Georgia and North Carolina banned cash advance loans in May 2004 and December 2005. The legislators in these states say they were compelled to act for the public good because of the claims from public interest group adversaries that pay day loans are a “predatory debt trap.”
The debt trap critique against payday loan companies seems based on three allegations: payday loans are expensive (“usurious”), payday lenders locate near their customers (“targeting”), and most payday customers are repeat (“trapped”) borrowers. After documenting that the typical customer borrows 8 to 12 times per year, the CRL (Center for Responsible Lending) concluded: borrowers are forced to pay high fees every two weeks just to keep an existing loan outstanding that they cannot afford to pay off. This “debt trap” locks borrowers into revolving high-priced short-term credit instead of reasonably priced longer-term credit.
Although the amount and availability of longer-term credit that may be available to payday loan borrowers, and the precise sources of that alternative credit, was never discussed, the debt trap critique has influenced lawmakers at state and municipal levels to restrict cash advance payday loans in their jurisdictions or to ban them outright.
Oakland and San Francisco limit the number and location of payday stores. Oregon and Pennsylvania recently joined Georgia and North Carolina in banning payday loans. New York, New Jersey, and most New England states have never allowed payday lending. By contrast, some western states (Washington, Idaho, Utah, and until recently New Mexico) have kept their laissez-faire policies toward payday lending.
The national patchwork system of payday loan regulation means that millions of people use payday loans repeatedly in some states, while their counterparts in other states must go without this often only legal source of bad credit loans. However one sees payday credit-as helpful or harmful-the patchwork regulations mean that millions of households are being wrongly treated by payday loan regulations.
The national adversarial controversy continues. Jane Bryant Quinn (financial columnist in Newsweek) recently warned that “payday loans can be a debt trap” (October 8, 2007).
The Federal Reserve Bank of New York Staff* tested the debt-trap claim of the payday advance loan by researching how households in Georgia and North Carolina have fared since those states banned payday loans. Their research investigated patterns of returned (bounced) checks at Federal Reserve check processing centers, complaints against tradional “approved” lenders and debt collectors filed by households with the FTC (Federal Trade Commission), and federal bankruptcy filings.
The monthly complaints data are new to this study; these data were obtained them from the FTC under the Freedom of Information Act. Changes in complaints within a state to identify changes in household welfare (well-being), a distinct advantage compared to the ambiguous measures (interest rates and repeat borrowing) emphasized by critics of payday lending. How do we know when credit is so expensive or burdensome that households are better off without it? The real test should be whether household welfare is higher with or without payday credit, and complaints are a measure of welfare.
Cutting to the chase, FRBNY Staff concluded that compared with households in states where payday lending is permitted, households in Georgia have bounced more checks, complained more to the Federal Trade Commission about approved lenders and debt collectors, and filed for Chapter 7 bankruptcy protection at a higher rate.
This negative correlation between reduced payday credit supply and increased credit problems, and decline in the general welfare in Georgia and North Carolina contradicts the debt trap critique of payday lending. The official citation to the referenced study is:
*Payday Holiday: How Households Fare after Payday Credit Bans
Federal Reserve Bank of New York Staff Reports, no. 309
November 2007; revised February 2008
