Providing credit to the poor

By Felix Salmon
November 18, 2009
Megan McArdle is cutting up her credit cards, but she doesn't want to force anybody else to do the same thing. She responds to my sentiment that credit should come from loans, not cards, thusly:


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Megan McArdle is cutting up her credit cards, but she doesn’t want to force anybody else to do the same thing. She responds to my sentiment that credit should come from loans, not cards, thusly:

I don’t think personal loans are a very good substitute for the kinds of emergencies that frequently beset the people who this would most effect–if your car breaks down and you can’t get to work, you don’t really want to wait until the bank approves your personal loan to get the car fixed. But there are a lot of people who think we could make the poor better off by essentially denying them access to credit, because credit extended to the poor carries high interest rates to cover the default risk, and many people get themselves into big trouble with it.

The problem is, there are two sets of outcomes. There are people who are made better off by payday loans or credit cards, because they get the car fixed and don’t lose their job. Then there’s a group, which seems to be smaller but significant, who end up much worse off.

McArdle is far too generous to the lenders here. For one thing, I made it clear in my post that credit cards are very good for transactional credit: if you need to pay the car-repair shop today, using a credit card is a great way of doing so. But you should also have a good enough relationship with your bank that by the time the credit-card bill comes due, you can pay it with the proceeds from a personal loan or line of credit.

Secondly, I don’t think for a minute that we should deny the poor credit; in fact I’m on the board of a non-profit institution which exists to provide credit to the poor, and I’m all in favor of that. It’s credit cards I don’t like, with their high fees and interest rates (and there are even exceptions to that rule, such as the ones provided by many credit unions). And I really dislike payday loans, which are pretty much universally predatory, especially when compared to similar products from community development credit unions.

Megan’s conceptual mistake here is clear when she says that “credit extended to the poor carries high interest rates to cover the default risk”. But in fact the interest rates on credit cards are really not a function of default risk at all. Mike Konczal had a great post on this back in May, where he showed pretty conclusively that credit-card interest rates were all about maximizing profit for the issuer, rather than compensating for default rates. And payday loans are even worse.

What earthly grounds does Megan have for saying that the number of people made worse off by payday loans is smaller than the number of people made better off by them? I suspect she considers the alternative to be no-credit-at-all-nohow-noway. But that’s not what anybody is proposing. I, for one, think that credit should be available to the poor, very much so. But not in the quantities and at the rates that it’s been available until now. There is such a thing as too much credit, and we crossed that line long, long ago.

Update: Megan responds. At length.

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