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Abstract

  1. Top of page
  2. Abstract
  3. INTRODUCTION: GREAT EXPECTATIONS
  4. PAYDAY LOANS AS CONSUMER FINANCIAL PRODUCTS
  5. INITIAL CFPB ACTION ON PAYDAY LENDING
  6. DEFENDERS OF PAYDAY LOANS AND LENDING PRACTICES
  7. MEASURES SUGGESTED BY PROPONENTS OF GREATER REGULATION
  8. THE CFPB'S REGULATORY OPTIONS AND THEIR CONSEQUENCES
  9. CONCLUSION
  10. REFERENCES

The Dodd-Frank Act of 2010 brings nonbank payday lenders under federal regulation for the first time. The question of precisely how to regulate the payday loan industry creates a number of difficult challenges for the newly created Consumer Financial Protection Bureau (CFPB). Whereas most consumer advocates would prefer to ban or strictly limit high cost payday lending activity and address unfair/abusive lending practices, the CFPB must also be attentive to the impact of regulation on credit access for low-wage, credit-constrained payday borrowers. This article highlights the policy, legal, and institutional issues raised during the CFPB's decision-making process. The CFPB has the opportunity to dramatically shift the longstanding consumer protection paradigm in favor of real-world protection of vulnerable borrowers and, thereby, to realize the hopes of the activists who helped to bring the Bureau into existence.


INTRODUCTION: GREAT EXPECTATIONS

  1. Top of page
  2. Abstract
  3. INTRODUCTION: GREAT EXPECTATIONS
  4. PAYDAY LOANS AS CONSUMER FINANCIAL PRODUCTS
  5. INITIAL CFPB ACTION ON PAYDAY LENDING
  6. DEFENDERS OF PAYDAY LOANS AND LENDING PRACTICES
  7. MEASURES SUGGESTED BY PROPONENTS OF GREATER REGULATION
  8. THE CFPB'S REGULATORY OPTIONS AND THEIR CONSEQUENCES
  9. CONCLUSION
  10. REFERENCES

When the Consumer Financial Protection Bureau (hereafter referred to as the CFPB or Bureau) opened its doors for business in July 2011, it was fortified by the support of numerous advocacy groups and three-quarters of US households (Consumers Union 2011). This support was vital to the agency's creation and would ultimately contribute strongly to success in obtaining Senate approval of a permanent director (Kirsch and Mayer 2013). Consumers, for their part, looked to the Bureau for actions consistent with the robust “cop on the beat” role that Elizabeth Warren had famously endorsed during and after the legislative campaign for the Dodd-Frank Act (DFA) and the CFPB (Nasiripour 2010; Warren 2011). They counted on the Bureau to take full advantage of the “opportunity to develop a coherent approach to regulation” based on a deep understanding of real-world business models and practices, borrowers, and products, across all sectors of the credit market (Barr 2012, 134).

As an initial effort to understand whether the CFPB is successfully developing such a coherent approach to regulation, this Commentary offers a selective look at the CFPB's early work using payday lending as a case study. Your authors believe that the manner in which the CFPB deals with payday lending will be a revealing “Rorschach” test of the Bureau's view of its role in public policy. We begin by introducing readers to controversies in the policy debate over appropriate regulatory actions in this market, offer an analysis of alternatives the Bureau will face, and then consider the implications of those choices for consumers and for the agency itself.

PAYDAY LOANS AS CONSUMER FINANCIAL PRODUCTS

  1. Top of page
  2. Abstract
  3. INTRODUCTION: GREAT EXPECTATIONS
  4. PAYDAY LOANS AS CONSUMER FINANCIAL PRODUCTS
  5. INITIAL CFPB ACTION ON PAYDAY LENDING
  6. DEFENDERS OF PAYDAY LOANS AND LENDING PRACTICES
  7. MEASURES SUGGESTED BY PROPONENTS OF GREATER REGULATION
  8. THE CFPB'S REGULATORY OPTIONS AND THEIR CONSEQUENCES
  9. CONCLUSION
  10. REFERENCES

