Wednesday, March 10, 2010

Payday Lenders and Competition

Left: The Free Market Fairy sez to customers of payday lenders, "youse likes yours kneecaps, you pays me, capiche?"

So the answer to ruthless and predatory payday lenders who charge 200% interest to their customers is... less regulation? And somebody actually says this sounds plausible?! Sounds plausible in a universe where unicorns are purple and cotton candy grows on trees, perhaps. Not plausible in *this* universe, though.

I just spent a long time reading that paper by the Kansas City Fed, and simply cannot see where the data supports the notion that competition actually works in the payday lender field. In fact, the paper specifically says that presence of competitors in a given market didn't seem to make any difference. The only possible "competition" that the paper mentions as possibly beneficial would be if banks and credit unions were allowed to make "payday loans"... but in fact, they're already allowed to issue short-term 30 day personal loans, they just choose not to do so for the most part.

The authors of the paper spend a lot of time noting that the interest rates on payday loans went up until they reached the legal limit when Colorado regulated payday lenders. But in fact that's true for *all* states, whether they had a legal limit or not -- payday loans have gone up in price nationwide over the past decade. Furthermore, when you look at the financials of payday lenders mentioned in this paper, any payday lender who decides to lower his interest rates is going to run into liquidity problems quickly. The average payday lender, according to this paper, has less than $100,000 in loans outstanding and despite charging 200% interest is only as profitable (in terms of profit margin) as your typical bank. Indeed, the problem in the payday loan industry may well be too MANY storefronts, the fixed costs of manning each storefront has to be divided across the number of potential customers, if there are too many storefronts and not enough customers per storefront, the per-customer cost of making a loan skyrockets.

This seems, to me, to be another one of those situations like healthcare where "free market competition" actually results in *higher* prices. There are only a certain number of customers in a given market, and each possible competitor has given fixed costs which his prices must pay for. Thus, just as markets with more empty hospital beds actually charge *more* per utilized hospital bed than markets with higher utilization because of the high fixed cost of maintaining hospital beds which must be divided across fewer customers per bed in the markets with "more competition", the Free Market Fairy seems to be doing the same thing with payday lenders. That is, she (he?) seems to be doing exactly the opposite of what you'd expect: Since no vendor is ever going to price his wares at less than what it costs him to provide them, more vendors serving the same number of payday loans customers seems to result in *higher* prices, not *lower* prices, because of fewer customers per vendor meaning higher rates needed to pay those fixed costs of maintaining a storefront. The Free Market Fairy simply doesn't behave the way that her (his?) admirers seem to think in this situation, but then, the Free Market Fairy isn't exactly a nice gal (guy?) anyhow, so ...

-- Badtux the Economics Penguin

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