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.

Comments
15 comments so far

>>credit-card interest rates were all about maximizing profit for the issuer>>

The price of just about anything is set by supply and demand, with sellers trying to maximize profit and buyers searching for low costs. Risk enters into the mix only to the extent it changes marginal cost.

Posted by foosion | Report as abusive

Thank you for mentioning credit unions. I have a credit card from a credit union which has reasonable terms and none of the high fees I’ve been reading about. It’s a mystery to my why more people don’t ditch banks for credit unions.

Posted by a | Report as abusive

No one is saying that payday loan institutions are model citizens in the financial system. Why are these institutions considered any more predatory than other banks? Because their interest rates are so high?

If it were the case that a borrower took a payday loan for thousands of dollars over a period of several months, then you might have an argument that the interest rates are beyond reasonable. But it’s a different story if it’s a loan of a few hundred dollars to be repaid over the course of the week or two. In this case, it’s scarcely worth it for the payday institution to even transact the loan. Under the latter scenario, the cost to process the loan requires a larger interest rate on a small principal. This scenario, as I understand it, is the more common of the two in reality: small, very short-term loans. Not great (relative to other types of short-term lending), but predatory?

As I said before, I’m not trying to praise payday lending; I’m just trying to shed light on its supposed vices. It could very well be that payday lending institutions should be more tightly regulated, given that its consumer borrowers have less recourse to the legal system in the event of a financial dispute. That may very well be the case, but seriously, enough with the blanket statements!

Posted by cicero785 | Report as abusive

Credit card companies have high fees and interest rates because they are offering “unsecured” loans that are inherently risky. Look at the massive losses of the credit card companies over the last year even with these “high fees and interest rates”, they obviously weren’t high enough.

We already have what are essentially “non-profit institutions which exists to provide credit to the poor”, they are called Fannie Mae, Freddie Mac and FHA, how are they working out?

If you don’t price credit properly you have losses, there is no free lunch

Posted by dis737 | Report as abusive

it’s a waste of time dealing with McArdle.She lives in glibertarian la-la land where everyone makes rational decisions and the poor are there because they’re lazy.

Posted by schooner | Report as abusive

But that group that supposedly ends up “much worse off” – is that even true? Basically, they were screwed to begin with, and then they go into bankruptcy if it doesn’t work out. There’s no debtor’s prison, so I don’t see how this outcome is so terrible. (Though I guess I should not say this out loud, since the stigma of bankruptcy is important to maintaining the financial system.)

Posted by milo | Report as abusive

When it comes to Megan McArdle, the best policy is the old Usenet standard: Please don’t feed the trolls.

Posted by AndrewBW | Report as abusive

If you’re “poor” and don’t have much in accessible savings cutting up your credit cards is beyond foolish. In fact, it might be foolish even if you do have an emergency fund set aside. Those cards provide a convenient safety net and are well worth the price no matter the interest rate. In this respect, I think the democratization of credit (mainly through cards) is a good development overall. Want to really help the poor? Don’t tax (or withhold) on the first 25k of income.

Posted by Sensei | Report as abusive

Stupid question: How come no competitors have shown up to offer payday loans at reasonable rates of interest? Anyone who tried could make a killing, couldn’t they?

Unless…

I’m tempted to say that since borrowing money at high rate to pay for everyday necessities is the surest way of getting into financial ruin, it’s best not to do it. Period. But this is easier said than done. So I’d qualify that by saying it might be ok to do, if one’s only temporarily ‘broke’, instead of being chronically ‘poor’.

For people who can’t afford necessities, the community as a whole (city, state, the Federal gov) should provide assistance or loans at low rate; instead of pushing them into the embrace of loan sharks. Yes, credit card companies, like pay day loan providers, are loan sharks. Once you get trapped there, you become the slave of your debt and servicing the high interests is all you can manage.

Of course, the last saving grace – bankruptcy – was made extraordinarily hard for average people a few years back, when they changed bankruptcy law. So you’d be in a nice deep hole that’s almost impossible to crawl out. It’s a shame that we allow people in need to be so exploited and then kicked them even deeper by denying them the only escape by way of declaring bankruptcy.

The entire social contract needs to be renegotiated, be it executive pay, Wall Street bonuses, labor laws, public discourse … I came to the US in ’97, and have unfortunately been watching the country slipping into the opposite of what I came here for. I’m doing fine personally, but the rise of the oligarchy and the privileged vs. the decline of the middle-class and general welfare of everyone and everything that’s not supported by the rich is so striking, it’s breathtaking.

Posted by jian | Report as abusive

I totally agree with this guy Marie Antoinette, I mean Felix Salmon. Absolutely, before you take out a payday loan, you should exhaust your personal line of credit. In fact, if that runs out, you should call your relationship manager and tell her the room charges at The Breakers were more than you expected, and you need the line amount increased. If she says no, remember that she’s just a flunky. Call your FA and tell him you’re moving your account to Goldman if he doesn’t get your line increased. Or call the guys you work with on the IB side and tell them that the next offering is going elsewhere unless the private banking group shapes up. Only when those approaches fail should you even consider a payday loan.

Posted by y81 | Report as abusive

Lots of poor people live hand to mouth and don’t have the discipline to build up a cash buffer. That’s where the credit demand comes from. Of course, since this is an expense, access to credit only makes poor people poorer (despite the fact that this activity wins Nobel prizes).

Posted by Max | Report as abusive

It’s lovely that you work with a non-profit that provides credit for the poor. Now go spend a month working at a for-profit business that actually deals with the poor on a daily basis and you’ll understand why most of what you write is blather.

Posted by Ted Craig | Report as abusive

People can use payday loan for any purpose like car repair, credit card payment, school fee etc and payday loan has to be paid back on the day you receive your salary. If you wish to extend the payment period, you can do so until your next payday, by just paying a small fee. earlier than the due date, without paying any penalty.

well. personal loan is very gud for poor and needy people.

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