Payday Lending Regulations Fail to Address Concerns of Discrimination

Lara Sofia Romero*

In Segregation in Texas, Professor Richard Epstein argues that the disparate impact standard is an “intrusive and unworkable test that combines high administrative cost with risk of inviting massive abuses by both the courts and the executive branch of government…” Indeed, in the context of payday lending, the disparate impact test is an unworkable test, but not so much for its risk of inviting massive abuses, but rather for the heavy burden the test places on claimants.

The Department of Housing and Urban Development’s formulation of the disparate impact test is a three-part inquiry: at stage one the claimant must show that a particular practice has a “discriminatory effect.” At stage two, the lender may justify its practices because they advance some “substantial, legitimate, nondiscriminatory interest.” At stage three, the claimant may override that justification by showing the legitimate ends of “the challenged practice could be served by another practice that has a less discriminatory effect.”

Even though evidence of discriminatory intent is not necessary, claimants still bear a tough burden at stage one in demonstrating with sophisticated statistical analysis demonstrable adverse effects and identification of the precise practice causing these effects. Such claims are particularly difficult to prove in lending cases because lenders may easily hide misuse of gender biases or stereotypes in determining rates, prices, and shop locations under the guise of “just doing business” or mere coincidence simply due to consumers’ purchasing choices. It is very rare for plaintiffs in disparate impact cases, except for a few highly sophisticated and well-funded litigants, to prevail. Borrowers have tried to launch cases against lenders for targeting minority communities, often referred to as “reverse redlining.” However, without access to companies’ internal documents or marketing strategies, a plaintiffs’ attorney faces an uphill battle in proving that payday lenders are marketing to minorities.

Sadly the law has done little to address realities regarding payday loans, let alone address data suggesting that subprime loans disproportionately burden women of color. As of yet, discrimination laws have been largely ineffective in combatting payday lending’s negative side effects against women of color. Borrowers tend to be disproportionately female - research suggests single mothers make up a key segment of payday customers, and African-American or Latino customers also make up a disproportionate number of payday loan users. While the industry denies targeting people of color, the reality is that payday loans stores are highly concentrated in African-American and Latino neighborhoods.

Only a few years ago, the scarcity of credit was a problem for women in low-income communities; today, there are more payday loan and check cashing stores nation wide than there are McDonald’s, Burger King, Sears, J.C. Penney, and Target stores combined. Payday lenders offer small, short-term loans (often two weeks or less) using a check dated in the future as collateral. Typical loans fees range from $15 to $20 per $100 borrowed. With short loan terms of less than one month, payday loans typically charge an annual percentage rate (APR) between 390% and 550%. These triple digit interest rates along with a business model that encourages repeat borrowing make payday loans one of the most expensive forms of consumer credit available. Most borrowers cannot repay the full loan by their next payday, so they are forced to renew the loan repeatedly for additional two-week terms, paying new fees with each renewal. These loans do not appear to rescue individuals from cycles of debt or poverty.

On the one hand payday lenders have the potential to serve a welfare-enhancing role for individuals in real financial distress who may not be adequately served by more traditional sources of consumer lending. For those living paycheck to paycheck, access to quick, short-term credit can make the difference between staying financially afloat and having one’s heat turned off.  Restricting this access through government regulation may drive up prices, resulting in a rationing of credit, thus making it impossible for would-be borrowers to afford any form of credit at all.

Further, law and economics theorists emphasize how strict enforcement of contracts and legislative restraint are necessary for optimal distribution of resources through market competition. Many subscribe to the notion that consumers remain free and moreover empowered to reject payday loans and bear responsibility for their failures to shop for or negotiate their loan contracts. Free market supporters propose that the market will cure any discriminatory contracting. In short, we would be better off when payday lenders go out of business due to lack of demand, not prohibited supply.

In reality, however, payday lenders seeking to maximize their profits have incentive to charge high fees and costs because many of the credit-constrained women of color purchasing these loans are desperate to obtain cash regardless of cost. The situation is particularly troubling considering the spillover effects that high-cost credit has on job productivity, children, hardship related to utilities, rent, medical bills and food payments, and the considerable burdens that communities bear as a result.

Behavioral economists have moved away from these unrealistic assumptions about decision-making and instead have recognized that people have a limited ability to calculate the gains and loses associated with various options and can be overwhelmed by choice and complexity. In particular, people are quite bad at anticipating their future needs and conditions. Women of color in low-income neighborhoods usually lack the resources to "shop around" and may wish to avoid the embarrassment of having their financial situation exposed to loved ones and the pressure from these same individuals to repay. There is also evidence that wording of educational materials can affect success in steering individuals away from potentially dangerous options. Describing the cost of payday loans, for example, in terms of annual percentage rates (for example, “Did you know you are paying over 465 percent interest per year?”) has proven ineffective; individuals who received these materials had difficulty understanding the concept of annual percentage rates and, furthermore, had no way to relate the number to the costs and experiences familiar to them.

These insights should influence the legal rules in place designed to provide financial education, promote savings, and build credit among low-income communities. Of course, courts should continue to primarily enforce voluntary agreements. However, courts and lawmakers should not overlook the importance of biases, stereotypes, societal norms, and behavioral propensities that may affect contracts in the real world. The current lack of federal regulation has left payday lending laws mainly to the states, which have adopted varied and incomplete regulations which some commentators refer to as “smoke and mirrors,” leaving many loopholes for payday lending abuses. The Equal Credit Opportunity Act and state discrimination laws are largely ineffective in addressing gender gaps in payday loan burdens because they target only clear disparate treatment and other overt and well-documented discrimination.

In September 2014, President Obama issued a challenge to cities, towns, counties and tribes across the country to become “My Brother’s Keeper Communities.” Backed by a five-year, $200-million investment from a variety of foundations and businesses, it is a public-private program that aims to provide mentoring and improve educational and professional opportunities faced by boys and young men of color. Unfortunately, there is no comparable, ongoing federal effort to identify challenges facing girls and women of color, review data and develop indicators to measure their progress, survey federal programs to see what is working or not working for them or, crucially raise $300 million from private sources to develop solutions for them.

Currently, the CFPB is considering whether to draw up new regulations. Back in November of 2013, they issued an advance notice of proposed rulemaking  seeking comment, data, and information from the public about debt collection, which is the single biggest source of complaints to the federal government. Women of color’s economic futures are disproportionately undermined by inequality. Furthermore, women breadwinners are on the rise among all races and ethnicities. All the more reason why the situation created by payday lending warrants a creative solution- one that takes into account contextualized realities, the need to educate consumers, and to alleviate the demand for payday loans by assisting low-income women of color out of poverty and into the middle class.

*Lara Sofia Romero is a J.D. Candidate in the Class of 2016 at New York University and a Staff Editor for the Journal of Law & Liberty.