Payday lenders seemingly have few friends in high places.
They've been banned in 10 states and the District of Columbia. State attorneys general have gone after them over complaints about deceptive practices and the targeting of vulnerable populations. Federal regulators have even worked to push payday loan stores out of the market by encouraging small-dollar loan programs at banks and credit unions.
But the payday loan business-or the "deferred deposit" trade, as the industry prefers to call it-recently found sympathy in a surprising place. The Federal Reserve Bank of Kansas City has issued a controversial report by a senior economist supporting some of the payday loan industry's long-standing contentions that short-term, high-interest loans bring benefits to low-income populations.
In particular, Fed economist Kelly D. Edmiston found evidence that, in states that ban or restrict payday loans, consumers have lower credit scores and make less use of traditional credit.
"I'm arguing that they either lose access to credit, or are using less healthy forms" of short-term borrowing, such as bounced checks, overdraft loans or even illegal loan sharks, says Edmiston, who
Edmiston's research included statistics showing the drop-off in traditional credit usage in Georgia after its 2004 ban on payday loans, as well as national credit bureau data that found that credit scores suffered.
Edmiston's conclusion-that "a lack of payday lending is associated with lower scores"-counters the work of economists and consumer watchdog activists who have found that much of the economic harm in low-income communities is created, rather than mitigated, by the $38.5 billion in loans made each year to 19 million households through payday lending outfits.
An influential research paper two years ago by Brian Melzer, an assistant finance professor at Northwestern University's Kellogg School of Management, laid out a case nearly the opposite of Edmiston's, finding that high-risk borrowers actually exacerbate their financial problems by taking on short-term loans that turn into a "debt spiral" of recurring fees and bulging principal.
Likewise, the Center for Responsible Lending asserts that payday loans are cement shoes for consumers. According to the group, the average $300 payday loan costs $800 in fees each year (which works out to a nearly 400 percent annual interest rate), and still leaves most borrowers with a $300 balance to carry over.
Josh Frank, a CRL senior researcher who took part in the Kansas City Fed's discussion panel, said Edmiston's study was inconclusive, if not misguided. By focusing on isolated data that looks at no other explanation for lower scores or use of credit, the Fed has not proven any correlation, he argues.
"These things associated with payday lending may not have anything to do with payday lending, and they probably do not," he says.
Frank suggests that researchers just as easily could have linked anti-payday loan policies to racial or cultural demographics to argue that "restricting payday loans changes the race makeup of a state ... or changes the religious composition of a state" versus states with no restrictions. "Those things obviously aren't true, but you could easily do that using this methodology," he says.
Sharing the debate panel with Frank and with Darrin Anderson, an executive from payday lender QC Holdings, Edmiston defended his research, pointing out that the results were not intended as an argument against bans but as a starting point for discussions on payday loan restrictions, which he says haven't been examined enough. "The evidence is mixed," he says with a shrug.
Anderson, QC Holdings' president and chief operating officer, sharply attacked the CRL for its claims on high-default rates for payday loan customers who churn through multiple loans. As for Edmiston's paper, Anderson says he was heartened by the "new evidence that consumers in counties where payday loans are offered have higher credit scores and fewer late-bill payment penalties than those in counties without access to payday loans."
Anderson also boasts about the payday lending industry's high satisfaction rate (92 percent is the figure he cites) among a customer base that averages $40,000 in annual income.
Presumably the industry is at least as satisfied with the new research from the Kansas City Fed.
