Annualized interest rates of two hundred percent a year?

by on July 27, 2010 at 7:17 am in Economics, Philosophy | Permalink

I read someone, somewhere arguing that Elizabeth Warren was the nominee to shut them down.  I am curious about the modern liberal take on autonomy and credit.  Let's say that two gay men, of unknown health status, want to have informed, consensual, unprotected sex.  Should the law prohibit this?  I believe the answer is no.  Furthermore it is not just a matter of enforcement difficulty, it is a question of autonomy.  If you don't think so, modify the example so that two heterosexual people want to have consensual but unprotected sex.  And so on.

The unprotected sex is riskier and less prudent than borrowing money at an annualized rate of two hundred percent.  Why prohibit one and not the other?  Many of the borrowers are being fooled, but others have legitimate reasons to seek the money, such as wanting to buy a birthday present for a visit to one's child, living with a separated spouse.

Is it that sex is sacred but borrowing money is not?  What if you're borrowing money to catch a plane to go have sex?  Isn't sex a big reason why people might borrow money at high annualized rates?  Aren't "sex decisions" some of the least rational we make and the most prone to error?

When I use the ATM, often I am outside the network and thus I am paying annualized interest rates of over two hundred percent a year.  Should someone (other than Natasha) stop me?  Should they only stop me when I am younger and poorer than is the current Tyler?  What about equality before the law?

How many of you would support this same woman — with enthusiasm — if she wanted to ban risky but consensual sex?

Just An Australian July 27, 2010 at 7:27 am

More reason to stop unprotected sex, since it’s more dangerous to other people. (err, of course, I am not in favor of that, but at some stage we’ll have to do something to align fraud rules here ;-)

But actually, no, we now from history that predatory lending must be suppressed and controlled in the interests of a stable society.

Dave July 27, 2010 at 7:37 am

Now you’ve connected financial protection into that whole Israeli court case about rape by deception (http://www.guardian.co.uk/world/2010/jul/25/saber-kushour-rape-deception-charge). Your presumption about informed is the key differentiator. Warren may differ with me on the margin, but I think her #1 complaint is deceptive lending. If it’s a loan, there should be a disclosed interest rate. I think the closer analogy to yours is: should a person be able to lie and say he/she has doesn’t have HIV before having unprotected sex when he or she knows they are positive? (http://en.wikipedia.org/wiki/Criminal_transmission_of_HIV)

Bill July 27, 2010 at 7:51 am

I like this sentence of your post:

“Many of the borrowers are being fooled, but….”

Many of the readers are being fooled, but….

Kristian Koerselman July 27, 2010 at 8:19 am

Does it perhaps have something to do with whether you trust the motives of the society/persons writing the laws for each particular law?

8 July 27, 2010 at 8:21 am

Since the government is going to eventually bail you out (be you a bank or a person) then yes, the government should stop you.

Since the the government is going to pay for your healthcare, then yes, it should stop gay people from having unprotected sex.

There probably needs to be a gay regulator to shut down the riskiest parts of gay culture. If the heterosexuals don’t get the message, increase the scope of regulation to include all sexual activity.

PeterW July 27, 2010 at 8:38 am

I think it IS in fact the case that sex is sacred, or at least that we apply very different moral standards to something so Darwinianly important. Note for example that we allow mate racism with nary a peep but act like we care deeply about all other forms of racism: http://www.overcomingbias.com/2010/02/mate-racism.html

Sleepy_Commentator July 27, 2010 at 8:46 am

“The unprotected sex is riskier and less prudent than borrowing money at an annualized rate of two hundred percent.”

Actually, this is rather debatable. The risk of contracting HIV as a result of unprotected sex, per encounter, is on the order of one chance per thousand. The risk of going bankrupt as the result of borrowing money at an annualized rate of two hundred percent might perhaps be somewhat higher.

Weak puns aside, I think it a very poor comparison. On the one hand, you have a government ‘forbidding’ autonomous and private behaviors, and writing laws that could only be effectively enforced through the dedicated efforts of a totalitarian state. On the other hand, you have the government refusing to extend the power of contract law to certain types of agreements, an act that involves relatively little cost or disruption.

libfree July 27, 2010 at 8:49 am

Isn’t the purpose of bankruptcy law to protect from the servitude of debt? We don’t have debtor’s prison anymore and we give all individuals a means of escape from substantial debt. I’m inclined to favor Tyler on this one.

babar July 27, 2010 at 9:10 am

we do protect people from “consensual” sexual relations where there is a large imbalance of power. you may disagree with where society draws the line in certain cases but the concept is clear. for instance, should it be legal if a drug company pooled the wives of men who were receiving a certain prostate therapy into a an executive harem as a condition of their husbands receiving the drug? no. and i am sure you economists can come up with examples where this would benefit all participants and/or save lives by some measure.

