There are serious flaws in the Defense Department’s recent Report on Predatory Lending Practices Directed at Members of the Armed Forces and Their Dependents (the “DoD Report”). Those flaws involve fundamental matters of both methodology and policy.
Hilary B. Miller, President, Payday Loan Bar Association

The DoD Report asserts — again adopting, without analysis or question, the CRL view — that the short-term nature of the loan, without more, renders a payday loan “predatory.” The sole support for this claim is the unsubstantiated statement that “75% of payday customers are unable to repay their loan within two weeks.” There is no factual basis for this statement.

Following is the statement of Hilary B. Miller, President, Payday Loan Bar Association, Regarding Predatory Lending Practices Directed At Members of the Armed Forces and Their Dependents before the Senate Committee on Banking, Housing and Urban Affairs.

Mr. Chairman and members of the Committee, it is a distinct honor to appear before you today. My name is Hilary Miller, and I am president of the Payday Loan Bar Associa-tion. I am here today as an expert in subprime lending, and I appear on behalf of the payday-advance industry’s national trade association, the Community Financial Services Association of America (“CFSA”).

Our bar association and CFSA both subscribe to the highest principles of ethical and fair treatment of borrowers. CFSA represents owners of approximately half of the estimated 22,000 payday-advance retail outlets in the United States. CFSA has established — and, critically, enforces among its members — responsible industry practices and appropriate consumer rights and protections, including special protections for the benefit of military personnel.

There are serious flaws in the Defense Department’s recent Report on Predatory Lending Practices Directed at Members of the Armed Forces and Their Dependents (the “DoD Report”). Those flaws involve fundamental matters of both methodology and policy.

Decisions having potentially far-reaching implications regarding the cost and avail-ability of consumer credit used by members of the Armed Forces must be reached only after careful gathering of data from a variety of sources and even-handed analysis of such data.

By failing to synthesize information from balanced sources — and by systematically excluding any input from independent economists, consumer-credit experts or the industry itself — the DoD Report presents the views only of opponents of the kinds of lending dis-cussed.3 The result is a biased, inaccurate and incomplete picture of the market for such credit, of the industry’s practices and, most importantly, of the likely impact on military consumers were the DoD Report’s recommendations to be adopted.

These protections and information resources for service members, which include prohibitions on garnishment and on contacting the chain of command for collection assistance, can be viewed in their entirety here.

A flawed report was perhaps predictable in light of the original directive of Congress that the Secre-tary of Defense consult with “representatives of military charity organizations and consumer organizations” but not with industry representatives, economists or consumer-credit experts. Section 579 of the National Defense Authorization Act for Fiscal Year 2006, P.L. 109-163, 119 Stat. 3276-77 (the “2006 Act”).

The language of the report reveals the author’s bias. Instead of providing an objective explanation of his findings, the author frequently employs normative and emotionally charged terms to describe subprime lending, thereby suggesting — without a basis in re-search — that such lending is a societal evil.

Our industry has a vital interest in making sure that military borrowers can repay their loans, for one simple reason: as lenders, we only make money when our borrowers repay us. If they do not pay, not only do we fail to collect their finance charges — which the DoD criticizes — but we also lose many times those charges in loan principal. In short, it is con-trary to our interests to have service members get into trouble with their loans. And the rea-son we lend to military borrowers at all is that the entirety of the available scientific data suggest that only a tiny percentage of military borrowers actually do get into trouble with payday loans. Anecdotes derived from a non-representative sample of this small group are now being used to drive public policy for the much larger numbers of military borrowers who use payday loans for their intended purpose and who repay their loans on time.

Here are some of the DoD Report’s principal flaws:
• The DoD report determines that payday loans are “predatory” solely by uncriti-cally adopting eight factors used by a vociferous opponent of the industry, the Center for Responsible Lending, without making an independent determination that such loans are “unfair” or “abusive” as required by the applicable statute. No other recognized authority has adopted these factors.

• According to DoD’s own internal data, fewer than 5% of service members have had a payday loan.

• Because fewer than 6% of payday loans ultimately default, at most 6% of that 5%, or 0.3%, of all service members have experienced financial difficulty with a pay-day loan. In other words, 99.7% of service members have either not had a payday loan or experience no financial difficulties with payday loans. There is simply no statistical evidence that payday loans contribute to military readiness problems to any measurable degree.

• Although some service members with financial problems have taken out payday loans, DoD has presented no data showing that payday loans cause financial prob-lems. Payday loans are intended to solve short-term financial problems, and the overwhelming majority of users employ them in that manner.

• DoD’s data regarding asserted hardship relating to payday loans consist of a mere 12 anecdotes drawn from the experiences of 1,400,000 or more service members.

• For a sample of service members with payday loans who have experienced bank-ruptcy, payday loans account for less than 4% of their total liabilities, and the fi-nancial difficulties suffered by such service members manifestly relate to preexisting (i.e., non-payday-loan) factors.

• DoD’s data regarding “targeting” of service members by payday lenders are flawed because they do not control for demographics and fail to include tests of statistical significance. The “targeting” argument assumes, in defiance of logic, that the industry would commit disproportionate resources to customers who ac-count for only 1% of revenues.

