payday lending regulation
02 Dec 2015I thought I’d jot down some notes/observations after this conversation about payday lending. Payday lending is an interesting subject to me, both because of the demonization of the market and the interesting economics at work – it provides an interesting microcosm of how attempts to regulate markets can backfire and/or fail.
1st premise: people wish to lower the market rates for payday loans (ignoring for the moment the various moral/ethical reasons for this). 2nd premise: the current rate for interest on loans is at a (dynamic) equilibrium allowing for firms to remain viable/profitable given costs of default/administration/etc.
When the equilibrium rate is perceived as being too high, the usual approach is to simply legislate a ceiling cap on rates that can be charged. When you do so, there are two options:
1) You set the rate too high, which creates a schelling point that encourages implicit collusion at this higher rate. There’s some empirical evidence that this already happens.
2) You set the rate too low, which means some portion of the supply (lending firms) will exit the market (voluntarily or go out of business), or reduce the scope or quality of their services.
Thus the two possible outcomes are: harm to low-income borrowers via increased rates, or harm to low-income borrowers via reduced market choice/options.
This all leads back to square one: if you want to eliminate high payday loan rates, there’s only one option: find and provide a better (more efficient) emergency funding option.
The natural and usual rebuttal to this is that regulators simply need to find the “right” rate at which to set the ceiling. I cannot write a better response to this fantasy than Hayek did 70 years ago.