JG July 27, 2010 at 9:12 am

There are a couple of issues: I think it’s more an issue of those who tend to take 200% loans are taking a much larger loan in terms of their net worth then the implicit risk of the net worth of the unprotected sex. For example, we don’t really have an issue with Bill Gates taking a $1,000 loan at a rate of 200% because we think it’s pretty clear that he’s fully understanding of the loan and capable of repaying it.

It’s a completely different scenario when someone with $5,000 in credit card debt takes a $1,000 loan with 200% interest. It’s unlikely this person is capable of repaying this loan so in practice this type of loan can only be enforced by the use of force an violence.

As a response: What does it mean for someone to be paying a 200% interest rate? If you assume interest payments will be made, it would mean that there is over a 100% chance of default so clearly there is a very high likelihood that no interest payments will be made.

Thought question: there is probably a certain interest rate where the practical repayment goes to zero. If a company comes to you asking for a loan willing to pay 7%, you might assume slightly higher risk, but not unheard of risk, now what if the same company with the same financials comes willing to pay 40% interest? It seems in the second case most people would feel quite uncomfortable even if they were willing to give the loan in the first case. There is an implicit asymmetry in high interest rate loans, the assumption is that even those taking the loans believe themselves to be very high risk and therefore think they are gaining value by taking a loan that implies it is unlikely to be repaid.

Cliff July 27, 2010 at 9:19 am

JG, this is gibberish: “What does it mean for someone to be paying a 200% interest rate? If you assume interest payments will be made, it would mean that there is over a 100% chance of default”

cynic July 27, 2010 at 9:25 am

It’s a question of expertise. Unprotected sex is a pretty common knowledge, and the population is educated about it. People generally can’t self-diagnose and prescribe medication, because that’s far outside their expertise, whether they know it or not.

The argument is that high-interest lending falls into this category. Probably some of it does. It’s quite similar to a lot of legal restrictions on what can and can’t be in a contract, simply because contracts that participants can’t fully understand are generally harmful/predatory, etc.

Joshua Johnson July 27, 2010 at 9:43 am

“When I use the ATM, often I am outside the network and thus I am paying annualized interest rates of over two hundred percent a year.”

There are plenty of free banks that offer ATM reimbursement. I just signed up for a credit union that offers ATM reimbursement, plus I get 3.51% APY on my checking account with no minimum balance. You earn the 3.51% up to a balance of $25,000. All that is required is 12 debit transactions, a direct deposit or ebill pay, and online statements. The account is called Kasasa, which is a company that apparently licenses this deal out to small credit unions and banks to attract members that are income generators just from debit transactions.

I don’t want to spam but I think other people would be interested since people reading this blog are probably closer to rational actors than the rest of society. More info at checkingfinder.com

Ken Rhodes July 27, 2010 at 9:59 am

Interesting analogy to sex, but not appropriate in its detail.

Is anybody proposing that payday borrowing should be banned? My understanding is that the uproar is against the payday lenders. The appropriate analogy, then, would be to outlaw prostitutes from selling unprotected sex to their clients.

Don’t we do that now in most jurisdictions?

floccina July 27, 2010 at 10:08 am

Many democrats seem to simultaneous believe that people do not learn from such scams and yet that all people can be schooled up to intelligence. Very interesting.

Democrats want to out law these loans but are often supporters of the tax on stupidity (that is the state lotteries).

The IRS often charges greater interest (if you include the late fees) than the 200% and this often falls on small construction contractors and handy men/fishermen/painters etc. who are far from affluent.

Mesa July 27, 2010 at 10:11 am

Once government starts insuring all of our problems, it has all the justification it needs to regulate our behavior. It’s a pernicious aspect of the welfare state.

figleaf July 27, 2010 at 10:17 am

Yup. Sex in this example is a red herring. As is the red-baiting of Elizabeth Warren. Instead, as various commenters (and a direct quote from the relevant legislation!) it’s not about limiting usury, it’s about limiting lying about it.

You may remember similar sky-is-falling arguments that the federal mandate to publish a uniformly-calculated interest rate (APR) for larger-ticket loans would destroy the financial industry back in the 1990s. Instead it helped consumers rationally select interest rates without materially harming lenders. Or without harming lenders in the aggregate. Though it did disadvantage those individual lenders who were best at and/or least scrupulous about disclosing real interest rates to prospective borrowers.