Payday loans, it has been asserted, lie at “the heart of debates about ‘alternative’ financial products” (Mann 2013, 1). Beginning in the late 1980s or early 1990s, the payday lending industry exploded as a source of small, short-term credit for people with a paycheck, a disability check, or some other consistent source of funds—predominantly the “working poor” (Mayer 2010). (A post-dated check is typically offered as collateral for payday loans.) Starting out as storefront outlets, payday lenders grew from a reported 200 nonbank loan offices in the early 1990s to almost 24,000 by the mid-2000s (Caskey 2001; Bianchi 2012). In 2007, the industry reported a customer base of 19 million borrowers, annual loans of $50 billion, and income from fees slightly under $9 billion (Fox 2007). Over time, the sector has become more complex as banks have entered the market and a myriad of other organizational arrangements and sales channels have developed, including a global Internet market (Consumer Federation of America 2011; Pew Charitable Trusts 2012; Montezemolo 2013).

Payday loans have been typically extended to individuals without traditional financial underwriting. Many payday borrowers have impaired credit histories and would be ineligible to borrow commercially under traditional credit standards. Payday loans are usually structured as small-dollar amount, close-end, single payment obligations with short durations (generally two weeks). On average, payday loans amount to just under $400. Fees (interest rates) are computed and most often advertised on a dollar amount per $100 borrowed basis. (The industry prefers the term “fees” to “interest rates,” however, the two will be used interchangeably here.) A common offering is a two-week loan with a $15 fee/$100 (principal), which translates to 391% annual percentage rate (APR; CFPB 2013a; Montezemolo 2013).

Until the advent of the CFPB, the regulation of the typical storefront payday lender was a matter reserved to the states. Even today, issues of fees and interest rates are left up to the states,1 but other aspects of the business including product features, lending practices, and marketing are within the purview of the Bureau. Eighteen states essentially prohibit payday loans by capping interest rates for a two-week payday loan at 36% APR or less. This would be the equivalent of $1.38 for a two-week loan of $100—an amount that makes offering such loans unattractive. Most of the remaining states impose some restrictions (e.g., limits on the size of the loan or the number of times it can be “rolled over”), but five states impose no restrictions (Morgan-Cross and Klawitter 2011; Pew Charitable Trusts 2012; Consumer Federation of America n.d.). On the basis of the data provided by the National Consumer Law Center, the average APR for a two-week loan in states where payday lending is permitted is 412% (Plunkett and Hurtado 2011).

Loan obligations are typically repayable on a lump-sum basis, but borrowers unable to repay on schedule are given the option of refinancing via a rollover. These rollovers are an integral part of the payday loan process—anticipated by borrowers and needed by lenders. A 2012 Pew Charitable Trusts survey found that only 14% of payday borrowers thought they would be able to repay their loan when it fell due (Bourke, Horowitz, and Roche 2012). A 2013 Pew report suggested that the industry's business model relies on rollovers because portfolios in which all loans are repaid on schedule would not generate sufficient income to support the business. Based on industry sources, the Pew study reports a breakeven point of four to five rollovers for each customer—a point that is exceeded by the majority of payday borrowers (Bourke et al. 2013). Indeed, half of all borrowers refinance their loans at least 11 times annually, thereby incurring cumulative interest charges and fees (CFPB 2013a). Although survey evidence is not entirely consistent on this point, the average borrower is in debt status between 150 and 212 (not necessarily continuous) days during his/her first borrowing year (Levy and Sledge 2012). A breakeven point equivalent to five rollovers would equate to 84 days in debt status.

The extensive survey evidence of payday lending documents a borrower population in which a high proportion of borrowers are chronically cash-strapped individuals. They use payday loans to meet necessary household expenses (e.g., utility bills) as well as periodic emergencies, and they have limited access to preferable borrowing alternatives (e.g., mainstream credit cards).

