself a favor in the coming days. While it's true you'll find payday lenders in poor neighborhoods, keep an eye out in the suburbs and middle-class neighborhoods. Because that's where they've been going.
Here's what the Austin Business Journal had to say:
According to Lyndsey Medsker, spokesperson for the Community Financial Services Association of America, which represents about 60 percent of the payday loan industry, those using payday loans are typically young people with an average income of $25,000 to $50,000.
After you're done reading this article and enjoying the rest Examiner.com has to offer, take a look at that article.
WHILE YOU'RE HERE, LET'S SEE WHAT ELSE WE CAN DISCOVER
We now have some idea of the people payday lenders are loaning to. We know that the borrower is giving some guarantee, though not a lot. What about the size of the loan? You hear different averages, but the general range is somewhere between $500 and $1500. Even if you drop it down to $100 and go as high as $2000, you're not really talking about a huge sum of money.
So what are the terms? Those vary, too, but it's really the controversial part. Because when you look at the rates, they're astonishing. Upwards of 3,500% effective annual rate. Sometimes around 17% bi-weekly.
There are two components that go into those rates.
The first is risk. The risk is high. People may simply ignore their debt, move, change jobs, quit... the opportunities for the borrower to default on the payday loan are high, and frankly, they wouldn't appear to have much to lose for doing so.
It should be noted, that the rates are high despite being short term. As anyone who has ever invested or been in finance can tell you, long term risks are generally greater than short term risk. There are a number of reasons for that, including ones you never think about, like inflation risk, but it's a pretty solid principle.
The second component is operation cost. The number of borrowers who need to come in for a payday loan is low, so in order to cover overhead, they need to have a high mark-up. This is true everywhere and in every industry. Grocery stores have very low mark-ups because they get their return on volume. Luxury car makers have very high mark-ups because they get fewer buyers.
HERE'S WHY ALL THIS IS IMPORTANT
Because what it tells us is that payday lenders - a group of lenders absolutely nobody in the universe would call a charity (in other words, they are supposedly the epitome of greed) - lends to low-to-middle-income borrowers with little credit history very small dollar amounts for very short terms (which reduces risk, see above) at extremely high interest rates.
Given that, why on Earth would anybody loan to the same group of borrowers a quarter of a million dollars with little guarantee at low-to-zero percent interest rates for long terms?
Yet that is the argument people must make when they blame Wall Street and greed. And indeed, Wall Street did just that. Why? Because the loans were guaranteed by on-paper assets. But the borrowers didn't own the asset. They didn't even own a piece of the asset because they put no or little money down. Fannie Mae and Freddie Mac owned the asset. Fan and Fred were buying up these assets so that they looked better on the books, which gave their officers huge bonuses (a number of those officers are advisors to Barack Obama).
They were also guaranteeing the virtue of the loan.
Combined with a buying frenzy - which is a result of lowering the bar, precisely what Democrats were trying to do - that actually pushed housing levels well beyond what the market demands (I believe the surplus in housing is something like 18 million units which is somewhere around 10% of households), you have a condition that will drive the asset's value-on-paper up.
And who was getting bought off by Fannie Mae and Freddie Mac? Who protected them, encouraged them and helped them and their allies in organizations like ACORN push more of this stuff to those borrowers?
DEMOCRATS DID IT. GOVERNMENT DID IT.
It can't be said enough. Wall Street screwed up. And so did Main Street. Everybody knows it, though of the four candidates for high office, only Sarah Palin said anything about it. But Wall Street and Main Street did not create the conditions for this to happen out of a desire for anything, least of all Social Engineering. Democrats in Congress did it.
Had the market been left alone, the only way that lenders would have lent to so many of its borrowers (and thereby create the chain of packaging and repackaging on those loans that exposed the market to risk) was if the interest rates were astoundingly high or if borrowers supplied huge down payments in order to protect the value of the asset. Neither of those things happened, because government meddled with the system. The problem was not deregulation, the problem was bad regulation.
Just look at the payday lenders.
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