As far as I can tell the intended effect of the actual law, and therefore Warren’s charter, would be to extend disclosure requirements to other elements of loan promotion with the result that those borrowers seeking 200% loans could locate them most efficiently. As could the vast majority of prospective customers who wished to avoid those lenders.

figleaf

Andrew July 27, 2010 at 10:34 am

“Markets need ——– —- information to make them efficient.”

It’s the other way around. And even if it is, is the government the one to provide the information.

Let’s start with the scary 200% number. It’s not real. when your “loan” is for 15 days annualizing it has no meaning. Are these people really rolling over their loans every 15 days for a year? Can these people go get an annual term loan?

Competition makes markets efficient. Warren should stand with me against the banking cartel. But, she obviously can’t do that because then she wouldn’t be offered the ring of power.

Andrew July 27, 2010 at 10:38 am

Oh please.

It’s so easy for you people to criticize payday loan places. You don’t live there.

It’s hard for you to go open one across the street that charges 1% less. So, you pass laws.

Roland July 27, 2010 at 10:43 am

As noted above, the law does nothing to limit rates — and there should be no limit as long as terms and conditions are transparent. The problem is that payday lending operations (subject to state control here in NC) have a bad track record when it comes to contriving opaque contracts.

Steve July 27, 2010 at 10:48 am

First, if we were sure that banning risky sex would be feasible and make people happier I’d be for it. This is the standard utilitarian criteria. But it’s not feasible and we don’t know.

We ARE pretty sure banning payday loans would though. And if we weren’t we could try banning them only in some rural and urban neighborhoods and seeing what happens to people’s finances. Experiment, experiment, experiment.

(P.S. About the ATMs, I think most people against payday loans want to cut those fees to ~25 cents.)

Philipp July 27, 2010 at 10:53 am

@Tyler:
Regarding the ATM fee: As a University of Chicago grad student, one of the most enlightening moments during the first year Price Theory class was Kevin Murphy talking about the implicit interest rate of the ATM fee.
Rational consumers set the marginal rate of substitution between consumption today and consumption in the future equal to the sum of differences between interest rate and the time discount factor (in continuous time, it’s an integral). The MRS is a constant independent of time so the integrand on the other side of the equation is decreasing with respect to the difference in time you are considering. The reason is that with a larger time horizon you sum over more terms . Thus the shorter the time period that you are considering, the higher the interest rate that you are willing to pay.

Slocum July 27, 2010 at 11:41 am

Also, don’t confuse a flat non-network ATM service fee with an interest payment. One is a flat fee and unrelated to the amount of the transaction, and the other is proportional to the transaction and dependent on the time of the loan.

With payday loans, the term of the loan is very short, so even a small fee (say $10 for $200 for 2 weeks) works out to a very high annual rate of interest (52 weeks / 2) * $10 = $260 annual interest on $200. This is definitely the way loan APR rates are calculated (interest+fees) on loans generally (which is why mortgage APRs are higher than the nominal interest rate).

For payday loans, nobody can afford to handle the paperwork of a loan (let alone the default risk) without charging a fee that makes the APR very high. The analogy to ATM fees is a good one–most of what payday loans charge are fees (like an ATM) rather than interest on the funds, but the fees are included in the APR calculation that leads to howls of outrage.

Tetrisd July 27, 2010 at 12:00 pm

My problem with this analogy is the bargaining power disparity. Money is incredibly important to the most basic elements of a person’s life — their home, transportation, status, food, education, etc. By contrast, unprotected consensual sex is nothing more than raw hedonistic pleasure. You don’t need unprotected sex to survive in the same way you need food and shelter. Thus, the bargaining power of the usury-rate lender on the one hand is relativley higher than the bargaining power of the condomless seducer. I think therein lies the an augmented justification for disparate treatment. However, I will concede that your argument is generally sound and a reasonable person could disagree that the augmented justification is still insufficient to abolish usury.

john personna July 27, 2010 at 12:05 pm

I agree that “someone, somewhere” was attempting to reposition Warren, and you shouldn’t have been part of it.

td July 27, 2010 at 12:16 pm

What in the hell are you taking about?

Cliff July 27, 2010 at 12:52 pm

buermann, Link please?

Do people that take out payday loans have credit cards with a sufficient cash advance limit and available balance to substitute for a payday loan?

