Round 2 on Predatory Lending: What Are Credit Unions Good For?

On Friday I wrote that I doubted that credit unions were going to be able to provide a painless substitute for payday loans.  Felix Salmon has responded at length, making three core arguments:

1.  Credit unions already pay their overhead with current operations, so adding on a payday lending service should give them a cost advantage over payday lenders

2.  Credit unions have a very low cost of funds, particularly in today's environment, where savings accounts might as well be paying interest in sticks of chewing gum.

3.  If customers want these loans, credit unions should offer them.

As I said in the post, I don't think arguments from the fact that almost no one seems to be doing this should be definitive--all innovations consist of something that no one was doing before.  But I will suggest some additional reasons for skepticism.

On the first point, as Felix in fact notes in his post, payday borrowers are looking in part for convenience.  They want many locations and extended hours so that they can go after whatever shift they're working.

Credit unions, being small, do not work this way.  My father-in-law used to drive something like 40 minutes to deposit checks at his credit union, and that's not all that unusual.  That's not somewhere you want to have to go in an emergency--particularly if you're a shift worker, instead of a college professor.

At the very least, to provide that level of availability, most credit unions would have to add shifts.  That's going to eat up some of your profitability--particularly since you'd get other customers coming in for other types of service, and because your location is likely to be nicer (read: more expensive to operate) than a typical payday lender or check cashing place.

On the second and third points, Felix and I see this a little differently.  Of course credit unions should strive to serve their members.  But they have obligations to their depositors, and to other borrowers, as well as to the people who want payday loans.

The reason that their cost of funds is really low is that they're funded by thousands of small savers who are willing to trade away interest earnings in exchange for peace of mind.  You shouldn't put that money into very risky loans--especially if you aren't planning on charging a rate of interest that makes up for that risk.  For the same reason that people shouldn't use their emergency fund to speculate on the currency markets, credit unions should think twice before getting into a high-risk loan business.

Ah, but those deposits are insured by the federal government, you will say.  And that is true.  But just as savings accounts should not be used for speculation, taxpayer dollars should not be used to backstop financially dubious lending operations.

A couple of further thoughts.  It's not clear to me how much synergy there is between payday lending and credit union operations.  To be sure, they are both in the business of lending.  But McDonalds and Per Se are both in the business of delivering food, and no one suggests that McD's should start a fine dining section--or that Per Se should start shoveling out mass-produced finger food.

Most obviously, this would confuse the brand--people who expected McDonalds to be fast, or Per Se to be exquisitely perfect, would be really upset with their experience.  But also, there's not actually that much overlap in what they do, except insofar as both involve fire and food.

Similarly, people who used their credit union for payday loans might have a different attitude towards their credit union afterwards--but also, staff and internal processes that are geared towards carefully disbursing funds with lots of oversight and attention to household budgets might not actually be very good at doing payday loans.  And if they got good at doing the payday loans, they might not be that great at their current core business of annoying the hell out of anyone who has ever tried to get a loan out of a credit union.  (When we bought a house, using in part some cash gifts we'd gotten for our wedding, I not only had to sign an affidavit swearing as to the provenance of those funds, but also had to provide them with--I kid you not--one of our invitations, along with a copy of our marriage license, and of the announcement in the newspaper.  Navy Federal provides great service.  But it is not speedy service.)

Along those lines, I've been thinking about the loan product that Felix Salmon has been touting as an alternative to payday loans.

Megan wonders whether it's only possible because state employees' paychecks are particularly reliable, but the structure of payday loans makes them all relatively safe: they're fully collateralized by the money coming at the next payday. You can only get one of these loans if you're employed, and you can demonstrate how much your next paycheck is going to be.

The NCSECU product is very well put together. It involves financial counseling; the creation of a savings account; and a modest interest rate of either 5% or 7%. It lacks the convenience of most payday loans: the credit union surely has shorter office hours than most payday lenders, and the product is more complicated. But the interest charged is so much lower that taking out one of these loans is always going to be a better idea than going to a payday lender who might charge upwards off 400% APR.

But this isn't quite right, I think.  First of all the NCSECU product requires direct deposit--which is to say that they demand to know, beyond a doubt, that they are going to have first crack at your paycheck.

That's not true of payday lenders.  You can close the bank account between now and payday.  Or you can write another check that will clear before theirs.  Doing it the NCSECU way lowers the risk to the bank--but it raises the risk for the borrower because it's harder for them to default.  (Not impossible: they could, frex, get fired for cause and not have a paycheck less time around.  I suspect that this risk is why the product is offered by . . . a state employees' credit union, where it is literally impossible that the member is going to be fired without pay in the next two weeks).

Someone who's budget is stretched really tight might find that the bank gets paid but the electric bill doesn't.  Good for the bank, bad for the person whose lights have been turned off.

There are undoubtedly some people who are better off with the NCSECU product.  Which actually raises an interesting question: if they became widespread, what would these products do to the market?

Presumably they would skim off the most stable customers whose finances were least in crisis.  But there would be some people for whom this was not a good product: they need the money RIGHT NOW, they need the option of defaulting.  Would the rest of the loan market collapse?  Or would it simply move to even higher interest rates?  In effect you'd see a miniature version of what happens in financial markets as a whole: the best off customers for payday loan services would be made better off, while everyone else became worse off.