Payday Loans vs. Loan Sharks
This old article from the Sacramento News & Review contains some interesting sentences about sub-prime credit:
While the Chicago Outfit may have been a bit heavy-handed in its debt-collection practices, the interest rate the crew charged for a loan was a bargain. A bargain, that is, compared to the fees charged by the numerous payday loan outfits in Sacramento and throughout the state.
Carlisi and company extended short-term credit, or “juice loans,” for fees that pencil out to an annual interest rate of 260 percent. The Outfit may be disappointed to learn that they were working for chump change. Had they waited a few years, and then come out West, they could have become payday lenders and made some real money.
Although the gratification of physically collecting a loan isn’t allowed, in California it’s perfectly legal for a state licensed payday lender to charge up to 5,474 percent annual interest in this rapidly expanding niche lending business.
I’ve been meaning to comment on this for a while, because this is really fascinating data. Readers who peruse the article from which this excerpt is lifted will note that the author uses this statistic to argue that payday rates are excessive and exploitative. Well, perhaps, but this data doesn’t render that claim obvious. The fact that payday loan rates are higher than loan shark rates could simply suggest either that payday lenders face higher costs of enforcement, higher default rates, higher transaction costs, lower-quality information, or some combination of these factors.
It’s easy to see how a legitimate, white-market business would have higher overhead costs than a black market loan scheme, if for no other reason than that a white-market business must handle contractual disputes with tools furnished by the legal environment. No such encumbrances burden black market creditors. As former Show-Me Institute Policy Analyst Justin Hauke put it in an op-ed: “At least with a payday lender, default is settled in court. In the black market, it usually involves a crowbar.” In this sense, the higher prices of payday loans likely reflect the premium that consumers are willing to pay for safety.