What I am thinking about is precisely what is wrong with the model of the payday loan – a high-interest rate loan made on a very short-term basis, predominantly to customers of modest means.

When you think about the alternatives, a regulated high-rate payday loan industry is more desirable than the underworld controlling this segment of the economy. If one falls delinquent on a payday loan or ultimately can't pay it, the consequences of negative amortization or bankrupctcy are are more preferable than getting kneecapped or killed.

OK, I'll be the lead-off batter! I think your question hits the nail on the head. I hate the entire payday loan business, as well as the rapid refund loan business. These short-term lending programs capitalize on the illiquidity of people who live paycheck to paycheck and in doing so charge high rates of interest (and fees) for taking on very little risk. Why should an institution need to charge a high rate of interest if the borrower has given a self-executing security interest in her tax refund, calculated and guaranteed by that institution, which will arrive in less than a week? the credit profile of the borrower may be poor, but the credit risk of this particular loan is not. Likewise, an online cash advance company requires that your paycheck be direct deposited into a checking account and then becomes authorized to debit that account. Not too risky.

But, you ask, what is the negative impact on the borrower? Is the borrower worse off by paying a high interest rate than not having access to that short-term loan? What are the loans used for, would be a nice question to ask. Payday loans are usually for less than $1000 (probably even less), so I think it's safe to say that the cash is used for consumables or at least ordinary expenses. (At personalcashadvance.com, the FAQ section states that state law requires loans be less than $500.) So, the borrower is short this month, takes out a loan that is repaid out of his paycheck, and is short again the next month. (The website also states several times that these loans are meant for small, unusual expenses and not intended for repeat use. This disclaimer must be in reaction to a law, I would assume.)

But, as you say, this situation is the same as credit card use, only at a higher rate. (The credit card company takes a higher risk of repayment, but at a lower rate of return.) By the way, nowhere on personalcashadvance.com could I find any rate or fee listed at all.

So, I hope some of our readers can help me back up my intuitive hate for these programs.

The policy arguments against payday loans are essentially the same as the policy arguments against rent-to-own. Condescension regins.

I was recently externing for a Judge in DC, and got to see F. Paul Bland argue a payday loan case before the Supreme Court. Could be a good interview:

F. Paul Bland, Jr., Staff Attorney pbland AT tlpj.org

But, as you say, this situation is the same as credit card use, only at a higher rate.

I disagree with that. Subprime credit card companies charge rates of 20-35% APR and with fees generate revenue per dollar of receivables somewhere in the 30-50% per annum range. I don't think the payday guys do that.

By the way, let's look at foreign (not your home bank) ATM fees. If you pay $1.50 to take out $100, there's no credit risk and the rate is about 1.5% per day since the receivable will net out that day or the next day via automated clearinghouse. Multiple that by 200 (business days per year) or 360 and you get your effective APR. Same thing with a payday loan.

By the way, the interest in the paycheck might be secured, but that doesn't mean there is no credit risk. The payday loan company assumes whatever default risk presented by the firm issuing the paycheck. So if I'm an employee of "Bob's Garage," that presents a different level of credit risk to the lender than if I were an employee of the federal government.

Christine: I have a sense that Ronald is seeking to study this industry, rather than condemn it or debate about it.

Ronald: Interesting project, almost Levitt-esque. A natural comparison would be other subprime lenders – pawnshops, rent-to-own, check cashing, quick tax refunds, etc. Some pawnshop chains are public companies, so you might be able to get useful financial data out of their disclosures. Perhaps the same is true for big payday loan companies. Relevant paper: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=771624

Dale, my comma was misplaced. I am also assuming that credit card rates are higher than payday lending rates. As far as ATM's go, I had assumed that the fee was to cover transaction costs of the foreign bank, not risk. I'm not sure if the issuing bank accepts the risk or the foreign bank.

So, we have something of a spectrum from Christine to Gordon. I'll start with two further comments. First, there is a considerable distinction between rent-to-own and payday lending. What we know empirically is that rent to own tends to flourish in jurisdictions in which payday lending is effectively prohibited: consumers with a choice avoid rent to own. The most obvious reason is that rent to own (like pawnshop lending) threatens the immediate loss of tangible personal property upon a future income disruption. The same property, upon a failure to repay payday loans, for the most part would be exempt from execution (at least in this country). That doesn't necessarily mean that we should ban rent to own, but it might suggest that banning payday lending will lead consumers to less savory lenders than tolerating payday lending.

