Results for “predatory borrowing”
4 found

Predatory borrowing?

From Luigi Zingales:

In fact, the authors find that more than 6% of mortgage loans misreport the borrower’s occupancy status, while 7% do not disclose second liens.

…The authors provide some interesting evidence in this context. They show, for example, that the misrepresentation is correlated with higher defaults down the line: delinquent payments on misreported loans are more than 60% higher than on loans that are otherwise similar. Thus, the errors do not seem to be random, but purposeful.

What the authors do not find is also interesting. The degree of misrepresentation seems to be unrelated to the incentives provided to the top management and to the quality of risk-management practices inside these firms. In fact, all reputable intermediaries in their sample exhibit a significant degree of misrepresentation. Thus, the problem does not seem to be limited to a few bad apples, but is pervasive.

Here is more, and here are comments from Arnold Kling, who has extensive experience in this area:
 I cannot tell whether the borrowers defrauded the lenders or the lenders defrauded the investors who bought the loans. I always presume that it is the borrower instigating the fraud. However, Zingales says that the bankers should be prosecuted. He makes it sound as if the lenders would record a loan internally as backed by an investment property and report it to investors as an owner-occupied home. That would require a much more complex conspiratorial action on the part of the lender, and until I learn otherwise, I will doubt that it happened.

The fallacy of mood affiliation

Recently I wrote:

It seems to me that people are first choosing a mood or attitude, and then finding the disparate views which match to that mood and, to themselves, justifying those views by the mood.  I call this the “fallacy of mood affiliation,” and it is one of the most underreported fallacies in human reasoning.  (In the context of economic growth debates, the underlying mood is often “optimism” or “pessimism” per se and then a bunch of ought-to-be-independent views fall out from the chosen mood.)

Here are some further examples:

1. People who strongly desire to refute those who predicted the world would run out of innovations in 1899 and thus who associate proponents of a growth slowdown with that far more extreme view.  There’s simply an urgent feeling that any “pessimistic” view needs to be countered.

2. People who see a lot of net environmental progress (air and water are cleaner, for instance) and thus dismiss or downgrade well-grounded accounts of particular environmental problems.  There’s simply an urgent feeling that any “pessimistic” view needs to be countered.

3. People who see a political war against the interests of the poor and thus who are reluctant to present or digest analyses which blame some of the problems of the poor on…the poor themselves. (Try bringing up “predatory borrowing” in any discussion of “predatory lending” and see what happens.)   There’s simply an urgent feeling that any negative or pessimistic or undeserving view of the poor needs to be countered.

4. People who see raising or lowering the relative status of Republicans (or some other group) as the main purpose of analysis, and thus who judge the dispassionate analysis of others, or for that matter the partisan analysis of others, by this standard.  There’s simply an urgent feeling that any positive or optimistic or deserving view of the Republicans needs to be countered.

In the blogosphere, the fallacy of mood affiliation is common.

Taxing Mechanical Engineers and Subsidizing Drama Majors

In The Student Loan Giveaway is Much Bigger Than You Think I argued that the Biden student loan plan would incentivize students to take on more debt and incentivize schools to raise tuition with most of the increased costs being passed on to taxpayers through generous income based repayment plans. Adam Looney at Brookings takes a deep dive into the IDR plan and concludes that it’s even worse than I thought. Here are some of Looney’s key points:

  • As recently as 2017, CBO projected that student loan borrowers would, on average, repay close to $1.11 per dollar they borrowed (including interest). Borrowing was often perceived to be the least favorable way to pay for college. But under the administration’s IDR proposal (and other regulatory changes), undergraduate borrowers who enroll in the plan might be expected to pay approximately $0.50 for each $1 borrowed—and some can reliably expect to pay zero. As a result, borrowing will be the best way to pay for college. If there’s a chance you’ll not need to repay all of the loan—and it’s likely that a majority of undergraduate students will be in that boat—it will be a financial no-brainer to take out the maximum student loan.
  • The data shows that roughly half of Americans with some college experience but not a BA would qualify for zero payments under the proposal, as would about 25% of BA graduates. However, the vast majority of students (including more than 80% of BA recipients) would qualify for reduced payments.
  •  [A] lot of student debt represents borrowing for living expenses, and thus a sizable share of the value of loans forgiven under the IDR proposal will be for such expenses…A graduate student at Columbia University can borrow $30,827 each year for living expenses, personal expenses, and other costs above and beyond how much they borrow for tuition. A significant number of those graduates can expect those borrowed amounts to be forgiven. That means that the federal government will pay twice as much to subsidize the rent of a Columbia graduate student than it will for a low-income individual under the Section 8 housing voucher program…

Looney agrees that the incentive to increase tuition will apply to some graduate and professional programs but he thinks there is less room to increase tuition at undergraduate programs because borrowing is capped (currently! AT) at fairly low rates. But he offers an even more plausible but disheartening scenario that takes us in exactly the wrong direction.

