August 25, 2010
David Zaring On Hawkins' Regulating The Fringe
Posted by David Zaring

Jim Hawkins thinks that fringe banking - payday loans, auto title loans, rent-to-own, and pawnbroking - needn't be regulated for the reason that people think it should be regulated.  It is his smart observation about the way that fringe banking loan contracts are structured that is the heart of the paper.  They are structured, he says, largely to avoid massive indebtedness.  And since massive indebtedness is the main reason that people think fringe banking should be regulated, they need to come up with another reason to do it. 

Hawkins is on to something here with his contract analysis, though I suppose there is an unanswered empirical question on how much actual indebtedness fringe banking creates that would bear on the argument.  Hawkins observes that fringe bankers won't get repaid if their customers are too deep in the hole, so rent to own, title loans, and pawnbroking gives those customers the opportunity to just stop paying, and give up the collateral.  Payday loans fall less comfortably in this paradigm, but such loans are on the order of hundreds, rather than thousands, of dollars.  If you are worried about massive indebtedness leading to financial distress, Hawkins observes, you might look at credit cards, rather than at fringe banking, because fringe banking tends to give indebted consumers an easy and quick out.

So far, so good.  But of course, massive indebtedness isn't the only reason people think a consumer credit regulator of fringe banking is needed.  It might be that people misapprehend the true costs of rent-to-own, or that they get distressed when they pawn their valuables, even though they can always let the pawnbroker keep them, rather than making their payments. It could be that it is unproductive to have members of the workforce risking their transportation to their jobs on consumer credit. 

I also wanted to know more about Hawkins' larger bottom line.  Should consumer credit in fact be regulated?  Hawkins limits his analysis to fringe banking.  But the upshot appears to be either that there should be a bit more caveat emptor in consumer credit ... or that it might be fine to regulate credit cards, which is where the real problem lies.  It is strange to finish an article and think that these two rather inconsistent approaches might be the way to go.

To that end, I'll note that the federal government has begun to regulate in this area anyway for counter-terrorism reasons.  So it is not the case that we're choosing between free markets and command and control here.  Also, there is another vision of consumer credit, which is that we ought to want Americans to participate in formal, not fringe banking, for civic reasons, making similar opportunities available to all, and that sort of thing.

I'm actually not sure where my own bottom line on consumer credit lies, so maybe I am like Hawkins in that regard.  But I do think that his observations about the way that fringe banking actually works add nuance to the issue.

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