Usurious Payday Loans: Myths, Flawed Studies, and Solutions

The trade association for payday lenders objected to what they called my "name calling" in their blog yesterday ... then called me a "pig." Why? Because I quoted Aristotle and told a story about Jesus. Well, to be fair, I did suggest their industry might be "evil," according to traditional definitions of the term. But that doesn't explain the payday defender who called me "Doofus Major du Jour."

There are some more civil arguments being used to defend payday lenders, however, and many commenters repeated them in the Huffington Post and in the DailyKos. These arguments are myths. They're being repeated by reasonable, well-intentioned people who have been misled by a wealthy lobby and its flacks.

Here's the truth, for all those well-meaning payday defenders out there: Payday loans weren't created to help underserved populations, but to exploit helpless people. Payday lenders are deeply connected to traditional banks, who freeze out certain customers so they can be preyed on by usurers. And that study you keep citing? It was paid for by industry money and used industry data, and a number of other studies refute it. But there's good news: Congress can fix the problem now.

A population in need? One common argument is that payday loans serve a group of people that can't get needed loans any other way. Shouldn't people be free to enter into contracts with one another, even if the terms seem outrageous to others? There are two problems with this argument. First, as a commenter pointed out, it can also be used to justify moral wrongs like slavery, too -- although slavery wasn't a perfect analogy. A better one would be "indentured servitude," where poor people would trade away their freedom for a period of years in return for a cash loan. Civilized countries decided that these agreements, although they were legal and enforceable contracts, were immoral and must be stopped.

This argument also ignores a critical fact: Big banks -- the same parties who have denied people more legitimate sources of credit -- are deeply embedded in the payday loan industry. Wells Fargo has funded more than one-third of all storefront lenders, Bank of America's a major shareholder in payday lender QC Holdings, and banks have been working with payday lenders to evade usury laws.

Banks force people into a financial squeeze where they have no other credit options by denying them traditional loans and credit cards, then profit from rapacious payday lenders who charge them rates that can approach 400% to 800% in annual interest. Payday loans don't help an "underserved population": they're part of an exploitative, interconnected system.

In other words, the "payday loan" problem is a problem with the entire banking industry.

People also have argued that it's not fair to quote annual interest rates. They sound high, but these loans only last for two weeks so nobody's really paying that kind of interest. Wrong: Payday loans target lower-income people and charge so much in interest that they're forced to "roll over" these loans again and again. An Indiana study showed that the average borrower took out more than ten loans per year, for example.(1) As cited by Kelly J. Noyes, a number of state studies show that rollovers are frequent. The Center for Responsible Lending found that 91% of loans were given to people who had borrowed five times or more during the course of a year. And Sen. Joe Lieberman's staff found that the typical lower-income borrower did not have enough money to pay back their payday loan without going into debt at the end of the two-week period.(2) That cycle is what nonprofit financial organization CouleeCap accurately describes as "Paycheck Poverty, " and their paper on the topic cites this widely-available statistic: There are one hundred times more payday loan operations today (as of 2007) than there were in the early 1990s.

Here's the significance of that figure: An industry that essentially didn't exist in 1990 had grown to 12-14,000 outlets by 2001 (Consumer Federation of America/PIRG) and continued to grow even before the latest downturn. Again: This is not an example of people serving an unmet need. It is a bank-fueled response to a bank-manufactured crisis.

Somebody is no doubt saying, "Hold on a second there, Mr. Piggy Doofus Major Du Jour. What about the Elliehausen study?" That would be the study that purported to find that payday loans serve a fairly typical population -- not exploited minorities and low-income communities -- and that was so widely reported and celebrated in certain parts of the press and in industry sources. In a typical boast, "Personal Money Store" wrote that it "chastens critics" of the industry.

The Flawed Study

We were told that this study exonerated the payday loan industry. Here's what we weren't told: We weren't told that the study was funded by the payday loan industry. We weren't told that the data used in the study was provided by the payday loan industry. And we weren't told that its author, professor and Federal Reserve economist Gregory Elliehausen, had been the payday industry's go-to guy for studies of this kind for years.