• Service members appreciate the convenience and ease of obtaining a payday loan; 78% of service members with payday loans agree that “most people benefit from the use of credit.”

• DoD’s principal recommendation is to reduce the maximum permissible charge on such loans to 36%, which is below lenders’ marginal cost — thereby driving le-gitimate, regulated lenders out of the market and compelling borrowers to deal with illegal lenders. Those lenders would just as likely pursue illegal collection methods.

• A 36% rate cap is not the only possible approach to addressing the needs of over-burdened service members. The industry has suggested allowing service members a longer repayment plan similar to that offered by the banks highlighted in the DoD Report. Our proposal to DOD was to allow service members to repay their defaulted loans over a term of six months or longer, and to limit interest rates to 36% in the post-default period. It is hard to understand why the bank program is embraced by DoD and the payday-advance industry’s proposal is ignored.

• Ironically, payday lending competes with bank and credit union overdraft charges and service fees and is often less expensive for the consumer. For example, if a service member is a Pentagon Federal Credit Union member, the charge for a $100 overdraft is $25; our industry typically charges only $15 for a $100 advance. Simi-larly, Pentagon Federal’s late charge on a credit card is $39, which explains why more than 70% of our customers use payday advances to avoid late fees.

In a comprehensive submission attached to these remarks, we discuss the DoD Report as it addresses payday lending. However, many of our criticisms of the DoD Report are equally applicable to the other forms of credit addressed in the DoD Report.
The DoD Report should be rejected, and the subjects raised by the report should be given appropriately balanced further study and analytical reflection by qualified experts.

Thank you for your interest. I will be pleased to take any questions.

Analysis
Payday Loans Are Not “Predatory”
The DoD Report adopts wholesale, and without critical analysis, a set of eight criteria promulgated by a vociferous opponent of the industry, the Center for Responsible Lending (“CRL”) , for determining whether a payday loan is “predatory.”4 No political, regulatory or academic authority has adopted CRL’s criteria. There exists no principled rationale for the use of these criteria to the exclusion of more established notions of what constitutes a “predatory” loan.

Although not clear from the DoD Report, it appears that both CRL and the author of the DoD Report believe that the CRL criteria should be applied disjunctively; i.e., that a loan that possesses any one of the eight criteria is “predatory.” Since all payday loans possess at least two of the CRL criteria (“high” cost and the use of a check-repayment mechanism), the DoD Report effectively classifies all payday lending as “predatory” — without making an independent determination, as required by Congress, of how payday loans are “unfair or abusive” (within the meaning of the 2006 Act6). By circularly defining payday loans to be “predatory,” the result of the DoD Report is a political statement, not science.

We discuss these eight factors individually.

— Interest Rate
The DoD Report’s principal objection to all of the types of loans it criticizes is their “high cost.”7 Yet no other authoritative source has classified any form of consumer lending as “predatory” based solely on pricing.
DoD Report at pp. 13-14.

A standard definition is an unsuitable loan designed to exploit vulnerable and unsophisticated bor-rowers. A predatory loan has one or more of the following features: charges more in interest and fees than is required to cover the added risk or cost of lending to borrowers with credit imperfections, contains abusive terms and conditions that surprise or trap borrowers and lead to increased indebtedness, does not take into account the borrower’s ability to repay the loan, or violates fair lending laws by targeting women, minorities and communities of color. Payday loans meet none of these criteria. See, generally, U.S. Dep’t of Treas-ury/U.S. Dep’t of Housing and Urban Development, Joint Report on Recommendations to Curb Predatory Home Mortgage Lending (2000), available at http://www.hud.gov/library/bookshelf12/pressrel/treasrpt.pdf (visited August 29, 2006).

Section 576(c)(2) of the 2006 Act defines a “predatory lending practice” as “an unfair or abusive loan or credit sale transaction or collection practice.”
DoD Report at pp. 13, 16-20.

As a general matter, consumer credit experts understand the term “predatory” to be rooted in decep-tive and/or illegal practices to coerce borrowers into unfavorable agreements. Stephen C. Bourassa, Predatory Lending in Jefferson County. University of Louisville 2003, http://www.lul.org/foreclosed.htm (visited Au-gust 29, 2006). See also, Remarks by Governor Edward M. Gramlich at the Housing Bureau for Seniors Conference, Ann Arbor, Michigan (2002):

In understanding the problem, it is particularly important to distinguish predatory lending from generally beneficial subprime lending. Predatory lending refers to activities and practices just cited — asset-based lending, loan flipping, packing of unnecessary fees and in-surance, fraudulent or deceptive practices. Subprime lending, on the other hand, refers to en-tirely appropriate and legal lending to borrowers who do not qualify for prime rates, those rates reserved for borrowers with virtually blemish-free credit histories. Premiums for ex-tending credit to these borrowers compensate lenders for the increased risk that they incur and range several percentage points over rates charged on prime loans. Although some have argued that these premiums are excessive, market forces should eliminate inappropriate spreads over time.

