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«OHIO STATE LAW JOURNAL VOLUME 66, NUMBER 4, 2005 Predatory Lending and the Military: The Law and Geography of “Payday” Loans in Military Towns ...»

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33 Christopher L. Peterson, Note, Failed Markets, Failing Government, or Both?

Learning from the Unintended Consequences of Utah Consumer Credit Law on Vulnerable Debtors, 2001 UTAH L. REV. 543, 563.

34 IND. DEP’T OF FIN. INSTS., supra note 30, at 1.

35 See Stay Away from Payday Lenders: There are Few, If Any, Sensible Reasons to Use 662 OHIO STATE LAW JOURNAL [Vol. 66:653 prices as a percent of the principal borrowed.36 For instance, if the consumer borrows $300 for two weeks in exchange for a fee of $52.50, lenders will often describe this as a “17.5%” loan. Lenders suggest payday loans compare favorably to bounced check fees, which average around $21.37 Critics of payday lending retort that a bounced check fee is a one-time charge that does not continue to compound again and again.38 For loans, annualized interest rates are the uniform metric which all mainstream creditors use to compare prices. Home mortgages, student loans, and automobile loans are all disclosed and regulated with an annual percentage rate terminology. Even other short-term lenders, such as credit card issuers, use annual percentage rates. Consumers wishing to compare the price of available credit options tend to be confused and surprised by different price quoting conventions for different types of credit. To those with limited financial literacy, or even to casual observers, a cash advance or purchase on a 17.5% APR credit card may be indistinguishable from a payday loan with 17.5%-of-principal fee. Most payday loan borrowers will be surprised to know that the interest rate of the latter loan is about 26 times more expensive than that of the former. Not surprisingly, one industry-sponsored telephone survey found that 72% of payday loan borrowers said they did not know the annual percentage rate of their most recent loan.39 More than half of the small minority who claimed to know their annual percentage rate incorrectly believed that their rate was far lower than it actually was.40 Annual percentage rate terminology is also appropriate for payday loans because these loans often compound for durations coming close to or exceeding a year. For any given loan, many payday loan borrowers simply lack the funds to pay on the due date and are accordingly forced to roll over the loan.41 Compelling evidence suggests that a substantial portion of the payday loan market is made up of extensions of previous loans, sometimes for protracted a Payday Lender, WIS. STATE J., Nov. 10, 2002, at B3.

36 Professor Johnson’s study of Ohio payday lending found that lenders systematically obscure their annual percentage rates by leaving them out of advertisements and refusing to provide Truth in Lending disclosures until after loan consummation. See Creola Johnson, Payday Loans: Shrewd Business or Predatory Lending?, 87 MINN. L. REV. 1, 38–41, 44 (2002).

37 BD. OF GOVERNORS OF THE FED. RESERVE SYS., ANNUAL REPORT TO THE CONGRESS

ON RETAIL FEES AND SERVICES OF DEPOSITORY INSTITUTIONS 5 (June 2002).

38 See John Hackett, Ethically Tainted, U.S. BANKER, Nov. 2001, at 48, 50.

39 JOHN P. CASKEY, THE ECONOMICS OF PAYDAY LENDING 3 (2002) (citing GREGORY

ELLIEHAUSEN & EDWARD C. LAWRENCE, PAYDAY ADVANCE CREDIT IN AMERICA: AN

ANALYSIS OF CUSTOMER DEMAND 54–55 (2001)).

40 Id.

41 Barr, supra note 20, at 156. Some lenders and borrowers use “same day advances” where “[t]he borrower pays the loan in full, but that same day takes out another payday loan in an amount equivalent to the balance paid earlier.” Id.