Having said that, I do think something more than paternalism can be suggested for banning payday lending. As with many consumer financial transactions, there are good reasons to doubt the ability of consumers to act with sufficiently full information and rationality to drive the market to a competitive endpoint. Here, for example, if location is really important, as some have suggested, then firms with a large number of branches might be able to charge supracompetitive prices. At the same time, the declining marginal costs of increased volume will make it hard for new locations to enter to compete with existing ones. We see market evidence of this from the pattern of large national lenders, who typically enter markets by buying existing locations rather than starting new ones. Furthermore, if we can worry about cognitive failures (something on which reasonable minds might differ), we would worry that consumers will underestimate the risks involved in dependency on a payday lender, particularly when what little evidence we have shows that rollover transactions are such an important part of the business model. Finally, if those points lead to an excess of payday borrowing, and if the financial distress from that borrowing generates externalities (as it probably does), then we would have a case for regulation, wouldn't we?

Lots of "ifs" in that paragraph, but I think that is a coherent theory isn't it?

As far as ATM's go, I had assumed that the fee was to cover transaction costs of the foreign bank, not risk. I'm not sure if the issuing bank accepts the risk or the foreign bank.

Payday loan companies have their operating and transaction costs too, no? My point wasn't so much how the expenses are allocated, but that the interest rate or fee on any small short term loan or receivable has to be high in percentage terms to cover the costs of doing business.

My bottom line on payday loans is this, however: Where else are people going to go for this sort of liquidity? The underworld stands at the ready to help.

If you are willing to venture into the land of cognitive failures, I think the work of David Laibson is certainly applicable to the payday loan issues. If you are not already aware if it, Laibson has, for example, a nice model that incorporates the irrationality of individual choice with respect to intertemporal decisions.

According to the FDIC, payday lenders typically charge $15-20 per $100 advanced for a two week period, which represents an APR of almost 400%.

The Uniform Retail Credit Classification and Account Management Policy, which is a policy issued by the Federal Financial Institutions Examination Council, establishes guidelines for extensions, deferrals, renewals, or rewrites of closed-end accounts, which include payday loans. Under this Policy, institutions should:
(1) limit the number and frequency of extensions, deferrals, renewals, and rewrites; (2) prohibit additional advances to finance unpaid interest and fees and simultaneous loans to the same customer, and (3) ensure that comprehensive and effective risk management, reporting, and internal controls are established and maintained. This policy is probably why personalcashadvance.com has disclaimers that the loans are not for repeat use.

I also wonder to what extent Christine is right that payday loans involve little or no risk to the lender. Payday lenders don't get repaid directly from the borrower's paycheck. They either take a check to be cashed at a particular future date or receive the right to debit the borrower's checking account on a particular future date (which is what personalcashadvance.com does). If the borrower's bank account has insufficient funds on the collection date, then the check bounces or the lender is unable to make the debit. Not everyone has direct deposit and even if they did, they may be able to withdraw all or most of the funds before the check is cashed or the electronic debit occurs. This problem of insufficient funds is not unusual. If the credit rating of the borrower is truly wretched, then the lender may have significant difficulty collecting on the loan.

It is also worth noting that if a borrower has insufficient funds in his bank account when the check or debit is due, the borrower will have to pay a nonsufficient fund fee on top of his payday loan fees, plus a fee to the lender for having insufficient funds. All of these fees may significantly increase the total cost of the loan for the borrower.

Ron (and Christine)
you might also want to check out this:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=694141
Predatory Lending and the Military: The Law and Geograpy of 'Payday' Loans in Military Towns
Here's the abstract:

Abstract:
A heated national debate has developed over whether one type of high-cost predatory lender, commonly known as "payday lenders," are targeting financially vulnerable military families and whether the law protects them from such predation. Writing within the relatively new interdisciplinary "law and geography" movement, this article provides geographic evidence that payday lenders do aggressively target American military personnel, irrespective of most forms of legal regulation. This paper first provides a comprehensive introduction to payday lending business practices and to the financial vulnerability of military personnel. In conducting our empirical research, we examined 20 states, 1,516 counties, 13,253 ZIP codes, nearly 15,000 payday lenders, and 109 military bases. We consistently found high concentrations of payday lending businesses in counties, zip codes, and neighborhoods in close proximity to military bases. Our observations were controlled by comparing payday lender densities in military areas to statewide averages and also by comparing payday lender locations to bank locations. Of the twenty states involved, the only legal strategy which prevented payday lender targeting of military personnel was New York's aggressive enforcement of civil and criminal usury law. Going beyond the debate over predatory lending to military personnel, our research provides a realist check on pure legal reasoning and unfounded faith in current consumer protection rules.

