Payday Lending: Regulation, Consumer Protection, and Alternatives, Papers of Chemistry

Download Payday Lending: Regulation, Consumer Protection, and Alternatives and more Papers Chemistry in PDF only on Docsity! U C L A UNIVERSITY OF CALIFORNIA LOS ANGELES LAW REVIEW JUST UNTIL PAYDAY Ronald J. Mann & Jim Hawkins Volume 54 April 2007 Number 4 855 JUST UNTIL PAYDAY Ronald J. Mann * Jim Hawkins ** The growth of payday lending markets during the last fifteen years has been the focus of substantial regulatory attention both in the United States and abroad, producing a dizzying array of initiatives by federal and state policymakers. Those initiatives have had conflicting purposes—some have sought to remove barriers to entry while others have sought to impose limits on the business. As is often the case in banking markets, the resulting patchwork of federal and state laws poses a problem when one state is able to dictate the practices of a national industry. For most of this industry’s life, just that has happened—the ability of lenders to take advantage of the laws of the least restrictive states has effectively displaced the laws of more restrictive states. Recently, however, significant changes in the policies of federal regulators have limited the ability of lenders to “export” less restrictive laws. Now, states can effectively police payday lenders within their borders for the first time. Yet as we enter an era in which states will be able to regulate payday lending more effectively, there has been little clear analysis regarding how they should do so. This Article provides a detailed explanation of the business models and regulatory regimes that exist today, together with a framework of options designed to implement various perspectives regulators might adopt. We emphasize three main points. The first is the unusual nature of payday lending, with very high interest rates accruing against necessarily limited-debt amounts. Unlike other consumer-lending products such as credit cards, the payday loan amount does not increase over time, but the repetitive short-term interest obligation can lead to a recurring-cash annuity for * Ben H. & Kitty King Powell Chair in Business & Commercial Law, and the Co-Director of the Center for Law, Business & Economics, University of Texas School of Law. We thank, among others who have provided useful insight, Michael Barr, John Caskey, Katherine Porter, John Pottow, Jacob Ziegel, and participants in workshops at Columbia Law School, the Payment Cards Center at the Federal Reserve Bank of Philadelphia, and at the Center for Law, Business & Economics at the University of Texas. For information about the industry, we thank John Abel (Pennsylvania Office of the Attorney General), Barton Applebaum (Illinois Department of Financial and Professional Regulation), Dennis Bassford (Moneytree), Drew Callan and Donald Gayhardt (Dollar Financial), Bob Cornaglia (Currency One), Mark Fleischer (Office of the New York State Attorney General), Steve Hanson (Oak Brook Financial), Sealy Hutchings (Texas Office of Consumer Credit Commissioner), Kara Marshall (Community Financial Services Association), Yolanda McGill (Center for Responsible Lending), and Hilary Miller (Payday Loan Bar Association). We dedicate this Article with love and appreciation to our wives, Allison Mann and Courtney Hawkins. ** Law clerk for the Honorable Jerry E. Smith of the Fifth Circuit Court of Appeals. Hawkins completed this Article while a Fellow at the Center for Law, Business & Economics at the University of Texas School of Law. 858 54 UCLA LAW REVIEW 855 (2007) literature, however, lacks a frank assessment of the complex regulatory problems that payday lending presents. Scholars calling for intrusive regulation or outright prohibition of payday lending have skipped over the necessary step of explaining precisely what it is about this market that is so offensive as to justify prohibition or regulation. High interest rates standing alone are not a sufficient basis for regu- latory intervention. Furthermore, such criticism has failed to explain how the elimination of payday lending would protect consumers who would then be drawn to other, even riskier sources of cash. Thus, our starting point is that a sensible scheme of regulation must rest on a determination that the transactions involve market failures, that the payday lending industry externalizes costs to the rest of society, or that the transactions offend social norms or justice in some other way.3 Regulation also cannot proceed sensibly without a rich understanding of the economics of the market, including information about the business model and the competitive structure of the industry. Most of the existing literature focuses on a single feature of the product—the high price—without considering the product’s business and regulatory context. Accordingly, in Part I, we attempt to craft a realistic assessment of the business model, competitive structure, and regulatory environment of the existing industry. We draw on existing empirical studies, government reports, as well as our own conversations with regulators and industry participants. As Part I explains, we write at a crucial and unusual moment in the regulatory history of consumer finance. Though the typical pattern for the last half century has been for federal preemption to expand consistently to prevent effective state regulation4—exemplified by regulation targeting credit card and subprime mortgage lending—the last few years have witnessed an unparalleled determination by federal regulators to withdraw from the field, leaving the way open for effective state regulation. 3. So, for example, discussions often focus on the concern that payday lenders might target insular groups, such as minorities, immigrants, or military service people. Payday borrowing by the military has been a hot topic since an August 2006 Department of Defense report estimated that as many as 17 percent of military personnel use payday loans. See U.S. DEP’T OF DEF., REPORT ON PREDATORY LENDING PRACTICES DIRECTED AT MEMBERS OF THE ARMED FORCES AND THEIR DEPENDENTS 17 (Aug. 9, 2006), http://www.defenselink.mil/pubs/pdfs/Report_to_Congress_final.pdf. Many military personnel, particularly the young, are persistently cash poor. Yet, they are unlikely to be laid off or to receive their payroll checks late or have them dishonored. So, it is not surprising that check-cashing stores, and the payday lending stores that have grown out of them, often appear near military bases. Moreover, the unstable location of military families makes them more likely to rent and less likely to own homes than similarly situated civilian families. Because the credit-reporting system disadvantages those who do not own homes, military families have a harder time gaining access to mainstream intermediate and long-term credit products, making short-term payday loans relatively more attractive. 4. For a lucid and comprehensive discussion, see Elizabeth R. Schiltz, The Amazing, Elastic, Ever- Expanding Exportation Doctrine and Its Effect on Predatory Lending Regulation, 88 MINN. L. REV. 518 (2004). Just Until Payday 859 Responding to that opportunity, Part II analyzes three distinct policy perspectives that individual states might endorse, matched with regulatory schemes that implement those perspectives. Recognizing that no jurisdiction in the United States has adopted a completely laissez-faire approach to the payday lending industry, the three perspectives that we consider lie along a spectrum from total prohibition, to a limited prohibition of indefinite rollover loans, to moderately restrictive licensing requirements. We first consider whether payday lending should be tolerated at all. To the extent that the payday lending market is inevitably connected with consumer deception and financial distress, we can make out a case for complete prohibi- tion. If consumers use the product because they do not understand the distress into which it can lead them, then it would be plausible to ban the product either on paternalistic grounds or to limit the broader social costs of their financial distress. For us, the strongest counterargument is that the prohibition of payday lending would only lead to a shift of lending activity—borrowers will continue to borrow but will do so using products that are more harmful than payday loans. But many empirical questions remain unanswered, especially about the interaction among fringe-credit products5 and about the borrower side of this market.6 Thus, it is difficult to evaluate the societal effect of payday lending. 5. For example, we know little about whether payday loans facilitate or substitute for other bor- rowing. Although the United Kingdom has produced an interesting report explaining how the various products work, where they are used, and what has happened when jurisdictions have tried to ban particular products, it remains unclear how alternative borrowing products interact with each other and which products are used by which sectors of the middle- and low-income populations. See UNITED KINGDOM DEP’T OF TRADE & INDUS., THE EFFECT OF INTEREST RATE CONTROLS IN OTHER COUNTRIES (2004) [hereinafter DTI REPORT], http://microfinancegateway.com/files/25620_file_The_effect_of_interest_rate_controls.pdf. In other words, if we knew that borrowers frequently used payday loans to pay the minimum balances on their credit cards or to recover pawned goods, we might have different concerns than if we thought that these products did not interact. 6. There is little information about the most common uses of the borrowed funds, and, in particular, whether there is reason to believe they encourage spending. The best studies of which we are aware suggest that the great majority of funds are not used for immediate consumption. For example, a study by Gregory Elliehausen and Edward Lawrence concludes that 65 percent of borrowers use the funds for “emergencies,” 11 percent for “planned expenses,” and 22 percent for “other.” Gregory Elliehausen & Edward C. Lawrence, Payday Advance Credit in America: An Analysis of Customer Demand 47 (April 2001) (Monograph #35, Credit Research Ctr., McDonough Sch. of Bus., Georgetown Univ.), http://www.cfsa.net/mediares/Reports/GeorgetownStudy.pdf. Similarly, a study conducted by Environics Research Group on behalf of the Canadian Association of Community Financial Service Providers reports that 92 percent of payday customers ascribe their use of the product to an immediate cash-flow crisis and 4 percent to immediate consumption. Environics Research Group, Understanding Consumers of Canada’s Payday Loans Industry 18 (June 9, 2005), available at http://www.cpla-acps.ca/english/reports/PaydayLoansReportPresentationJune9.ppt. Also, studies have reached differing conclusions about the demographics of payday borrowers. For example, industry- funded studies suggest that the customer base is relatively well-off. See id. at 5 (suggesting that payday loan users in Canada are about as likely to have incomes above $60,000 as below $40,000); see also National Endowment for Financial Education, The Debt Cycle: Using Payday Loans to Make Ends 860 54 UCLA LAW REVIEW 855 (2007) In any event, states that decide that an outright ban is best can eliminate this product if they have the political will to do so. Drawing on the experience of New York, we argue that the key is a hard and fast usury limit, coupled with vigilant enforcement against efforts to import rates from other states. As we explain in Subpart I.C, recent actions of federal banking regulators have limited the ability of banks to force states to permit the importation of out-of-state inter- est rates. Thus, states for the first time have a realistic option of excluding payday lenders from their borders. The second possibility is to ban indefinite rollover loans—transactions in which payday customers borrow repetitively instead of repaying their loans. We develop the reasons why indefinite rollover loans might—or might not—trouble thoughtful regulators. In turn, we discuss initiatives necessary to ban these loans effectively. Although many states have adopted legislation purporting to curb rollovers, few, if any, states have enacted legislation that will be successful in that respect. Accordingly, we argue that legislatures should combine a statewide database of all licensed lending transactions with a rule that bans not only immediate rollover transactions but also requires a substantial cooling-off period between transactions. Finally, we offer a comprehensive set of proposals for jurisdictions that wish to allow licensed lenders to operate within their borders but also want to police abuses. These proposals proceed on two fronts. The first is a microfront, designed to make the product more transparent so that customers can easily and reliably understand the charges they will pay if they use the product. We would retain the licensing regimes that are common in most jurisdictions, but we would add two new initiatives. First, we would ban the sales of associated products, like insurance or membership fees, that increase the cost of credit but are not readily reflected in the price given to customers. Second, we would abandon the mis- guided Truth In Lending Act disclosure regime7 in favor of a simpler, more Meet 9 (undated summary of Feb. 2002 panel discussion) [hereinafter NEFE White Paper], available at http://www.nefe.org/pages/whitepaperpaydayloans.html (suggesting that customers typically have incomes between $25,000 and $50,000). On the other hand, at least some independent studies present starker data. See id. at 9–10 (suggesting a median income of $23,690 in Chicago payday loan customers). The most that can be said with certainty is that payday lending customers are sufficiently well-off to have bank accounts. Finally, despite pathbreaking studies of consumer bankruptcy, there is little research about the role of fringe products in the finances of the financially distressed. For some evidence on that question, see Robert Mayer, One Payday, Many Payday Loans: Short-Term Lending Abuse in Milwaukee County (Loyola Univ. Chi., Working Paper, undated), available at http://www.luc.edu/depts/polisci/research/mayer21.pdf. 7. 