In Part One, I proposed the following heuristic regarding paternalism:
To summarize, although it is not a proper function of government to proscribe “bad” decision making, perhaps a few isolated, objectively defensible carve-outs can be allowed in which the government makes it just a little bit harder to make a bad decision. Perhaps. Stated differently, a paternalist exception that actually proves the libertarian rule should probably be embraced and not shunned.
But does this qualify as such an exception?
In a payday loan transaction, the lender makes a small advance (typically $100-$500) to its customer, agreeing to hold a personal check for the loan amount plus a fee until the customer’s next payday. … The borrower receives cash immediately. Fees charged can range from $15 to $30 on each $100 advanced, although the typical fee is at the lower end of that range.
The fee may seem modest when presented as a dollar amount, but when calculated as an annual percentage rate (APR), the cost is relatively high. A charge of $15 to borrow $100 for 14 days amounts to an APR of 391%. A survey by consumer advocates found APRs on 14-day payday loans ranging from 390% to 871%.
No fewer than five separate bills were introduced in this session of Congress to limit or even ban payday loans. No fewer than four federal financial regulatory agencies, including the Federal Reserve, have launched investigations of the practice. Not to mention the states.
There are many other examples of financial market proscriptions in the name of paternalism — usury, loan sharking, “refund anticipation loans,” and that perennial favorite of libertarians, “price gouging” — that all attempt to block voluntary transactions by competent adults.
It is a basic principle of economics* that more choices lead to higher potential utility for consumers. Stated differently, restricting freedom of choice and freedom of contract always makes people worse off.
So what right, exactly, does a politician, regulator or bureaucrat have to say that a payday loan, even one with a stratospheric interest rate, is “wrong” for a given borrower in a given circumstance, and therefore ban it?
Note that the common, if indelicate, response that “people are stupid” is not relevant. That observation serves as a justification (perhaps) for labeling requirements and “Truth in …” laws such as the Truth in Lending Act. More information, like more choices, can be a good thing, if the cost of presenting that information does not exceed the benefit it provides.
But that’s not the same as a ban. Even a fully informed consumer who is perfectly willing to pay an “outrageous” (i.e., a usurious) interest rate is barred from doing so. Why?
It also can’t be merely a manifestation of the general defense of “unconscionability” in contract law. “Unconscionabilty” is an “as applied” concept: unconscionable in what context? Umbrella proscriptions declare a contract invalid not “as applied,” but facially. So the argument becomes circular: Such loans are unconscionable because they’re, um, unconscionable? That’s a no-go as well.
Perhaps it’s an externality argument — A 390% APR on a payday loan might not offend the borrower, but it offends us, and we therefore are entitled to block it, not to help the borrower, but to help ourselves. “Will of the majority” and such.
That way madness lies. It is the ultimate slippery slope. If we can ban, for our selfish goals, an offensive interest rate imposed on others, then what other “offensive” strictly private activities might we start banning?**
So I ask again: What precisely is the justification for a government to ban voluntary, fully informed, fully private loans — or other private contracts, or other private activities generally?
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(*Which is why, apparently, some economists try to argue the exact opposite. Go figure.)
(**Some of you might be able to guess where I could go with this line of reasoning — see Lawrence v. Texas. Fans of Overlawyered might also think “foie gras.”)
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POST SCRIPT: Not long after I finished this post, an interesting item popped into my news aggregator. I’ll excerpt it here without comment —
Need cash to pay your next bill? Send us a text message, we’ll send you the money in just a few minutes.
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Lending cash to young people through SMS messages at rates banks can only dream of is becoming increasingly popular in Nordic countries, according to a survey conducted by Finland’s financial watchdog. … In Finland and 12 other EU countries these lenders are out of reach of financial regulators because they do not collect funds from the public, the watchdog said.Those who accept a loan offer get the money transferred to their bank account just a few minutes after sending an SMS with their national identification number. For a two-week loan of 100 euros the payback is 120 euros, equivalent to an annual lending rate of about 1,000 percent, which would be illegal in some European countries.
Discuss.
11 Comments
Compare $30 per $100 dollars borrowed to $17 (or quite a bit higher!) per bounced transaction… with $10 dollar transactions… when the next day is pay day. That is, a $17 fee for borrowing $10 for less than 24 hours.
How’s THAT for interest? And yes, that’s a bank rate (actually, many banks charge more than $17 for a bounced check, I hear).
I once bounced a check by less than $1.
When it comes down to it, the money changes will need only to itemize the fees in the same manner my mortgage lender does: service fees, origination fee, mortgage insurance, background check, recording fee, title insurance and any number of other one time expenses that they can dream up. A good chunk of the payday loan fees probably would not be considered interest by ordinary business accounting, but rather be expensed as the cost of originating the loan (office staff, ‘insurance’ for bad loan repayment, etc.) with a modest interest rate nominally stated.
