KU finance professor Bob DeYoung is the main source in Freakonomics Radio’s latest episode, “Are Payday Loans Really as Evil as People Say?”
Journalist Stephen Dubner looks at the economics and moral implications of payday loans, which are short-term financial instruments that have received criticism from President Barack Obama, federal regulators and advocates for low-income individuals.
“Critics say short-term, high-interest loans are predatory, trapping borrowers in a cycle of debt,” Dubner writes. “But some economists see them as a useful financial instrument for people who need them.”
Freakonomics notes roughly 20,000 payday loan shops exist in the U.S., with a total loan volume estimated as around $40 billion a year.
Dubner turned to DeYoung for an objective, academic perspective on the payday lending industry (an oftentimes political and controversial subject).
DeYOUNG: Most folks hear the word payday lending and they immediately think of evil lenders who are making poor people even poorer. I wouldn’t agree with that accusation.
DeYoung and three co-authors recently published an article about payday loans on Liberty Street Economics, a blog run by the Federal Reserve Bank of New York, titled “Reframing the Debate About Payday Lending.”
DeYOUNG: We need to do more research and try to figure out the best ways to regulate rather than regulations that are being pursued now that would eventually shut down the industry. I don’t want to come off as being an advocate of payday lenders. That’s not my position. My position is I want to make sure the users of payday loans who are using them responsibly and for who are made better off by them don’t lose access to this product.
Payday loans are criticized for high interest rates, sometimes 400 percent on an annualized basis, but DeYoung argues that you’re missing the point if you focus on annual interest rates.
DeYOUNG: Borrowing money is like renting money. You get to use it two weeks and then you pay it back. You could rent a car for two weeks, right? You get to use that car. Well, if you calculate the annual percentage rate on that car rental — meaning that if you divide the amount you pay on that car by the value of that automobile — you get similarly high rates. So this isn’t about interest. This is about short-term use of a product that’s been lent to you. This is just arithmetic.
The episode concludes with DeYoung’s argument that payday loans are “not as evil as we think.”
DUBNER: Let’s say you have a one-on-one audience with President Obama. We know that the President understands economics pretty well or, I would argue that at least. What’s your pitch to the President for how this industry should be treated and not eliminated?
DeYOUNG: OK, in a short sentence that’s highly scientific I would begin by saying, “Let’s not throw the baby out with the bathwater.” The question comes down to how do we identify the bath water and how do we identify the baby here. One way is to collect a lot of information, as the CFPB suggests, about the creditworthiness of the borrower. But that raises the production cost of payday loans and will probably put the industry out of business. But I think we can all agree that once someone pays fees in an aggregate amount equal to the amount that was originally borrowed, that’s pretty clear that there’s a problem there.
DeYoung is the Capitol Federal Distinguished Professor in Financial Markets and Institutions at the KU School of Business.