15 U.S.C. §§ 1601–1667. Many stores compete on the basis of this fee and advertise the infor- mation so that it is available even before the borrower enters the store. However, to the extent the products involve hidden fees, a well-crafted disclosure requirement would focus competition on price and service. Just Until Payday 863 pieces of information about the borrower, including proof of identification, evidence of income, and a current bank statement.19 The store will evaluate past borrowing history and those criteria using a software program, functionally parallel to the credit scoring that credit card issuers use to evaluate their customers.20 In some cases, though certainly not all, the data might be checked against a database with information about prior behavior available from a company like TeleTrack.21 If the loan is approved,22 the funds are advanced immediately.23 If the loan goes into default, it is difficult to generalize about collection processes, which plainly vary. For the large providers, however, collec- tion efforts typically stop short of litigation, largely because of the small amounts at stake and the limited likelihood of enforcing a judgment against a defaulting payday loan customer.24 The industry depends heavily on retail-store locations, generally because of the sense that many customers will travel only to the store that is nearest their place of employment. As described in an Federal Deposit 19. See generally Charles Gerena, Fed. Reserve Bank of Richmond, Need Quick Cash?, REGION FOCUS (Summer 2002), available at http://www.richmondfed.org/publications/economic_research/ region_focus/summer_2002/feature3.cfm. For specific lenders describing their own requirements, see Advance Am., Cash Advance Ctrs., Inc., supra note 13, at 4 (noting that customers usually must have “proof of identification, a pay stub or other evidence of income, and bank statement”); First Cash Fin. Servs., Inc., supra note at 12, at 5 (“To qualify for a short-term advance, customers generally must have proof of steady income, a checking account with a minimum of returned items within a specified period, and valid identification.”); QC Holdings, Inc., supra note 15, at 3 (“To obtain a payday loan from us, a customer must complete a loan application, maintain a personal checking account, have a source of income, and not otherwise be in default on a loan from us.”). 20. E.g., ACE Cash Express, Inc., Annual Report (Form 10-K), at 9 (Sept. 12, 2005) (“For the short-term consumer loans we offer, the customer’s application data is electronically transmitted to our centralized computer system, which scores the loan with a proprietary loan-scoring system. An approval or denial is communicated back to the store, where the required loan documentation or adverse action form is printed for the customer.”); First Cash Fin. Servs., Inc., supra note 12, at 5 (“Computer operating systems in the Company’s payday advance stores allow a store manager or clerk to recall rapidly customer check cashing histories, short-term advance histories, and other vital information.”). 21. The industry sources to whom we have spoken suggest that they do not use sources like TeleTrack regularly because its data are so spotty that it is not often useful. One explained that it only lowers the rate of default by about 25 percent. Interviews with Anonymous (spring 2006) (on file with authors). 22. We have not found any public information about denial rates, but interviews with industry sources suggest that approval rates are quite high (in the range of 90 percent). Id. Presumably this means that 90 percent of the people that have the relevant information receive loans, not that 90 percent of the people that enter the store seeking a loan are successful. 23. See Advance Am., Cash Advance Ctrs., Inc., supra note 13, at 4 (“Immediately upon completion of the approval process, the customer is given cash or a check . . . .”); SHEILA BAIR, UNIV. OF MASS. AT AMHERST, LOW-COST PAYDAY LOANS: OPPORTUNITIES AND OBSTACLES 24 (2005), http://www.consumercreditresearchfoundation.org/_files/AnnieECaseyStudy.pdf. 24. Sources in the industry advise us that defaulted payday loan debt sells for about three cents on the dollar, considerably less than the ten to twelve cents on the dollar for which first-run defaulted credit card debt sells. Interviews with Anonymous (spring 2006) (on file with authors). 864 54 UCLA LAW REVIEW 855 (2007) Insurance Corporation (FDIC) study by Mark Flannery and Katherine Samolyk, the typical store is surprisingly small, with an outstanding loan portfolio of less than $100,000 and annual revenues of about $350,000. As stores age, their profitability increases substantially—a typical new store will make fewer than 1000 loans per year, while a mature store will make more than 8500 loans per year.25 Because so many of a store’s costs are fixed, the costs per loan from the mature stores are much lower than the costs per loan from the newer stores.26 It is generally thought that repeat customers are important to the business model.27 Flannery and Samolyk report that about 46 percent of all loans are either renewals of existing loans or new loans that follow immediately upon the payment of an existing loan (rollovers).28 At the same time, however, Flannery and Samolyk find no evidence that loan rollovers and repeat borrowers affect store profits beyond their proportional contribution to total loan volume.29 It is possible that the Flannery and Samolyk study understates this phenome- non. For example, a study by the Center for Responsible Lending, using data from North Carolina regulators, reports that 91 percent of loans are made to borrowers with five or more loans per year.30 Similarly, Paul Chessin’s recent analysis of Colorado data suggests that about 65 percent of loan volume in the state comes from customers that borrow more than twelve times per year. Chessin notes a particular pattern—“borrowing from Peter to pay Paul”—in which customers avoid renewal limits by alternating between lenders, using the funds from each lender to pay off the other in turn.31 Although loss rates are lower than the riskiness of the customer base might suggest, losses still consume a substantial portion of industry revenues. 25. Flannery & Samolyk, supra note 9, at 9. In the Federal Deposit Insurance Corporation (FDIC) study, a mature store was one more than four years old. Id. at 8–9. 26. See ERNST & YOUNG TAX POLICY SERVS. GROUP, THE COST OF PROVIDING PAYDAY LOANS IN CANADA 39–43 (2004) [hereinafter E&Y CANADA STUDY], http://www.cpla-acps.ca/english/ reports/EYPaydayLoanReport.pdf. Chris Robinson at York University has made this same point: Large operations have lower costs than small operations, allowing larger lenders to make a profit with stricter rate caps. CHRIS ROBINSON, REGULATION OF PAYDAY LENDING IN CANADA (2006), available at http://www.acorn.org/fileadmin/Centers/Press/Report/Payday_Lending_Canada.pdf#search=%22acorn%20 study%20payday%20lenders%20canada%22; see also James Daw, Consumer Protection in the Wind on Payday Loans, TORONTO STAR, May 30, 2006, at D6 (discussing the Robinson report). 27. The dependency makes sense. We know from annual reports that rollover loans are faster and easier for customers to obtain than the initial loan and that they are less expensive for lenders to process. See QC Holdings, Inc., supra note 15, at 8 (“Once the initial application and loan process is completed, future transactions can be processed in only a few minutes.”). 28. Flannery & Samolyk, supra note 9, at 12–13 fig.2. 29. Id. at 2. 30. KEITH ERNST ET AL., QUANTIFYING THE ECONOMIC COST OF PREDATORY PAYDAY LENDING 2 (2004), http://www.responsiblelending.org/pdfs/CRLpaydaylendingstudy121803.pdf. 31. Chessin, supra note 17, at 411. Just Until Payday 865 In Flannery and Samolyk’s sample, for example, losses and collection expenses amounted to roughly $6 per loan at mature stores and about $9 per loan at young stores.32 When added to local operating expenses, but excluding any allocation for overhead for the chain, this produces a total cost per $100 of $11 for mature stores and $14 for young stores, an amount sufficiently below the typical fee of $15 to $20 per $100 to leave an opportunity for profitable operation.33 The multivariate analysis that Flannery and Samolyk provide suggests one other key point of interest: The costs of serving high-frequency borrowers are much less than the costs of serving low-frequency borrowers. This is true, they emphasize, both because the loss ratios are significantly lower for high-frequency borrowers and because the operating costs are lower.34 As sources in the industry explained to us, a loan to a first-time borrower is likely to require verification of the validity of a telephone number and a bank account, as well as some investigation of the identity of the borrower.35 Those steps—which are costly in the context of a loan with a fee of only $30—can be omitted for repeat customers. Also, the mere fact that a borrower is a repeat borrower provides valuable information about reliability: This is a customer with a demonstrated propensity to repay, something that a first-time customer will not have demonstrated. B. The Competitive Structure of the Payday Lending Industry Because an understanding of the competitive landscape is important to designing a sensible set of policy recommendations, it is useful to sketch the basic structure of the payday lending industry. For present purposes, four sets of players are important: mom-and-pop providers, large national providers, banks, and Internet providers. 1. Mom-and-Pop Providers First, there is a very large and vaguely defined set of local providers that we might euphemistically call mom-and-pop providers. Because these entities are not publicly traded, it is hard to generalize about them. A couple observa- tions, however, are useful. On the one hand, the fact that much of the growth of the larger providers has come from acquisitions of mom-and-pop 32. Flannery & Samolyk, supra note 9, at 10. This is consistent with the loss rates that Paul Chessin reports. See Chessin, supra note 17, at 408 (reporting loss rates of about 3.3 percent). 33. Flannery & Samolyk, supra note 9, at 10. 34. Id. at 16–17. 35. Interviews with Anonymous (spring 2006) (on file with authors). 868 54 UCLA LAW REVIEW 855 (2007) consequence in the payday lending market.46 To be sure, from about 2000 to 2005, banks facilitated the growth of the national payday lending providers by partnering with them, so that the providers could avoid local usury restrictions through the shelter of federal rules preempting the application of those restrictions to banks. As we discuss below, that practice is largely, if not entirely, a thing of the past.47 It is also true that most of the large national payday lenders are funded by some of the largest banks. For example, press reports suggest that Wells Fargo provides funding for Advance America and Cash America, that JPMorgan Chase provides funding for Cash America and ACE Cash Express, and that Bank of America and Wachovia provide a syndicated credit line to Advance America. On the equity side, Fidelity Funds is the largest single stockholder in ACE Cash Express, and JPMorgan and Bank of America both own more than 1 percent of Cash America.48 But despite those investments, the role of banks in the current market is indirect and marginal. We discuss in the closing section of Part II some reasons why we think this is unfortunate. 4. Internet Providers The hardest sector of the industry to understand is the Internet-only providers. It is clear that they exist; indeed, they have their own search aggregator (paydayloanoffers.com), which provides advice on the best available payday loan terms on any given day. You need only Google “payday loans,” and you will see a large group of sponsored and natural links to online providers. To get a sense for the most successful providers, we looked at the sponsored-links websites that appeared when we conducted searches on “payday loans” on 46. Wells Fargo Bank does offer a payday lending product: Direct Deposit Advance. See Wells Fargo Checking—Direct Deposit Advance Terms and Conditions, https://www.wellsfargo.com/wf/ checking/dda/terms (last visited Nov. 12, 2006). We discuss this product in note 257. One reason banks do not play a more direct role is cultural. Subprime borrowers might not want to use banking services even if banks offered payday loans. Commentators from the United States, Canada, and Australia have noted this problem. See NEFE White Paper, supra note 6, at 13 (discussing the distaste payday customers have for the “mahogany and brass” atmosphere of U.S. banks); IAIN RAMSAY, ACCESS TO CREDIT IN THE ALTERNATIVE CONSUMER CREDIT MARKET 36 (2000), http://cmsweb.ca/epic/internet/ incmc-cmc.nsf/vwapj/ramsay_e.pdf/$FILE/ramsay_e.pdf (suggesting that Canadians with low incomes are distrustful of banks because banks are intimidating and treat lower-income customers poorly); DEAN WILSON, CONSUMER LAW CTR. VICT. LTD, PAYDAY LENDING IN VICTORIA—A RESEARCH REPORT 80 (2002), http://www.consumer.vic.gov.au/CA256902000FE154/Lookup/CAV_Credit_Research/ $file/payday.pdf (attributing the preference of Australian consumers for payday lenders to the perception that banks provide bad service to consumers). 