If attorneys general get after these businesses they will merely respond with better accounting.
Iam not a lawyer. And, this may not apply strictly to payday loans or even genral banning of acts, but a justification for government sticking its nose into such transactions is implicit in your question: “What precisely is the justification for a government to ban voluntary, fully informed, fully private loans — or other private contracts, or other private activities generally?”
The government probably should step in in some manner to help make sure the transaction is really voluntary, fully informed, and fully private. Especially, when there is a significant power or information difference between the parties. Basically, maintaining a fair market.
I just thought of another reason for loans in particular. Who enforces repayment of the loan? The government which in a democracy menas all of us. Since, the government is the representative of the people do we really want our government in the business of enforcing outrageous loan terms on people who may or may not have entered into the agreement fully informed.
If enconomists disagree about a ‘Basic principle of economics” possibly it’s not a basic principle…
I inadvertently overdrew a $3.92 check on the day before pay day. My bank charged a $35 bad check fee, then graciously a $6 “retry ” fee, to pay the check. I’d have been much happier to pay 1000% interest on $3.92 for one day, than $41 in bank fees for the same service.
The government probably should step in in some manner to help make sure the transaction is really voluntary, fully informed, and fully private. Especially, when there is a significant power or information difference between the parties. Basically, maintaining a fair market.
The government (or, quite often, attorneys) deciding that it knows better than us which deals consumers want to make ex ante is the first step towards the government regulating the market by dictating what prices and services may be offered. The principle needs to be defended even if one finds the business or customer base less than exquisitely tasteful, or if we think that we are too clever to engage in such services. What’s the difference between stopping a consumer from purchasing a payday loan and stopping a consumer from eating a pint of Ben & Jerry’s?
The payday-loan banks are responding to market demand, a demand that used to be filled by organized crime, which would offer penalties somewhat more punitive than $35 fees.
Mark, numerous banks provide overdraft protection; I once mistakenly set an automatic bill payment to the 30th of every month rather than the last day of every month, and overdrew my account by a thousand bucks a few months ago in a 31-day month. Cost me under a dollar. If your bank won’t waive the fees, switch banks.
I can go one better. My bank processed my rent check twice and withdrew the money from my account each time. This caused me to “bounce” 8 checks. I was on a camping trip at the time and away from the Internet so I didn’t catch it for a week. When I finally found out the bank credited my account with all of the $40.00 fees that it had charged me and the $750 for the rent check. I was on my own for the $25 to $50 fees from the people I had written “bad” checks to. Ended up costing me about $300. I called the State Banking Commission and was told that I had no recourse against the bank for an “honest error”.
Jim, if you’re a good customer, you might find the bank very accommodating if you threaten to take your business elsewhere. (capitalism is neat that way.)
The government probably should step in in some manner to help make sure the transaction is really voluntary, fully informed, and fully private. Especially, when there is a significant power or information difference between the parties. Basically, maintaining a fair market.
On what do you base the assertion that there is an information difference? All the information is AVAILABLE to the customer, who CHOOSES to disregard it, or not to consider the long term consequences of habitually using the service. Is it an unfair maket anytime one party has a weaker negotiating position? Ultimately, what you’re asking for is government to remove the natural consequences of living hand to mouth, and with them the rewards for budgeting and saving. The first part of that sounds wonderful, until you consider that these loans are high risk, and no one lends money out of the kindness of their hearts. The market dictates that the return on these loans will be exactly as high as it needs to be for sufficient people to accept the risk of making them to meet the demand. The only way to negate that effect is for government to artificially lower the risk or subsidize the return, which forces me, as a fiscally responsible taxpayer, to subsidize other people’s irresponsibility. If the public is accountable to pay for the consequences, then the public rightly is entitled to a say in the decisions leading to the consequences, which means the government telling the likely customers for these loans how much of their paycheck they’re allowed to spend. As stupid as I think it is for someone making minimum wage to spend money on various personal vices when they could be saving it, I’ll defend their right to do so, because I value my own freedom to make my own financial decisions. So you see where your position leads?
Dweeb, they already told me that if I don’t like it I can find another bank. The only reason that I’m staying is that it is the same bank that the company I work for has it’s accounts at. I don’t want to have to wait 3 to 5 days for my per diem checks to reach my account when I make a trip.
they already told me that if I don’t like it I can find another bank.
You can call their bluff, or not. It’s up to you. I’d also look into whether they’re liable for the costs you incurred due to their mistake.
The only reason that I’m staying is that it is the same bank that the company I work for has it’s accounts at. I don’t want to have to wait 3 to 5 days for my per diem checks to reach my account when I make a trip.
You could always cover the gap with a payday loan đŸ™‚