In the case of payday loans, the cost of credit, standing alone, is neither “unfair” nor “abusive,” even though the interest rates on such loans (expressed as an annual rate) are nearly universally in the triple digits. Rather, such pricing has been found to be justified by the fixed costs of keeping stores open and the relatively high initial default rates on such loans. To the extent that CRL — and the author of the DoD Report, by unquestioningly adopting CRL’s political views — claim otherwise, their views are inconsistent with the research of federal consumer credit regulators.

In large measure, the perceived high cost of payday lending is driven by the small dol-lar amount of each loan, the high cost of maintaining stores in operation (both during and outside of traditional business hours), and the costs of marketing, originating and collecting such loans. Payday loans are thus “expensive” for the same reason that, for example, small quantities of food, available on a 24/7 basis from 7-Eleven, cost more than the same items purchased in bulk from Sam’s Club during regular business hours. Likewise, so-called “low-documentation” mortgage loans have higher default rates and are more expensive than those based on more time-consuming credit investigations.10 Consumers who buy in small quantity and want it “right now” and with no “hassle” pay higher prices for those privileges. This is not an unfair or deceptive business practice; it is part of the American system of freedom of economic choice.

There is no evidence that payday-loan pricing causes economic harm. Indeed, bor-rowers’ economic welfare is generally enhanced, rather than reduced, as a result of such borrowing. Any analysis of the cost of payday-loan credit must take into account the cost to the borrower of not obtaining such credit. For example, a consumer with limited credit alter-natives may write a check drawn on insufficient funds. Even if the depository bank pays the overdraft, the cost of such credit is substantial, because the consumer is charged a service charge of $18 to $25 (or more) for the overdraft.11 But in most cases, middle-income con-sumers do not find that their banks are willing to pay overdrafts; rather, the checks are re-turned unpaid. When the check “bounces,” not only does the consumer’s bank impose its service charge, but the consumer is also subjected to a returned-check fee by the merchant to whom the check had been written — generally another $25 or more. Thus, the total cost of “bouncing” a check, which may provide a consumer with a few days or weeks of credit until the check is paid is often $45 or more. Alternatively, a consumer with limited credit alterna-tives may engage in self-help to obtain an extension of credit in the form of a deferred pay-ment of rent, a utility bill, or an installment due on a mortgage or a car loan. Such late payments will generally subject the consumer to late fees — penalties charged by the land-lord or creditor which are very substantial relative to the true amount of temporary credit of which the consumer has availed himself. If the payment is made to a utility, often the con-sumer is subject to disconnect and/or reconnect fees. These charges have also risen to the point that consumers will almost always find it less expensive to employ a payday advance instead. Academic literature supports this welfare-enhancing view of payday lending.

The pricing of payday loans is thus not “unfair” because, among other reasons, given the costs of providing credit, such pricing does not result in a grossly disproportionate ex-change of value with the consumer or excess profitability to the lender.

A recent study by Karlan and Zinman (2006) provides the best and most complete sci-entific answer to the question, “Do high-interest short-term loans harm consumers?” The authors used a lender to conduct a large-scale, randomized trial in which marginal borrowers who would not ordinarily receive access to short-term loans were granted loans. Those who received these loans were, one year later, less likely to be poor, unemployed or hungry.13 There is no comparably rigorous study showing a contradictory result.

The cost of overdraft-protection credit can be astronomical and generally exceeds the cost of com-parable payday-loan credit. Banks are not required to disclose these costs as an annual rate. For unknown reasons, the DoD Report does not address them.

The notion that the borrower engages in his own welfare-enhancement calculus is likewise suggested by Thomas E. Lehman of Indiana Wesleyan University:

In all likelihood, the borrower cares not what the “effective APR” is on the loan. The real price signal to which the borrower responds is the flat fee that is charged to hold the postdated check. If the value attached by the borrower to the immediate cash advance ex-ceeds the value of the [principal] plus the fee one or two weeks hence, then the borrower will undertake the transaction . . . .
“In Defense of Payday Lending,” The Free Market, Ludwig von Mises Institute, Vol. 23, No. 9 (2003).

In summary, there is no authoritative or theoretical support for the DoD Report’s conclusion that the “high” interest rates traditionally charged on payday loans, without more, render them “predatory.”

— Short Minimum Loan Term
The DoD Report asserts — again adopting, without analysis or question, the CRL view — that the short-term nature of the loan, without more, renders a payday loan “predatory.”

The sole support for this claim is the unsubstantiated statement that “75% of payday customers are unable to repay their loan within two weeks.” There is no factual basis for this statement.

Both CRL (and the author of the DoD Report) assume, without factual basis, that the reason all payday loans that have been renewed, or “rolled over,” is that the borrowers were unable to repay them. This conclusion is but one of many possible conclusions why borrow-ers may choose to extend the maturity of their loans. None of the academic literature in this field addresses the reason for “rollovers.”

Even assuming that the average number of rollovers cited for non-military users were correct, the rate of repeat usage of payday loans among military borrowers is known to be much lower. In a recent independent study, 49% of military enlisted payday-loan borrowers reported they have used a payday loan no more than twice in the last year (compared to 16% of the general population of payday borrowers); 79% said they had no more than four loans in the last year (compared to 65% of the general population).