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.