47. See infra notes 69–77 and accompanying text. 48. JPMorgan, Banks Back Lenders Luring Poor With 780 Percent Rates, BLOOMBERG NEWS, Nov. 23, 2004, http://www.bloomberg.com/apps/news?pid=71000001&sid=ayYDo5tpjTY8. Just Until Payday 869 Google, Yahoo!, and MSN.49 These searches produced a total of eight sites: mycashnow.com (Google, Yahoo!, and MSN), tendollarpaydayloan.com and paydayselect.com (Google and Yahoo!), nationalfastcash.com and 1000- easy-payday-loan.com (Yahoo! only), paydayok.com (Google only), and cashadvancenetwork.com and instantcashloantillpayday.com (MSN only). Several things are interesting about those search results, starting with the fact that the dominant rate for the most prominent advertisers in the online market appears to be about $10 per $100, significantly below the $15 per $100 rate that seems to be the benchmark rate for the retail locations of the large national providers,50 and considerably lower than the typical rate identified in a major 2004 survey by the Consumer Federation of America (CFA).51 Also, the Internet providers are all Internet fronts, meaning that little about the firms is evident from the websites. A careful reading of the website will not reveal whether a bank is involved, in most cases will not give a brick-and-mortar location for the lender,52 and does not suggest whether any of the large national providers are involved. The only information of significance about the lawfulness of the transactions is an assertion that the transactions are governed by the law of the lender’s location.53 49. These searches produce different results, even on the same day. We report here a set of companies found based on repeated searches on May 14 and 15, 2006. 50. The rates at the sponsored-link websites varied. See 1000 Easy Payday Loan, http://www.1000- easy-paydayloan.com (providing $10 per $100); Payday Loans and Cash Advances at PayDay OK, http://www.paydayOK.com (same); Ten Dollar Payday Loans, http://www.tendollarpaydayloans.com (same); see also Cash Advances at Payday Select, http://www.paydayselect.com ($15 per $100); Quick and Affordable Cash Advances, http://www.mycashnow.com ($18 per $100); Cash Advance Network, http://www.cashadvancenetwork.com ($30 per $100); Instant Payday Loans, http://www.instantcashloantillpayday.com ($30 per $100); National Cash Fast, http://www.nationalcashfast.com (unspecified rates) (all last visited Nov. 12, 2006). 51. JEAN ANN FOX & ANNA PETRINI, CONSUMER FED’N OF AM., INTERNET PAYDAY LENDING: HOW HIGH-PRICED LENDERS USE THE INTERNET TO MIRE BORROWERS IN DEBT AND EVADE STATE CONSUMER PROTECTIONS 22 (2004) [hereinafter CFA SURVEY], http://www.consumerfed.org/pdfs/Internet_Payday_Lending113004.pdf. 52. Of the eight sites, only paydayselect.com and paydayok.com offered any address; both offered (different) post office boxes in Ruidoso, New Mexico. The CFA survey suggests that this is not a new problem. See id. at 20–22. Those sites now list Delaware addresses and show licenses indicating that they are subject to Delaware law. 53. Of the eight, only three identify what that law is: Mycashnow.com selects the law of Grenada, MyCashNow—Disclosures, http://www.mycashnow.com/Cash-Today-disclosure.php (last visited Mar. 4, 2007), and paydayselect.com and paydayok.com select the law of New Mexico. It is unlikely these choice-of-law clauses are enforceable because most states’ long-arm statutes permit states to enforce their own laws for loans to citizens within the state. For a detailed account of this jurisdictional issue, see Frank Burt et al., Journey to the Fringe: A Survey of Select Fringe Lending Products, in CONSUMER FINANCIAL SERVICES LITIGATION INSTITUTE (11TH ANNUAL), at 349, 381–82 (PLI Corporate Law & Practice, Course Handbook Series No. 8565, 2006). 870 54 UCLA LAW REVIEW 855 (2007) Several possibilities exist about these lenders, all of which are speculative in the absence of direct evidence that we have been unable to obtain. One possibility is that the only way these lenders can profit at the low rates is by cheating. There certainly is considerable indirect evidence to support that perspective. For example, the CFA survey suggests that the overwhelming majority of these lenders charge fees that far exceed the maximum permitted under the law of the location of their customers.54 Similarly, many of these lenders may violate federal law by forcing borrowers to grant them electronic access to their bank accounts.55 There are other possibilities, of course. One regulator who has dealt with some of these providers suggests that they can profit at rates lower than the large national providers because they avoid the costs of retail-branch locations.56 This raises the possibility that the market for payday loans is segmented, between the relatively low-income customers that seek out lenders based solely on retail proximity to their employer and the relatively better-off customers that use broadband Internet access and Google searches to find their payday lender of choice.57 This is not to say that there is no fraud in the Internet payday lending industry. On the contrary, illegal lending is common in this sector.58 For exam- ple, both New York59 and Pennsylvania60 have had recent notable enforcement actions against Internet providers. It is not clear to us, however, that those kinds of providers are the providers purchasing sponsored advertisements on Google or other major Internet search engines. Rather, they seem to us a sort of Internet underworld much like the brick-and-mortar underworld that populates some share of the mom-and-pop providers. Recent activity in the industry—most notably the acquisition by Cash America (a large national operation) of a major licensed 54. See generally CFA SURVEY, supra note 51, at 22. 55. See generally id. at 34 (discussing the Electronic Fund Transfer Act, 15 U.S.C. § 1693k (1998), which prohibits a credit transaction conditioned on electronic access to the borrower’s deposit account). 56. Interview with Sealy Hutchings, Gen. Counsel, Tex. Office of the Consumer Credit Comm’r, in Austin, Tex. (Feb. 28, 2006). 57. One website specializing in payday loans in Houston illustrates how the Internet may enhance competition among lenders generally. Cash Advance Loan Houston promises to display five lending options for people seeking a payday loan in Houston. See Houston Cash Advance Loans, http://www.cash-advance-loan-houston.com (last visited Jan. 11, 2007). 58. See Associated Press, Payday Lenders Use Internet to Avoid Law, USA TODAY (Dec. 1, 2004), available at http://www.usatoday.com/tech/news/2004-12-01-usurious-lending-online_x.htm. 59. See Press Release, Office of N.Y. State Attorney Gen. Eliot Spitzer, Internet Concerns Top Consumer Complaints (Feb. 8, 2006), available at http://www.oag.state.ny.us/press/2006/feb/feb08a_06.html (discussing enforcement action against New York Catalog Sales). 60. See Press Release, Pa. Office of Attorney Gen., Commonwealth Shuts Down Alleged Illegal Web-Based “Payday Lending” Scheme (Sept. 28, 2005), available at http://www.attorneygeneral.gov/ press.aspx?id=670 (discussing enforcement action against Ace Pays). Just Until Payday 873 But concerns of regulators about the transparency of operations did cause one large partnering bank to leave the Federal Reserve System to avoid the scrutiny of federal regulators.73 Since the FDIC had not acted, state banks remained relatively free to engage in this activity. Thus, the County Bank of Rehoboth Beach, Delaware gained considerable notoriety for its continued participation.74 In July 2005, however, the FDIC issued its Guidelines on Payday Lending.75 Although these regulations do not directly prohibit partnering with third-party payday lenders, they do impose onerous capital requirements and compel institutions to “[l]imit the number and frequency of extensions, deferrals, [and] renewals.”76 In practice, these new regulations have made it impractical for state-chartered banks to continue partnering with the major national providers. Accordingly, by early 2006, the “rent-a-charter” era had come to an end.77 Chairman, Fed. Reserve Bd., Remarks at the Fifth Regional Issues Conference of the Fifteenth Congressional District of Texas, (June 13, 2006), available at http://www.federalreserve.gov/boarddocs/ speeches/2006/20060613/default.htm (praising the spread of payday lenders as a source of alternative financial services for lower-income families). 73. First Bank of Delaware relinquished its Federal Reserve membership in 2003, and thus became subject to regulation by the FDIC. See Letter from Jean Ann Fox, President, Consumer Fed’n of Am., to Donald E. Powell, Chairman, FDIC (Oct. 9, 2003), available at http://www.consumerfed.org/pdfs/fdicletter10-2003.pdf. To get a sense for the concerns of the applicable regulator (the Federal Reserve Bank of Philadelphia), see the skeptical comments about the safety and soundness of payday lending in Robert W. Snarr, Jr., No Cash ‘til Payday: The Payday Lending Industry, COMPLIANCE CORNER (Fed. Reserve Bank of Phila., Phila., Pa.), 1st Quarter 2002, at CC1, available at http://www.phil.frb.org/src/srcinsights/srcinsights/pdf/ccq1.pdf. 74. For instance, Dollar Financial had an important relationship with the County Bank of Rehoboth Beach. See Dollar Fin. Corp., supra note 42, at 11. 75. See FDIC: Guidelines for Payday Lending, http://www.fdic.gov/regulations/safety/payday (last visited Mar. 4, 2007). 76. Id. 77. The clearest signal is the Eleventh Circuit’s per curiam decision in April 2006 to dismiss as moot a major case involving a challenge by several state-chartered banks to a Georgia law designed to exclude the partners of those banks from operating in Georgia. BankWest, Inc. v. Baker, 446 F.3d 1358 (11th Cir. 2006) (per curiam), vacating as moot, 411 F.3d 1289 (11th Cir. 2005). The annual reports from large payday lenders filed in the second half of 2005 confirm that payday lenders got the message. See, e.g., ACE Cash Express, Inc., supra note 20, at 9 (“The revised FDIC guidelines became effective on July 1, 2005, and affect the loans offered at our stores by Republic Bank. In fiscal 2006, we have introduced two new loan products to our Texas customers and one new loan product to our customers in Arkansas and Pennsylvania that provide alternatives to the loan product offered by Republic Bank. These new loan products will provide consumers who exceed the maximum allowable payday loans under the revised FDIC guidelines access to the credit they require.”); Dollar Fin. Corp., supra note 42, at 11 (“The Payday Lending Guidance, among other things, limits the period a borrower may have payday loans outstanding from any FDIC-insured bank to three months during a twelve-month period. As a result of the Payday Lending Guidance, we are transitioning from the bank-funded consumer loan model to the company-funded consumer loan model in most of the states where we previously offered bank-funded consumer loans. As part of this transition, we terminated our relationship with County Bank and amended our relationship with First Bank, in each case by mutual agreement.”). 874 54 UCLA LAW REVIEW 855 (2007) 2. State Regulations As federal regulators remove the protective umbrella of federal law, we enter an era in which states will be free to make their own choices about payday lending. As far as we can tell, all states that tolerate payday lending have some scheme of licensing or regulation. The first question, however, is whether states will tolerate payday lending at all. On that question, current state law varies greatly.78 In an effort to provide an orderly description of the landscape as it exists today—a snapshot at the end of the rent-a-charter era—we identify three distinct regulatory regimes: explicit toleration; formal, but underenforced prohibition; and true prohibition. We recognize the difficulties of understanding the actual regulatory practices in any particular state. But there is considerable illustrative value in summarizing some representative examples. For this purpose, we have chosen Michigan as an example of explicit toleration, Texas as an example of formal but underenforced prohibition, and New York as an example of true prohibition. a. Explicit Toleration State law related to payday lending varies greatly, but the most common situation is a statute that explicitly authorizes the practice. The Community Financial Services Association (CFSA), a trade group representing the major payday lenders, has supported a model bill in numerous state legislatures in recent years,79 and has had noted success in obtaining adoption: The CFSA website claims that a majority of the states have adopted “balanced, responsible legislation,” which presumably resembles their bill.80 The model bill contains several notable features: Loans can only be made for $500 or less;81 loans can only be renewed one time;82 borrowers can rescind a loan within 78. For detailed breakdowns of the different state laws governing payday lending, see Flannery & Samolyk, supra note 9, at 30 tbl.1; Moss, supra note 2, at 1740. The most comprehensive and accessible information is at NAT’L CONSUMER LAW CTR., 2005 SUMMARY OF STATE PAYDAY LOAN ACTS (2005), http://www.consumerlaw.org/action_agenda/payday_loans/content/NCLC_SUMMARY.pdf. 79. The Community Financial Services Association (CFSA) supports the Deferred Deposit Loan Act, see Email from Kara J. Marshall, Staff Attorney, Cmty. Fin. Servs. Ass’n, to Jim Hawkins (May 25, 2006, 16:37:43 CST) (on file with authors), adopted by the Committee on Suggested State Legislation of the Council of State Governments, see Deferred Deposit Loans, in 61 SUGGESTED STATE LEGISLATION 34, 34–37 (2002) [hereinafter Model Deferred Deposit Act], http://www.csg.org/programs/ ssl/documents/2002.pdf. For a discussion of the lobbying and the model bill, see Chessin, supra note 17, at 398. 