Christine: If you really hate these programs, how about organizing a group of like-minded individuals to pool some money together and offer a similar service. You could charge a much lower rate and still make money because the industry, as currently constructed, is obviously charging rates which in no way reflect the risk involved or what the market should bear.....I'm confident this could work because academics and politicians (see WalMart & the Maryland legislature)invariably know more about a consumer service than the greedy @%$#@s actually providing the consumer service.

The study that Dan Markel mentioned above is truly embarrassing. It has no regressions. Not a single one. Consequently, it does not control for anything. A respectable study must control for the following characteristics of the nearby non-military populations: income, unemployment/underemployment levels, % home ownership, median age, % of households headed by a female, family size, racial composition, % of immigrants, education levels... you name it. This paper essentially assumes that all those characteristics are distributed equally across each state, and that military bases are placed in random locations. To calculate the “predicted” number of payday lenders, for example, it simply calculates statewide number of payday outlets per person and multiplies that by number of people in the zip code. It’s like saying that Beverly Hills and South Central LA should have the same number of payday lenders per person. Even for those silly “findings”, they don’t report t-statistics (is the difference between “predicted” and “actual” number of lenders significant?).

Pure garbage. Took me about 3 minutes to figure it out. Unfortunately, most papers that make similarly sweeping claims are of the same quality.

The paper Dan M linked is being published in Ohio State Law Journal. I think Kate's point about the weakness (or, in her view, complete irrelevance) of law review ranking/reputation as a signal of article quality is probably most persuasive with respect to empirical pieces. Law review editors have limitations as evaluators of traditional legal scholarship, but nowhere near as severe as their limitations evaluating empirical work; there's simply no reason to think that getting good 1L grades (the criterion for most law review editorships) indicates an ability to separate impressive from flawed empirical work.

It does seem bad that a law review picked it with such a glaring flaw, but a professor did just recommend it to another professor here on this site...

Another few thoughts, as this topic winds down:

First, it is clear that payday lending rates are much higher than credit card rates, probably about 20 times as high in APR terms (400% versus 20%). It also is relevant that these are not short-term rates in truth; the data we have make it clear that most of the interest comes from long-term semi-permanent borrowers. The hardest question for me, as to which I have no real data yet, is the extent to which those fees in fact understate the true rates. As commenters noted, there is considerable potential here for later fees for bounced checks in the like -- "shrouded" charges, to use Laibson's term -- that might drive the "true" rates higher. My guess, completely uninformed, is that those fees are prevalent in some payday lending niches but not others, but I don't yet have a good handle on that.

Kate is correct that my goal is to study payday lending, not to bury (or embrace) it. My coauthor Jim Hawkins and I picked this industry because it probably is the most reputable of the fringe lending industries, in that it involves set fees rather than complex APR calculations and doesn't pose problems with collateral valuation by consumers. Thus, in a way it presents the most interesting regulatory questions. If we can't tolerate this industry, then we have to take an unusually strong stance against lending to the marginally banked. I think we confront head-on the issue whether banks should be involved or not, the possibility for an increased role of the welfare state (if we choose not to permit this lending), and some interesting federalism questions. But, as Kate and Dan allude to, there are a number of dubious empirical facts that presently are being used to inform legislative debates. So we will need to untangle some of those issues, before making any informed proposals about short-term lending to credit-impaired borrowers. I thank everyone for the suggestions.

Law student editor: that was a funny comment, but not entirely fair. It’s one thing for a colleague outside your field to recall seeing something vaguely relevant and point it out to you without investigating the quality first – and it’s completely different for a journal editor to read a paper (presumably carefully) and recommend it for publication.

In a calmer mode, I should commend the authors of that paper for impressive data-gathering efforts. Good idea, a lot of work, bad implementation.

I thank Kate for the defense. I can't vouch in any way for the study's soundness, nor did I endorse it; I just thought it might be "vaguely relevant."

