Economics and Policy in Payday
Lending Markets
PROFESSOR VICTOR STANGO
UNIVERSITY OF CALIFORNIA, DAVIS
GRADUATE SCHOOL OF MANAGEMENT
Introduction
 My background:
 Academic (Dartmouth, UCD, others)
 Federal Reserve (Chicago, NY)
 Research:
 Competition/regulation in banking (mostly credit cards)
 Consumer decisions and consumer protection in banking
(mostly in debt markets, a little in payday)
 Caveats
The Big Questions
 Does access to high-interest credit help or harm
borrowers?
 What constitutes sound law and public policy toward
payday lenders and other providers of short-term
credit?
Roadmap
 State of the academic research on payday lending
 The ascendance of behavioral economics in policy
 Getting the (behavioral) economics right: examples
 Questions
My Points, Broadly
 The body of accepted economic research on payday
lending is substantive and provides a credible
scientific foundation for policy and legal discussions
 Behavioral economics will not go away; indeed, its
lens will be the primary one through which
policymakers view payday lending
 There is reason to feel good about both
developments
State of the Science: What Do We Know?
 We now have a substantive body of social science on
a variety of questions
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Much of this is well-formulated research by academic
researchers at top universities
In other words, this is work to which serious people in the law
and policy realms will attend
 Research covers a wide range of topics,
methodological approaches
State of the Science: What Do We Know?
 Competition
 Accepted academic evidence that payday markets are
competitive, in the broad economic sense (i.e., that firms are
not earning monopoly profits)
 The effects of price controls
 Little evidence that payday lending markets defy Econ 101
State of the Science: What Do We Know?
 Access and outcomes
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Bankruptcy, credit scores
Employment
Bill payment, overdrafts
Health care, crime, food
Death(!)
 Results-wise, a mixed bag: “One possible conclusion is
that payday loans are, financially, neither destabilizing
nor greatly beneficial simply because they are small and
unsecured, which limits their potential risks and
benefits”
– Bhutta (2012), “The Effect of Access to Payday
Financial Health…”
Loans on
State of the Science: What Do We Know?
 Borrower “rationality”
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Understanding of fees/terms/APRs
Co-holding of high- and low-interest debt/assets
Reaction to framing of loan costs
Self-assessment of loan maturity (rollovers)
 Upshot:

Again, mixed; little evidence that biases are more pronounced here than in, e.g., credit
cards (or tanning salons!)
 “The two main [preliminary] takeaway findings are that most of the
customers expected/understood that they were likely to keep borrowing
after the first loan. The second is that about 60% predicted with
reasonable accuracy (within one pay period) the date when they would
finally be free from debt.”
- Personal correspondence, Ronald Mann (Columbia), 10/29/2012
What Research Hasn’t Settled
 How to measure “worse off”?
 What is the mix of those helped vs. harmed?
What’s “Harm”?
 Any one outcome may not be clear evidence of harm
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Bankruptcy? Default?
Subjective; highly individualized
 Access to credit may “improve” welfare by some metrics
and “hurt” by others
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Even at the individual level
 Must ask “relative to what”?
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What is the effect at the moment of decision to borrow?
How does payday loan debt enter the economic decision (e.g., to
declare bankruptcy)?
The Mix of Helped vs. Harmed
 Economic research often looks at average effects,
which misses this
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Critical for policy, or understanding any damages borrowers
might or might not suffer
 Average effects mask any underlying diversity in how
access to credit is associated with the full range of
changes in outcomes
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Minor inconvenience or major disaster averted/caused?
Summary on Research
 Why a good thing overall?
 Credible both as fact-finding and a signal about openness of
questions
 Even when ambiguous, can only elevate the discussion
 Demolishes less methodologically sound approaches that, e.g.,
confuse correlation with causality, or simply assert harm via
“unconscionable” fees
 Even statements about what we don’t know are written by
credible academics and appear in credible academic outlets
The Ascendance of Behavioral Economics
 What is it, again?
 Incorporates psychology into economics
 Some behavioral “biases” relevant in debt markets:
 Hyperbolic discounting (self-control problems)
 Optimism about future income
 Optimism about frequency of future bad events
 Bounded rationality (innumeracy, myopia, inattention,
heuristics etc.)
