Felix Salmon responds rather pungently to my post on debt. I certainly didn't mean to imply that Felix's position is unreasonable--it's not, and a lot of people hold it. I just think it's tricky.
I'll cover some of our disagreements in a minute, but I think this is really interesting:
McArdle is far too generous to the lenders here. For one thing, I made it clear in my post that credit cards are very good for transactional credit: if you need to pay the car-repair shop today, using a credit card is a great way of doing so. But you should also have a good enough relationship with your bank that by the time the credit-card bill comes due, you can pay it with the proceeds from a personal loan or line of credit.
Secondly, I don't think for a minute that we should deny the poor credit; in fact I'm on the board of a non-profit institution which exists to provide credit to the poor, and I'm all in favor of that. It's credit cards I don't like, with their high fees and interest rates (and there are even exceptions to that rule, such as the ones provided by many credit unions). And I really dislike payday loans, which are pretty much universally predatory, especially when compared to similar products from community development credit unions.
Megan's conceptual mistake here is clear when she says that "credit extended to the poor carries high interest rates to cover the default risk". But in fact the interest rates on credit cards are really not a function of default risk at all. Mike Konczal had a great post on this back in May, where he showed pretty conclusively that credit-card interest rates were all about maximizing profit for the issuer, rather than compensating for default rates. And payday loans are even worse.
What earthly grounds does Megan have for saying that the number of people made worse off by payday loans is smaller than the number of people made better off by them? I suspect she considers the alternative to be no-credit-at-all-nohow-noway. But that's not what anybody is proposing. I, for one, think that credit should be available to the poor, very much so. But not in the quantities and at the rates that it's been available until now. There is such a thing as too much credit, and we crossed that line long, long ago.
It's an odd fact that poor people shun bank accounts at an astonishingly high rate. Rather than pay $10.00 a month for a checking account, they'll pay more than that to a check cashing place. Of course, it's not like banks are going after those clients, because they're not very profitable--small accounts still have almost all the transaction costs and overhead of large ones. But why don't the customers go after the banks?
The plausible reasons I've heard:
- Check cashing places give you the money immediately
- Poor people are disproportionately subject to judgments and garnishments that make it preferable to operate in cash
- People working off the books don't want a trail for the IRS to follow
- For people with low incomes, the costs associated with a mistake--bounced check fees, for example--can be devastating. But if you don't have the fees, people will overdraw their accounts.
- Check cashers keep longer attractive hours and have better service
As Felix could no doubt attest at great length, this problem has proven hella stubborn.
The problem of payday lenders and credit cards, however, is not a problem of the unbanked. If you don't have a relationship with a bank, you almost certainly do not have a credit card, and you definitely aren't using a payday lender.
So why are people using credit cards and payday lenders?
Credit cards have low transaction costs, which is why, as Felix argues, people use them for sudden emergencies. Many of them would be better off if they did go to their credit union for a personal loan to pay off the balance. On the other hand, if you're planning to pay off the balance in a couple of months, that's overkill--and the loan inquiry will ding your credit.
Payday loans are a different question. There's a lot of literature on them, but most of it agrees on a few points. For our purposes, the salient characteristics of payday borrowers are a) they have little-to-no money in the bank b) they have moderate incomes and c) they are fairly severely credit constrained. Virtually all payday borrowers use some other sort of credit (Stegman and Faris, 2003). At least 60% of them have access to a credit card (Lawrence and Elliehausen, 2008). 73% of them have been turned down for a loan in the past five years, or received less credit than they asked for. If they're turning to payday loans, it's because they have maxed out those other forms of credit, and they have some pressing cash flow need.
Payday borrowers do not necessarily turn to payday lending out of ignorance; a majority of them seem to be aware that this is a very, very expensive form of financing. They just have no better options.
The biggest problem with payday loans is not the one-time fee, though that is steep; it's that people can get trapped in a cycle of rolling them over. Paying $15 to borrow a few hundred bucks in an emergency is bad, but it's probably manageable for most people. Unfortunately, since payday borrowers are credit constrained, have little savings, and are low-to-moderate income, they often have difficulty coming up with the principal when the loan is due to pay off. The finance charges add up, making it difficult to repay the loan.
According to Lawrence and Ellihausen, about 40% of payday borrowers fall into that problem category: they have rolled over a loan five or more times in the past year. A hard core of about 20% had rolled over 9 or more advances.
Judging who is worse off is a pretty tricky task. Would payday borrowers be better off if they had no other debt, and could go to their credit union for a tidy personal loan? That's unquestionable. By the time they're at the payday loan stage, however, that doesn't seem as if it's usually an option. I'd say that the people who are rolling over 9 or more loans are definitely worse off, the people rolling over 5-9 loans are probably worse off, and the majority who are rolling their loans over no, or a few times are probably better off, given the circumstances they were in when the time came to get the loan. People who roll over loans only a few times are not trapped in a debt cycle, and (I'd guess) are unlikely to have been using the loans for ordinary expenses.