It seams we are stricken with the decision to limit the rights of the innocent to protect the rights of those who we perceive as not having the ability to make their own decisions.

I'm of the belief that this country, which was supposedly based entirely of the idea of freedome, should maintain that logic. In other words, the government should stay out of it.

Brandon Drury

After reading some of the articles
one should check on what happens with some companies in ohio when you can not pay. One company I know of called a borrower 63 times in a 6 day period when she offered to make payments. She was told that it was against state law and that she needed to pay in full or face criminal charges. They told her she needs to pay in full and then take out another loan. She decided to file a chapter 13. They refused to take her attns. information and told her that she must pay this outside the chapter 13 or she would be charged with a criminal offense. Anyone one can fall into this trap. in Ohio ban them all.

Jim- did the Ohio company successfully take criminal action against your friend?

I'm afraid that most of the people here demonstrate a great deal of ignorance regarding the PDL industry. I'd like to set the record straight on a number of comments:

RMann: "What I am thinking about is precisely what is wrong with the model of the payday loan"...

You begin not by stating a hypothesis, but by leaping to a conclusion. This causes you to seek out only that information which supports your conclusion, and ignore everything else.

RMann: "That seems to turn in part on two things – exactly what are people doing with the money?"

With regards to any possible restriction or ban on PDLs, this question is utterly irrelevant. We live in a free society. If you do a real-world analysis, you'll discover that people use these loans for what they are intended as: to pay for short-term needs of the kind experienced by people living paycheck to paycheck. i.e. to repair a broken vehicle.

Dale: "When you think about the alternatives, a regulated high-rate payday loan industry is more desirable than the underworld controlling this segment of the economy."

Leave it to a fellow Motley Fool writer to make an intelligent comment. I'd also add that the real-world alternative -- that of a person bouncing multiple checks and incurring $30 NSF fees for each one -- is a vastly inferior alternative.

Christine: "These short-term lending programs capitalize on the illiquidity of people who live paycheck to paycheck and in doing so charge high rates of interest (and fees) for taking on very little risk. "

Christine purports to "hate" the payday lending industry, demonstrating her bias, and regrettably spouts a complete falsehood regarding a critical factor about the sector: high default rates. Defaults run upwards of 20%, and only after collection efforts do most lenders charge-ff (lose) about 6% of principal. Now everyone go and run a few numbers using a loss of principal of that magnitude and couple it with monthly store expense. Maybe then you'll realize exactly why fees are as "high" as they are in the PDL business. The free market takes care of itself -- fees are set in such a way as to allow PDLs to make a profit even in the face of these enormous defaults. The average PDL has a net profit of 12-14% -- that's right, they keep 12-14 cents per dollar earned. Hardly what you'd expect from such "high" fees.

Christine: "So, the borrower is short this month, takes out a loan that is repaid out of his paycheck, and is short again the next month."

PDLs do not loan anyone more than 25% of their paycheck. Christine also indirectly supports the victocratic method espoused by anti-PDL activists: they ignore the fact that the borrower bears a degree of personal responsibility. They should not take out the loan unless they have a reasonable expectation of being able to pay it back. I don't charge my credit card more than I can pay, or take out a mortgage I know I can't pay, or even buy lunch at a restaurant if I don't have money in my pocket.

Christine: " I am also assuming that credit card rates are higher than payday lending rates."

Ignorance demonstrated. Case closed.

RMann: "...if location is really important, as some have suggested, then firms with a large number of branches might be able to charge supracompetitive prices."

Location is the single most important criterion in determining store placement. FIrms do not undercut each other -- ever -- in this industry because to do so would be suicidal.

RMann: "At the same time, the declining marginal costs of increased volume will make it hard for new locations to enter to compete with existing ones."

Incorrect. A high-traffic, high-visibility location can and does attract multiple PDLs. (Have you actually visited payday lending locations? Something tells me you are working strictly on theory here...)

RMann: "We see market evidence of this from the pattern of large national lenders, who typically enter markets by buying existing locations rather than starting new ones."

Incorrect. The largest PDLs have been opening de novo stores at a rate that far, far exceeds that of purchased locations. Look over the recent quarterly reports of any of the public companies for examples.

RMann: "if the financial distress from that borrowing generates externalities (as it probably does), then we would have a case for regulation, wouldn't we?...Lots of "ifs" in that paragraph, but I think that is a coherent theory isn't it?"