80. The Community Financial Services Association of America, http://www.cfsa.net/regulated_ states.html (last visited Feb. 6, 2007). 81. Model Deferred Deposit Act, supra note 79, § 6 at 35. 82. Id. § 8 at 36. Just Until Payday 875 a day;83 lenders must obtain licenses to operate;84 lenders cannot use threats of criminal prosecution as a collection tool;85 and, most striking, fees are capped at 20 percent of the first $300 lent and 7.5 percent of any funds lent over $300.86 Michigan’s 2005 adoption of the euphemistically named Deferred Presentment Service Transactions Act is a good example of a statute that draws from the CFSA’s model act and tolerates payday lending.87 This is a detailed statute, with thirty-three sections divided into four articles. Setting aside the first article (which offers a title and a series of definitions),88 the remaining articles deal with licensing,89 regulation of the transaction,90 and remedies.91 The licens- ing article requires a license for any company engaged in the business of “deferred presentment service transactions,” except for a federally insured bank.92 The statute defines “deferred presentment service transaction” to include any transac- tion in which the licensee agrees to pay the customer a sum of money, in exchange for a fee, and then to “[h]old a customer’s check for a period of time before negotiation, redemption, or presentment of the check[ ].”93 To obtain a license, the licensee must show a net worth of at least $50,000 per location, up to a maximum requirement of $250,000, as well as “the financial responsibility, financial condition, business experience, character, and general fitness to reasonably warrant a belief that the applicant will conduct its business lawfully and fairly.”94 Each licensee is also obligated to post a $50,000 surety bond.95 Of greatest interest, Michigan’s licensing article includes a provision—which is not in the CFSA’s model act—that requires the state commissioner of the office of financial services to develop a statewide database “that has real-time access through an internet connection . . . [and] is accessible at all times to licensees,” which will, among other things, allow any licensee to “[v]erify whether a customer has any open deferred presentment service transactions with any licensee . . . .”96 83. Id. § 6 at 35. 84. Id. § 16 at 37. 85. Id. § 20 at 37. 86. Id. § 5 at 35. 87. See Deferred Presentment Service Transactions Act, ch. 487, 2005 Mich. Legis. Serv. 244 (West) (codified at MICH. COMP. LAWS ANN. §§ 487.2121–.2173 (West Supp. 2006)). 88. MICH. COMP. LAWS ANN. §§ 487.2121–.2122 (West Supp. 2006). For other similar examples, see CAL. FIN. CODE §§ 23000–23106 (West 1999 & Supp. 2006); 815 ILL. COMP. STAT. ANN. § 122/1-1 (West 1999). 89. MICH. COMP. LAWS ANN. §§ 487.2131–.2142 (West Supp. 2006). 90. Id. §§ 487.2151–.2160. 91. Id. §§ 487.2165–.2173. 92. Id. § 487.2131. 93. Id. § 487.2122(1)(g). 94. Id. § 487.2132. 95. Id. § 487.2134. 96. Id. § 487.2142. 878 54 UCLA LAW REVIEW 855 (2007) providers, which typically have operated under the shelter of an out-of-state bank. Here, Texas provides a good example.115 Like many states, Texas has a complex set of usury ceilings with different levels applicable to different kinds of loans. In general, however, the highest per- missible ceiling for loans below $250,000 is capped at 24 percent.116 Yet, Texas has, for many years, had a special statute to permit low-dollar consumer-finance transactions, referred to as “cash advance loans.”117 The problem, however, is that this statute does not authorize charges at a level typical of the standard payday lending product. Specifically, the maximum charge it permits is capped at a fixed fee of $10 per $100 of cash advance, plus $4 per month. So, for a loan of $300 for two weeks (a typical product), the maximum fee would be $16,118 much less than the $45 fee the typical payday lender would charge based 115. Although we do not discuss it in detail here, Canada provides an even starker example. Formally, Canada’s federal usury limit of 60 percent, Canada Criminal Code, R.S.C., ch. C-46 § 347(2) (2006), would make payday lending illegal. Yet, the evidence suggests that payday lending has been flourishing in recent years, unfettered by prosecution. The Toronto Star reported that as of 2005, there had been no prosecutions against payday lenders. Jim Rankin & Nicole MacIntyre, Loans Firm Curbed, TORONTO STAR, Aug. 31, 2004, at A1. The highly visible growth of the payday lending industry, however, has produced a backlash in the last year or so, reflected in a growing number of highly visible actions challenging what, in some cases, might be flagrantly illegal activity. E.g., Kilroy v. A OK Payday Loans, Inc., No. S041137, 151 A.C.W.S. (3d) 927 (B.C.S.C. Aug. 9, 2006), available at 2006 A.C.W.S.J. LEXIS 6646 (holding in a class action that the rates charged by payday lenders exceeded the criminal statutory limit); Daw, supra note 26 (describing police action against one payday lender in Manitoba); Carol Goar, Payday Loan Industry in Court, TORONTO STAR, Feb. 1, 2006, at A18; Jim Rankin, Suit Against Payday Lender Gets a Boost, TORONTO STAR, Mar. 6, 2006, at A12; Class Action Certified in Payday Loan Case, CBC NEWS, May 12, 2006, http://www.cbc.ca/money/story/2006/05/12/rentcash.html?ref=rss. The standard product issued by the large lenders apparently complies with usury laws by offering the borrowers the option of repaying loans in cash with only 60 percent interest. If the borrower is unable to repay in cash, the lender cashes a check (charging the standard payday loan rate as a check-cashing fee) and uses the proceeds to repay the loan. See, e.g., Dollar Fin. Corp., supra note 42, at 18–19. It remains to be seen whether the adoption by the Canadian Payday Loan Association of a voluntary code of compliance will stem criticism. The Code of Best Business Practices bans, among other things, rollover loans and associated products. Canadian Payday Loan Ass’n, Code of Best Business Practices, http://www.cpla-acps.ca/english/consumercode.php (last visited Mar. 4, 2007). It does not, however, specifically regulate the basic rates that members charge, id., which is the basis for much of the existing litigation. The situation is now drawing substantial attention at the federal level, where the Standing Senate Committee on Banking, Trade and Commerce has published a detailed report concluding that the spread of payday lenders is “alarming, since we do not believe that they are adequately regulated.” STANDING SENATE COMM. ON BANKING, TRADE & COMMERCE, CONSUMER PROTECTION IN THE FINANCIAL SERVICES SECTOR: THE UNFINISHED AGENDA 79 (2006). For a lucid and balanced discussion of the Canadian situation, see Jacob Ziegel, Payday Loan Bedlam Cries Out for Legal Fix, NATIONAL POST, Mar. 15, 2006, at FP23. 116. TEX. FIN. CODE ANN. § 303.009 (Vernon 2006) (ceiling based on twice the federal T-bill rate that floats between 18 and 24 percent per annum). 117. Id. ch. 342. 118. $10 + (0.5)($4)(3). Just Until Payday 879 on a $15 per $100 fee schedule. Accordingly, Texas is listed prominently on the CFSA website as a state with laws “that are unfavorable” to the industry.119 Yet, when we review annual reports for the large national providers, we discover that most of them—Advance America, Cash America, Ace Cash Express, Dollar Financial Corp., and QC Holdings—have locations in Texas.120 Indeed, several companies even locate their principal offices in Texas.121 In each case, the annual reports indicate that the lenders do not operate directly in Texas; rather, they operate using rates imported through their partnership with an out-of-state bank, most often County Bank of Rehoboth Beach, Delaware.122 As discussed above, the FDIC’s decision to stop this kind of rate importation has driven County Bank and similar banks from this business. Thus, it appears that Texas and similarly situated states will have an opportunity in the next few years to make a real choice about whether to tolerate payday lending.123 c. True Prohibition The final existing regulatory outcome is outright prohibition of payday loans. A good example of this approach is in New York, where the general usury limit is 6 percent per annum,124 with an exception that permits banks to charge 16 percent per annum.125 What raises our interest, however, is the utter absence 119. CFSA, STATES RESPOND TO EMERGING INDUSTRY 1 (2003), http://www.cfsa.net/govrelat/ pdf/states%20respond%20to%20emerging%20industry.pdf. 120. We should also add two regional publicly traded providers with a substantial presence in Texas: EZCorp and FirstCash. 121. First Cash Fin. Servs., Inc., supra note 12, at 1; Cash Am. Int’l, Inc., supra note 40, at 1. 122. E.g., Dollar Fin. Corp., supra note 42, at 11. 123. There is one particular problem that Texas regulators face, which arises from Texas’s odd credit service organizations statute, TEX. FIN. CODE ANN. ch. 393 (Vernon 2006). That statute permits brokers to charge a fee for finding credit for distressed borrowers. It has found favor in recent years as a vehicle for consumer lenders to avoid usury restrictions by charging a brokerage fee that is parallel to the standard interest charges lenders would charge. Indeed, as we understand it based on interviews with Texas’s Office of Consumer Credit Commissioner, most payday lenders operating in the state as of 2006 rely on this structure. See Erick Bergquist, One More Reason to Pursue Alternate Models in Payday, AM. BANKER, Feb. 28, 2006 (discussing reliance on a credit service organization model by national providers losing their bank partners but wishing to continue operations in Texas); Interview with Sealy Hutchings, supra note 56. Surprisingly enough, the Fifth Circuit recently has validated this apparently evasive tactic. See Lovick v. Ritemoney Ltd., 378 F.3d 433, 436 (5th Cir. 2004) (dismissing RICO claims brought by borrower from car-title lender). It remains to be seen whether Texas courts would adopt the same view, especially if the litigation were brought by the Office of Consumer Credit Commissioner, rather than a private plaintiff. There also is the likelihood that the Texas Legislature might explicitly close this loophole entirely as part of payday lending legislation currently under consideration. 124. N.Y. GEN. OBLIG. LAW § 5-501 (McKinney 2001). 125. N.Y. BANKING LAW § 14-a(1) (McKinney 2001); see also Seidel v. 18 E. 17th St. Owners, Inc., 598 N.E.2d 7 (N.Y. 1992) (discussing the relative severity of New York usury laws). 880 54 UCLA LAW REVIEW 855 (2007) of New York locations from the annual reports of the large national providers. Not a single one of those providers appears to have locations in New York. Interested in how this can be so—given the ease with which bank- partnered providers have operated in Texas—we spoke to an officer in the New York Attorney General’s Office responsible for usury enforcement.126 He stated that New York has managed to exclude payday lenders only through conspicuously aggressive enforcement. Thus, he is quite confident that the large national providers know that they would face litigation immediately if they opened stores in New York. In his view, the out-of-state national providers, even if they rented charters from an out-of-state bank (like County Bank), could not possibly prevail because the loans in fact are made by the national providers, not by the banks.127 The difference, it seems, is not in the usury limit but in the ability of regulators to bring and prevail in litigation to enforce those limits. As the rent-a-charter era closes, it should be even easier for states like New York to repel the national providers, if they choose to do so.128 II. POLICY PERSPECTIVES ON PAYDAY LENDING If we are correct, the rapid growth of payday lenders, coupled with the end of the rent-a-charter era, presents state legislatures and policymakers with a sharply defined opportunity to decide the terms, if any, on which payday lending should be tolerated. Existing scholarship has provided little guidance for policymakers wrestling with those questions. Scholars generally have proposed increased regulatory oversight based on the assumption that regulation, or even prohibition, is self-evidently desirable. In our view, the rationales for regulating payday lending markets are difficult to assess. We try here to sketch what seem to us the most obvious arguments for, and against, different rationales for regulation. In general, we suggest three perspectives that policymakers might adopt. First, policymakers might conclude that the market is inherently objec- tionable, and thus that laws should be enacted that in practice prohibit 126. Interviews with Anonymous (spring 2006) (on file with authors). 127. This argument was successful in Georgia, where a state statute designed to prevent rent-a- charter operations in the state bars rate importation if the bank’s local agent retains more than 50 percent of the revenues (which apparently is always the case in these relationships). Efforts by the large national providers to enjoin operation of the statute as preempted failed at the trial court and before a panel of the Eleventh Circuit, before the case ultimately was dismissed as moot, apparently because of the cessation of this kind of banking activity discussed above in Subpart I.C. BankWest, Inc. v. Baker, 411 F.3d 1289 (11th Cir. 2005), vacated as moot, 446 F.3d 1358 (11th Cir. 2006). 