The industry's defenders take the position that the size of the industry—an annual loan volume of over $40 billion—reflects the need for this financial product (Silver-Greenberg 2010; Bianchi 2012). They argue that loans empower consumers by giving them a way of meeting short-term cash needs and thereby avoiding far more expensive late fees and credit delinquencies. It should not be surprising then, according to payday lending supporters, that the vast majority of borrowers are quite satisfied with their experience with the industry (Elliehausen 2009). The payday lending industry's leading trade association contends that anti-payday lending activists claim to represent the best interests of consumers, but these activists actually “seek to limit the already small number of short-term credit options available and tighten consumer access to credit” (Community Financial Services Association of America n.d.).

Critics of payday loans argue that lenders exploit the economic desperation of borrowers. The intrinsic structural features of these loans (especially their high cost, short duration, and repayment schedule similar to a balloon payment on an installment loan) combined with common industry practices that support the product (such as lack of financial underwriting and liberal refinancing) constitute “debt traps” that should be regulated and curtailed by the CFPB pursuant to its power under the DFA to eliminate “unfair, deceptive or abusive acts and practices” (Montezemolo 2013, 20).

INITIAL CFPB ACTION ON PAYDAY LENDING

  1. Top of page
  2. Abstract
  3. INTRODUCTION: GREAT EXPECTATIONS
  4. PAYDAY LOANS AS CONSUMER FINANCIAL PRODUCTS
  5. INITIAL CFPB ACTION ON PAYDAY LENDING
  6. DEFENDERS OF PAYDAY LOANS AND LENDING PRACTICES
  7. MEASURES SUGGESTED BY PROPONENTS OF GREATER REGULATION
  8. THE CFPB'S REGULATORY OPTIONS AND THEIR CONSEQUENCES
  9. CONCLUSION
  10. REFERENCES

Given the controversial nature of payday lending, it is hardly surprising that the issue moved to the center of the CFPB's radar screen early in the agency's existence (Johnson 2011/12). It carried considerable symbolic significance to those who followed the agency that payday lending was selected by the Bureau as the subject of its first informational field hearing, convened on January 19, 2012 in Birmingham, Alabama (Cordray 2012). Juxtaposing a somewhat murky segment of the household credit community—lenders whose products bear stratospheric price tags and other questionable features—with a borrower segment heavily weighted toward low-income, employed, minority adults with few financial resources to meet recurring income shortfalls, the topic was guaranteed to generate controversy (Martin 2011; Skiba 2012). In many ways it was one of the most complex and fraught issues the Bureau could have chosen for its debut.

In the wake of the Birmingham event, the CFPB did not tip its hand regarding the specific direction of any future payday lending action it might pursue. Nonetheless, the hearing clearly underscored the thorny dilemma the Bureau would face in dealing with the small-dollar/short-term household credit sector: how to make sure that credit is available to low-income, high-risk borrowers while assuring that prices, loan terms, and financial practices do not take unfair advantage of the average borrower's financially stressed situation.

The Bureau's payday lending activity in the period from its formation in July 2011 until October 2013 amounted to a deliberate but brisk strategy of learning, information gathering and analysis, and clarifying its regulatory authority before taking more definitive action. An outline of major CFPB initiatives during its first two years includes these milestones:

  • Study and Examination of Questionable Practices. In January 2012, the CFPB initiated an ongoing program to examine (supervise) nonbank lenders including payday and other short-term, small-dollar credit institutions and produced a field examination manual dealing with advertising, marketing, and collection practices (CFPB 2012a). The manual examines payday materials and practices to see if they adequately inform potential debtors of the risks, policies, and payment terms of the loans.
  • Information Gathering and Public Outreach. In the same month, the Bureau held its debut field hearing in Birmingham, Alabama, to gather information about the payday industry from borrowers, lenders, and public officials.
  • Data Collection and Analysis. In April 2013, the Bureau published a data-based White Paper surveying payday lenders, borrower characteristics, usage patterns, and product features as well as identifying major consumer financial safety risks (CFPB 2013a).
  • Jurisdiction. In late September 2013, the Bureau clarified the scope of its authority by enforcing the civil investigative demands it had issued to several Native American tribes in conjunction with their payday lending business. The tribes had resisted the CFPB investigation by claiming immunity as “sovereign” nations (CFPB 2013c).
  • Law Enforcement. Late in 2012, the Bureau obtained its first federal court order, in partnership with five states, and obtained consumer refunds, civil damages, and injunctive relief against a payday debt relief provider for violations of the DFA, the Telemarketing Sales Rule, and various state laws (CFPB 2012b). In November, 2013, the Bureau took its first solo enforcement action against a payday lender. The Bureau ordered Cash America International, Inc., to refund $14 million to consumers for “robo-signing” court documents (i.e., signing important documents without careful review by a knowledgeable party) in debt collection lawsuits (CFPB 2013d).