Even in a theoretical world where consumers did not understand the costs of payday loans in comparison to credit card cash advances, still competition would drive the cost of payday loans down to normal profits for the cash advance places, right? I just don’t believe that these check cashing stores I see around are making super-normal profits. At least between payday loan places, a person would be able to compare costs pretty easily, right?

Meg July 27, 2010 at 1:30 pm

Depends on whether there’s alternatives. For example, at the moment, it impossible for some motivated people to find employment. Even if they do, minimum wage may not cover the necessities. Essentially, in those cases America has turned into a giant company store scam. Limiting access to credit prevents structural problems from being masked at the additional expense, stress and demonization of those most penalized by them. Our current economic situation illustrates the danger of supporting growth through consumer debt, without consumers benefiting from that growth such that they could pay down the debt incurred. Eventually, either lenders stop lending or people stop paying and the whole thing comes tumbling down.

Pender July 27, 2010 at 1:34 pm

If your thesis is that American norms and constitutional law provide a broad right to privacy with regard to social, sexual and familial relationships, but NOT with regard to commercial relationships, then I’m not entirely sure what to say except that you are not the first to comment on the discrepancy.

Your argument can go the other way too, though. If you disapprove of a legislative ban on 200% interest rates on the grounds that private parties should have the autonomy to bind themselves to contracts regardless of whether it’s a good idea, should we also abolish minimum wage laws? Workplace safety laws? Bans on indentured servitude or even outright slavery, as long as the arrangement is entered consensually? Doesn’t your apparent argument (“if risky sex is legal, ____ should be legal too”) apply to these things with equal force?

The alleged inconsistency between laws about social/sexual/familial relationships on the one hand and commercial relationships on the other been embedded in our law and widely acknowledged since the New Deal marked the end of the Lochner era. I don’t know what this specific interest rate regulation really adds to the debate, at least on the terms that you’ve argued it.

Bernard Guerrero July 27, 2010 at 2:30 pm

Ladies & Gentlemen, as one of the Lenders Of Ill-Repute at the heart of the discussion above, I’m a little surprised at the generally fact-free nature of far too many of the comments above. I’m prevented from jumping into the middle of things given my own position, but a meta-point stands out to me. Despite a number of intelligent-sounding comments, very few of you actually seem to know how these loans or this business actually work in practice. This disturbs me because I often find myself following threads on this and similar sites and thinking that the comments sound really sharp. :^)

Slocum July 27, 2010 at 3:06 pm

The difference is that there is not a whole industry trying to figure out how to trick you into having risky sex again and again and again.

No? Not the porn industry? Not the strip-club industry? Not the sex-toy industry? Not ‘Big Lingerie’?

This comment, though, hits the nail on the head I think. Liberals believe in allowing individuals to make their own decisions about their lives & bodies when and only when those decisions don’t involve buying anything from a corporation. If they do involve such transactions, then for liberals the focus shifts away from the individual to the industry, and individuals are judged to be helpless dupes who will be easily tricked by greedy corporations into making ‘bad choices’ unless saved by paternalistic government interventions.

Jon July 27, 2010 at 5:13 pm

Hi Tyler Cowen. I don’t think anyone buys your argument. Jon

Allan Beatty July 27, 2010 at 7:11 pm

It’s meaningless to annualize the interest rate of a 15-day loan? I’d like to see anyone try that line of reasoning when a cop pulls them over for doing 60 in a 35 zone. “But officer! It’s meaningless to say I was going 60 miles per hour — I’ve only been driving for a minute!”

Steve Sailer July 27, 2010 at 7:39 pm

It’s fascinating how the history of the biggest American public health story of the last half century, the AIDS epidemic, has been rewritten to conform to the demands of Who? Whom? thinking.

We’ve all been taught to reason according to the following logic:

A. Gays Are Good;

B. So, Anybody Who Mentions Anything Not Good About Gays Must Be:

C. Bad

Therefore, the AIDS epidemic couldn’t possibly have been self-inflicted. It had to be the fault of, say, Ronald Reagan, or of homophobia, or of something, anything, other than what it was.

QED

Pender July 27, 2010 at 8:52 pm

What a surprise: here’s Steve Sailer, right on cue, with the scent of a minority in his nose and a bevy of unsolicited and irrelevant insults on his tongue.

Steve, you’re not allowed to oppose marriage rights for gay people and then complain when a gay person doesn’t form a stable, sexually monogamous long-term relationship. If you want gays to have safe sex, support our right to marry. It’s like complaining that black people are financially unsophisticated while simultaneously trying to make it illegal for blacks to open IRAs.

