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Personal Responsibility Versus Government Oversight

Tuesday, March 27, 2012 11:26am
Tug of war
A common platform for debate between the country’s two largest political parties involves the role of government. Conservatives often tout the importance of personal responsibility, arguing that freedom is only achieved if people decide their own fate instead of allowing others to decide that fate for them. Democrats are often on the other side of the fence, escorting in a more powerful government, usually on the grounds of promoting equality amongst the socioeconomic classes. Interestingly, this same platform can be used as a lens to view the short-term lending industry and to consider some of the positions proponents and opponents have on payday loans.

A Quick Summary of the Arguments

In the world of payday loans, the line drawn in the sand for this topic of personal responsibility versus government oversight doesn't separate political parties, but two main players in the payday lending industry: consumer advocates and lenders.

While consumer advocates aren’t involved in the actual transactions, they are an outspoken group whose actions and words have played a large part in the regulation and opinion of payday loans. They want more government oversight in order to prevent payday loan lenders from preying on consumers. They see the high interest rates, short terms, and physical location of store-front payday lenders as predatory and unacceptable. If most advocates had it their way, payday loans would be completely abolished, but others will settle with simply having the industry more regulated.

Lenders, on the other hand, are fighting to keep the government away from their industry. Due to their vested financial interest in keeping payday lending as profitable as possible, few can blame them. These loan originators and their supporters feel allowing the government to interject in this industry is discrediting the intelligence of their clientele: just because many short-term financing borrowers make low wages, it doesn’t mean they don’t understand financial contracts or need somebody holding their hand while they make decisions.

A Delicate Balance

For outsiders looking in, it’s difficult to make a firm decision as to which party is correct. While both of the above-mentioned camps are usually very passionate about their stances, even the most extreme advocates and the most money-hungry lenders can at least see where the opposing viewpoints are coming from. That’s precisely why little has been done to either regulate or deregulate the payday loan industry: lawmakers don’t know whether there truly is a problem with short-term lending or what the fix to that problem is.

The Consumer Financial Protection Bureau (CFPB), headed by Richard Cordray, is a perfect example of an oversight agency that’s caught in the middle of these two feuding viewpoints. The CFPB was created in 2010 as a result of the Dodd-Frank Bill, and has been designed to protect the public from poor lending practices. With the mortgage industry, the CFPB has had little trouble establishing where it stands, as the line drawn between moral and immoral has been far more pronounced. But in the world of payday loans, the CFPB is still trying to gather intelligence to determine what course of action is necessary.

“We recognize the need for emergency credit. At the same time, it is important that these products actually help consumers, rather than harm them,” said Cordray in a press release. “We will systematically gather data to get a complete picture of the payday market and its impact on consumers.”

CFPB will need to delicately balance all of the needs and desires of those involved in the payday loan industry.

Usury and Alternatives

Cordray’s comment about the need for emergency credit plays a huge role in why payday loans are permitted to exist in the first place. People need access to short-term financing, especially those who make low wages. The problem is borrowers seek payday loans because they’ve exhausted other all other legal means of financing.

If those other means have been depleted, that usually means borrowers have suffered severe credit dings. When borrowers have poor credit, lenders are usually safe to assume that they’re of higher risk. Transactions of higher risk call for higher interest rates so that lenders can make up for defaults with higher payments. And higher interest rates typically lead to more defaults.

Some call the higher interest rates usury, but due to the default rate, lenders must charge high interest in order to stay in business.

And that’s the payday loan paradox: it’s a cycle where both lender and borrower are looking out for their best interests—but in order for it to exist, those in need of money must endure poor loan terms that work to perpetually keep them in a state of financial hardship.

Additionally, lenders argue if payday loans were abolished, then those in need of emergency money would be forced to turn to loan sharks. Those illegal lenders compensate for their lost money with much steeper fees or other non-monetary payments that are far less favorable to borrowers.

While the government decides where exactly they stand on this issue, the best weapon both consumer advocates and lenders have is education. If both of these groups work to inform borrowers of the risks involved with payday loans, then they will both promote a healthier lending environment.

And a healthier lending environment may very well indirectly satisfy the desires of both consumer advocates and lenders, as borrowers will become less and less victimized, and the government may find itself less needed.