While the CFPB has learned a lot about payday lending from its research, examination process, public engagement, and enforcement activities, the single most important finding has been that the payday lending business model and product design can generate a cycle of debt for a large fraction of borrowers who access that source of credit. Data published by the Center for Responsible Lending, the Pew Charitable Trusts, and the Bureau itself demonstrate that a sizable fraction of payday borrowers find it very difficult to pay off a high-cost, short-term, single payment (balloon) loan on schedule (King and Parrish 2011; Bourke, Horowitz, and Roche 2012; Borné and Smith 2013; CFPB 2013a). As a result, by taking out a payday loan, borrowers are at high risk of stepping onto a debt treadmill whereby their options are to roll over their debt (thereby accumulating fees and interest over a protracted period of time) or to suffer adverse financial consequences, including default and bankruptcy (Skiba and Tobacman 2011; Melzer 2011).

DEFENDERS OF PAYDAY LOANS AND LENDING PRACTICES

  1. Top of page
  2. Abstract
  3. INTRODUCTION: GREAT EXPECTATIONS
  4. PAYDAY LOANS AS CONSUMER FINANCIAL PRODUCTS
  5. INITIAL CFPB ACTION ON PAYDAY LENDING
  6. DEFENDERS OF PAYDAY LOANS AND LENDING PRACTICES
  7. MEASURES SUGGESTED BY PROPONENTS OF GREATER REGULATION
  8. THE CFPB'S REGULATORY OPTIONS AND THEIR CONSEQUENCES
  9. CONCLUSION
  10. REFERENCES

As expected, payday lenders dismissed the CFPB's concern that structural features of the prototype payday loan and the corresponding lending process were harmful to the majority of borrowers who were unable to pay them off promptly. In comments issued shortly after release of the White Paper, lawyers and other representatives of payday lenders expressed concern that while excess debt loads might conceivably be regarded as a legitimate policy concern, the CFPB White Paper over-reached when it unfairly blamed lenders for sins actually committed by borrowers. One law firm with payday industry clients asserted that the adverse “cycle of borrowing” (a.k.a. “debt trap”) and the significant levels of fees and costs incurred by borrowers over time should be attributed to consumer behavior and product misuse—not to the payday business model and features of product design (Greenberg 2013).

In considering potential action to address consumer problems, earlier financial regulators were constrained to determine whether lending practices were unfair and/or deceptive. In addition to these two standards, the CFPB was authorized under the DFA to decide whether practices were “abusive.” For an act or practice to be considered abusive, it must either “materially interfere” with the ability of a consumer to understand a financial product or take “unreasonable advantage” of: a consumer's lack of understanding, inability to protect his/her interests, or his/her reasonable reliance on the lender (DFA 2010). Among three enumerated ways in which a financial product can take unreasonable advantage of a consumer, the most threatening to the payday lending model, in our view, is taking unreasonable advantage of a consumer's inability to protect his/her interests in using the loan product.

The argument against characterizing payday loans as abusive can be illustrated by referring to the work of economists Marianne Bertrand and Adair Morse (2011) who assert that empirical research “has not been able to ascertain whether … a predatory view of payday lending is warranted.” The fact that borrowers roll-over their debts for extended periods of time, they state, “certainly does not prove that these individuals are being fooled or preyed upon by payday lenders” (Bertrand and Morse 2011, 1866).

