Payday Lending, Bankruptcy, and Insolvency

Table of ContentsI. Introduction 608II. The Payday-Lending Debate 613III. The Regulation of Payday Lending 624A. State Regulation 624B. Federal Regulation 626IV. Measuring the Effect of Payday Lending 627A. The Effect of Changes in State Laws Regulating Payday Lending 630B. The End of the Rent-a-Charter Era 636V. Conclusion 638Tables 640I. IntroductionIn a typical payday loan, a consumer writes a $300 check that is payable in two weeks and receives $255 in cash.1 These terms translate into an annual percentage rate in excess of 450% and a compounded interest rate in excess of 6,800% per year.2 Despite these extremely high rates, the loans are popular; some estimate that payday lenders extend as much as $50 billion in loans each year.3Some scholars and consumer advocates call for strict usury limits or other laws designed to curtail or eliminate payday lending,4 and a growing number of state legislatures have heeded their call.5 We are also likely to see a substantial increase in federal regulation as the Dodd-Frank WeQI Street Reform and Consumer Protection Act6 grants the new Bureau of Consumer Financial Protection authority over payday lenders.7 This Act prohibits the new bureau from setting an interest-rate cap.8 However, the new bureau might try to use its authority to regulate "unfair, deceptive, or abusive" acts to sharply curtail payday lending on the grounds that these loans cause "substantial injury to consumers" without offering sufficient countervailing benefits.9Some argue that payday loans only appear expensive if one assumes that the consumer has the same options available to the middle-class critic - many payday loan borrowers are severely credit constrained.10 A payday loan may be less expensive than bouncing a check, and payday loans may offer better credit terms than pawnshops and rent- to-own stores.11 More importantly, payday lending may be better than no credit at all. If a payday loan allows the consumer to repair her automobile, then it may save the consumer's job and prevent further financial difficulties.12 Critics counter that payday loan borrowers do not repay their loans quickly and instead renew their loans repeatedly; consumers can become ensnared in a debt trap and incur hundreds of dollars in fees for each small loan and can lead to insolvency or bankruptcy.13 Critics further allege that payday lenders target military and minority populations,14 making these groups especially vulnerable. Some scholars take a more agnostic view of payday lending, arguing that this industry is unlikely to have a significant effect on the financial health of consumers because the dollar amounts involved are too small, and the number of available alternatives is too great,15 or because payday lenders and other fringe credit providers take steps that ensure that their customers repay.16 The existing empirical literature is inconclusive; some papers find results consistent with the debt-trap hypothesis while other papers find results consistent with the positive or agnostic views of payday lending.17This Article adds to the empirical literature on payday lending in three ways. First, this Article makes use of the claim that payday lenders target military and minority populations. If payday lending does affect financial distress, its effect should not be uniform throughout the state. …