No doubt Prof. Elliehausen is a dedicated scholar and good person. But there's a reason the industry chose him for this study. His 2001 paper on the topic drew similar conclusions, contradicting numerous other studies. So did 2006 NFI working paper on this topic . "NFI" is the "Networks Financial Institute" at Indiana University, whose advisory council includes the head of Patriot Investments and the retired CEO of Monroe Guaranty, and whose partners include the Indiana Bankers Association. Not a consumer representative in the bunch.

In other words, the industry knew what it was getting ideologically when it chose Elliehausen. But, needless to say, the paper could still be a sound piece of research. Is it? A careful reading of the paper raises more questions that it answers. First, the data was pulled from member companies of the Community Financial Services Association of America (the "pig" folks), which partially funded the study.

Both the funding and the data source represent a conflict that should have been noted in press accounts of its findings. In addition, CFSA companies don't necessarily include the most predatory lenders (maybe they'll be glad I gave them that concession), especially the ones that operate in ghettos and other minority communities.

Given the above, Prof. Elliehausen's demographic conclusions (especially about race) should be viewed with great skepticism -- especially in the face of numerous other studies which found that payday lenders prey on minorities and other lower-income groups.(3) When a study is an outlier -- when its findings contradict those of multiple other studies -- that should always raise questions.

This dubiously-selected population was then surveyed by telephone, a method which would have excluded some lower-income loan recipients. (See, for example, "Coverage Bias in Traditional Telephone Surveys of Low-Income and Young Adults.") Prof. Elliehausen's decision to then build a "psychological model" based on these surveys raises even more questions.

Another possible methodological flaw: "This paper uses all consumers and consumers who revolve credit card balances as benchmarks" (Elliehausen, p. 25). But many payday borrowers only "revolve" their loans because of the extraordinarily high interest rates involved. And the assumption that "consumers often use bank credit card debt in the way they might have used unsecured personal loans" is open to debate.

Most tellingly, Elliehausen points out that "participation (in his survey) was voluntary and not random." That can create a "selection bias" that casts doubt on the findings, especially on a topic which involves both public shame and fear of strangers asking questions on the phone (especially in lower-income communities).

I wonder how many people who quote the Elliehausen study have ever actually read it?


Fortunately, solutions to the payday loan problem are close at hand. First, the confusion and misinformation surrounding the payday loan industry shows how badly we need a Consumer Financial Protection Agency, ideally one that's distinct from the Federal Reserve and its economist-advisors (including Prof. Elliehausen). Only an independent CFPA can sift through the misinformation to protect consumers. Secondly, it underscores the need for the Senate to pass the Whitehouse/Marquette Amendment, which restores the states' ability to set interest rates for lending within their own states. It's not an anti-usury law itself, it just gives states back the right to set interest rates for their citizens. (It would be interesting to see how "states' rights" advocates vote on this amendment.)

Sarah Palin should be a big supporter of these changes, too. After all, she said she thought that "US law should be based on the God of the Bible" -- and we know what He thought about usury.

As for that industry blog that called me a "pig," he also said I was "seeking left-leaning applause." Hmm ... a left-leaning pig? Reminds me of Animal Farm, which is appropriate for Orwellian statements like "the payday industry helps families."


(1) Indiana Department of Financial Institutions. (n.d.) Summary of payday lender examination, 7/1/99-9/30/99. Indianapolis, IN.
(2) See Noyes; also, Drysdale and Keest, The Two-Tiered Consumer Financial Services Marketplace: The Fringe Banking System and Its Challenge to Current Thinking About the Role of Usury Laws in Today's Society
(3) See, for example, Race Matters: The Concentration of Payday Lenders in African-American Neighborhoods in North Carolina.

Richard (RJ) Eskow, a consultant and writer (and former insurance/finance executive), is a Senior Fellow with the Campaign for America's Future. This post was produced as part of the Curbing Wall Street project. Richard also blogs at A Night Light.

He can be reached at ""