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How Do We Solve a Problem like Debt Traps

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At a conference recently, I learned that cash advance lending company Amscot Financial, whose founder, President and CEO is Scottish native Ian MacKechnie, is the third largest buyer of tootsie rolls in Florida. However it is not the choice of confection that is keeping payday lending in the press of late, but rather the dramatic rise in debt traps that are consuming individuals today.

The much reported research by Pew Charitable Trusts, Payday Lending in America: How Borrowers Choose and Repay Payday Loans, notes that some fifty-eight percent of payday loan borrowers have trouble meeting monthly expenses at least half the time, and a worrying seventy-eight percent of borrowers rely on information from lenders, not independent market analysts or comparison sites, when choosing to borrow money.

Furthermore, it was found that twenty-seven percent of payday loan borrowers say the loans caused them to overdraw from their accounts and seven out of 10 borrowers used these loans to pay for essentials such as rent, utilities and credit card bills.

This, by chance, comes as we find out mainstream banks are providing cover for activity from collections of small dollar loans. While big firms like JPMorgan Chase, Bank of America and Wells Fargo do not directly deal in advance loans, it was found by the New York Times that they enabled online payday lenders to deduct payments from customer accounts, even in the 15 states where such loans are banned.

With this dent in the reputation of payday lenders across the US, some representative organisations have sought to fight back. Responding to the Pew research, the Community Financial Services Association of America (CFSA) have said in a statement: "In our current economy and constricted credit market, it is critical that consumers have the credit options they need to deal with their financial challenges."

This is a very typical justification of the type of product payday lenders sell. Effectively what is being said here is that payday lenders are given license to sell expensive credit to vulnerable people because of a failed banking system. In other words, banks are acting irresponsibly, so why shouldn't payday lenders capitalise on that?

But if these lenders were responsible they would admit that their product is not financially beneficial for the vast majority of their customers, and that cheaper products, like those from a credit union, would be better.

The trouble is if a lender did admit this they would be limiting the profit they could draw off the backs of the poor, while reducing the lifespan of their business. We might do well to ask ourselves: can we trust a business that relies on poorer consumers for profit to admit to them that they are ripping them off?

The answer, I think, is no. So you might say the solution here is more regulation. But the regulation is already there. On banks giving cover to online payday lenders for example the Federal Trade Commission has authority to take action against illegal payday lending under federal laws such as Electronic Funds Transfer Act. The issue here, according to the Centre for Responsible Lending, is not regulation, but enforcement.

Of course more could be done. The Consumer Financial Protection Bureau, who have responsibility over regulating credit providers, plan to extend its consumer complaint system to include short-term credit in the third quarter of this year, according to reports by Business Week.

Richard Cordray, the CFPB's Director, has also promised to work further with state attorneys general when they encounter "jurisdictional issues" related to products that can lead to debt traps.

In the mean time more could be done to make consumers aware of responsible alternatives such as credit unions. A payday loan can cost an individual on average around $15 to $30 in fees on every $100 borrowed which means that a loan of $300 with $20 fees will cost $360 if paid on time. If a loan's lifespan is two weeks and you pay it in four, the overall cost could end up being $420 (perhaps more if there are high late charges).

For a loan from a credit union the price is completely different. In most outlets a sum between $100 and $300 can be borrowed for a small application fee of $15, and can be extended from between 4 and 37 days, with a small interest rate of 15 per cent. A cost comparison between payday loans and credit union loans show the latter to be far cheaper, while they also offer budgeting and debt management advice.

While many states have gone to great lengths to curb the sway of payday lenders there is still more work to go. More enforcement by the law, better understanding by the regulators and increased focus on responsible alternatives. As Jamie Dimon, the chief executive of JPMorgan Chase, vows to change how the bank deals with Internet-based payday lenders, more banks should reassess their policies.

Everyone should be able to enjoy tootsie rolls if they so wish, but they shouldn't have to be in a dangerous debt trap to do so.

Presented By Chivas Regal Scotch Whisky