Reducing the Cost of Being Poor

February 20th, 2009 by Al Lewis (alewis)

Imagine a way to stimulate the economy and put more money into the hands of both the working poor and small businesses, while reducing both the foreclosure rate and the federal deficit, all without raising taxes.

Economic alchemy, you say?   Read on.

Chances are, if you in the demographic which reads these essays, you have never applied for, or probably even heard of,  a so-called ”payday loan.”    A “payday loan” requires the borrower to assign his next paycheck to the lender in exchange for receiving about 85% of it in cash immediately.  They are an expensive but dependable lifeline for tens of millions of people who live paycheck to paycheck, perpetually playing catch-up on mortgage and credit card payments.

A 85% payout on a two-week loan works out to such a high annual percentage rate (APR) that in California, for example, the allowable ceiling is 459%.  The reason that the APR is so high is not just that some people have no other choice and don’t understand APRs, though this is true too.   It’s also that the cost of running these loan stores, doing these microloans one at a time, person-to-person,  is high enough that even with usurious APRs,  the lenders rarely live in luxury.

Imagine instead that the government charters (and receives a free share in) corporations which do the same thing.  Only as part of their charter they agree to lend at least 95 cents on the dollar — still a very high APR but a tiny fraction of what it was.  As part of the government charter, these new corporations can contract directly with employers, facilitating the paycheck advance on a large scale.  The employers put up some security in order to participate, to cover any defaults.  In exchange, they receive some of the profits from the loans, thus encouraging them to offer this “benefit” to their employees, making  their employees aware that they can now get advances for 95% of their paychecks.

The income of the working poor immediately rises 10% — an amount which for some will exceed the benefit of the tax cut in the stimulus package.  The entire 10% gets recycled into the economy within the week, thus stimulating the economy.  (Otherwise, why borrow against a paycheck?)   Some of this money is used to pay mortgages, thus reducing the foreclosure rate.  Employer profits increase due to the overrides.  And finally, these chartered corporations partly owned by the government – whose lending practices would be carefully monitored to prevent any Fannie Mae type debacles – should be quite profitable themselves, as they have access to low-cost federal capital.  This reduces the deficit.

Who loses?  The streetcorner moneylenders.  And, unlike you, they are not in the demographic which reads these essays, so I won’t have to change sleeping locations every night.

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11 Responses to “Reducing the Cost of Being Poor”

  1. harvardeconomist Says:

    This is the smartest idea I’ve heard of in microlending. Microcinance is sort of a backwater of economics right now but if they could come up with stuff lke this it would move front and center and “real” economists wouldn’t look down on it like they do

    Your blog never ceases to innovate

  2. bceconomist Says:

    except I am not sure the numbers are right. I really don’t think “tens of millions” of people use payday loans. Maybe millions, not tens of millions. even so, a GREAT idea.

  3. firsttimereader Says:

    Is this even what microfinance is? I thought it was that stuff they do in India, that that guy won the Nobel Prize for.

  4. joelkeith Says:

    I think any time you create a method of lending to poor people it’s microfinance. That Indian guy came to the US to build his busniess here and screwed up. He tried to apply trhe same model there that they use in India. (I acutally think he was from Bangladesh.) he didn’t know about payday loans or anything like that. this is a much better idea than whatever it was that he did

  5. armchaireconomist Says:

    this is a whole new way of looking at it. It’s not microfinance becasue it’s not for small businesspeople, though I imagine some people use these loans becuase they have a side business, or their spouse has a business. This could make a whole new market for small lending. Microfinance, I understand, is very labor-intensive and can’t make any money. THis swwms to automate the system. BUt even 99% is still usury!

  6. alewis Says:

    OK, here goes:

    (1) Pediatricians say that “a child is not a small adult.” Likewise, microlending is not just making small loans. There has to be something different about the process of making those loans. So this proposal would qualify as “microlending” though as noted microfinance is something related to this, but instead geared towards investment-lending, not lending to someone who needs to make ends meet. My fault for using the word “microfinance” as a category, which I did because people have heard of it because of

    (2) the guy who won the Nobel Prize — who was indeed from Bangla Desh, not India

    (3) I don’t know whether it’s millions or tens of millions of people who live paycheck-to-paycheck and get these loans at least occasionally

    (4) It is still usury even when a quasi-governmental corporation does it, but nothing like 85% of the paycheck, which works out to hundreds of percent a year in interest. If you object to my proposal, then you object to any high-risk small lending, and too bad for you.

  7. georgem Says:

    I think these loans are illegal in some states, whcih means the terms are even worse and totally unregulated. you can’t legislate a market out of existence

  8. harvardeconomist Says:

    Another thing is that large companies could do this themselves, a total disintermediation. They have accrued vacation time etc. as collateral. BUt one way or another your major point, that this is a market in breakdown, is legit even if you can’t quite articulate why it is in breakdown.

    by the way, I hope you appreciated no references to your sociopathic former fiancee in my last comment. Lesson learned

  9. alewis Says:

    :) I notice you got in one final dig even as you said you weren’t.

    I think that companies which wanted to sign up would provide accrued vacation and sick as part of the collateral for individuals, in addition to some overall collateral. The default rate should be close to zero,

  10. nprjunkie Says:

    You should put this one on NPR. It’s exactly their speed, not that any of the listeners have ever heard of a payday loan

  11. Poor Credit Mortgages Foreclosures Says:

    I found your blog via Google while searching for poor credit mortgages foreclosures, thank you for posting g the Cost of Being Poor | ThinkOOB!

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