128. Consider, for example, Betts v. McKenzie Check Advance of Fla., 879 So. 2d 667 (Fla. Dist. Ct. App. 2004) (holding that a payday loan was usurious because it was consummated before Florida adopted its deferred presentment statute to validate the industry). Just Until Payday 883 that require money immediately may have a limited taste for price shopping.136 This problem is exacerbated by the small size of the loans, which makes the gains from even a major price difference quite small as an absolute matter.137 The third and perhaps most serious competitive problem comes from the market structure. As discussed above, it is widely thought—at least by the large national providers—that location is of paramount importance.138 Thus, the retail store that is most conveniently located for a particular customer based on her residential and commuting patterns has a strong advantage over all other stores. Moreover, because the profitability of an individual location depends on building a relatively large portfolio of transactions and customers, there is a natural limit on the density with which profitable locations can be established. That limit well might hinder the effectiveness of price competition. On the other hand, the apparent clustering of payday lending stores in suitable neighborhoods suggests that this problem can be overstated. For some, the failure of market forces to drive prices to a competitive level would be an adequate basis for governmental intervention. The basic argu- ment, articulated most effectively by Stewart Macaulay and Art Leff, and previously applied by one of us to the credit card market,139 is that a government inappropriately cedes regulatory power to a private enterprise when it allows businesses to define the terms of commerce in industries in which competitive forces do not constrain the terms. For others, however, the patent futility of crafting regulatory solutions to all instances of market failure will make it important to identify some harm to be addressed. In the consumer-credit area, the harm comes from the finan- cial distress that attends poor decisionmaking by customers in the market.140 136. BAIR, supra note 23, at 29. 137. John Pottow suggests an apt analogy to tipping on small checks, where many of us routinely round up to the nearest dollar, even if it results in a percentage tip that is far beyond our normal practices on substantial purchases. Interview with John Pottow (spring 2006) (on file with authors). 138. Flannery & Samolyk, supra note 9, at 10. See, e.g., ACE Cash Express, Inc., supra note 20, at 17 (“We believe that the principal competitive factors in the check cashing and short-term consumer loan (also known as payday loan) industry are location, customer service, fees, convenience, range of services offered, speed and confidentiality.”); First Cash Fin. Servs., Inc., supra note 12, at 3 (“Management seeks to locate new stores where demographics are favorable and competition is limited.”); id. at 7 (“The Company believes that the primary elements of competition in these businesses are store location . . . .”); QC Holdings, Inc., supra note 15, at 8 (“We believe that the primary competitive factors in the payday loan industry are store location and customer service.”). 139. See Ronald J. Mann, “Contracting” for Credit, 104 MICH. L. REV. 899 (2006) (discussing Stewart Macaulay, Private Legislation and the Duty to Read—Business Run by IBM Machine, the Law of Contracts and Credit Cards, 19 VAND. L. REV. 1051 (1966), and Arthur Alan Leff, Contract as Thing, 19 AM. U. L. REV. 131, 144 (1970)). 140. This paragraph summarizes an argument made in more detail in chapter 5 of RONALD J. MANN, CHARGING AHEAD 60–72 (2006). 884 54 UCLA LAW REVIEW 855 (2007) Specifically, there is good reason to think that financial distress generates costs for society as a whole that are not borne by the parties to the transaction. Thus, the loss from financial distress does not end when a single creditor fails to obtain repayment from the loan that it has advanced. Rather, financial distress has a series of broader effects. It increases the burden on the social safety net: Those in distress are unlikely to contribute funds to support the social safety net, but are quite likely to draw on the resources others have contributed. This is particularly true if financial distress leads to illness; some data, principally in work by Melissa Jacoby,141 suggests such a link. Those in financial distress are likely to have trouble finding gainful employment, which means that the rest of society will not receive the positive spillover effects that would otherwise accrue from the exercise of their human capital. Finally, financial distress is likely to impose costs on dependent family members. In sum, the best case against payday lending is that the market is plagued by cognitive failures, unlikely to be well policed by competitive forces, and likely to generate external costs borne by the rest of society. It is simply not plausible, the argument goes, that a person of ordinary capacity would sensibly decide to borrow money at a rate of 400 percent, using a loan that, in most cases, is likely to remain outstanding for months, if not years. In assessing the weight of this problem, it bears noting that those who will be harmed by the market failure are systematically likely to be far from the top of the distribution of income and wealth. 2. The Case in Favor of Payday Lending As the discussion in Part I suggests, a majority of American jurisdictions in recent years have adopted legislation that specifically authorizes payday lending. It would be naive to suppose that the legislators that voted for those bills carefully evaluated the relevant social interests. Nevertheless, several arguments support the legislation, three of which seem substantial: the benefits of permitting lending; the relatively weak link between lending and financial distress; and the likelihood that a ban on payday lending will lead borrowers to shift to credit products that are relatively worse for borrowers who would otherwise use payday loans. 141. See Melissa B. Jacoby, Does Indebtedness Influence Health? A Preliminary Inquiry, 30 J.L. MED. & ETHICS 560 (2002) Just Until Payday 885 a. The Benefits of Allowing Payday Lending The first point is simple, reflecting a general suspicion of wholly paternalist intervention in consumer-credit markets. The one thing that we know for sure about payday lending is that it is attractive to a large number of consumers in the Western economies that tolerate it. The product’s rapid growth is not limited to the United States, but is apparent in Australia, Canada, and the United Kingdom as well.142 Moreover, because the overwhelming majority of payday lending transactions do not result in default on the part of the borrower, there is some reason to think that many of the transactions benefit both the borrower and the lender. It is easy for upper-middle-class academics that study the topic to think that this lending is unduly risky and that those that engage in it would be better advised to tighten their belts and resist the temptation to borrow. It will be much less clear to the borrower—almost by definition a person struggling to make it from paycheck to paycheck—that the transaction involves a luxurious excess. We of course know very little about exactly what the customers of payday lenders do with the funds that they borrow. Surely some of them use the funds on vicious habits that reflect poor choices, but just as surely at least some of the borrowers are responsible individuals using the funds to purchase food or medicine.143 b. Payday Lending and Financial Distress The second point in favor of payday lending focuses on a weak link in the discussion in Part II.A.1, which assumes that toleration of the payday lending market substantially increases the incidence of financial distress. Although there must be some transactions in which the additional funds available from a payday lender tip the scale toward insolvency, these small loans probably do not contribute substantially to financial distress and insolvency. A comparison 142. The first payday lender in Australia appeared in 1998, and by 2001, eighty-two payday lending businesses were offering 12,800 loans a month. WILSON, supra note 46, at 34. Though currently a small industry, experts predict it will grow along the same lines as in the United States. Id. at 11. In Canada, one survey reports that nearly a million Canadians, about one in every thirty-two people, have used a payday loan at least once. Richard Brennan, Nicole MacIntyre & Jim Rankin, Ontario Has Begun Payday Lender Probe: Loan Industry Is Unregulated, TORONTO STAR, June 22, 2004, at A17. There are more than 1200 payday lending stores in Canada, and reports estimate that payday lending generates more than a billion dollars a year in revenue. See Rankin & MacIntyre, supra note 115, at A1; ACORN CANADA, PROTECTING CANADIANS’ INTEREST: REINING IN THE PAYDAY LENDING INDUSTRY 2 (2004). 143. See supra note 6 (discussing the available evidence). 888 54 UCLA LAW REVIEW 855 (2007) less reputable fringe credit providers does not seem enough to justify the continuation of current practices in the payday lending industry.”151 In our view, however, a fair look at the evidence makes that conclusion fairly debatable. To us, the evidence makes it at least possible that the consumers that have made payday lenders so profitable have done so for one general and rational reason: The products of payday lenders provide a better mix of benefits and risks than the competing products consumers would choose if payday lenders were banned. The most persuasive source here is the DTI report, which concludes a survey of European and American markets with this view: “Where low-income borrowers have more than one credit option, consumers’ choices in relation to lending models appears [sic] rational on both cost and utility grounds.”152 Though scholars in many jurisdictions—Canada,153 Australia,154 and of course the United States155—often assert that low-income borrowers act irrationally when they use payday loans, they have not provided evidence to support those assertions. A quick glance at five of the leading alternatives to payday lending shows the sense in Jim White’s perspective: “I think even the poorest consumers are quite savvy. They understand the alternatives and make choices about borrowing that are wise for them even when the decisions seem foolish or wasteful to middle-class observers.”156 (1) Banks An effective attempt to ban payday lending might be successful if banks were to take the place of fringe payday lenders that currently provide credit to subprime borrowers. Michael Barr has made sound recommendations for products that banks could offer to compete with payday lenders.157 And Sheila Bair’s recent extensive report on the potential role of banks in payday lending (Bair Report) provides a thoughtful and promising analysis of several business models that banks might use to operate profitably in this market.158 We remain skeptical, however, that banks could fill the place of payday lenders without substantially duplicating the product payday lenders offer. 151. Wilson, supra note 2, at 165. 152. DTI REPORT, supra note 5, at 12. 153. RAMSAY, supra note 46, at iii, 24. 154. Wilson, supra note 2, at 163. 155. See Hellwig, supra note 2, at 1582 (assuming consumers are irrational because they use payday loans over longer periods). 156. White, supra note 110, at 466. 157. Barr, supra note 2, at 163–64. 158. BAIR, supra note 23, at 34–37. Just Until Payday 889 For one thing, history suggests that banks will not operate in these markets unless they are permitted to charge higher rates. For example, before consumer credit was deregulated in the United States, banks would not make small, unsecured, high-risk loans to borrowers because of the high transaction costs associated with such loans.159 In Germany’s and France’s strict rate-cap environments, high-risk borrowers are simply excluded from accessing credit; banks do not fill in the gap left by payday lenders.160 To be sure, as the Bair Report discusses, there have been numerous policy initiatives in this country designed to support active participation by depository institutions.161 But for the most part, the low-rate programs that the Bair Report discusses (involving rates in the range of 12 to 20 percent per annum) are not profitable.162 Those we have spoken to in the industry assert with great confidence that banks will profit from a payday lending product that undercuts the existing market only by hiding back-end fees or tying the product to some other service on which the banks profit substantially.163 At the core, the problem is that the payday lending product competes directly with the overdraft product,164 and banks that wish to market the overdraft will not want to offer unprofitable or break-even, short-term lending products.165 Moreover, borrowers likely have little to gain by shifting to the overdraft product. The overdraft is characterized by cascading fees—a fee in the range of $20 to $30 for each check that the customer bounces each month.166 The payday product, by contrast, contemplates a single fee, in the same range, that covers an advance for the entire remainder of the payroll period. Upon payment of that single fee, the customer can use the funds to pay each of the obligations that would have resulted in separate overdraft fees. Admittedly, the interest rates on the payday lending product are high. But the product has two advantages over the overdraft product. First, and most importantly, it seems fairly clear that overdraft products are more expensive than payday lending products. They often escape criticism largely because existing regulations in this country 159. Hellwig, supra note 2, at 1569–70. 