Industry attorney Hilary Miller joined and extended the debate regarding the Bureau's new abusiveness authority. His three-part argument (1) rejects the claim that payday loans produce consumer injury (“there is no scientific support for [the claim of injury]; it exists only in Center for Responsible Lending anecdotes and screeds”), (2) defends payday loans as being no different, in material ways, than credit cards (hyperbolic discounting is also a feature of mainstream credit cards and no-one claims they are abusive), and (3) challenges the legal basis for any CFPB consideration of interest rates in conjunction with an abusiveness analysis. “The CFPB has no authority to set or limit interest rates. Sec. 1027(o). By logical extension, I would argue that the CFPB has no authority even to take interest rates into account in determining a consumer loan product to be ‘abusive’” (Miller 2010).

A somewhat different argument, this one put forward by Paige Skiba, an economist at Vanderbilt Law School, confirms empirical evidence of high APRs, short loan durations, rollovers and defaults, and behavioral biases such as borrower's myopia. Nevertheless, Skiba does not find a compelling legal link between these factors and the regulatory frameworks available to help consumers overcome the “misuse” of payday loans (Skiba 2012). Skiba's basic argument is that payday borrowing has value because it smoothes out income and consumption from one period to another. Her conclusion is that “while triple-digit interest rates may sound outrageous, borrowing against future paychecks at such a high APR can be worth it if consumers' marginal utility is raised sufficiently to outweigh the expenditure they will make on interest (1027).” And, “when used in the appropriate circumstances and in moderation, and when paid off promptly, payday loans have the potential to increase individuals' utility in a way that is difficult to achieve using any other form of credit. This is especially true because many forms of credit are seldom available to the population that tends to use payday loans” (Skiba 2012, 1028). Skiba sees payday loans as a tool for coping with emergencies, not for meeting recurring long-term needs. In practice, a 2012 Pew survey found that 69% of payday borrowing was for recurring expenditures such as utility bills, rent, mortgage payments, or food, while only 16% was applied to emergency uses (Bourke, Horowitz, and Roche 2012).

Taken together, the anti-regulation narrative—notwithstanding high borrowing costs and adverse consequences for many consumers—exalts personal responsibility, informed consent, imperfect regulation, and the supposedly negative welfare effects of constraining a “popular” form of lending.

MEASURES SUGGESTED BY PROPONENTS OF GREATER REGULATION

  1. Top of page
  2. Abstract
  3. INTRODUCTION: GREAT EXPECTATIONS
  4. PAYDAY LOANS AS CONSUMER FINANCIAL PRODUCTS
  5. INITIAL CFPB ACTION ON PAYDAY LENDING
  6. DEFENDERS OF PAYDAY LOANS AND LENDING PRACTICES
  7. MEASURES SUGGESTED BY PROPONENTS OF GREATER REGULATION
  8. THE CFPB'S REGULATORY OPTIONS AND THEIR CONSEQUENCES
  9. CONCLUSION
  10. REFERENCES

Consumer advocates and scholars with foundation support buttressed the CFPB's “debt trap” concerns and responded to critics of regulation with work of their own.

In a September 2013 report issued by the Center for Responsible Lending (CRL), Susanna Montezemolo offered a “structural” argument whereby any one of a set of five standard payday loan features and business policies would create “problems for borrowers” and the composite of all five would create a “high likelihood of repeat borrowing and a long-term cycle of debt” (Montezemolo 2013, 2). The payday loan characteristics and business policies cited by Montezemolo are:

  • Lack of financial underwriting for affordability
  • High fees (often on the order of 400% APR)
  • Short payback period (usually two weeks)
  • Balloon repayment feature
  • Collateral in the nature of a post-dated check or debit on deposit account

Montezelomo's review of state reforms of payday lending divides states into two basic groups: 29 states with no substantive restrictions on payday lending and 21 states (plus the District of Columbia) with significant reforms that either eliminate or limit this form of lending. Within the latter group, 15 states essentially ban payday loans by invoking usury limits or otherwise severely capping the interest that can be charged on payday loans. Among states that decrease payday lending without eliminating it, Montezemolo points approvingly at Washington State's limit of eight payday loans per year. Despite an increase in the allowable loan size in Washington to $700, a before–after comparison (2009 vs. 2011) there revealed a sharp reduction in annual loans per borrower from 7.9 to 3.7, a corresponding decline in days of indebtedness (155 reduced to 105 per year), a 76% reduction in statewide loan volume (with 43% fewer borrowers), and a lowering of the average APR from 256% to 182% (mainly because of longer loan terms).