The problem is that you are dancing in the world of theory and not examining reality. Payday lending is regulated in almost every state. If want you desire is an outright ban, you will harm the very people you purport to be saving.

The problem is you are attacking the wrong problem. The issue does not lie with payday lenders. If it is the PDLs that make you unhappy, then why not attack the source of the problem? The problem rests with traditional banks and financial institutions that have utterly turned their backs on this demographic. These corporations will not service these people because they do not see a profit potential in them. Now, rather than find ways of encouraging banks to attract the payday lending customer by offering them products they need, anti-PDL groups instead assault the one service that has not abandoned these people.

When a person is in need of quick and convenient cash, where can they get it? What other business allows a total stranger to walk into their store, leave them a bad check and a promise to pay up in two weeks -- with no form of collateral whatsoever?

And NO, your theory is in NO WAY coherent. It proceeds from multiple false assumptions and inaccuracies.

Dan Markel, quoting the biased study regarding Payday Lending to the Military: "We consistently found high concentrations of payday lending businesses in counties, zip codes, and neighborhoods in close proximity to military bases."

Yes, and I'm sure one would consistently find high concentrations of BMW dealers in ritzy neighborhoods, car rental companies near airports, cigarette vending machines in bars, and fast food restaurants along highways.

BUSINESSES CLUSTER in the areas most likely to generate consumer use of those businesses. Kudos to Kate Litvak for discrediting that ridiculous study.

RMann: "First, it is clear that payday lending rates are much higher than credit card rates, probably about 20 times as high in APR terms (400% versus 20%). "

Sir, the use of APR's is an unfortunate one. I submit that it is not applicable to payday advances. Say I take out a $100 loan from a PDL, and it costs me $15 to do so. The "APR" on that loan is 390%! But look at fees at other merchants. Suppose I bounce a $100 check. I get hit with a minimum NSF fee of $30 by my bank. The APR is 650% -- and that's if we use a 14-day pay period. In fact, it is a one-time FEE, not appropriate to translate to APR (which, if we did, would be infinity). Suppose I pay my $100 credit card balance late? The company charges me a $28 fee for doing that, making the APR 728% --again assuming a 14-day pay period.

But do consumer groups get up in arms about ATM and NSF fees? No. Anti-PDL ideology makes people inclined to view fees inappropriately as APRs because the product is called a "loan."

RMann does acquit himself, however: " So we will need to untangle some of those issues, before making any informed proposals about short-term lending to credit-impaired borrowers. "

Given that so many of your statements are false, that would be a good idea.

Payday Loan: "It seams we are stricken with the decision to limit the rights of the innocent to protect the rights of those who we perceive as not having the ability to make their own decisions."

Good point. It is often said that anti-PDL activists are screaming "CRIME" for which they cannot find victims. The demand exists for a reason.

RMann -- I am happy to be interviewed for your topic. As the only US journalist to comprehensively cover the PDL industry, I can provide you with a good deal of data.

I recommend you thoroughly read over the quarterly reports of the following ticker symbols:

FCFS, QCCO, AEA, AACE, CSH, DLLR, and EZPW

I suggest you visit some payday lenders and speak to customers. I suggest you do a search and examine the locations of payday lending stores in relation to each other.

And read some of my articles:

http://www.fool.com/news/commentary/2005/commentary05080405.htm

http://www.fool.com/news/commentary/2005/commentary05060708.htm

http://www.fool.com/news/commentary/2005/commentary05080407.htm

Jeremry, no they did not file criminal charges. I spoke with Ohio AG and department of commerence and is not a treble or criminal act. Theses PDL's need to
be put out of business. I suggest
you read Ace pay day lending and what the State Of West Virginia did to get the PDL's out of W.VA.

Lorenzo , Theses PDL's are not a business. They prey on people that
can never get out of the trap. Ohio will shut theses PDL's down.

hey jeremry and lorenzo pdl is a choice for people to make themselves.Blame this growing need on banks who wont lend to people unless they have money.lets educate people instead of taking away peoples only avenues to get money.these businesses come down to personal responsabilties/so lorenzo lets shut down mcdonalds because it makes us fat dont sell beer cause you'ell get drunk oh and lets take away christmas cause people spend to much and they get in debt your arguement against pdls is stupid