160. DTI REPORT, supra note 5, at 40. 161. BAIR, supra note 23, at 21–28. 162. For instance, neither the Windward Community Federal Credit Union’s product, which has a 12 percent APR, nor the North Side Community Federal Credit Union’s product, which has a 16.5 percent APR, are profitable. Id. at 22–23, 26. For discussion of a more recent credit-union effort, see Katie Kuehner-Hebert, CUs in Ohio Team Up to Offer Payday Alternative, AM. BANKER, July 13, 2006. 163. Interviews with Anonymous (spring 2006) (on file with authors). 164. See Barr, supra note 2, at 163–64. 165. BAIR, supra note 23, at 34 (“Why offer a small dollar line of credit linked to a checking account at an 18% APR if a bank can collect many multiples of that by assessing a $17 to $35 fee each time a customer overdraws his/her account?”). 166. Id. at 10–13. 890 54 UCLA LAW REVIEW 855 (2007) treat those products as if they do not involve credit,167 even when they are marketed in a way that contemplates regular advances. Second, and relatedly, the payday lending product is relatively transparent (especially as we envision it in the discussion below), with a price that is simple for customers to understand. The overdraft product, by contrast, is much harder for customers to price, if only because it frequently will be difficult for them to predict when they are issuing checks that will bounce. Because all payday lending customers have some bank account—an account on which their repayment check must be drawn—there is certainly the potential for bank competition. In the end, however, the message we take from the Bair Report is that banks that work very hard on this problem with the help of regulators might develop the ability to serve with profit some small number of the less troubled customers of payday lenders. In reality, regulators are not comfortable that they adequately can supervise the extremely high- volume, low-amount lending transactions in which sophisticated payday lenders engage. Moreover, the costs of branch banking are likely to make it hard for banks to compete directly against the most sophisticated payday lenders, which will be able to establish highly dispersed retail locations more cheaply than banks. (2) Subprime Credit Cards Another obvious alternative to payday lending is the subprime credit card. If payday loans were banned, at least some payday lending customers could shift to subprime credit card products. This is perhaps the most perverse outcome. If forcing customers to overdrafts is bad because they are expensive and opaque, shifting consumers to credit cards is much worse.168 Also, as discussed above, it appears that many payday lending customers are already using credit cards to their fullest extent. Thus, it seems unlikely that a ban on payday lending would result in a shift to credit card lending. Rather, it would result in a shift to the less appealing products discussed in the three Subparts that follow. 167. Both the Bair Report and Michael Barr note that banks benefit from the fact that overdraft fees are not subject to the TILA’s requirement of disclosing the APR because consumers do not appreciate the relative costs of this form of credit. Id. at 34; Barr, supra note 2, at 164. Consumer advocates are pressing for an amendment to Regulation Z that would apply the TILA to bounced- check-protection programs. See Mark E. Budnitz, Developments in Payment Systems Law, 10 J. OF CONSUMER & COM. L. 5 (2006). 168. See generally MANN, supra note 140, at 45–72. Just Until Payday 893 of large publicly traded companies.185 At least in the United States, this is associated with a stigma against pawn shops: “[T]he [pawnbroking] industry has difficulty shaking the ‘pawnbroker stigma.’ The composite image of the pawnbroker is that of a shady, unkempt, over-weight character working out of a filthy, run-down, back street hock shop . . . providing continuing support to ‘druggies’ and other ‘low lifes’ in exchange for pawns of stolen goods.”186 (4) Rent-to-Own In rent-to-own (RTO) transactions, consumers acquire goods, such as televisions or furniture, in exchange for periodic payments. Consumers make either weekly or monthly payments to the renting party. If the consumer cannot make the payment, the consumer must return the goods.187 Eventually, the consumer owns the goods after paying for a specified period.188 The RTO industry is “a $4.5 billion industry of approximately 7,500 stores with about 3.5 million customers.”189 RTO lenders appear to compete directly with payday lenders. As the DTI report cogently notes, the relation between RTO transac- tions and payday loan regulation is demonstrated by the facts that RTO transactions are permitted in most U.S. states but are concentrated in states with the fewest other credit options for lower-income individuals190 and are stronger in states with interest-rate ceilings.191 The consumer preference for payday loans over RTO transactions is quite sensible. For one thing, RTO transactions are not governed by the Fair Debt Collection Practices Act.192 RTO transactions functionally require consumers to pay very high interest rates to obtain goods, such as, in one example, paying $1709 to obtain a 20-inch television with a retail price of under $300.193 RTO transactions have the undisclosed processing fees of payday loans194 and the 185. Id. at 459. 186. Jarret C. Oeltjen, Florida Pawnbroking: An Industry in Transition, 23 FLA. ST. U. L. REV. 995, 995 (1996). Survey evidence from Australia suggests a similar perspective. Thus, Australians report that they prefer payday loans over pawn transactions because pawnbrokers are less professional than payday lenders, and because going to a pawnshop reveals a greater admission of desperation or is more demeaning. WILSON, supra note 46, at 79. 187. For a comprehensive discussion, see Martin & Huckins, supra note 2. 188. Id. at 385. 189. Id. 190. DTI REPORT, supra note 5, at 14. 191. Id. at 13. For a detailed account of state laws on rent-to-own transactions, see Martin & Huckins, supra note 2, at 396–400. 192. Martin & Huckins, supra note 2, at 391. 193. Id. at 401. 194. Id. at 403–04. 894 54 UCLA LAW REVIEW 855 (2007) behavior-driven late fees of credit cards.195 RTO dealers list retail prices of their goods much higher than the market value of the goods to confuse consumers.196 Therefore, RTO transactions not only have the adverse effects of pawnshop lending (customers lose their property), but they also have much less transparent pricing to the customer (because of the long sequence of payments required to purchase). Indeed, RTOs might be the worst product for consumers, pairing a risk of forfeiture for nonpayment with the most serious cognitive problems. (5) Illegal Sources Finally, when borrowers have no other legal credit options, they will seek illegal credit options. For instance, evidence confirms that loan sharks remain common in Australia.197 Responsible Australian policymakers, like then minister of fair trading Judy Spence, have claimed that banning payday lending would lead directly to individuals with low incomes patronizing loan sharks.198 The DTI’s arguably self-interested take on illegal lending in the United Kingdom versus illegal lending in France and Germany suggests a similar relation: “The credit impaired in France and Germany appear more likely to use illegal lenders than in the U.K. where there are legal credit options for such borrowers.”199 Thus, the DTI reports, 3 percent of UK borrowers admit to using illegal lenders, as opposed to 7 percent in France and 8 percent in Germany.200 Comparing people who have been denied a loan reveals an even greater difference, with 4 percent in the United Kingdom admitting using illegal lenders, contrasted with 12 percent in France and 10 percent in Germany.201 If we assume that illegal sources of credit and the extralegal collection methods on which they rely are disadvantageous as compared to legal sources, then we should worry about legal rules that will expand the market share for the illegal products. * * * 195. Id. at 403–04. 196. Drysdale & Keest, supra note 173, at 615–16. 197. Wilson, supra note 2, at 165. 198. Id. at 165 (citing Press Release, Australian Office of Fair Trading, Payday Predators Panned (Aug. 31, 2000)). 199. DTI REPORT, supra note 5, at 44. 200. Id. 201. Id. For more detailed survey research on that topic, see POLICIS, ECONOMIC AND SOCIAL RISKS OF CONSUMER CREDIT MARKET REGULATION (2006), available at http://www.policis.com/ financial_services_market_regulation.htm. Just Until Payday 895 We are largely agnostic about the merits of the arguments presented above. In our view, the discussion about these arguments is important because policymakers deciding whether to authorize payday lending should start by deciding exactly why they do—or do not—think it contributes to the welfare of their constituents. Those for whom the arguments in favor of payday lending are not persuasive should be reluctant to support the spread of payday lending in their jurisdiction. Those who (like most legislators in this country) cannot justify a complete ban on payday lending should read on to consider precisely what type of lending they should tolerate. B. Should Repetitive Payday Lending Be Banned? A distinct question is whether habitual use of payday loans should be tolerated. As discussed in Part I, it is clear that rollover payday loans are common in the industry. Indeed, the Flannery and Samolyk study contemplates that the profitability of the large national providers might depend on rollover payday loans.202 In some cases, the results can be startling. For example, one recent enforcement action targeted an illegal series of rollovers in which one borrower paid over $19,500 in interest over eight years on a series of loans that eventually reached a principal balance of $1875.203 This raises the prospect of an intermediate policy perspective: A state might tolerate payday loans in the abstract, but prohibit rollover loans. Indeed, this is not a hypothetical perspec- tive. Most of the states that have adopted legislation authorizing payday loans have modified the model CFSA statute in ways designed to make rollover lending more difficult. Unfortunately, as we discuss below, it appears that none of the statutes that prohibit rollover loans has been drafted in a way effective to prevent customers from becoming trapped in an indefinite cycle of payday borrowing. Whether a prohibition on rollover loans makes sense depends, in part, on whether such a ban would effectively abolish the payday lending market altogether. If a ban on rollover loans would effectively ban the market entirely, or drive all reputable providers from the market, which is much the same thing from a policy perspective, then a policymaker contemplating a ban on rollover loans should consider its goals. 202. For our discussion of why rollovers play an important role in lender profitability, see supra notes 27–28 and accompanying text. 203. See Press Release, Wash. State Dep’t of Fin. Insts., DFI Bans Payday Lender from the Industry and Orders Restitution to Consumers (Sept. 11, 2006), available at http://www.dfi.wa.gov/consumers/ news/2006/expressit.htm. 898 54 UCLA LAW REVIEW 855 (2007) a database, the borrower that wishes to borrow repetitively need only cycle its borrowings between more than one lender, just as a distressed consumer need only use cash advances on one credit card to make a minimum payment required to keep a second card active. These databases are increasingly common—Delaware, Florida, Idaho, Indiana, and North Dakota all have implemented them in the last few years.210 The second necessary feature is an effective cooling-off period between loans.211 These periods exist in a number of states, with periods ranging from one to seven days,212 typically imposed after a long string of borrowing. Indiana’s provision213 (the most restrictive), requires a seven-day cooling-off period after six consecutive transactions. As far as we can tell, however, only Indiana has both a cooling-off period and a limit on repetitive lending that is policed by reference to a statewide database. This, then, is the closest any state has come to enacting an effective ban on repetitive payday lending. And even there, a reasonable skeptic might say that the cooling-off period is too short to be effective. No period less than fourteen days will ensure that a typical borrower with a two-week pay cycle is forced to go through an entire cycle without obtaining funds from a payday lender. In sum, most legislatures have determined that the best outcome is some form of an intermediate policy: restricting or prohibiting the kinds of repetitive payday lending transactions that indicate that a customer is irretrievably enmeshed with payday loans. But few (perhaps none) of the legislatures that have taken that policy view have adopted a system that is likely to eliminate repetitive payday borrowing. 210. Id. For a typical statute, see FLA. STAT. § 560.404(18)–(19) (2003). 211. The CFSA’s model statute includes a ban on rollover loans, but includes neither a statewide database nor a cooling-off period. See Model Deferred Deposit Act, supra note 79, § 8 at 36. 