As the payday lending industry has grown rapidly over the past decade, particularly in lower-income and minority communities, the usual critics of free-market commerce have found yet another capitalist whipping boy ripe for attack. These critics, often posturing as “consumer advocates,” charge that payday lending exploits the poor and lower-income customers that comprise its target market, preys on their lack of financial sophistication, leads them into chronic borrowing habits at “excessively high” effective interest rates, and generally takes advantage of their weak bargaining position.

The “solution” proposed by these critics is further government regulation of the financial institutions that provide payday lending services, usually in the form of caps on the fees that these business firms can charge. Of course, further government intervention is not the answer. Indeed, it is previous government regulation in the consumer finance industry that has, in part, led to the rapid growth of the very payday lending practices so reviled by critics. As always, the law of unintended consequences prevails, leading to outcomes that are directly opposite those sought by government regulators.

Payday lending, sometimes known as a “payday advance” or a “deferred deposit” loan, is a short-term two- to four-week loan backed by a postdated personal check that a borrower agrees to cover with sufficient funds out of his or her next paycheck. In effect, the borrower issues a postdated check to the payday lender in exchange for immediate cash, usually in the amount of $100 or $200.

The typical fee for this service is $15 or $20 per $100 borrowed, so the postdated check is written for an amount equal to the sum of the desired loan plus the related fees. The payday lender holds the check until the agreed-upon date, at which point it is cashed and (hopefully) covered by the borrower’s payday deposit.

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Source: The Free Market

(To be continued…)

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