2005] PREDATORY LENDING AND THE MILITARY 663 durations. North Carolina regulators found that about 87% of borrowers would roll over any given loan at least one time with any given lender.42 Not counting debtors who borrowed from multiple locations, nearly 40% of North Carolina borrowers renewed their payday loans more than ten times.43 The Indiana Department of Financial Institutions study found that 77% of all payday transactions were extensions of previous loans.44 In Oklahoma, the average payday loan customer took out 4.3 payday loans during a four-month period from August 2004 to November 2004—just over one per month.45 Consumer advocates have found that the average payday loan customer borrows 10.19 payday loans per year.46 In Iowa, the Division of Banking found an average of

12.5 loans per year per customer.47 An industry-sponsored study found that 30% of borrowers had seven or more loans in a year, and that about 75% of borrowers rolled over their loan at least one time.48 Regulators in Illinois found payday loan borrowers “who were borrowing continuously for over a year on their original loan.”49 An empirical study by Professor Creola Johnson found that payday lenders repeatedly roll over payday loans even in states with statutes prohibiting this practice.50 Moreover, there are frequent reports of loans outstanding for one, two, or even three years.51 Collectively these statistics have led consumer advocates to argue that payday loans trap borrowers into a cycle of “chain debt.”52 Payday lenders argue that the high prices and long durations of their loans are justified by the high administrative costs of doing business and by the high 42 OFFICE OF THE COMM’R OF BANKS, supra note 31, at 6.

43 Id.

44 IND. DEP’T OF FIN. INSTS., supra note 30, at 3.

45 OKLAHOMA TRENDS, supra note 32, at 9.





46 FOX & MIERZWINSKI, supra note 29, at 8.

47 Kathleen E. Keest, Stone Soup: Exploring the Boundaries Between Subprime Lending and Predatory Lending, in CONSUMER FINANCIAL SERVICES LITIGATION 2001 at 1107, 1114 (Practicing Law Institute Corporate Law and Practice Course Handbook Series B-1241, 2001) (citing IOWA DIVISION OF BANKING, SURVEY (Dec. 2000)).

48 ELLIEHAUSEN & LAWRENCE, supra note 39, at 54–55. This study likely understates the duration of payday loans because it relies on a sample of more affluent payday borrowers, only surveys borrowers willing to discuss their loans, and did not reach borrowers who had their telephone service disconnected.

49 ILL. DEP’T OF FIN. INSTS., SHORT TERM LENDING: FINAL REPORT 30 (1999), http://www.state.il.us/dfi/ccd/pdfs/Shorterm.pdf.

50 Johnson, supra note 36, at 32–33.

51 See Peterson, supra note 33, at 569 n.167 (payday loan store cashier stating loans accrue interest for “two or three years” in state with twelve-week limit on rollover duration);

FOX & MIERZWINSKI, supra note 29, at 8 (loan renewed 66 times for two and a half years).

52 See, e.g., Barr, supra note 20, at 149; Johnson, supra note 36, at 6–7.

664 OHIO STATE LAW JOURNAL [Vol. 66:653 default rates.53 Scholars have countered that high payday loan prices actually “mutually reinforc[e]” loan losses because the high prices induce default, which in turn raises prices.54 Moreover, even if payday loan loss rates justify higher pricing, the payday lending business has still proven wildly profitable. A Federal Deposit Insurance Agency official wrote that, despite credit and reputational risks, “higher pricing on payday loans promises higher revenues and wider margins for lenders.”55 One economics professor has estimated that payday lending operations “earn ten to twenty times higher ‘return on equity’ than traditional banks.”56 Similarly, after the Tennessee Legislature took steps to legalize payday lending, the Tennessee Department of Financial Institutions conducted a follow-up survey, finding that licensed payday lenders “earned over [30%] return on investment in the first nine months of legal operation.”57 But perhaps most interesting is that payday lender profits come disproportionately from high-frequency borrowers. Peter Skillern’s study of the North Carolina market found that 85% of payday lender revenue in that state comes from borrowers receiving five or more payday loans in a year.58 Critics of the payday lenders have also complained of a culture of disregard for the rule of law in the industry. For example, in 713 payday lender inspections conducted over a three-year period, North Carolina banking officials found 8911 violations of simple state consumer-protection rules.59 Payday lenders in many states refuse to obtain licenses required by state law.60 Over a thousand payday lenders in Texas openly ignore state interest rate limitations.61 Creola Johnson’s study of Ohio payday lenders found that payday lenders in 53 See Marcus Franklin, Payday Loans Role Debated at Forum, DAYTON DAILY NEWS, Nov. 9, 1999, at 1B.

