Professor Victor StangoUniversity of California, Davis

Graduate School of Management

Economics and Policy in Payday Lending Markets

Introduction

My background: Academic (Dartmouth, UCD, others) Federal Reserve (Chicago, NY)

Research: Competition/regulation in banking (mostly credit

cards) Consumer decisions and consumer protection in

banking (mostly in debt markets, a little in payday)

Caveats

The Big Questions

Does access to high-interest credit help or harm borrowers?

What constitutes sound law and public policy toward payday lenders and other providers of short-term credit?

Roadmap

State of the academic research on payday lending

The ascendance of behavioral economics in policy

Getting the (behavioral) economics right: examples

Questions

My Points, Broadly

The body of accepted economic research on payday lending is substantive and provides a credible scientific foundation for policy and legal discussions

Behavioral economics will not go away; indeed, its lens will be the primary one through which policymakers view payday lending

There is reason to feel good about both developments

State of the Science: What Do We Know?

We now have a substantive body of social science on a variety of questions Much of this is well-formulated research by academic

researchers at top universities In other words, this is work to which serious people in

the law and policy realms will attend

Research covers a wide range of topics, methodological approaches

State of the Science: What Do We Know?

Competition Accepted academic evidence that payday markets are

competitive, in the broad economic sense (i.e., that firms are not earning monopoly profits)

The effects of price controls Little evidence that payday lending markets defy Econ

101

State of the Science: What Do We Know?

Access and outcomes Bankruptcy, credit scores Employment Bill payment, overdrafts Health care, crime, food Death(!)

Results-wise, a mixed bag: “One possible conclusion is that payday loans are, financially, neither destabilizing nor greatly beneficial simply because they are small and unsecured, which limits their potential risks and benefits” – Bhutta (2012), “The Effect of Access to Payday Loans on

Financial Health…”

State of the Science: What Do We Know?

Borrower “rationality” Understanding of fees/terms/APRs Co-holding of high- and low-interest debt/assets Reaction to framing of loan costs Self-assessment of loan maturity (rollovers)

Upshot: Again, mixed; little evidence that biases are more pronounced here than

in, e.g., credit cards (or tanning salons!)

“The two main [preliminary] takeaway findings are that most of the customers expected/understood that they were likely to keep borrowing after the first loan.  The second is that about 60% predicted with reasonable accuracy (within one pay period) the date when they would finally be free from debt.”

- Personal correspondence, Ronald Mann (Columbia), 10/29/2012

What Research Hasn’t Settled

How to measure “worse off”?

What is the mix of those helped vs. harmed?

What’s “Harm”?

Any one outcome may not be clear evidence of harm Bankruptcy? Default? Subjective; highly individualized

Access to credit may “improve” welfare by some metrics and “hurt” by others Even at the individual level

Must ask “relative to what”? What is the effect at the moment of decision to borrow? How does payday loan debt enter the economic decision

(e.g., to declare bankruptcy)?

The Mix of Helped vs. Harmed

Economic research often looks at average effects, which misses this Critical for policy, or understanding any damages

borrowers might or might not suffer

Average effects mask any underlying diversity in how access to credit is associated with the full range of changes in outcomes Minor inconvenience or major disaster

averted/caused?

Summary on Research

Why a good thing overall? Credible both as fact-finding and a signal about

openness of questions Even when ambiguous, can only elevate the discussion Demolishes less methodologically sound approaches

that, e.g., confuse correlation with causality, or simply assert harm via “unconscionable” fees

Even statements about what we don’t know are written by credible academics and appear in credible academic outlets

The Ascendance of Behavioral Economics

What is it, again? Incorporates psychology into economics

Some behavioral “biases” relevant in debt markets: Hyperbolic discounting (self-control problems) Optimism about future income Optimism about frequency of future bad events Bounded rationality (innumeracy, myopia, inattention,

heuristics etc.)