My point is not that you’re a bigot (though you are); it’s that your arguments are consistent only in isolation. When considered together, it becomes apparent that you’re arguing in bad faith. The only common thread between your positions is hatred of gay people, but because naked animus doesn’t get any respect in halfway intelligent circles, you pretend (and maybe believe) that your anti-gay positions come from neutral principles. It requires only a small step back to see your disingenuousness.

WindyCityEagle July 28, 2010 at 8:47 am

I think floccina brings up an extremely interesting point. If our moral dilemma is the “fleecing of the stupid”, then how can we possibly tolerate state lotteries? It seems extremely hypocritical to safe that a payday lender must disclose an interest rate, but a state lottery need not display how much you’re expected to lose(i.e. a sign that says something to the effect of “If you buy 10 dollars of lottery tickets, you will on average lose 5 dollars”).

Wag July 28, 2010 at 11:36 am

Glad to see you finally recognize that the banks exist to f*** people over, and spread disease (i.e., toxic assets).

Jason July 28, 2010 at 1:26 pm

I would be unopposed to allowing people to borrow money at 200% interest as long as they thought it was a turn-on. The ATM machine should say: “You are taking out only $20, so this fee works out to 200% annualized interest. You are being ripped off. Does that turn you on? Yes/No”

I think most people just want to conduct business with lenders and ATM machines, though.

Brian Bergfeld July 28, 2010 at 11:50 pm

Tyler, you should get a checking account with Schwab. They reimburse all ATM fees. It actually makes it fun to go to an out-of-network ATM because you can scoff at the $3 fee warning before you take out your $20.

The Tim Channel July 29, 2010 at 4:08 am

There is another thing that is totally out of whack on these payday loans. They are charging excessive interest rates on loans that are essentially risk free. On top of that, if the borrower were to close his checking account before the lender collected, the state becomes the ‘enforcer’ of the loan when the lender turns the check over to the state as a ‘bad’ check. Some states have outlawed the police from collecting on these loans, but many have not.

Another example in this genre are the loans that require you to surrender your car title. The lender gets title to a vehicle that is worth many times the amount of the loan given. This is yet another form of fully collateralized loan that is slapped with an interest fee utterly unrelated to the ‘risk’ of the lender.

The argument that if we outlawed these businesses it would result in a black market for such loans has some truth to it, but that’s hardly an argument for continuing to mainstream a practice that (like torture e.g.) has traditionally been illegal.

Enjoy.

CMN July 31, 2010 at 12:50 am

You know, it is against the law in most places to knowingly transmit HIV if your partner is unaware of your status, even if the sex is consensual. Just like payday lending should be illegal, because even though it is consensual, the payday lenders aren’t disclosing how much they want to infect their borrowers and keep them coming back every week for more.

Cowboy July 31, 2010 at 1:39 pm

“My problem with this analogy is the bargaining power disparity. Money is incredibly important to the most basic elements of a person’s life — their home, transportation, status, food, education, etc. By contrast, unprotected consensual sex is nothing more than raw hedonistic pleasure. You don’t need unprotected sex to survive in the same way you need food and shelter. Thus, the bargaining power of the usury-rate lender on the one hand is relativley higher than the bargaining power of the condomless seducer. I think therein lies the augmented justification for disparate treatment. However, I will concede that your argument is generally sound and a reasonable person could disagree that the augmented justification is still insufficient to abolish usury.

Posted by: Tetrisd”

What about the bargaining power of people who choose to make their own decisions re their own lives based on their own values and their own resulting assessment of risk/reward and profit/loss ?

I see nothing in the examples of anyone forcing anyone else to have sexual preference, protected or unprotected sex or to use any particular ATM (or any ATM at all). You have your own sexual choices choices, including celibacy. You have your own financial choices including electronic funds transfer, credit cards, checks or (gasp!) carrying cash. You make your choices based on your own set of values and your own unguaranteed assessment of risk/reward.

I may choose to greatly over-pay (based on your assessment of value) for something to be certain that I can get it when I want it. I may find the value of that assurance to be of far greater value than you do, regardless of whether you consider the ‘purchase’ to be of vital necessity.

I may decide that the experience of partaking in a particular activity at some point in my life is worth the risks associated with that activity. As long as I am not demanding that you also assume those risks, and as long as I am willing to assume the responsibility for the consequences of my decision, why are you declaring that you must make my decision?

You are, in fact, trying to grant yourself superior ‘bargaining power’ in the universe of transactions by declaring universal values for others regardless of their own perception of value.

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