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Economy

There’s No Free Lunch – Even in Banking

By Sarah Brodsky on Jan 28, 2008

In the latest proof that foolishness knows no party, Bill Clinton and Arnold Schwarzenegger have teamed up to write about payday loans in the Wall Street Journal:

Imagine the economic and social benefits of putting more than $8 billion in the hands of low- and middle-income Americans. That is the amount millions of people now spend each year at check-cashing outlets, payday lenders and pawnshops on basic financial services that most Americans receive for free — or very little cost — at their local bank or credit union.

The high interest rates charged on payday loans reflect how much riskier those loans are than the typical transactions higher-income people handle at full-service banks. When a mainstream bank lends money, the borrower is typically someone who has deposited money there and who has a relationship with the bank. Payday lenders don’t have that security.

Payday lenders’ high charges and fees reflect a cost, and that cost won’t go away just because people switch to full-service banks. Someone has to pay for risky loans, and if the lenders don’t, someone else — probably taxpayers — will have to. Or, as a result of usury laws, poor people won’t be able to borrow money at all.

Clinton and Schwarzenegger suggest that their plan won’t be costly because it will just encourage people to use cheap services that are already there. But switching risky loans from one kind of bank to another won’t make the cost go away.

Poor people can escape payday loans if they earn more than they spend, save enough to deposit money in an account, gain financial literacy and form relationships with mainstream banks. That’s a worthwhile goal, but we can’t achieve it with a quick fix.

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Sarah Brodsky

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