Costly Cash: Don't Expect Federal Regulators to Protect You From Payday Loans

Almost every month, the major consumer and financial regulators in the U.S. issue warnings about payday lenders.

At the end of February, top government regulators at the Federal Reserve Bank of San Francisco and the Federal Deposit Insurance Corp. held a symposium to "inform community leaders and stakeholders about the dangers of payday loans and some of the better alternative products that are available." On its website, the Federal Trade Commission says "regardless of their name, these small, short-term, high-rate loans by check cashers, finance companies and others all come at a very high price." And on March 2, the nonprofit Better Business Bureau released a warning against online payday lenders, saying they trap consumers in a "debt spiral."

And yet the movement to regulate the payday lending industry on a federal level has lost steam, partly because lawmakers seem to have come around to the industry's point of view rather than the consumer's.

"Crippling Effects"

Last year, fresh off the financial crisis, strident lawmakers pledged to strengthen consumer protections against predatory mortgage lenders that lured borrowers with zero-interest loans and option-ARM loans (which give borrowers the ability to choose what kind of payment to make each month). These loans drove many homebuyers into foreclosure and bankruptcy. So, legislators pledged to form a Consumer Financial Protection Agency that would look into all sorts of questionable financial practices, including payday loans. Two bills were introduced to curb payday lenders -- one in the Senate from Sen. Dick Durbin (pictured) and another in the House from Rep. Luis V. Gutierrez, both Illinois Democrats.

"Within blocks of my home in Springfield, Illinois, there are payday lenders charging interest rates of two and three hundred percent of the value of the loan," said Durbin, in a statement when he introduced the bill."These excessive rates are often hidden and can have crippling effects on those individuals who can afford it least. Congress must enact protections against predatory lending. America's working families depend on it." Durbin's bill called for a 36% interest rate cap on these loans.

And Gutierrez said in a statement that the "status quo in the payday lending industry is unacceptable," and he vowed to "fight to provide a federal safety net for the working poor."

Frustrated Consumer Advocates

Today, the promises to fight the financial industry's predatory practices and protect consumers seem to have been forgotten. The Consumer Financial Protection Agency might never be formed. The payday lending cap isn't high on Durbin's current agenda. "There is a chance this comes up during the debate on financial regulatory reform in the Senate," says Max Gleischman, national press secretary for Durbin. "It's unclear when that may happen, but later this spring is a possibility."

And Gutierrez's effort to include an amendment on payday reform in the Wall Street Reform and Consumer Protection Act was defeated in committee. Says Guitierrez, who continues to support forming a consumer protection agency: "Taxpayers deserve an institution that guards them from misuse and abuse of their hard-earned dollars, and we are long overdue in providing them the watchdog they deserve."

Community activists who work closely with people caught in debt spirals due to the high-cost loans taken out from payday lending stores are frustrated. They say the inaction on the part of legislators is hurting the most vulnerable members of society, especially in the Great Recession that has taken jobs away from over 8 million people in the last two years.

"We have to create laws that are in the best interest of our society, not businesses," says Emily DeMaria, vice president of community development at nonprofit United Way Capital Area in Austin, Texas. "Think about it. Time and again the tradition of usury has been found to be wrong, whether in the Bible or in the Islamic Koran, and that's because of the harm it does to society." DeMaria is working on an initiative with lower- and moderate-income "unbanked" people in Texas to help them access affordable credit and find ways to save money.

Follow the Money

A big part of the reason for this loss of steam in Washington is that the payday industry has been spending a lot of money there. The industry's trade group, The Community Financial Services Association, spent $2.56 million lobbying Congress in 2009, or 74% more than in 2008, according to opensecrets.org, run by the nonpartisan nonprofit Center for Responsive Politics.

At least three payday lenders even makethe organization's list of the top 15 financial industry donors to current lawmakers, including the nation's largest bank, Bank of America (BAC) and credit card lender American Express (AXP). Cash America International (CSH) contributed $629,229 million and was ahead of MasterCard International (MA) and conglomerate General Electric (GE) on the list. Advance America Cash Advance Centers (AEA) contributed $335,275, while QC Holdings (QCCO) gave $305,569, according to opensecrets.org.

"We, and other industry participants, have been very active on Capitol Hill this year educating members about the service we provide and the lack of real alternatives for our customers," said Daniel Feehan, CEO of Cash America International, in a conference callto discuss earnings with analysts.

A March 9 report in The New York Times detailed how Sen. Bob Corker (R-Tenn.) helped remove a provision from the Senate's financial overhaul legislation that would have given the proposed consumer protection agency the power to regulate payday lenders. The Times account raised questions about campaign contributions Corker (and other legislators) have gotten from payday loan industry donors. Wrote the Times: "Asked whether the industry's campaign contributions to [Corker] had shaped his thinking about the issue, he replied, 'Categorically, absolutely not.'"

More Protections for Military Personnel

Payday lending is primarily regulated at the state level, which is why each state has its own story. At the federal level, only the military is protected. In October 2006, Congress passed a law capping all lending to military personnel to a maximum of 36% APR after a report from the Defense Department called payday lending "predatory" and said among other things that the lenders "seek out young and financially inexperienced borrowers who have bank accounts and steady jobs, but also have little in savings, flawed credit or have hit their credit limit."

Even though the findings mirror the research not just for military personnel but from consumer advocates across the country, the law doesn't apply to all American citizens, and the industry has fought such rate caps.

"We can't make a profit on 36% loans," says Steven Schlein, a spokesman for the payday lending trade group, the Community Financial Services Association.

Still, at least 16 states have rate caps on payday lending ranging from 17% to 60%, according to the Center for Responsible Lending. And more states are setting limits. In Colorado, a bill was introduced that would cap payday loan rates at 36%, and a similar effort is going on in Montana. In Arizona, a temporary exemption from its 36% cap will expire on June 30.

Getting Around the Rules

However, payday lenders are always looking for loopholes, as in Ohio, where citizens in 2008 voted to cap rates at 28% on payday loans. "The rationale was not to drive them out of business, but to find a way to provide loans with less burdensome interest rates for the needy," says Richard Cordray, Ohio's attorney general. But payday lenders relicensed themselves under Ohio's small-loan and mortgage-loan laws, and continue to operate without really changing how much they charge borrowers.

"The gist is that they charge rates that are within limits imposed by law, but other fees are tacked on, and the effective costs translate into a rate that is close to where they were, and in some cases are even more costly," says Cordray. "Further efforts to close the loopholes have met with no success."

Editor's Note: This is the fourth in a series of stories about money stores and payday lending that DailyFinance is running this week. On Tuesday, we published stories about the payday lending industry's growth during the Great Recession and about how a Texas retiree wound up with a 375% loan for $4,000. On Wednesday, we looked at how several cities in Texas are restricting the spread of money stores in their towns. Thursday examined Congress's lost zeal for regulating payday lenders. And Friday's final installment reviews some alternatives to payday loans for folks who find themselves strapped for cash.