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This Government Agency Is Seriously Overstepping Its Bounds

Thaya Brook Knight

The Consumer Financial Protection Bureau (CFPB) has a mission:
to protect consumers from unfair, deceptive, or abusive practices.
According to a new national poll by the Cato Institute in collaboration
with YouGov, protection from deceptive practices is just what the
American public wants. Asked to prioritize regulatory goals, the
majority of respondents put “protect consumers from
fraud” front and center.

Unfortunately, the CFPB continually misses the mark, issuing
rules that make splashy headlines but in practice do little to stop
bad behavior. Its latest proposed rule, expected to become final
soon, doesn’t target fraud itself. Instead, it goes after an
entire industry and will significantly reduce consumers’
access to credit at the exact moments they need it most.

This rule would restrict the ability of short-term lenders,
often known as “payday” lenders, to continue offering
their services. These loans require no credit check and no
collateral. For a flat fee, usually about $15 per $100 borrowed,
the lender provides a loan lasting about two weeks. The borrower
gives the lender a post-dated check for the full amount of the
loan, plus the fee. At the end of two weeks, the lender deposits
the check. If the borrower does not have the funds to repay the
loan, the borrower can roll it over, taking out a new loan for
another $15 per $100 fee.

The CFPB has claimed that these loans create a “debt trap” for borrowers, the majority of
whom do roll over the loan. To protect people from these
“traps,” the CFPB wants to institute new compliance
requirements. If payday loan consumers end up accruing fees
equivalent to 36% or more of the amount originally borrowed as a
result of rollovers, the CFPB’s compliance requirements would
kick in, requiring lenders to assess the borrower’s ability
to repay the loan in the two-week period, and limiting the number
of times a loan can be rolled over.

But the word “trap” is misleading. In fact, the
terms of the loans are remarkably clear. “Borrow $100.”
“Pay $15 plus the amount borrowed.” “Payment is
due in full in two weeks.” Try putting the terms of any other
credit instrument—a credit card, an auto loan, a
mortgage—into just 15 words. Even putting such loans into 15
pages would be a challenge. In fact, payday loans are a viable
business model precisely because they’re quick and require
little paperwork, making it feasible for them to lend to people
with poor credit.

Those who use payday loans agree. As the Cato poll finds, the
majority of payday borrowers say they receive good information
about rates and fees from their payday lenders. The fact that
payday borrowers remain in debt longer than two weeks is not
evidence of deception; according to a recent Pew survey, the majority of borrowers correctly
estimated how long it would take them to pay off the debt, even
though for most of them, that would mean several months of
repayment.

Using payday loans can be expensive. Often opponents of the
loans cite the fact that the fees can ultimately total more than
the amount initially borrowed if the loan is rolled over many
times. Each time the loan is rolled over, the borrower effectively
takes out a new loan and pays the applicable fees on the amount
borrowed.

While some compare this fee to an interest rate, arguing that
the total fees paid on a loan are comparable to an annual
percentage rate (APR), in reality they are simply a flat fee for
each $100 borrowed for a set period of time. It’s true that
the fees can add up, especially if a borrower rolls over the loan
multiple times, but it doesn’t make the loans deceptive.
Limiting the effective APR would limit the number of times a loan
could be rolled over, requiring borrowers to pay on the spot. Given
the way payday loans are often used, being able to roll over the
loan is a benefit to borrowers who might need more time to save up
the cash.

New technologies and the widespread use of smartphones have made
financial transactions easier and more widely available. Reducing
regulatory barriers to the development of these products may be the
best way to improve financial access for low- and moderate-income
Americans. In the meantime, the CFPB needs to focus on preventing
and punishing fraud, rather than making news with rules no one
wants or needs.

Thaya Brook
Knight
is associate director of financial regulation studies at
the Cato Institute.