Behavioral Economics and Policy

Behavioral economics is a well-established field and is not going away

Behavioral economics is playing an increasingly important role in policymaking, at the CFPB and elsewhere “Abusive” may encompass mistakes due to behavioral biases The view that some borrowers have such biases will be an

intellectual underpinning of policy Concerns about “shrouding” (in, e.g., mortgages and credit

cards) may be more important to the CFPB right now – but biases (e.g., optimism) are the greater perceived concern re: payday lending

Why This Might Be a Good Thing

Looking at behavioral economics simply as a set of models broadening the argument for regulation is perhaps too narrow

Now, we have: Models with clear predictions Serious academic researchers who have tested, and

will continue to test, these predictions Serious people in law/policy circles who will (or

should) pay attention

Example #1: Payment/Interest Bias

Accepted work in behavioral economics shows that some borrowers have trouble converting periodic payments into APRs, and vice versa And that such a payment/interest bias might provide a basis

for “shrouding” APRs and emphasizing periodic payments

One might see an assertion that this would be an issue in payday lending, in two ways: Because emphasizing fees is generically “shrouding” that

might reduce competition Or, if “The fee structure of payday loans makes it difficult

for consumers to compare directly the costs associated with a payday loan to the costs associated with other consumer credit products.”

Example #1: Payment/Interest Bias

Insight #1: If all lenders in a market quote prices the same way (e.g., in fees), then this bias cannot confuse customers about which are the low-price firms in that market

Insight #2: Bertrand and Morse (2009) use an “APR treatment” [presenting borrowers with payday loan APRs and a comparison set of credit card/auto/mortgage APRs] and find no significant or small effects on borrowing

Example #2: Hyperbolic Discounting

The assertion: people are impulsive in a way that leads them to over-consume or over-borrow, in a way they later regret At least one study argues that this explains some

payday borrowing

A key, from the model: this will increase borrowing via discretionary purchases, via spending binges or splurges that are later regretted

Example #2: Hyperbolic Discounting

Why this is important: a recent Pew report finds that the majority of payday loans are used for non-discretionary recurring purchases, or for emergencies Neither is the type of spending predicted to increase if an

individual is “hyperbolic” Spending on “something special” or “other” represents 13% of

loans

Not to say that these people aren’t hyperbolic – but if they are, the splurge happened before they arrived at the payday lender And, arguing that splurges only happen because people anticipate

getting payday loans presents a view of borrower behavior that is pretty forward-looking (i.e., not behaviorally “myopic”)

Example #3: Rollovers

The assertion: borrowers who roll over loans do so because they under-estimate ability to repay Focuses regulatory attention on rollovers

Evidence, part I: Preliminary new research (quoted above) showing that

many borrowers get their predicted maturity pretty much right

Evidence, part II: More broadly, from behavioral household finance:

experience is a powerful de-biasing tool Could argue that those with multiple rolled-over loans

would be expected to have the greatest familiarity with the product – and with their own predilections

Example #4: Survey Evidence

An example assertion: “If faced with a cash shortfall and payday loans were unavailable, 81 percent of borrowers say they would cut back on expenses” Makes the downside of regulation appear small

What does behavioral economics say? A pervasive feature of consumer decision-making with

behavioral biases (e.g., hyperbolic discounting) is not doing what one says/intends!

Also, research from survey design shows that respondents may choose responses based on social pressure or stigma

The Usefulness of this Approach

Payday loans/borrowers are different Simplicity/salience of fees Yields cash: salience of purchases Built-in “cooling off” period Etc.

Mapping findings from another market (e.g., credit cards) into payday markets is not a given Careful analysis can be very illuminating

Summary

Academic attention to payday lending markets has increased dramatically Provides an independent, evidence-based foundation

for assessing claims about payday borrowers and lenders

Ascendance of behavioral economics is a net positive as well Provides sharp predictions that can be tested for

intellectual coherence, and with data

Thanks!