After reviewing state payday reform initiatives and dismissing a self-regulatory approach based on industry-sponsored “best practices,” the CRL report encourages Congress to enact a 36% APR limit applicable to all borrowers (not just members of the military, as is the case now), and recommends that the CFPB and other regulators take three additional actions:

  • Require lenders to carry out financial underwriting that takes into account ability to repay and to meet routine household expenses
  • Limit the period of time during which a borrower may be in debt-status to 90 days a year, consistent with the 2005 FDIC Payday Loan Guidelines
  • Prohibit the requirement that borrowers present lenders a post-dated check or authorize electronic access to deposit accounts as collateral for a loan (Montezemolo 2013).

At the end of October 2013, the Pew Charitable Trusts (Pew) published the third in a series of reports on payday lending, this one devoted to “policy solutions” (Bourke et al. 2013). The report included a detailed analysis of the Colorado model of payday loan reform. From the outset, the Pew report recognized three guiding principles: (1) short-term, small-dollar, payday loans have, provisionally, a legitimate role to play in the household credit market, although further study might indicate that borrowers could do better without them; (2) payday borrowers are at elevated credit risk and therefore some—but not an excessive amount of risk premium—is justifiable; and (3) conventional, lump-sum payday loans have inherent structural flaws that make them unaffordable and dangerous to borrowers. The authors noted that the lump-sum payday loan models consumed a third of the average borrower's paycheck, whereas most borrowers could afford no more than 5% in order to leave enough for ordinary budget needs.

The last of these observations—unaffordability—suggested the importance of financial access as a major reform objective and prompted the conclusion that a properly designed installment payment system could provide a viable mechanism for budgeting affordable amounts of interest and principal over time. Pew Trusts focused first on the issue of affordability and then on the objective of reducing loan activity by limiting renewals. It examined these by exploring a complicated but innovative payday lending law passed by the Colorado legislature in 2010.

The central feature of the Colorado law was modification of the traditional two-week payday loan into a six-month product with no prepayment penalty. The new product was bound by a 45% APR cap, but with an origination fee (refundable on a pro-rated basis depending on the actual duration of the loan) and a maintenance fee beginning in the second month, the effective interest rate could be much higher. While lump sum repayments were not prohibited outright, virtually all lenders converted to the installment method.

Data from 2012 indicated that the average loan under the new rules was repaid in approximately three months, with a corresponding 129% APR. This brought the ratio of loan payments to biweekly gross income down from approximately 33% to 4% (by far and away, the lowest in the country). Comparing 2012 results with 2009 in Colorado, borrowers spent 44% less for loans that were equivalent in median size, and the market shrunk by 15% (number of borrowers). Part of the spending reduction was attributable to a 60% drop in the average APR (129% in 2012 vs. 319% in 2009). The Pew authors also documented a sharp increase in loan duration (99 days vs. 19 days) and comparable reduction in the annual number of loans per borrower (2.3 vs. 7.8).

The Pew report offered several recommendations, two of which seem inspired by Colorado's reforms:

  • Limit payments to an affordable percentage of a borrower's periodic income (five percent or less)
  • Spread costs evenly over the life of the loan (as in Colorado's pro-rating of the loan origination fee).

By issuing reports such as those of CRL and Pew, critics of payday lending offered an alternative to the payday industry's narrative of borrower responsibility for any problems with payday loans, constructed their own narrative based on evidence of actual consumer hardship, and offered recommendations for a strong federal approach to regulatory reform.

