The New York Federal Reserve Board, charged with overseeing Wall Street banks, turned over its normally staid official blog this week to a highly contentious argument in defense of high-cost payday lenders, who are partially funded by the same big firms the Fed is supposed to be regulating.
Michael Strain, a resident scholar at the ultra-conservative American Enterprise Institute think tank, co-authored the piece. While posts at the New York Fed’s Liberty Street Economics blog always caution that the views expressed do not reflect the position of the regional bank, it is highly unusual to have anyone from an ideological think tank write an article there. A review of the last three months of Liberty Street Economics posts shows no other instance of this happening.
The article, “Reframing the Debate About Payday Lending,” begins by almost taunting the many critics of payday lenders, who charge low-income borrowers upwards of 400 percent interest for short-term loans (typically due within two weeks, or the next “payday”).
“Except for the ten to twelve million people who use them every year, just about everybody hates payday loans,” Strain and his co-authors write, dramatically mischaracterizing what drives users to the services. Payday loan users typically have few alternatives to maintain their bill payments, especially as banks have denied them lending services. It is not love that motivates them; it is desperation.
Payday lenders thrive the most where banks have the fewest locations, according to a 2013 Milken Institute report. In fact, it’s a two-step process: banks abandon low- and moderate-income communities, ceding the field to payday lenders who they fund. Mega-firms like Wells Fargo Bank of America, US Bank, JPMorgan Chase and PNC Bank provided $1.5 billion in financing to the payday loan industry, as of 2011.
The New York Federal Reserve regulates many of the activities of these big banks, which profit from the continued success of payday lenders.
Hosting arguments defending payday lending, featuring work from a leading conservative think tank, undermines any semblance of independent oversight.
Donald Morgan, an assistant vice president in the Research and Statistics Group at the New York Fed, also contributed to the post, with professors from the University of Kansas and Columbia University.
Several claims in the post lack context or are just wrong. For example, the authors write that payday lending is “very competitive,” without mentioning that the competition is primarily on volume rather than price; generally payday lenders charge the maximum interest and fees their state will allow. The one study they cite to argue that competition in payday lending lowers prices actually found that “payday loan finance charges gravitated toward the price ceiling over time.”
Similarly, they claim that payday lenders make justifiable profits given their fixed costs and losses on loans, neglecting the impact of the business on individuals. Indeed the entire post takes the perspective that there is no alternative for lending to the poor but to charge 400 percent interest rates, despite potential lower-cost options like competition from the U.S. Postal Service.
The authors conclude that the only problem with payday loans is that their loans roll over, seemingly oblivious to the fact that this is the lenders’ entire business model, to trap borrowers in an endless cycle of debt. Two-thirds of all borrowers took out seven or more loans per year, representing 90 percent of the dollars advanced, according to a Consumer Financial Protection Bureau study in 2013. The CEO of leading payday lender Cash America admitted this at a financial services conference in 2007, saying, “You’ve got to get that customer in, work to turn him into a repetitive customer, long-term customer, because that’s really where the profitability is.”
Michael Strain’s employer, the American Enterprise Institute, is a longtime champion of “expanding liberty, increasing individual opportunity and strengthening free enterprise.” Its board of trustees features “leading business and financial executives,” including from Wall Street firms like AQR Capital Management, Eagle Capital Management and private equity firm Kohlberg Kravis Roberts.
The article comes just as the CFPB considers how to best regulate payday lending, and the authors appear focused on influencing that debate. “More research should precede wholesale reforms,” they write.
Caption: Signage advertising short-term loans stands in front of stores in Birmingham, Alabama, on Tuesday, Feb. 10, 2015.