A 50 Basis Point Cut? Try 50,000 …

Yesterday, Attorney General Jay Nixon and several legislators called for reform to Missouri’s payday loan industry, arguing that it engages in predatory lending practices targeted at uniformed consumers. As evidence, Nixon cites the fact that Missouri lenders charge an average APR of 422 percent on payday loans, with some companies charging as high as 1,950 percent.

Nixon would enact legislation to cap payday loan interest rates at 36 percent and eliminate the practice of renewing outstanding loans, a practice that consumer groups argue traps borrowers in a vicious cycle of spiraling debt.

I have no doubt that some payday lenders engage in morally questionable lending behavior, but capping the rate of interest is not going to solve this problem. Consumer interest rates are primarily determined by credit risk, and if the Legislature caps the rate at which lenders can charge interest on their loans, lenders will be forced to issue fewer of them. And since payday loan consumers have the highest risk of default, they are the people most likely to be priced out of the market.

Moreover, it is likely the case that if borrowers are in such desperate financial straits as to borrow money at a rate of 1,950 percent, they will find a lender — whether legally with a payday lender, or illegally in the black market. And at least with a payday lender, default is settled by foreclosure on some kind of collateral. In the black market, it usually involves a crowbar.

In short, payday loan reform is one of those “feel good” legislative issues that does little to fix the problem it is targeted to address. If legislators are concerned with predatory lending practices, they should work to increase consumer education, rather than pricing consumers out of the market entirely, forcing them to obtain funds under much worse conditions. Capping the rate of interest is simply bad policy.