Just say no to usury laws

Hilzoy reads an NYT article and waxes sarcastic:

Ohio lawmakers sought last spring to aid borrowers like Ms. Minda by capping annual interest rates for payday lenders at 28 percent, a sharp reduction from 391 percent. But lenders are fighting back in a novel way, collecting enough signatures, once certified, to force a vote in November on a ballot measure that could overturn legislation that established the rate cap.

"You can't make a payday loan cheaper than the industry does," said Steven Schlein, a spokesman for the Washington-based Community Financial Services Association of America, which represents lenders."

Yet somehow, banks and credit cards remain in business. I wonder how?

By lending to people who are better credit risks.  If you have a credit card or a bank willing to lend you money, you don't take out a payday loan (except for an economist of my acquaintance who is researching payday loans).  The people who get them are the most financially marginal members of society--i.e., the people least likely to pay them off.

Nonprofits have tried to enter the market in order to offer the loans at lower interest rates.  People without other access to credit say they need them to cover emergencies.  What those non-profits have found is that in order to cover their default risk, and the transaction costs of manking a lot of small-denomination loans, they need to charge shockingly high interest rates--291% annual, at one non-profit covered by the New York Times.

If that's the interest rate at which payday loans break even, it's pretty obvious that capping the interest rates at 28% will put an end to the industry.  Hurrah!  Say the credit nannies.  Not so fast.  If people really need the money, and don't have anywhere else to get it, you've just put them in a nasty fix.  Ban payday loans and you'll drive them to even worse alternatives:  pawnbrokers, loan sharks, or losing their job because they can't afford to fix the car.  Loan sharks didn't used to be just for gambling debts and illegal finance; they used to be staples of poor neighborhoods.  And you can't declare bankruptcy against an illegal debt.  Especially not with your kneecaps broken.


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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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