On July 1, a number of bills directed at short-term lenders (“payday” and “title” loan companies) took effect. The purpose of the bills was to stop the “unfair” interest charges for very short-term loans.
| BY TOM POTIOWSKY |
ON JULY 1, a number of bills directed at short-term lenders (“payday” and “title” loan companies) took effect. The purpose of the bills was to stop the “unfair” interest charges for very short-term loans. Basically, with fairly strong public support, our lawmakers felt that these short-term lenders were preying on the unfortunate who were facing cash-flow shortages. So they capped the interest rate and fees that could be charged.
But if we look at the economics behind this industry, we may find a different story as to whether the government has truly helped those in need.
Private markets are amazingly efficient. When they work properly, people get the goods and services they desire at the lowest price. But as great as private markets can be, they don’t always work as planned and then government sometimes is needed to do the job.
Back to the short-term lenders. At the end of 2006, there were 346 licensed short-term lenders. For a 14-day loan period, the Division of Finance and Corporate Securities found that the average finance charge per $100 was about $18.83. This works out to an annual percentage rate of around 491%. Would not any reasonable person call this a market failure?
Not so fast.
For the short-term lender market to be a market failure, one party has to have more (or less) information about the other party and the details of the transaction. Short-term lenders are regulated so the finance charges, duration of loan, collateral and all the terms of the contract are upfront. But who is likely to go to a short-term lender? Those who are strapped for cash for making payments that are due now. How creditworthy are these people? Not very, or too difficult to tell on short notice, so the lender charges a higher interest rate than conventional lenders. Is this a market failure? No, not in the economic sense. There is a short-term need for cash by the demanders, and the short-term lenders, the suppliers, provide a service to meet this demand. The market is working very efficiently to satisfy people’s wants and desires.
You really have to stretch logic to claim that this was a market failure and necessary for government to intervene. The bills passed by the Oregon Legislature go after the supplier to supposedly help the demander, and so far cutting the supply seems to be working. As of late July, 102 licenses had been surrendered and this number is likely to climb. The remaining short-term lenders cannot charge more than 36% interest, plus a 10% loan origination fee up to $30.
But has this helped the demanders, those who find themselves strapped for cash? They have fewer places to go for a loan and the lenders still in business will be very choosy. The supply has been affected, but not the demand.
I think the short-term lender market is a society failure, not a market failure, and that’s why government got involved. The outrageous interest rates would not have existed if people were not willing to pay them because of their economic situation. Markets are nondiscriminatory. They do not care if one party made bad financial decisions in the past.
Thus going after the short-term lenders will not truly solve the problem. We have to recognize the role of the consumers whose tough economic conditions brought them to this market and ask what we can do to assist them. There are many education programs available from both government and private agencies. One that I am very familiar with is the Oregon Council on Economic Education (I sit on its board). We need to help families make better decisions concerning their financial well-being. If we do, short-term lenders charging 491% will disappear on their own.
No one supplies if no one demands.
Tom Potiowsky is an economics professor at Portland State University and the former state economist.
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