THE CFPB'S REGULATORY OPTIONS AND THEIR CONSEQUENCES

  1. Top of page
  2. Abstract
  3. INTRODUCTION: GREAT EXPECTATIONS
  4. PAYDAY LOANS AS CONSUMER FINANCIAL PRODUCTS
  5. INITIAL CFPB ACTION ON PAYDAY LENDING
  6. DEFENDERS OF PAYDAY LOANS AND LENDING PRACTICES
  7. MEASURES SUGGESTED BY PROPONENTS OF GREATER REGULATION
  8. THE CFPB'S REGULATORY OPTIONS AND THEIR CONSEQUENCES
  9. CONCLUSION
  10. REFERENCES

From our vantage point as observers of the policy debate, the discussion of payday regulatory options (circa November 2013) appears to be more flash mob than chamber music. Although there is clearly some growing coherence among the positions staked out by the major players, the ultimate shape of the piece is yet to be fully revealed. Certain themes, however, have begun to emerge; we outline them in this section.

The Bureau will have considerable discretion to decide how to balance its concerns about access with its obligation to provide consumer protection. As further discussed below, the CFPB could opt to frame the debt trap issue as a problem arising from the lenders' material interference with a borrowers' ability to understand the product and how it functions. Alternatively, it could frame the matter directly as an issue of product design in which elements baked into the body of the payday loan, itself, substantially compromise the ability of borrowers to protect themselves against debt traps. Both approaches are consistent with the Bureau's new abusiveness authority under DFA Section 1031(d). Whichever way the Bureau decides to go, it will, almost certainly, reach conclusions about characteristics of the borrower population and the context in which borrowing activities take place. The CFPB will also have to reach conclusions about the depth and frequency of the injuries borrowers suffer—specifically from the so-called debt trap. Most important, the Bureau will have to decide on policy prescriptions that fit the most compelling explanations for the available evidence regarding payday lending.

A strong conceptual argument for taking a real-world approach was recently offered by the Bureau's former research director, Sendhil Mullainathan and colleagues in an influential article published in Science (Shah, Mullainathan, and Shafir 2012). The question they pose is: how does being poor influence such basic economic transactions as shopping and borrowing? The simple summary is that scarcity (poverty) leads people to attend to certain problems hyper-intensely while at the same time overlooking others. In the context of borrowing, the authors provide experimental evidence suggesting that economic scarcity leads individuals to neglect the long-term consequences of the amount they borrow and thus encourages over-borrowing.

The experimental evidence adduced by Shah, Mullainathan, and Shafir has important implications for sorting out the problem of payday lending among the population of actual payday borrowers: it identifies a characteristic of the population at risk (the poor), the harm suffered (the consequences of over-borrowing), and the behavioral context (urgency and stress) in which borrowing occurs. In effect, it provides a strong foundation for the Bureau to knit together what Silber and many other legal scholars have recognized (building on the work of behavioral psychologists as far back as George Katona in the 1950s) as being an artificial disconnect between consumer protection law and observed, everyday experience (Katona 1951; Silber 1990, 2012; Jolls, Sunstein, and Thaler 1998; Mullainathan and Shafir 2013).

The CFPB is unlikely to spend much more time “surveying the field to determine where and how to focus its on-going regulatory efforts” (Greenberg 2013). The general assumption among stakeholders, external analysts, and others on top of the matter is that the Bureau is likely to initiate a payday loan rulemaking process in reasonably short order. What are its main options?

In the unlikely event that the Bureau chooses to embrace a “soft” (nonprescriptive) product disclosure approach as its main (or exclusive) remedy for debt trapping, it would have to anticipate an extraordinarily critical reception from the consumer advocacy community. Many of those most steeped in payday lending (apart from industry representatives) are advocates who have worked on the issue extensively at the state level. It is not surprising that the recommendations framed by Pew and the Center for Responsible Lending reflect state experience and reflect the most successful models of reform. None of the states showcased by Pew or CRL has taken a pure disclosure approach nor has information disclosure been at the heart of any analytic work about payday lending published by the CFPB. Thus, if the Bureau chooses to pursue a stand-alone informational disclosure strategy (even with the addition of a financial literacy and assistance component or the adoption of a dramatic warning label format along the lines illustrated by Chris Peterson or Jeff Sovern) (Peterson 2012; Sovern 2013), it would risk severe backlash and reputational injury. If the Bureau moves the cop off the beat, the new CFPB logo would surely become “the cop is a deadbeat.”

