Credit crunch gives ‘borrowing’ a bad name
Seattle Post Intelligencer
January 9, 2009
by: Tim Miller
The credit crunch is giving "borrowing" a bad name. That's unfortunate because, under the well-meaning pretext of protecting the poor, some activists are determined to limit the financial options of those who need them most. Arbitrarily restricting people's borrowing options is exactly the wrong way to weather a recession. But this is exactly what some state legislatures are doing by effectively banning short-term loans.
The ultimate irony is that while some loan options are coming under assault, policy makers have stood idly as young Americans are overdrawing their bank accounts at an alarming rate -- a habit that comes at a far greater cost than any other conceivable short-term loan.
According to a recent study from the Federal Deposit Insurance Corp., overdrawing some bank accounts by just $1 for two weeks can result in $37 or more of fees, or a 96,200 percent annual percentage rate. Further, the vast majority of banks (71 to 89 percent) with automated overdraft programs don't tell customers an overdraft has occurred until after the transaction has been completed. It's no wonder that studies have shown that banks are charging Americans $17.5 billion in these fees each year.
Worse still, the most vulnerable Americans -- youth and those with lower incomes -- are disproportionately affected by hidden fees associated with over-drafting. For these groups, overdraft "protection" is serving as a substitute for more traditional short-term lending. If they are short a couple of dollars between paychecks, many are choosing the simple process of overdrawing their checking account, instead of taking the time to apply for a loan or get a cash-advance.
But overdraft fees don't compare well to more formal borrowing options. These are intended to serve as quick cash for an emergency that arises between paychecks. With a short-term payday loan, a borrower typically gets a $100 loan and agrees to return the money two weeks later with a $15 fee attached.
But believing these loans are unfair and a recipe for insolvency, some policymakers have decided that it's these short-term payday loans from which borrowers need to be saved. Their financial cure? Regulate these loans into oblivion.
A new Ohio law, for example, mandates that payday lenders must loan $100 for a maximum $1.08 fee. To people with poor credit histories. That's not how to run a business, it's how you ruin one -- while destroying a credit option along the way.
A recently released Dartmouth College study found that after Oregon's imposed a similar rate cap, "former payday borrowers responded by shifting into incomplete and plausibly inferior substitutes," mostly "through checking account overdrafts of various types and/or late bills."
It's not a secret that financial success depends on having a full financial toolbox. And sure enough, researchers from George Mason University and Colby College have found that short-term payday loans provide options that substantially improve the chances of a borrower's ability to financially survive.
Given these realities, we shouldn't be shutting down credit; we should be encouraging more lenders to compete, which would lower fees further.
A bounced check penalty typically costs about $25. The average credit-card late fee is $30. A checking account overdraft with a merchant charge can cost as much as $60 per check. What's more, these fees are rarely transparent, and bounced checks or late fees typically lower credit scores. The hidden costs of low scores results in thousands of dollars more for home, car, and other credit loans far into the future.
No one pretends any borrowing is a cost-free "solution" to economic difficulties. But because getting rid of short-term credit options does nothing to reduce debt, neither are they the culprit.
The causes of our debt-ridden society are complex. But there is a longstanding and proven principle that is utterly simple: Raising the tide that lifts all boats can only be achieved by protecting -- not restricting -- the freedoms that give meaning to personal responsibility.
Tim Miller is the communications director for the Center for Consumer Freedom, a nonprofit organization that promotes personal responsibility and protecting consumer choices.