212. Cooling-off periods are part of the regimes in Alabama (one day), Illinois (seven days), Indiana (seven days), North Dakota (three days), and Oregon (one day). See also, e.g., Johnson, supra note 2, at 66 (“[I]n Iowa and other states that prohibit rollovers but allow a customer to have two loans with the same lender, lenders could claim technical compliance with the state law prohibition against rollovers while allowing consumers to continually roll an existing loan into a new loan as long as the lender does not exceed the maximum loan amount. This possible end-run around the rollover prohibition prompted the Iowa Division of Banking to issue an interpretive bulletin informing lenders that the prohibition on rollovers means that they cannot issue a new loan to a consumer until at least one day after payment of the previous loan . . . . Unlike Iowa, other states have not even tried to clarify the interrelationship between statutes that prohibit rollovers and statutes that allow multiple outstanding loans. Therefore, payday lenders in these states may practice rollovers even where it is technically illegal.”) (footnotes omitted); PayDay Loan Consumer Information, supra note 209. 213. IND. CODE § 24-4.5-7-108, -404 (2006). Just Until Payday 899 C. How to Design Regulatory Schemes That Target Abuse Finally, we consider the view that the payday lending model should be permitted to function without substantial constraint to the product itself. That does not suggest, however, that the industry should be immune from regulation. As discussed above, no U.S. jurisdiction has adopted that perspec- tive. The task, rather, is to define the purpose of these regulatory schemes, as a precursor to assessing how well they work. In general, the two most obvious bases for regulation in a jurisdiction that wishes to allow payday lending would be (1) to limit the cognitive problems discussed above; and (2) to limit the likelihood of abusive conduct by lenders. Thus, the discussion above presents the view that payday lending might be permitted because, in the range of prices and attributes at which the product typically is offered, the product is attractive to even well-informed customers, particularly when it is compared to high-cost alternatives like overdraft products and risky products like credit cards, pawnshop lending, and RTO transactions. At the same time, even in the jurisdictions that regulate the market, it is hard to deny that transactions occur on terms outside those normal parameters.214 This might be because the lenders charge fees that differ from those that they disclose. Or it might be because the lenders charge fees that grossly exceed the specified limits—fees far beyond the amounts necessary for a well-organized business to profit. Or it might be because the lenders package the payday lending product with other related products for which they charge unreasonable amounts, all with the purpose of charging unlawfully high fees.215 In general, it is safe to assume that some lenders engage in this conduct with an intention to profit through avoidance of industry norms or legally prescribed limits. The task, then, is to devise a regulatory regime that will allow legitimate providers to proceed with as little burden as possible while hampering the activities of those that currently operate with flagrant illegality.216 Logically, the first question in designing a scheme to limit abuse is whether the abused customers can solve the problem themselves, simply by enforcing 214. See, e.g., ConsumersUnion.org, Study: Payday Lenders Continue to Ignore State Laws Related to Fees and Protections (July 2, 2003), available at http://www.consumersunion.org/pub/ core_financial_services/000203.html (survey of thirty-one payday lenders in Texas indicating that none were in compliance with applicable state law). 215. This seems to have been the preferred practice of the “loan shark predator” discussed above. See Escobedo, supra note 39. 216. We do not address the problem of regulating Internet payday lending. Our impression is that effective regulation of that sector will have to come first from the U.S. Congress. A good place to start, however, would be to require that lenders provide a brick-and-mortar address of their headquarters. 900 54 UCLA LAW REVIEW 855 (2007) their rights through litigation.217 For several reasons, that seems implausible. As Iain Ramsay points out in the Canadian context, “[t]he small amounts at stake mean that few individuals are likely to litigate in the event of a dispute.”218 Even if attorneys were to work for free or operate under a fee-shifting mechanism, the small damages involved might not deter lenders.219 Moreover, the nature of the customer base makes reliance on litigation problematic. Lower-income people have fewer professional contacts, so it is harder for them to enforce their rights.220 In Australia, commentary suggests that “low-income consumers will not have the resources to apply to court to complain of hardship or unconscionability.”221 Even if they had the resources to find attorneys and pay court fees, studies show that “low-income consumers are unlikely to take legal action in relation to a loan dispute, on the basis of factors such as cost, a sense of powerlessness, and a fear of acrimonious disputes.”222 Thus, even recognizing that payday lending customers are not the poorest segment of U.S. society, we remain skeptical that direct litigation alone will allow victimized customers to enforce regular compliance with articulated regulatory requirements. Trying to fill the gap, we suggest a two-part approach. First, we suggest a number of direct transactional regulations, many (but not all) of which appear in one form or another in the deferred presentment statutes recommended by 217. Other countries purport to regulate payday loans through judicial review. For example, the British Consumer Credit Act empowers courts to lower interest rates that are unconscionable or “extortionate and grossly exorbitant.” Consumer Credit Act, 1974, c. 14, § 39 (Eng.); Moneylenders Act, 63 & 64 Vict. 155, c. 51, § 1 (1900) (Eng.). Similarly, several Canadian provinces regulate excessive credit charges and credit contracts by allowing courts to reopen consumer transactions that are unconscionable. See, e.g., Alberta Unconscionable Transactions Act, R.S.A., ch. U-2, § 2 (2000) (empowering judges to review and alter transactions in which “the cost of the loan is excessive and . . . the transaction is harsh and unconscionable . . . .”); Manitoba Unconscionable Transactions Relief Act, R.S.M., ch. U20, § 2 (1987) (same); New Brunswick Unconscionable Transactions Relief Act, R.S.N.B., ch. U-1, § 2 (1993) (same); Newfoundland and Labrador Unconscionable Transactions Relief Act, NFLD. R.S., ch. U-1, § 3 (1990) (same); Prince Edward Island Consumer Protection Act, R.S.P.E.I., ch. U-2, § 2 (1988) (same). Also, some Canadian borrowers have sought judicial review of payday transactions—both individually and through class actions. E.g., Affordable Payday Loans v. Beaudette, 2004 Carswell Ont. 3210, 2004 WL 1663120 (Ont. S.C.J.) (July 29, 2004); Jim Rankin, Borrow in Haste Repay Forever, TORONTO STAR, Nov. 21, 2005, at B03. The Australian Uniform Consumer Credit Code similarly empowers courts to review unconscionable interest rates and to reopen unjust transactions. UNIF. CONSUMER CREDIT CODE, 2001, §§ 70, 72 (Austl.). 218. RAMSAY, supra note 46, at 18. 219. Hellwig, supra note 2, at 1587. 220. RAMSAY, supra note 46, at 19. 221. Wilson, supra note 2, at 162. 222. Id. at 163–64 (citing HAZEL GENN, PATHS TO JUSTICE: WHAT PEOPLE DO AND THINK ABOUT GOING TO LAW 101 (1999)). Just Until Payday 903 that there is a single fee234—it increases the likelihood that borrowers accurately will understand (and compare) the cost of borrowing.235 b. Disclosure Requiring parties to disclose information is a common form of consumer- protection regulation.236 In this context, as discussed above, the Truth in Lending Act,237 like similar regulations in countries such as Australia238 and Canada,239 imposes a uniform interest-rate disclosure obligation on payday lenders.240 Regardless of the merits of such regulation, several aspects of the payday lending industry make the current mandatory disclosures counterproductive. The most basic problem is that TILA communicates the wrong information to borrowers: the annual percentage rate. While the APR may provide a good comparison mechanism for loans generally,241 studies suggest that requiring APR disclosures on payday loans is ineffective.242 An Australian survey found that 234. To be sure, this recommendation leaves unsolved the problem of overdraft fees assessed by the customer’s bank when payday lenders unsuccessfully attempt to collect checks from their customers. Our vision of a single fee is undermined if the banks at which defaulting borrowers have their accounts impose substantial overdraft fees when the checks that they have given their payday lenders bounce. Because those banks are not a party to the lending transaction, however, it is harder to justify regulating the fees that they can charge; these bounced checks, after all, are not all that different from any other bounced checks issued by their customers. 235. We are skeptical of Chris Robinson’s proposal for Canada that rates be determined either by a fixed rate per amount borrowed (plus a set per loan fee and an interest rate), or by different fees for different amounts borrowed (for example, 12 percent for the first $250 borrowed and 6 percent for everything higher than that amount). See Daw, supra note 26, at D6. Even if this scheme works under finance theory, we worry that the average borrower would find it difficult to understand these more complex pricing schemes. 236. See MANN, supra note 140, ch. 13. 237. 15 U.S.C. §§ 1601–1693 (2000). 238. UNIF. CONSUMER CREDIT CODE, 2001, §§ 14–15 (Austl.) (governing contracts); id. § 143 (governing advertisements). 239. E.g., Manitoba Consumer Protection Act, R.S.M., ch. C200, § 4(3) (1987); Newfoundland and Labrador Consumer Protection Act, NFLD. R.S., ch. C-31, § 16 (1990); Nunavut Consumer Protection Act, R.S.N.W.T., ch. C-17, § 5 (1988); Prince Edward Island Consumer Protection Act, R.S.P.E.I., ch. C-19, § 16 (1988); Yukon Consumer Protection Act, S.Y.T., ch. 40, § 5 (2002). 240. 15 U.S.C. § 1632 (2000). 241. See Hellwig, supra note 2, at 1593 (arguing that APRs are important tools). 242. Graves and Peterson argue the opposite. They claim that APRs are appropriate because (1) many borrowers roll over loans, so payday loans “often compound for durations coming close to or exceeding a year”; (2) “annualized interest rates [for loans] are the uniform metric which all mainstream creditors use to compare prices”; and (3) borrowers would confuse loan prices quoted “as a percent of the principal borrowed” with APRs from other products. Graves & Peterson, supra note 15, at 662–63. We find this reasoning unpersuasive. Studies do not suggest that rollover loans typically extend for a year. At most, Graves and Peterson’s research established that some borrowers rolled over loans 12.5 times—less than half of a year in the worst scenario. Id. at 663. Also, even if APRs were useful in mainstream credit (which we doubt), that does not tell us how we should disclose 904 54 UCLA LAW REVIEW 855 (2007) 78 percent of Australians measured the cost of their payday loans in a dollar amount, not in an interest rate,243 suggesting that people do not think of payday loans in terms of an abstract rate but rather a concrete cost. Evidence from the United States backs up this claim; previous scholars have found that although most people do not understand APR disclosures,244 they do understand the finance charge, which is a dollar amount.245 Interest-rate disclosures are misleading because the amount of the fee charged generally does not depend on the number of days until the borrower’s payday.246 An interest-rate disclosure would suggest that the rate changes every day depending on which day in the pay cycle the borrower obtains the loan, when actually the cost is uniform throughout that cycle. This confusion does nothing to help consumers evaluate competing products. The current regulatory scheme is also problematic because consumers often get the information too late in the process for it to be useful.247 Most courts merely require that the lender provide the required disclosure sometime before the contract is signed, but consumers have no opportunity to comparison shop if they receive the disclosure immediately before the deal is done.248 The model act supported by CFSA follows this same pattern. Lenders must disclose the APR, but only when the customer signs the contract—not before, when the customer might still be interested in price comparisons.249 A sensible scheme would require that the basic fee be prominently posted so that consumers could compare the fees available from different providers without incurring substantial transaction costs. Finally, there is, at least presently, a substantial problem of noncom- pliance. A study of payday lenders in Ohio suggests that 68 percent of payday pricing information to people using fringe products. It is essential to evaluate the specific credit mechanism in question. As Sunstein observes, “[b]ecause of bounded rationality, some frames will have more of an impact than others. For those who suffer from serious forms of bounded rationality, steps like those in the Truth in Lending Act may well do little good.” Cass R. Sunstein, Boundedly Rational Borrowing, 73 U. CHI. L. REV. 249, 261 (2006). Finally, annualized interest rates are not the uniform-pricing guide in short-term lending: Overdraft fees from banks—a major competitor for payday loans—are not expressed in terms of APR but in simple dollar amounts. 243. WILSON, supra note 46, at 77. 244. Hellwig, supra note 2, at 1591–92. 245. Id. at 1593. 