In 2007, the FDIC set up an ill-conceived program for 30 banks to offer short-term loans of up to $1,000, at a maximum APR of 36%. They thought this “Affordable and Responsible Consumer Credit” program would prove that lenders could make a profit under these conditions while still serving the consumer’s needs.
The results are akin to the hapless ski jumper at the opening of Wide World of Sports, who slips, falls, flails, smashes through a banner, and lands with a resounding thud on the landing pad.
While payday loans are approved in a mere 15 minutes, most of these FDIC-sponsored loans took more than 24 hours to approve -- failing consumers who needed their funds immediately; some required direct deposit, credit checks and possibly a financial literacy class or collateral (none of which are required for a PDL); some required a portion of the loan be put on deposit (not part of the PDL process); only a few thousand loans were made because of said inconveniences (compared to 100 million loans annually for PDLs due to their convenience); and none of the institutions actually made a profit while some lost money, even when including an origination fee of up to $50 (whereas PDL’s profitability allows them to be widespread and easily accessible).
For the FDIC, it’s the agony of defeat – which naturally didn’t stop them from calling the program a success. Let’s also remember that the only reason 30 institutions came on board to offer these loans because they’d receive “favorable consideration under the Community Reinvestment Act”. In other words, participating banks had to be bribed to get them on board.
What can we learn from this ridiculous experiment? Not surprisingly, we discovered that a government-administered program for short-term credit failed to serve the real needs of real Americans. After all, consumers are not stupid. They know how to shop for the best deal. The rates and fees on the FDIC’s products, despite being 95% cheaper, did not balance out the consumer’s desire for quick, convenient cash provided without a bevy of requirements, and handled with a minimum of invasiveness.
The market provided an alternative and it failed. And it will fail over and over again, unless and until the benefits of a new product outweigh those of the current one. That won’t keep grandstanding politicians like Senator Herb Kohl (D – WI) from trying, though. He just introduced a bill to allow “mainstream financial institutions” 60-day loans of up to $2,500, and reimbursement them for a portion of defaults. Sen. Kohl proves my point: the only viable alternatives are those subsidized by government.
Of course, if government will reimburse the lenders for a portion of defaults, then who’s left holding the bag? You and me, because you can bet the federal government won’t chase after small-dollar debtors with the zeal of the IRS. Those defaults could run into the billions.
We’ve already seen the damage caused by the CARD Act, which Kohl voted for. Nobody will argue that credit card regulations could use some reform, but the immediate result of this legislation was to restrict credit, cause minimum payments to rise, and jack up some people’s base rates. What unforeseen consequences of Kohl’s payday loan legislation are waiting to harm consumers?
It’s enough of an affront for the FDIC to call this program a success, but lest you believe the FDIC is some neutral entity, think again. The FDIC is all about banks, not alternative financial services. Let’s remember how the FDIC blitzkrieged the payday loan industry in March of 2005 when, without any warning, they effectively banned the rent-a-charter model. The intent was to push consumers out of payday loans and into banks, in an effort to get more people hooked on overdraft protection (which is more expensive than PDLs). Nice.
Now the FDIC is at it again. With their 2009 FDIC National Survey of Unbanked and Underbanked Households, they claim “that these survey results will help better inform the industry and policymakers about economic inclusion issues, and promote the goal of ensuring that all Americans have access to basic, safe, and affordable bank services.”
All Americans do have access to these services. It’s just that many choose not to conduct their business with a bank. Many choose alternative financial services for a reason. Figure 4.12 of the survey is very telling in this regard. Nearly 50% of those without a bank account chose not to have one due to one of the following reasons: too expensive, not convenient, lack of trust, or lack required services.
With respect to lending, even people with great credit are having a hard time getting a bank loan these days. It’s easier to get a loan from a PDL and you get personalized attention. More than half of the PDL stores in the U.S. are mom-and-pops. They are literally a neighborhood service, and are on a first-name basis with their customers. Banks don’t offer that, and when it comes to short-term credit, people feel more comfortable knowing that someone is there to help them without the dehumanizing service a bank offers.
So to label someone “unbanked” or “underbanked” instantly identifies the survey as biased, as it offers the implicit assumption that doing regular business with a mainstream bank is somehow “correct” or “better”, that one should be “banked”. This perspective is insulting and elitist to the millions of Americans who know exactly what they are doing with their own money, and why they are doing it. New York City has subway stations every few blocks, but if it’s raining or snowing and I’ve got my kids, maybe it’s just easier and more convenient to hail a cab. Does that make me “undertransported”?
Payday loan customers use the product for a reason. They are not stupid. They know what the product costs, the terms are clearly disclosed, and 93% of all loans are paid back on time. The payday loan industry serves millions of people each year, and has an impressive satisfaction rate.
The only people who have a problem with payday loans are those who don’t understand them, don’t use them, or want to make political (or financial) hay out of them. To them I say, “it’s none of your business”.
How is this actionable?
The data from this survey further proves what I and other experts have said for a long time: that payday loans have a definite place in our society. The most recent version of the CFPA bill rightly has no payday loan restrictions or rate caps. So, for the six stocks in this sector -- First Cash (FCFS), Advance America (AEA), EZCorp (EZPW), Dollar Financial (DLLR), Cash America (CSH), and QC Holdings (QCCO) -- it means a substantially decreased federal legislative threat. Since a rate cap amendment couldn't get attached to the CFPA, and an earlier attempt by Sen. Durbin to cap rates via amendment to the CARD act also failed, it demonstrates that Congress understands the need for payday loans. Although all of the stocks appear to be reflecting this news in their most recent run-up, I still believe they are all trading below fair value.
I'll examine them in more detail in an upcoming article.
Disclosure: No position in any stocks mentioned