54 Barr, supra note 20, at 155 n.148; see also Joseph E. Stiglitz & Andrew Weiss, Credit Rationing in Markets with Imperfect Information, 71 AM. ECON. REV. 393 (1981).

55 Barbara A. Monheit, Consumer Financial Services Litigation: The Regulators Speak,

1361 PRACTICING LAW INSTITUTE: CORPORATE LAW AND PRACTICE COURSE HANDBOOK

SERIES 459, 503 (March-May 2003) (PLI Order No. B0-01TA).

56 Mike Hudson, Going for the Broke: How the ‘Fringe Banking’ Boom Cashes in on the Poor, WASH. POST, Jan. 10, 1993, at C4.

57 FOX & MIERZWINSKI, supra note 29, at 8.

58 PETER SKILLERN, CMTY. REINVESTMENT ASS’N OF N.C., SMALL LOANS, BIG BUCK$:

AN ANALYSIS OF THE PAYDAY LENDING INDUSTRY IN NORTH CAROLINA 4 (2002),

http://www.cra-nc.org/small_loans_big_bucks.pdf.

59 OFFICE OF THE COMM=R OF BANKS, supra note 31, at 2.

60 There are widespread reports of unlicensed payday lenders in many states, including California, Florida, and North Carolina. See infra notes 84, 106, and 130 and accompanying text.

61 JEAN ANN FOX, CONSUMER FEDERATION OF AMERICA, UNSAFE AND UNSOUND:

PAYDAY LENDERS HIDE BEHIND FDIC BANK CHARTERS TO PEDDLE USURY 13 (Mar. 30,

2004), http://www.consumerfed.org/pdfs/pdlrentabankreport.pdf.

2005] PREDATORY LENDING AND THE MILITARY 665 that state systematically provided false and misleading information on loan contract terms, illegally advertised the cost of credit without using annual percentage rate terminology, and allowed “consumers to roll over payday loans in violation of state law.”62 And there are widespread reports that many payday lenders use false but intimidating threats of criminal prosecution under “bad check” laws.63 Needless to say, criminal prosecution has not been a remedy available to traditional creditors since debtors prisons were outlawed after the Civil War.64

2. Payday Lending in History:

Ancient Lineage and Recent Resurgence Payday loans are only one recent incarnation of a consumer financial product dating back to our earliest recorded civilizations. While it is true that the use of a negotiable instrument (or an agreement to allow an electronic debit) as a form of collateral is a relatively recent innovation amongst consumer borrowers, pledging to pay one’s earnings in the immediate future in exchange for money today is ancient. High-cost loans with contractual terms similar to payday loans have existed for thousands of years. Even before governments learned to coin currency, records of ancient Mesopotamian and Mediterranean civilizations amply document high-cost consumer loans payable in grain, animals, or metal.65 Just as today’s debtors collect wages and borrow money using checks, ancient peasants, who earned a living raising grains and animals, repaid their high-cost debts in kind.66 While today’s borrowers wonder whether they will have sufficient funds in their accounts to cover a check post-dated two weeks in advance, ancient debtors “dreaded ‘the end of the moon’” when their high-cost loans came due.67 And, like today’s high-cost debtors, ancient borrowers signed short-term loans intending to repay quickly, but in fact found themselves committed to loans that “often compounded over long periods.”68 “Because [high-cost] creditors lent to those in desperate need of food or shelter, the 62 Johnson, supra note 36, at 32–33.

63 In only one year, payday lenders filed 13,000 criminal charges against their customers in one Dallas precinct. 146 CONG. REC. S178 (daily ed. Feb. 1, 2000) (statement of Sen.

Lieberman). See also Fox & MIERZWINSKI, supra note 29, at 10 (discussing threats of criminal prosecution in Ohio).

64 Christopher L. Peterson, Truth, Understanding, and High-Cost Consumer Credit: The Historical Context of the Truth in Lending Act, 55 FLA. L. REV. 807, 846 (2003).

65 See SIDNEY HOMER & RICHARD SYLLA, A HISTORY OF INTEREST RATES 25–31 (3d rev. ed. 1996).

66 Id.

67 Id. at 35.

68 Id. at 40.



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