Behavioral Economics and Policy
 Behavioral economics is a well-established field and is
not going away
 Behavioral economics is playing an increasingly
important role in policymaking, at the CFPB and
elsewhere
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“Abusive” may encompass mistakes due to behavioral biases
The view that some borrowers have such biases will be an intellectual
underpinning of policy
Concerns about “shrouding” (in, e.g., mortgages and credit cards)
may be more important to the CFPB right now – but biases (e.g.,
optimism) are the greater perceived concern re: payday lending
Why This Might Be a Good Thing
 Looking at behavioral economics simply as a set of
models broadening the argument for regulation is
perhaps too narrow
 Now, we have:
 Models with clear predictions
 Serious academic researchers who have tested, and will
continue to test, these predictions
 Serious people in law/policy circles who will (or should) pay
attention
Example #1: Payment/Interest Bias
 Accepted work in behavioral economics shows that some
borrowers have trouble converting periodic payments
into APRs, and vice versa
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And that such a payment/interest bias might provide a basis for
“shrouding” APRs and emphasizing periodic payments
 One might see an assertion that this would be an issue in
payday lending, in two ways:
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Because emphasizing fees is generically “shrouding” that might
reduce competition
Or, if “The fee structure of payday loans makes it difficult for
consumers to compare directly the costs associated with a payday
loan to the costs associated with other consumer credit products.”
Example #1: Payment/Interest Bias
 Insight #1: If all lenders in a market quote prices the same
way (e.g., in fees), then this bias cannot confuse customers
about which are the low-price firms in that market
 Insight #2: Bertrand and Morse (2009) use an “APR
treatment” [presenting borrowers with payday loan APRs
and a comparison set of credit card/auto/mortgage APRs]
and find no significant or small effects on borrowing
Example #2: Hyperbolic Discounting
 The assertion: people are impulsive in a way that
leads them to over-consume or over-borrow, in a way
they later regret
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At least one study argues that this explains some payday
borrowing
 A key, from the model: this will increase borrowing
via discretionary purchases, via spending binges or
splurges that are later regretted
Example #2: Hyperbolic Discounting
 Why this is important: a recent Pew report finds that the
majority of payday loans are used for non-discretionary
recurring purchases, or for emergencies
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Neither is the type of spending predicted to increase if an individual
is “hyperbolic”
Spending on “something special” or “other” represents 13% of loans
 Not to say that these people aren’t hyperbolic – but if
they are, the splurge happened before they arrived at the
payday lender
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And, arguing that splurges only happen because people anticipate
getting payday loans presents a view of borrower behavior that is
pretty forward-looking (i.e., not behaviorally “myopic”)
Example #3: Rollovers
 The assertion: borrowers who roll over loans do so
because they under-estimate ability to repay
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Focuses regulatory attention on rollovers
 Evidence, part I:
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Preliminary new research (quoted above) showing that many
borrowers get their predicted maturity pretty much right
 Evidence, part II:
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More broadly, from behavioral household finance: experience is a
powerful de-biasing tool
Could argue that those with multiple rolled-over loans would be
expected to have the greatest familiarity with the product – and with
their own predilections
Example #4: Survey Evidence
 An example assertion: “If faced with a cash shortfall
and payday loans were unavailable, 81 percent of
borrowers say they would cut back on expenses”
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Makes the downside of regulation appear small
 What does behavioral economics say?
 A pervasive feature of consumer decision-making with
behavioral biases (e.g., hyperbolic discounting) is not doing
what one says/intends!
 Also, research from survey design shows that respondents may
choose responses based on social pressure or stigma
The Usefulness of this Approach
 Payday loans/borrowers are different
 Simplicity/salience of fees
 Yields cash: salience of purchases
 Built-in “cooling off” period
 Etc.
 Mapping findings from another market (e.g., credit
cards) into payday markets is not a given
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Careful analysis can be very illuminating
Summary
 Academic attention to payday lending markets has
increased dramatically
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Provides an independent, evidence-based foundation for
assessing claims about payday borrowers and lenders
 Ascendance of behavioral economics is a net positive
as well
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Provides sharp predictions that can be tested for intellectual
coherence, and with data
Thanks!