August 25, 2010
Katie Porter on Hawkins' Regulating on the Fringe
Posted by Christine Hurt

    Hawkins’ paper tackles conventional wisdom and points out untested assumptions, and I think he deserves credit for staking out a fresh view of fringe banking. We all benefit when a scholar pushes the existing literature, even if we ultimately are not persuaded.

    The premise of Hawkins’ paper is that the relationships between fringe banking (such as payday loans, title lending, etc) and financial distress is “dubious.” He argues that prevention or reduction of financial distress is a principal rationale for intervening into fringe credit markets but that such regulation cannot be justified because the structure of fringe banking products actually prevents borrowers from financial distress.

    As an initial matter, I think Hawkins makes an important contribution by pressing for a sharper elucidation of the concept of financial distress. He largely seems to settle on “unmanageable debt” as the definition of financial distress (but then sometimes waffles to say it is also the inability to pay one’s bills.) This latter condition can exist wholly without debt; people with very low incomes cannot pay even modest medical bills or utility bills. Yet they have not borrowed in the sense of accessing consumer credit markets. I think Hawkins largely abandons the struggles-with-bills idea in favor of equating financial distress with unmanageable debt.  He then strands his readers, however, by failing to define unmanageable debt. He explores some definitions on pp. 10-12 but does not say where he comes out. Does unmanageable debt mean generally not paying debts when they come due, a traditional measure of insolvency used for example in the Uniform Fraudulent Transfer Act? Note that definition does not require an inability to pay, just the failure to do so. Or does unmanageable debt occur when a household exceeds a clear benchmark such as having debt payments that exceed 40% of its income? Or is it a subjective standard—unmanageable debt occurs when a debtor throws up her hands and declares that they can’t pay, say by defaulting on loans or filing bankruptcy? Hawkins perhaps can’t afford to delve too deeply into these important questions and still have ample time to describe the structure of fringe banking products, but I think his failure to define unmanageable debt qua financial distress troubles his overarching analysis.

     Specifically, I think that the relationship between financial distress and fringe banking that animates policymakers and advocates is not the one that Hawkins’ uses. He says that fringe banking products do not cause unmanageable debt because the products themselves do not involve substantial amounts of borrowing and are often repaid without formal collection—for example, by repossession of a car offered up for a title loan. To use other examples from the paper, because payday loans are small in amount or because secured credit cards have an escape hatch (you just never get your deposit back and the creditor closes the account), then these products cannot be plausibly linked to unmanageable debt.  I think that defense of fringe banking is undermined when we expand the scope of what we mean by unmanageable debt. We might think of unmanageable debt as an overarching state of affairs that shapes how a person interacts with the economy and society. In such a view, the act of taking out a title loan and losing one’s car could well deepen financial distress. A person might be stigmatized by using a fringe banking product; they might experience stress or anxiety about having the potential loss of their car as the consequence of non-payment; and despite Hawkins’ effort to minimize the value of the lost property (noting that debtors perhaps have only $700 in equity in their cars), that is a non-trivial amount of assets. We live, after all, in a world in which the median net worth of a non-homeowner in 2007 was $5,100. And surely those who take out auto-title loans are severely constrained in any effort to borrow to obtain new transportation. The effect is that loss of a vehicle—even for a short period while they obtain alternate transportation—a potentially devastating event in terms of their employment and well-being (even if it seems small in raw dollars).

    Of course, my hypothesized consequences of title lending are empirical claims, backed by only intuition masquerading as evidence. Yet, the same critique can be made of Hawkins’ paper. He sets out to undermine an empirical claim (use of fringe banking causes financial distress) but does not put this to an empirical test or even suggest how such a test could be made. Instead he narrows the definition of “related to financial distress” to equate with “adding a significant number of dollars to one’s debt burdens.” He then relies on the small dollar amount of fringe banking product to debunk the relationship. In so doing, he fails to see financial distress as a rich phenomenon. It may well be that the loss of one’s car, or the fear of having losing even a single paycheck, is precisely what finally tips people into bankruptcy—even if these events might have an objective effect on one’s financial situation that seems negligible.

    I think the harm of financial distress that motivates some push for regulation is not that the fringe banking debt is unmanageable itself but rather a belief that the “bucks” need to “stop” somewhere. The premise is that people in some situations just should not borrow on certain terms or at certain costs because doing so is inconsistent with social norms. We ban offering a kidney as collateral for precisely this reason, although it may well be that people with a fragile financial situation need their cars or their next paychecks more urgently than they need their kidneys. Another lurking, largely unarticulated idea in the fringe banking critiques is that many of the borrowers may themselves be receiving government or social support, and that we wish to curtail high-cost forms of borrowing as means of giving “our” money to fringe lenders as profit. This is precisely the argument that I make each year about Refund Anticipation Loans (a form of fringe banking that Hawkins does not discuss) because a very large fraction of those using Refund Anticipation Loans receive the Earned Income Tax Credit. I object to my tax dollars, intended for wealth-building for low-earners, being left behind in the tax office as profit for Jackson Hewitt and its affiliated lenders. This argument too is not new; we put limits on the kinds of food that people can buy with TANF for the same reason.

    I also think Hawkins overstates the degree to which the arguments for regulating fringe banking are premised on financial distress, and in particular, the degree to which a Bureau of Consumer Financial Protection was predicated on preventing financial distress. I think the primary justification for regulating fringe banking is that much of that activity is the result of misunderstanding, distortions in markets, and sometimes outright fraud. Those concerns are precisely the core of the Bureau of Consumer Financial Protection, which can act to prevent “unfair, deceptive, or abusive practices,” a standard that is delineated to focus on informational failures. While Hawkins asserts that “researchers have spent little effort establishing the arguments for paternalistic interventions into fringe credit markets,” two recent papers have done exactly that. Marianne Bertrand & Adair Morse conducted an experiment at a national payday loan chain that showed that more salient disclosure can reduce people’s payday lending. ( Sumit Agarwal, Paige Marta Skiba, and Jeremy Tobacman show that most people who borrow on payday loans have substantial liquidity available on their credit cards that would be a less expensive alternative. . While Hawkins may characterize it as paternalistic to think that people should understand their financial transactions and seek to maximize their self-interest in those transactions, I see such behavior as central to a functional market. 

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