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You can’t pay bills with paternalism

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Your car breaks down, and it’ll cost $300 to fix. What do you do?

Well, perhaps you rearrange your budget and cut back on other spending for a few weeks. Maybe you have room left on a credit card. Perhaps you can hold off paying a bill. Or you have family who could tide you over without giving you grief. You generally manage your finances well and have good credit, so you know if need be, you could take out a small loan.

But what if you were an unwed single mother, a high school dropout, trying to make ends meet but barely scraping by from week to week? What if you had made your share of mistakes with credit, and that last thing you wanted to do was spend your time away from work fidgeting nervously in a bank office waiting and waiting to see if you were going to get a check or just another rejection (and worse, a lecture). What if all you wanted was a small amount to cover till you got paid, without the hassle of banks and business hours and having your financial history dissected in front of you? What if you could have that, but it would be costly?

That is an option you’d have with payday lending, which is currently illegal in North Carolina. Basically, a payday borrower would obtain the $300 in cash by presenting a check for the $300 plus a transaction fee, say $45, to be cashed by the lender in two to four weeks’ time. Payday lending was allowed in North Carolina for a while by a 1997 bill that was allowed to sunset in 2001.

Opponents of payday loans say the loans’ high cost typically $15 per every $100 borrowed (small loans, $500 or less) over two weeks — takes advantage of poor people in need. Projected beyond two weeks to a full year, the cost amounts to about a 400 percent annual percentage rate (APR). The loans often cause borrowers to need to take out successive loans till they can finally pay them off, they say. Payday lenders make people in need worse off and profit from them.

Except that removing that option is what is leaving consumers worse off. Researchers at the Federal Reserve Bank of New York studying the end of payday lending in Georgia and North Carolina found that people in those states "bounced more checks, complained more about lenders and debt collectors, and have filed for Chapter 7 (‘no asset’) bankruptcy at a higher rate" than they would have if the lenders were still legal. The increase in bounced checks especially cost consumers millions of dollars per year.

"Forcing households to replace costly credit with even costlier credit," they wrote, "is bound to make them worse off."

And that gets to the heart of the matter. The state ban on payday lending is typical government paternalism, taking away options from people to prevent them from making harmful choices, all the while imposing a net greater harm through unintended consequences. What the ban does is presume to know individuals’ situations better than they. What it cannot do is change the fact that people will continue to face unexpected shortfalls, and that the poor and least creditworthy have the fewest legal solutions available to them but the same desire to get help.

A bill, SB 89, before the General Assembly would legalize payday lending again. My study on payday lending offers several findings pertinent to the debate:

  • About five percent of people use payday lenders, including currently in North Carolina (they go to storefront lenders across state lines or to higher-cost online lenders)
  • Payday customers understand the loans’ high cost, though they don’t like it
  • Payday customers appreciate several nonmonetary aspects of the loans, including convenient hours and locations, ease, discretion, friendliness, lack of credit risk, and ability to avoid unpleasant personal interactions with friends, families, employers, bankers, and creditors
  • About 95 percent of payday loans are repaid
  • Nine out of ten people in a tight spot might definitely rule out a payday loan, but the tenth might give it serious consideration; however, since North Carolina has ruled it out for him, the tenth might be stuck with even less desirable options
  • Absent payday loans, other options carry fees that equate with high effective APRs: bounced-check fees (3,520 percent without overdraft protection and 704 percent with); utility disconnect or reconnect fees (240-420 percent); credit card late payments (965 percent); and borrowing from an online payday lender (650-780 percent) or loan shark (indeterminate)

"The reality is that decent, hard-working families who end up with too much month left at the end of their money will go underground if necessary to get help," UNC researchers Michael A. Stegman and Robert Faris explained. They recounted an anecdote about an owner of a check-cashing company in a state that bans payday loans. "He sees the neighborhood loan shark turn up in one of his busiest stores every Friday afternoon to extend credit and receive payments from customers who have just cashed their paychecks."

That stark reality is why economist Robert Lawson once dubbed an Ohio proposal to put payday lenders out of business the "Loan Shark Full Employment Act." It is also one reason why North Carolina policymakers should consider legalization here. On the balance of things, taking away choices from the poor for their own good has left them worse off.

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Jon Sanders is an economist studying state regulations, that spreading kudzu of invasive government and unintended consequences. Serving as Senior Fellow of Regulatory Studies and also Research Editor at the John Locke Foundation, Jon gets in the weeds of all… ...

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