Posted by Todd Zywicki:
Effects of Payday Lending Regulations:
http://volokh.com/archives/archive_2009_03_01-2009_03_07.shtml#1236347546
Substantive regulation of consumer credit generally has one intended
effect and three unintended consequences. The good effect is less of
whatever it is that is regulated. So if regulators cap interest rates
through usury regulations, for instance, interest rates on average
will be lower. But there are also unintended consequences: (1) term
repricing (i.e., substitution of up-front fees like annual fees,
downpayments, or points), (2) product substitution, such as less use
of the regulated product (such as credit cards) and more use of
alternative products (such as layaway or payday lending), and (3) if
term and product substitution is not perfect, there will be credit
rationing. The basic question for regulators, then, is whether once
the benefits and costs of the regulation are tabulated, do the overall
benefits exceed the costs.
Jonathan Zinman of Dartmouth has an interesting new paper out on the
effects of payday lending regulation in Oregon that looks at these
factors. Here's his findings (as summarized in the abstract):
Many policymakers and some behavioral models hold that restricting
access to expensive credit helps consumers by preventing
overborrowing. I examine some short-run effects of restricting
access, using household panel survey data on payday loan users
collected around the imposition of binding restrictions on payday
loan terms in Oregon. The results suggest that borrowing fell in
Oregon relative to Washington, with former payday loan users
shifting partially into plausibly inferior substitutes. Additional
evidence suggests that restricting access caused deterioration in
the overall financial condition of the Oregon households. The
results suggest that restricting access to expensive credit harms
consumers on average.
And in the paper he fleshes out some of the substitution effects--the
substitution effect for payday lenders seems to be primarily for
checking overdraft protection and late bill payments (presumably in
preference to bounced checks) along with some residual rationing
effect:
I find that the Cap dramatically reduced access to payday loans in
Oregon, and that former payday borrowers responded by shifting into
incomplete and plausibly inferior substitutes. Most substitution
seems to occur through checking account overdrafts of various types
and/or late bills. These alternative sources of liquidity can be
quite costly in both direct terms (overdraft and late fees) and
indirect terms (eventual loss of checking account, criminal
charges, utility shutoff). Under the broadest measure of liquidity
in the data, the likelihood of any expensive short-term borrowing
fell by 7 to 9 percentage points in Oregon relative to Washington
following the Cap. This jibes with respondent perceptions, elicited
in the baseline survey, that close substitutes for payday loans are
lacking.
Next I examine the effects of the Cap on the summary measures of
financial condition that are available in the data: employment
status, and respondents� qualitative assessments of recent and
future financial situations. Estimates on individual outcomes are
noisy but consistent with large declines in financial condition.
Estimates on a summary measure of any adverse outcome�-being
unemployed, experiencing a recent decline in financial condition,
or expecting a future decline in financial condition� suggest large
and significant deterioration in the financial condition of Oregon
respondents relative to their Washington counterparts. As such the
results suggest that restricting access harmed Oregon respondents,
at least over the short term, by hindering productive investment
and/or consumption smoothing.
This finding is interesting for a couple of reasons. First, a number
of researchers have observed that despite the "high" APR on payday
loans, the cost of a payday loan is probably less than the cost of
bounced check once the returned check fees are taken into account. It
looks like there is some evidence that consumers are using payday
loans (and related products like overdraft protection and late bill
payments) to prevent bounced checks. Second, some research has
suggested that many consumers who are unable to gain access to payday
loans they generally turn to pawn shops as the next-best substitute.
Zinman finds in surveys that about 15 percent of respondents report
that if they were unable to get a payday loan they would have turned
to something like a pawn shop, car title loan, or credit card (there
is some evidence that consumers use payday loans even when they could
use credit cards for some reason). So overdraft protection loans,
Zinman suggests, are closer and less-inferior substitutes for payday
lending.
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