The following in an edited version of a letter sent to the Consumer Financial Protection Bureau, submitted as part of the “comment period” required under Dodd-Frank after the CFPB issues proposed rules to govern an industry.
I write in opposition the Bureau’s proposed rules for small balance and auto title lending. The most significant flaw in the Bureau’s methodology when it was formulating its rules was that it never visited with any borrowers. This lack of consumer interaction has resulted in a flawed perception of small balance lending.
I’d like to share my background as well as first-hand experiences I have had with small balance lending consumers. From roughly 2006 through 2010, I was the co-founder of a firm that made loans to mom-and-pop small balance lending businesses. As part of our due diligence process on each lender, we visited with them to observe operations and speak with customers.
The majority of these visits were in lower income, minority neighborhoods, frequently criticized as “being taken advantage of by predatory lenders”. I asked each consumer numerous questions.
92% said they were taking out a loan because of an unexpected expense, usually health care and car repairs. These unexpected expenses happened six times per year. Only 10% kept a household budget. The average number of loans taken out per year per consumer was eight. Loans were repaid in full 92% of the time, and only 2% experienced four rollovers. Those who experienced three or more rollovers never used the product again.
The surprise was that consumers were very aware of their choices when faced with unexpected expenses. These “unsophisticated borrowers” knew exactly what options they had, and they ruled them out. In general, people were unwilling to part with an item and take out a pawn loan. Most had considered an auto title loan, but did not want to risk losing the vehicle.
83% had, at some point, borrowed from a friend, employer, or family member. However, they no longer used this option for one unanimous reason: it created relationship problems.
4% had a credit card, but preferred the small balance loan because “I don’t want to get caught paying the credit card company for ten years”.. It suggests that when given an option to pay a minimum, they were aware that their own behavior was such that it was preferable to repay the lump sum of a small balance loan.
Only 5% -- 1 of 20 – had ever obtained some kind of unsecured loan from a credit union or similar source. The reasons given were that 1) the process to secure the loan took too long, and 2) no such loans were available in their area.
86% said they knew they could bounce a check but recognized it as being more expensive than a small balance loan.
12% of respondents said they were able to even put money aside for emergencies, worse than the 42% national average who cannot afford a sudden expense of more than $400.
88% said that if small balance lending did not exist, they would select another already-discarded method of obtaining that credit.
Here is the thing that really struck me about my own experience: when it came to the concept of small balance loans, the people that need them most are normal people with everyday problems. By normal people, I refer to the fact that these turned out not to be the “working poor” that I kept hearing about, but average everyday Americans. I was surprised, because my own impression of users was not only organically wrong, but supported by a lot of daily media coverage.
While my experiences are anecdotal, they involved real people, making real emotional and psychological choices they were fully aware of. My conclusions were:
1. Most consumers are aware of the pros and cons of all credit choices, and choose small balance lending because they believe it is best for them at the time.
2. Most consumers know small balance lending is an imperfect solution, but a solution nonetheless, and they’d be worse off without it.
3. Most consumers know that if they default, it isn’t the end of the world. There is no effect to their credit, and they are sent to a collection agency.
4. Once bitten by multiple rollovers or defaults, most consumers know that small balance lending is not a choice suited to them.
This is not to say that the worst cases sensationalized in the media do not occur. Nor that among the thousands of lenders there aren’t those who are unscrupulous. Yet this is no different than any business in a free market capitalist economy.
However, the conclusions of the CFPB, as reflected in its proposed rules, is that borrowers are ignorant when it comes to small balance lending, and must be “protected” to such an extent that it means killing small balance loans altogether.
In the words of Frank Zappa, this is the equivalent of treating dandruff by decapitation.
Americans are capable of making their own choices about credit, as they make choices about everything else every day of their lives. However, there is a need for reasonable regulation, and it is provided already by the states.
The Bureau’s proposed rules are, by definition, unreasonable in that the Bureau itself admits it will kill a choice. What do consumers do when one choice is taken away? The need does not vanish. They will choose another form of credit, one they have already rejected, to accomplish their goals.
But I think there’s an even greater problem with the rules. I like the concept of an “ability to repay”, but just like any other loan, that determination is incumbent upon the lender to make, and not something that has to satisfy a one-size-fits-all rule set by government. We don’t see this government requirement for credit cards, or even for mortgages which are now more stringently regulated. Why is it there for small balance loans? Why are banks left to make their own underwriting decisions on ability to repay, yet not small balance lenders? It doesn’t make sense.
The government can’t ask a lender to underwrite to an individual when most borrowers comes from two-adult homes. They would have to underwrite to the entire household, which is where a lender would get an accurate accounting of income and expenses.
The CFPB has been put in a difficult position. Its charge is to regulate financial products, yet small balance lending already is regulated in almost every state it exists in. The studies are comprehensive and unequivocal regarding consequences when the option is taken away – things are worse for consumers. Did the CFPB ignore these studies when crafting its rules?
Please note: the CFPB, despite having all this data, has absolutely no proof that small balance lending is harmful to consumers.
Americans have been put in a place where the use of short-term credit is a virtual, and increasing, necessity. Taking that option away only makes things worse. The CFPB shouldn’t mess with a product simply because it has been handed a situation that exists because of larger macroeconomic issues.
America needs to tackle issues of financial freedom, financial education, financial responsibility, wages, job growth and other macroeconomic problems. That’s what solves those issues that do exist within the short-term credit industry. That’s not the CFPB’s job, however.