If the Bureau decides to define the problem as one coming directly from the structural design of the loan product, it could find that payday loans and lending practices are abusive to the population-at-risk. The abusiveness standard would represent a potentially significant change in the existing consumer protection paradigm. Justifying payday lending rules based on the new statutory standard of abusiveness would shift the basic inquiry away from the accuracy, presentation, and sufficiency of product information and its impact on the “reasonable man,” to one which focuses on the abusive marketing and dangerous design of financial products in relation to the behavior of all of the people who actually consume them. The new standard does not directly nullify doctrines which have protected sellers by letting them avoid claims made by “unreasonable” buyers. But it does, potentially, reach more of the sales practices that involve exploitation of known cognitive limitations and behavioral vulnerabilities (Silber 2012). The abusiveness standard also bypasses the traditional consideration of whether the costs of a questionable business practice are outweighed by its benefits before finding it to be “unfair” (Federal Trade Commission 1980; CFPB 2013b).

As noted previously, the Bureau has received strong encouragement to examine structural, product design solutions along the lines identified by the Center for Responsible Lending, the Pew Charitable Trusts, and others. In addition, since the late 1990s, state advocates for payday loan reform have been working to encourage their legislatures to cap interest rates, limit rollovers, make payments more affordable to borrowers, incorporate ability-to-pay features, and constrain the level of payday activity in various other ways. These advocates will certainly be urging the Bureau to assay performance in their states and to learn from their experience.

Some of the proposals to regulate the structural characteristics of payday loans strike at their fundamental character. For example, the Pew report recommendation that any small-dollar loan should be affordable—along the lines of Colorado's 2010 law—would strike dramatically at the notion that payday loans can and should be paid off during a single paycheck period and would sharply reduce overall borrowing costs. Similarly, CRL's proposals that payday lenders underwrite the affordability of these loans and not use post-dated checks (or claims on a borrower's deposit account) would represent major breaks from past practice. Such policies would, however, strike a blow for consumer protection while preserving some degree of credit access.

CONCLUSION

  1. Top of page
  2. Abstract
  3. INTRODUCTION: GREAT EXPECTATIONS
  4. PAYDAY LOANS AS CONSUMER FINANCIAL PRODUCTS
  5. INITIAL CFPB ACTION ON PAYDAY LENDING
  6. DEFENDERS OF PAYDAY LOANS AND LENDING PRACTICES
  7. MEASURES SUGGESTED BY PROPONENTS OF GREATER REGULATION
  8. THE CFPB'S REGULATORY OPTIONS AND THEIR CONSEQUENCES
  9. CONCLUSION
  10. REFERENCES

If, as generally anticipated, the CFPB goes forward with a payday loan rulemaking process in the near future, it will have the benefit of already having received a great deal of input from its own staff, from members of the public, and from industry, consumer, and scholarly sources. As an agency committed to “evidence-based regulation,” it will certainly not suffer from a lack of evidence; if anything, it will have a surfeit (Kennedy, McCoy, and Bernstein 2012).

But evidence alone is insufficient to determine what the CFPB should do with respect to payday loans. The larger question is how the agency will decide to frame the question and whether it will begin to use new legal principles and theories of the consumer that are related to the new and controversial standard of abusiveness. While the CFPB answer is not yet known, it has an opportunity to dramatically shift the long-standing consumer protection paradigm in favor of real-world protection of vulnerable people, illuminate the new agency's potential, and help determine whether the great expectations of the CFPB's supporters have been justified.

REFERENCES

  1. Top of page
  2. Abstract
  3. INTRODUCTION: GREAT EXPECTATIONS
  4. PAYDAY LOANS AS CONSUMER FINANCIAL PRODUCTS
  5. INITIAL CFPB ACTION ON PAYDAY LENDING
  6. DEFENDERS OF PAYDAY LOANS AND LENDING PRACTICES
  7. MEASURES SUGGESTED BY PROPONENTS OF GREATER REGULATION
  8. THE CFPB'S REGULATORY OPTIONS AND THEIR CONSEQUENCES
  9. CONCLUSION
  10. REFERENCES
  1. 1

    The Dodd-Frank Act explicitly prohibits the CFPB from establishing interest rate or fee ceilings.