Because the IDR subsidy is based primarily on post-college earnings, programs that leave students without a degree or that don’t lead to a good job will get a larger subsidy. Students at good schools and high-return programs will be asked to repay their loans nearly in full. Want a free ride to college? You can have one, but only if you study cosmetology, liberal arts, or drama, preferably at a for-profit school. Want to be a nurse, an engineer, or major in computer science or math? You’ll have to pay full price (especially at the best programs in each field). This is a problem because most student outcomes—both bad and good—are highly predictable based on the quality, value, completion rate, and post-graduation earnings of the program attended. IDR can work if designed well, but this IDR imposed on the current U.S. system of higher education means programs and institutions with the worst outcomes and highest debts will accrue the largest subsidies.

Looney does a back of the envelope calculation and estimates that typical graduates in Mechanical Engineering will on average get a 0% subsidy but graduates in Music will get a 96% subsidy, in Drama a 99% subsidy and Masseuses a 100% subsidy on average. This of course is exactly the wrong approach. If we are going to subsidize, we should subsidize degrees with plausible positive spillovers not masseues.

The problem is not just the subsidy but the encouragement this gives to create low-value programs:

  • …institutions will have an incentive to create valueless programs and aggressively recruit students into those programs with promises they will be free under an IDR plan….The fact that a student can take a loan for living expenses (or even enroll in a program for purposes of taking out such a loan) makes the loan program easy to abuse. Some borrowers will use the loan system as an ATM, taking out student loans knowing they’ll qualify for forgiveness, and receiving the proceeds in cash, expecting not to repay the loan….I suspect that such abuses will be facilitated by predatory institutions.

Overall, the student loan program, as currently written, is looking to be one of the most costly, inefficient and unwise government programs of the 21st century. As I said in my first post, “fixing” the program is likely to drive ever more increasing intervention into higher education much as has happened with health care. My guess is that no one really thought this albatross through.

Banning Payday Loans Harms Borrowers

A new NBER paper by Allcott, Kim, Taubinsky and Zinman takes a close look at the behavioral economics of payday loans and finds that most common regulations make borrowers worse off.

Critics argue that payday loans are predatory, trapping consumers in cycles of repeated high interest borrowing. A typical payday loan incurs $15 interest per $100 borrowed over two weeks, implying an annual percentage rate (APR) of 391 percent, and more than 80 percent of payday loans nationwide in 2011-2012 were reborrowed within 30 days (CFPB 2016). As a result of these concerns, 18 states now effectively ban payday lending (CFA 2019), and in 2017, the Consumer Financial Protection Bureau (CFPB) finalized a set of nationwide regulations. The CFPB’s then director argued that \the CFPB’s new rule puts a stop to the payday debt traps that have plagued communities across the country. Too often, borrowers who need quick cash end up trapped in loans they can’t afford” (CFPB 2017).

Proponents argue that payday loans serve a critical need: people are willing to pay high interest rates because they very much need credit. For example, Knight (2017) wrote that the CFPB regulation \will significantly reduce consumers’ access to credit at the exact moments they need it most.” Under new leadership, the CFPB rescinded part of its 2017 regulation on the grounds that it would reduce credit access.

At the core of this debate is the question of whether borrowers act in their own best interest. If borrowers successfully maximize their utility, then restricting choice reduces welfare. However, if borrowers have self-control problems (“present focus,” in the language of Ericson and Laibson 2019), then they may borrow more to finance present consumption than they would like to in the long run. Furthermore, if borrowers are “naive” about their present focus, overoptimistic about their future financial situation, or for some other reason do not anticipate their high likelihood of repeat borrowing, they could underestimate the costs of repaying a loan. In this case, restricting credit access might make borrowers better off.

First, the authors find that borrowers clearly understand their own behavior. When asked, borrowers predict that they have a 70% probability of borrowing again in the next eight weeks which is almost exactly (74%) the actual borrowing probability. Experienced borrowers are better at predicting their own probabilities of borrowing again so learning also takes place.

Just because they can predict their own behavior doesn’t meant that borrowers like their own behavior (a drunk might predict they will get drunk again without “desiring” to get drunk again) and indeed the authors show with a clever experiment that many borrowers are willing to pay to modestly constrain their own choices. Overall, however, borrowers gain from payday lending so when the authors model payday loan regulations with borrower preferences (their “best”, long-run preferences) regulation reduces welfare:

Payday loan bans and tighter loan size caps both reduce welfare in our model. By contrast, 18 states have banned payday lending, and some states have particularly stringent loan size caps, such as the $300 limit in California.

The best regulation in the model is a rollover restriction which prevents borrowers from borrowing again and again and again. Rather than a blanket regulation, however, I’d prefer a self-exclusion option which would allow people to ban themselves from borrowing in much the same way that people with gambling problems can ban themselves from gambling establishments.

The bottom line is that payday lenders are serving a need and benefiting their customers. Preventing people from accessing payday lenders typically makes them worse off but that doesn’t mean that the customers are entirely sensible or without problems both internal and external. The most revealing statistic in the paper is one the authors mention only in passing:

although our participants are liquidity constrained and we sent two reminder emails, our gift card vendor reports that only 44 percent of the $100 gift cards were claimed

It’s no surprise that people who leave free money on the table have planning problems and need to borrow, it’s just that preventing them from borrowing doesn’t make them better off.