Government‐Directed Lending Comes to America
In perhaps the greatest example of wishful thinking we’ve seen in recent times, the Consumer Financial Protection Board Administrator Richard Cordray testified before Congress last month that banks and credit unions should step up their loans to low‐income workers with poor credit by creating new products that compete with payday loans. It is a notion that’s completely at odds with the actions of the CFPB as well as the capabilities of banks and credit unions.
Since its inception the CFPB has all but declared war on payday and title loan companies, the two entities that do the most lending to people with poor or nonexistent credit. The CFPB resents them because the loans are costly and in their view potentially exploitative: a typical loan would be for three or four weeks and amount to $400, with $500 to be repaid at the end of the term. A 25% interest rates for a loan of less than a month amounts to an astronomical annual percentage rate and the CFPB and Department of Justice have deemed it to be needlessly excessive. They have made a concerted effort to make it difficult or impossible for these businesses to survive via something called “Operation Choke Point. ” For instance, it is now much more difficult for these businesses to get bank accounts.
The retrenchment of the industry has created a lacuna: despite fervent wishes to the contrary by the CFPB, many low‐income workers find themselves in need of credit, and it’s unclear what will fill this niche.
What is abundantly clear is that banks and credit unions will not be the ones to do this. The large banks in particular feel–rightly or wrongly–to be the government’s victims in the aftermath of the Great Recession, as Congress and the various regulatory agencies sought to assign blame for the financial crisis. The Justice Department fined several banks billions of dollars in the last decade, and not a single one of those banks came out of those negotiations feeling warm and happy thoughts about the federal government. The notion that they would pick up a new and likely unprofitable business line because Richard Cordray asked them to is absurd when they risk being charged with exploiting these people by loaning them money, as they were with their mortgage loans.
Besides, banks have never been particularly adept at retail innovation: opening more branches has been the extent of their efforts. Retail banking is a conservative business that is ill‐suited and disinclined to take risks or try new things.
In my experience banks find it difficult to change their hidebound ways. Twenty years ago I completed my Ph.D. in economics. The day I arrived at my parents’ house with my degree in hand my father made me put on a suit and accompany him to some meetings with various banks and finance companies. He was a bankruptcy attorney and one of his concerns was helping his clients establish some modicum of credit after filing. A good proportion of his clients were forced into bankruptcy by a single unforeseen incident–a health emergency, a divorce, or the short‐term loss of a job.
Once these people escaped their debt and were past their crisis, he reasoned, there was no reason why a profit‐maximizing business shouldn’t extend them credit, especially if it was secured by some sort of asset. So I spent the day meeting with various banks to discuss the plight of a couple of his recent clients who needed capital to buy a truck for their profitable small business.
My presence didn’t change a thing: Not a single bank would consider making a $10,000 secured loan for a $20,000 truck. They understood our point and often even agreed that these loans could very well make good business sense for them, but lending to a bankrupt is not what banks do, profits be damned.
We ultimately did find financing for his clients, from the household finance and installment loan companies in our city. These firms that were able to think creatively and understand the situation these people were in. The people there knew the community and the people who lived there and had the wherewithal to think on their feet and make decisions that can’t be easily covered by a blanket rule.
Eight percent of the population does not have a bank account and fully twenty percent of the population is considered to be “underbanked” in that they sometimes obtain financing outside of the normal bank/credit union route. Over a third of all households do not own their own home, which in today’s world can limit access to credit too. These people need to be able to access credit outside of the banking system. Making life more difficult for entities whose business model is to lend to this cohort helps no one.
A few years ago one of my graduate school roommates, who had risen to become a vice president at a major regional bank, embarked on an ambitious plan to help his employer enter the market to provide loans to the underbanked. The effort failed miserably: their bank proved itself unable to make quick decisions on lending, and as a result few people in that market found it of any use. The default rates on their loans were acceptably low but they didn’t come close to covering their investment in this market and they abandoned their efforts within a year.
There is no doubt that there are still some bad actors that take advantage of low‐income borrowers, but we are approaching a situation whereby the government considers any entity lending money to the underbanked to be exploiting them. The pendulum has swung too far: we need a government regulator to allow companies to make loans to the underbanked and make a profit in doing so, because squeezing them out, which the CFPB seems intent on doing, won’t benefit anyone.
