Hidden Consumer Loans: An Analysis of Implicit Interest Rates on Bounced Checks by Mark A. Fusaro, Department of Economics, East Carolina University, finds that the median interest rate on bounce protection loans is in excess of twenty times that of payday loans. 

Fusaro writes, “Payday lending attracts attention for its high interest rates, but bounce protection loans are much more expensive. When the amount borrowed is low and the time outstanding is short, the effective interest rate paid on this loan can be quite high.”

Additional findings include:

• People of all income levels overdraft equally often
• Customers using bounced checks as personal loans account for twenty percent of overdrafts
• Service charges are a profitable income source for banks
• When a bank pays overdrafts, customers overdraft 50% more

Study highlights

An article in the New York Sun reports, “Credit card companies offer residents of majority black communities a lower credit limit than residents with the same profile who live in white neighborhoods, an economist at the Federal Reserve Bank of Boston has found.”

The study, “Credit Card Redlining”  is by Ethan Cohen-Cole.

Cole found that a 1% increase in the percentage of blacks in an area corresponds to a reduction in available credit of $123. Moreover, moving from an 80%-majority white neighborhood to an 80%-majority black neighborhood reduces credit by an average of $7,357.

Ohio’s Buckeye Institute asks, Is the Center for Responsible Lending being Hypocritical? They write:

 ”…there is research indicating that CRL is being funded by organizations that have business practices are not much different than those being used by payday lenders. While CRL’s research should be examined on its own merits (and it has been found lacking when examined by many economists, such as Dr. Tom Lehman), media members and legislators should question the consistency of CRL accepting funding from organizations that use the very practices it decries.

CRL is largely funded by the Center for Community Self-Help, which encompasses a variety of organizations, such as a venture capital firm and a credit union. These organizations cater to low-income Americans but often use the same tactics that CRL attacks when others do it. The Consumers Rights League recently completed a report that outlines some of the actions taken by organizations under the banner of the Center for Community Self-Help that are attacked by CRL when done by other organizations:

Aggressive debt collection As the Consumers Rights League report puts it, “Records show that Self-Help organizations have taken foreclosure or eviction steps against its low-income customers for as little as $62,332 in 2005 and $50,768 against another in 2002. And despite CRL’s public advocacy on behalf of small borrowers, Self-Help’s record includes lawsuits against countless small-dollar borrowers, including suits for as little as $96.”

Profiting from subprime mortgages  Although the CRL attacks subprime lending, it has no qualms about taking funds from organizations that profit from it. As Business Week reported, “Paulson & Co., [a hedge fund] which has seen its assets under management soar this year through fortuitous bets in the subprime market, has given $15 million to the Center for Responsible Lending, a Washington nonprofit that has been lobbying on Capitol Hill for passage of bankruptcy legislation.”

Making large profits of loans to the poor  As the Consumers Rights League notes, “Self-Help pays typically between zero and four percent interest on the loans it obtains, many of which come from government-supported entities…. But Self-Help charges interest far above the charitable rates at which it borrows. In 1998, the last year it reported interest rates on its publicly disclosed federal tax form, the Self Help Venture Fund reported that their average interest rate was more than 10 percent. For reference, that is approximately three percentage points higher than the average home mortgage rate in 1998, according to HSH Associates Financial Publishers. That adds up to a nearly 40 percent premium over the average rate. The Ventures Fund made other loans at interest rates as high as 13 percent.”

There is nothing inherently wrong with the Center for Community Self-Help aggressively pursuing debtors, taking contributions from businesses that profit from subprime mortgages, or making a profit on loans to the poor. But when its advocacy arm, the Center for Responsible Lending, attacks these same practices when other organizations do them, it calls its credibility into question.

Payday Pundit says, “Amen to this.”

Interesting discussion on a the Volokh Conspiracy blog prompted by a column, “In Defense of Usury” in the Wall Street Journal by Dean Karlan and Jonathan Zinman. 

Several of the commenters raised the challenge that nothwithstanding the authors’ conclusions, very high interest rates are still “immoral” and should be banned. But I don’t really follow the logic of the critique–if there are no externalities, and those that borrow are better off as a result, what exactly is the argument for why high interest rate loans are immoral and should be prohibited?

…compared to bounced check fees and overdraft protection.  The payday lending industry has been making this point for years, but now economists are catching up.  This article on the blog of the Left-wing magazine Mother Jones discusses research by East Carolina University Professor Marc Anthony Fusaro.   

From the article:

     Fusaro looked at overdraft protection as a form of a short-term loan and found that people who occasionally bounce checks (between 1 and 10 times a year) pay interest rates exceeding 6,000 percent. Chronic bouncers in the study, who make up a small percentage of bank customers, paid more than $3,000 in fees annually for the privilege. The average size of the overdraft was pretty small, between $90 and $300. The most extreme case in the study was one poor soul who had a $3 overdraft outstanding for one day, which resulted in an intereste rate of 260,245 percent, a hefty surcharge for using a debt card for a latte.

The Center for Responsible Lending continues to promote a report, “Financial Quicksand” that reaches conclusions about the payday lending industry that have been debunked by Veritec Solutions, the data gathering company whose numbers CRL misused. 

Veritec found that conclusions made in the CRL Report are not an accurate reflection of statistical information.

False conclusion #1: Ninety percent of payday lending revenues are based on fees stripped from trapped borrowers

False conclusion #2: The typical payday loan borrower pays back $793 for a $325 loan

False conclusion #3: Regulator data corroborates high levels of loan flipping and that regulator data confirms that most borrowers renew payday loans many times per year.

The complete Veritec report is here.

Terry Kibbe of the Consumers Rights League weighs in.    From her piece in today’s Los Angeles Times:

“The Center for Responsible Lending and other so-called consumer advocacy groups rely on shoddy research in stirring gender, racial and class sensitivities to make the case against payday loans, as they did during their successful crusades in Georgia and North Carolina to run payday shops out of business. Though they claimed that the elimination of payday loans saved Georgia residents approximately $154 million per year, that claim was refuted by a Federal Reserve report (pdf) indicating that consumers ended up paying more through overdraft bank charges and late fees. Critics of payday loans are content to ignore that the mass of payday borrowers are middle-income, educated consumers.”

Terri goes on to oppose “big brother” restrictions on payday lending. 

Communities affected by natural disasters are more resilient and less likely to face foreclosure if they have access to payday loans, says a working study, “Payday Lenders: Heroes or Villains?” by researcher and University of Chicago faculty member, Adair Morse.

From the press release:

The study finds that payday lenders provide critical capital to people in disaster-struck communities. Morse found that banks and other forms of credit were no substitute for payday loans, “…banks cannot serve the welfare-enhancing role for individuals in distress that payday lenders serve.”

“My results have important policy implications,” concludes Morse. “If the existence of payday lending is valuable for those facing personal disaster in a way that other financial institutions cannot provide, then regulators should strive to make access to finance easier and more affordable, not ban it,” Morse wrote, “…if payday lending is welfare improving for at least some portion of the population, a move to ban payday lending is ill advied.”

Marc Kilmer, a policy analyst with the Columbus, OH-based Buckeye Institute for Public Policy Solutions has written a piece critical of Ohio’s legislators.

Ohioans did not send legislators to Columbus to make their personal financial decisions for them. Considering the poor state of Ohio’s budget, it seems ironic that some in Columbus think their time is best spent focusing on the financial choices of others.

Kilmer previously authored the study Consumer Choice vs. Over-Regulation.