From the Janesville Gazette (6/13/09)
By Mark Schug
Last month, a coalition of Wisconsin legislators announced the introduction of a bill that would limit consumers’ access to lines of short-term payday loans.
While some legislators backing this “reform” have good intentions, it belies a certain economic illiteracy that they can’t see what the unintended consequences of a rate cap would be. The bill’s central regulation is a ban on interest and fees that, combined, total less than two pennies for every dollar borrowed in connection with a short-term loan. This is an outright price control that will ultimately hurt the consumers it is supposed to protect.
Anyone who has taken high school economics should see how this artificial price control would cause problems, but it seems that many have forgotten the lessons of Econ 101. A recent poll found that a large percentage of Americans actually support federal price controls on everything from sports cars to cups of coffee.
What price-control supporters don’t understand is that when a new price level is imposed by legislation, consumers will want more of the product than suppliers can provide. So in the case of short-term loans, the result of a legislative price control will be shortages in the market. At a number as low as 36 percent, those shortages will be severe.
Such legislation is the equivalent of capping the price of a gallon of milk at 32 cents. To a consumer, that might sound great, but any Wisconsin dairy farmer would be able to explain the negative consequences.
And milk consumers would soon be upset at their own shortsighted desires. They would experience milk shortages—the inevitable result of setting milk prices below market rates.
The greatest damage will be done to those individuals who responsibly use payday loan services. Borrowers choose these short-term payday loan products because they have found them to be their best alternative.
And borrowers’ other options are never good. They can’t go to a traditional bank because banks don’t usually make personal loans for just a few hundred dollars. Remaining options, such as overdraft fees, bounced checks, or just paying bills late, are more costly and problematic.
Government price controls are not the answer, and there is a better way.
Increased competition in the short-term loan market seems, on balance, to be a far better solution than government-sanctioned controls. Wisconsin’s financial institutions are already bringing new products to the market. Some Wisconsin credit unions, for example, offer a new program called Real Solutions. This program offers small loans with competitive annual percentage rates. They often include starting saving programs to establish an emergency fund, as well as financial education and counseling.
Legislators should focus on programs that ensure Americans will have the tools and information to make the best possible choices for their own needs. While payday loans might be expensive, imposing price controls will have unintended consequences that will harm the same Wisconsinites supporters of this legislation are trying to help.
Mark Schug is professor emeritus and former director of the Center for Economic Education at UW-Milwaukee. He is a national consultant on economic and financial education. E-mail: Econliteracy@gmail.com.