246. Cf., e.g., ACE Cash Express, Inc., supra note 20, at 3 (reporting that loans are made “until the customer’s next payday”); Cash Am. Int’l, Inc., supra note 40, at 4 (“These cash advance loans generally have a loan term of 7 to 45 days and are generally payable on the customer’s next payday.”); Ten Dollar Payday Loan.com’s payment schedule, TenDollarPaydayLoan.com, Frequently Asked Questions, http://www.tendollarpaydayloan.com/faqs.asp (last visited Mar. 4, 2007). 247. Hellwig, supra note 2, at 1590–91. 248. Bertics, supra note 2, at 148–49. 249. Model Deferred Deposit Act, supra note 79, § 3 at 35. Just Until Payday 905 lenders either failed to disclose interest rates or disclosed them inaccurately.250 In part, a simple desire to hinder competition may be the cause,251 but it is also surely attributable in part to the mismatched disclosure scheme that requires lenders to advertise rates in terms that seem absurdly high even for relatively mainstream products.252 The best solution, from our perspective, is to adopt a simple disclosure scheme, with which reputable lenders readily can comply. We would require lenders to display in a prominent way the fee per $100 borrowed. This disclo- sure requirement solves the problems identified above: It (1) tracks with the survey data that customers use their actual cost to make decisions and not an interest percentage;253 (2) eliminates the confusion caused by different interest rates for different time periods; (3) ensures borrowers obtain the information up front at little cost; and (4) encourages compliance by allowing lenders to avoid stating misleadingly high APRs. 2. Indirect Reforms: Fostering a Better Class of Lenders The preceding Subpart discusses ways to enhance the transparency of the payday lending market, hoping to foster some competition through the provi- sion of simple and accessible information. The central point of our proposal, however, is to draw a line between mainstream payday lending transactions, which are to be tolerated, and extramarket, abusive transactions, which are to be pursued and sanctioned aggressively. Our proposal for fencing off abusive transactions has two parts. The first is the simplest: drawing a line between the mainstream payday lending market and the abuses that involve fees not justified by ordinary costs and competitive pressures. The landscape of U.S. regulation makes it clear that states can see the difference between regulatory systems that involve fee caps that close off 250. Johnson, supra note 2, at 46. 251. See id. at 25. 252. See Hellwig, supra note 2, at 1597; Johnson, supra note 2, at 25. Canadian payday lenders have also balked at disclosing APRs. Canadian Ass’n of Cmty. Fin. Serv. Providers, Payday Loan Association Supports Consumer Protection Legislation and Consumers’ Right to Full Disclosure, July 29, 2005, http://www.globeinvestor.com/servlet/ArticleNews/story/CNW/20050729/1307295753 (“‘The Ontario Government has asked all lenders in the province to disclose an annual cost of borrowing, even if a loan is taken out for only a few days. While this is like asking hotels to disclose a daily room rate of $200 as an annualized figure of $73,000, we are advising association members to respect the law and disclose accordingly,’ says [Bob] Whitelaw.”). 253. A glance at the websites of Internet payday loan providers suggests both that this is a piece of information that consumers generally find valuable and, less happily, that providers with high rates have a penchant for shrouding this figure rather than blazoning it upon their home screen (or, as with tendollarpaydayloan.com, incorporating it into their domain name). 908 54 UCLA LAW REVIEW 855 (2007) held payday lenders dropped 10 percent or more.263 Similarly, after the corporate scandals of the last few years, the officers of large entities realistically will fear substantial criminal penalties if they allow their businesses to operate in a way that does not reflect a serious effort to comply with applicable regulations. Prosecutions of larger entities are also much more useful as a regulatory matter. If the government finds a sole payday lending store violating a regulation, the importance of a prosecution is minimal—it only affects the small number of transactions at that store. In contrast, if a large entity violates regulations in all of its stores across the country, prosecutors have the opportu- nity to affect the many transactions at all of these stores by prosecuting that one entity. In addition, if the number of potential violators is smaller—that is, if a small number of entities offer all the payday loans in the United States in contrast to the large number of small payday lenders currently offering loans, the government will be able to pursue a larger percentage of the violators. Further, prosecuting large companies would have a greater deterrent effect on other payday lenders than prosecuting small payday lenders. Deterrence is a function of the actor’s perception of the severity of the punish- ment and the likelihood of being prosecuted. Prosecutions of large companies receive publicity, and publicizing prosecutions makes would-be violators think that the risk of being prosecuted is greater. Another noted benefit in enforcing compliance with large companies is that it is much easier for regulators to monitor the activities of a small number of relatively large companies than it is to monitor the activities of a large number of small and evanescent competitors. Aside from the simple economies of scale, publicly traded companies are more likely to have detailed data about their operations. Furthermore, the data is more likely to be reliable than it is for smaller companies that are unlikely to rely on independent auditors. All in all, the emergence of large-scale entities into the market would ease the task of the supervisory regulator. A market composed of large actors also solves some of the problems with civil enforcement noted at the beginning of Part II.C. Because the policies of large entities often would be uniform across a large number of transactions, class actions would be a more viable mechanism for pursuing actions challenging abusive practices. 263. Flannery & Samolyk, supra note 9, at 20 n.31. Our primary argument is not that large payday lenders worry that the public might think their conduct is unsavory, but rather that these large providers worry that the public might consider their conduct illegal, so that investors would not consider them strong investments. Yet, to the extent that publicly held companies account for ethical investors in setting policies, encouraging large providers may curb unsavory lending practices. Just Until Payday 909 Although it is harder to be sure, there also is some reason to think that entry into the market by larger and better-capitalized companies ultimately could lead to better products and prices for the customers in the market.264 The most obvious reason for this is that high-quality payday lending, like other developed forms of lending, is a business that depends heavily on sophisticated information technology and standardized operations for which there are substantial economies of scale.265 What little empirical evidence we have seen suggests that this is a serious issue.266 To see how this works, consider the annual report of Cash America International, Inc., one of the largest payday lenders in the United States.267 This firm has grown steadily through acquisitions in the past few years, using a simple model in which it takes over a promising location and then rapidly improves the profitability of the location through installation of the company’s centralized management and standardized operations.268 Other large payday lenders also boast that their proprietary computer information systems and point- of-sale technology are pivotal components that increase their stores’ productivity and allow them to effectively expand through acquisitions.269 264. See Samuel Hanson & Donald P. Morgan, Predatory Lending? (May 4, 2005) (unpublished manuscript, on file with author) (concluding through empirical analysis that payday lending rates are significantly lower in jurisdictions with a greater number of lenders per capita). 265. See Barr, supra note 2, at 157–58 (making a similar argument about consolidation). 266. See Morgan Stanley Equity Research, supra note 63, at 16 exhibit 10 (using data from several large chains to illustrate correlation between costs of operation and size of chain). 267. Cash Am. Int’l, Inc., supra note 40, at 1. 268. Id. (“The Company’s growth over the years has been the result of its business strategy of acquiring existing pawnshop locations and establishing new pawnshop locations that can benefit from the Company’s centralized management and standardized operations. In 2003, the Company expanded this strategy to include acquiring existing cash advance locations and establishing new cash advance locations.”). See also, Dollar Fin. Corp., supra note 42, at 6 (noting that “our centralized support centers [are] a competitive advantage”). 269. First Cash Fin. Servs., Inc., supra note 12, at 3 (“The Company utilizes a proprietary computer information system that provides fully integrated functionality to support point-of-sale retail operations, inventory management and loan processing. Each store is connected on a real-time basis to a secured off-site data center . . . .”). See also ACE Cash Express, Inc., supra note 20, at 5 (“To better service our customers and manage our stores in the most profitable manner, we have developed proprietary information systems, including a point-of-sale system and a management information system, designed for the efficient delivery of our financial services with the proper balance of corporate management. Our in-house information systems team has built a reliable and scalable technology infrastructure that will allow us to grow our business without significant additional capital expendi- tures. . . . By implementing our Operational Goals and information systems, we are typically able to increase revenue and gross margin in our acquired stores and to enhance the acquired stores’ service offerings.”); Dollar Fin. Corp., supra note 42, at 6 (“Our proprietary systems are used to further improve our customer relations and loan servicing activities, as well as to provide a highly efficient means to manage our internal as well as regulatory compliance efforts.”); id. at 16 (“The point-of-sale system, together with the enhanced loan-management and collections systems, has improved our ability to offer new products and services and our customer service.”). 910 54 UCLA LAW REVIEW 855 (2007) The problems for smaller companies are easier to see. Smaller companies are less likely than the larger players to have ready access to credit services, such as TeleTrack, to determine if applicants have other outstanding payday loans or credit problems.270 Smaller companies are less likely to have specialized central processing, which seems to be highly efficient in this industry.271 Indeed, because the larger companies for the most part are companies that have other products (check-cashing services being the most common), the ability to spread administrative costs over more locations and products seems to be quite important. For example, Ernst & Young’s study of Canadian payday lenders confirms that lenders with different types of products and not just payday loans had significantly lower costs per $100 of payday loans.272 In the end, the data we have about the industry—principally from the FDIC study (in this country) and the Ernst & Young study (in Canada)—strongly suggest that economies of scale give the larger lenders lower costs of doing business, and thus higher profitability.273 One last consideration relates to the way that payday loan transactions interact with the credit-reporting system. Because payday lenders do not report positive transactional data to the three large consumer-reporting agencies, there is a concern that the payday borrowers will not form credit histories that would facilitate mainstream borrowing.274 This issue gained prominence with the passage of the Fair and Accurate Credit Transactions Act of 2003 (FACT Act). Section 312 of the FACT Act requires the Federal Trade Commission (FTC) and federal banking agencies to prescribe guidelines to ensure the accuracy and integrity of information furnished to consumer-reporting agencies (CRAs).275 Section 318 requires the FTC to conduct an ongoing study of the accuracy and completeness of consumer-credit reports and to report on four specific topics related to credit-report accuracy, including—of relevance here—whether there are any common financial 270. Barr, supra note 2, at 151. 271. See Flannery & Samolyk, supra note 9, at 11 (describing such costs for payday lenders). 272. E&Y CANADA STUDY, supra note 26, at 34. 273. Flannery & Samolyk, supra note 9, at 2; E&Y CANADA STUDY, supra note 26, at 46. 274. Academics have noted this problem. See Barr, supra note 2, at 124; see also Brooks, supra note 2, at 997. 275. Fair and Accurate Credit Transactions Act of 2003, Pub. L. No. 108-159, 117 Stat. 1952 [hereinafter FACT Act]. As part of that process, these agencies have solicited comments on the types of errors, omissions and other problems that may impair the accuracy and integrity of information provided to consumer-reporting agencies, including the omission of “potentially significant information about the consumer account or transaction, such as credit limits for or positive information about the account.” Federal Trade Commission, Interagency Advance Notice of Proposed Rulemaking, 71 Fed. Reg. 14,419 (Mar. 22, 2006) (to be codified at 16 C.F.R. pts. 660-61).