In what will likely be Richard Cordray’s final major act as director of the Consumer Financial Protection Bureau, the agency last week issued the first federal rule on payday lending, an umbrella term for short-term, high-interest loans to cash-strapped Americans. Critics argue that payday lenders take advantage of vulnerable people by trapping them in a cycle of debt. CFPB’s rule seeks to break this cycle and prevent loans from being issued unless borrowers have the ability to repay.
The CFPB, the Elizabeth Warren brainchild created during President Barack Obama’s first term, has managed to survive in the hostile territory of the Trump era. Its budget remains intact, its enforcement robust, and its rules have avoided nullification from Congress. However, one adversary—a former corporate lawyer running a separate federal agency—responded to the payday rule in a way that not only would keep the cycle of debt alive, but transfer the lending power to big banks.
The typical payday loan customer borrows $350 for two to four weeks, usually until their next paycheck (hence the term “payday loan”). The lender takes between $10 and $30 for every $100 borrowed. If the borrower cannot pay in full, they can roll over what they owe into another loan, triggering the same charges. Over 80 percent of all payday loans are re-borrowed within a month, and by the time it’s paid off, the average payday or auto-title loan (where the customer uses their car as collateral) carries an annual percentage rate between 300 and 400 percent. More than 12 million Americans use payday loans each year.
CFPB’s rule gives payday lenders two options: They can conduct a “full-payment test,” confirming that the borrower can repay the entire loan on time and meet basic living expenses without re-borrowing, or they can offer a “principal-payoff” loan that allows gradual repayment of the debt in small installments. Even under the second option, borrowers would not be able to take out more than three short-term loans in rapid succession.
Consumer protection advocates weren’t initially thrilled with CFPB’s proposal, and the final rule still gives reason for concern. To determine borrowers’ ability to repay, payday lenders would use information from notoriously inaccurate credit reporting bureaus like Equifax. Enforcing payment test is inherently more difficult than, say, limiting payments to a percentage of a borrower’s paycheck—a provision that was considered but rejected. Plus, the rule doesn’t cover longer-term installment loans, which are often just as costly. Payday lenders have already shifted toward this option, and have been plotting for years on how to work their way around the rules.
Nevertheless, even critics of the initial proposal praised CFPB, hoping that the rules would steer borrowers toward safer and cheaper low-dollar loans, like those provided by community banks and credit unions. But within an hour of CFPB’s announcement, a less scrupulous federal agency intervened.
The Office of the Comptroller of the Currency (OCC), and its temporary leader Keith Noreika, has become Richard Cordray’s biggest nemesis in Washington. The OCC is the government agency that oversees national banks, and Noreika was a finance lawyer with numerous bank clients. He was installed at OCC in May as a temporary “special government employee,” which excluded him from ethics disclosures while evading the Senate confirmation process. Joseph Otting, the actual nominee, is awaiting confirmation, and Noreika has actually exceeded the time limits placed on a special government employee, watchdogs contend. When his temp gig ends, Noreika is expected to go back to defending the same clients he regulated.
In the meantime, Noreika has taken direct aim at the CFPB. When the bureau issued a rule to stop banks from preventing class-action lawsuits, Noreika—who tried that very tactic while defending Wells Fargo—released a study saying the rule would raise the cost of credit by 25 percent. Then, right after the payday rule announcement, Noreika opened the door for national mega-banks to provide a payday-style product known as “deposit advance.”
For years, banks like Wells Fargo and U.S. Bank allowed customers with paycheck direct deposit to take an advance on that money for a fee of about $10 per $100 borrowed. The bank would extract payment from the borrower’s account when the loan came due. This is functionally the same as a payday loan, and the fees were nearly as high. Consumer groups begged regulators to crack down on the practice, and eventually, OCC issued guidance warning banks that small-dollar loans had to be affordable, with ability to repay taken into account—the same principles as the CFPB’s rule. Noreika rescinded this guidance last week without even giving CFPB a heads-up. In a statement announcing this action, OCC said broadly that banks should manage risk and “reasonably” underwrite these loans, but added nothing specific. So big banks could step back into the small-dollar loan market, knowing that federal regulators would be unlikely to stand in their way no matter what.
Banks would have a significant leg up on payday lender competitors for short-term loans. You can’t really get a payday loan without a bank account; lenders take either a post-dated check or authorization to debit the account in order to ensure payment. All those customers could now shift to their own bank for one-stop access to easy credit. Since wage stagnation and persistent inequality ensures the need for low-dollar loans, the dueling regulatory moves could occasion a shift, from payday lenders’ gouging customers to big banks doing it.
Noreika said in a statement that he rescinded the guidance to avoid “duplication” with the CFPB rule. But CFPB clearly targeted payday lenders and not banks; in fact, there were exemptions for community banks and credit unions that make relatively safer low-dollar loans. So now, a poor person who needs cash to meet a sudden or recurring expense can get a long-term, costly loan from the payday lender, to be paid in installments; or they can get a short-term loan from their bank, which will likely get rolled over multiple times and not be paid off for months, at potentially even greater cost. Banks have more resources than payday lenders to garnish borrowers’ wages or sue them for repayment. The end result looks as bleak for borrowers now as it was before the CFPB’s rule.
With Trump’s team in place, we could have expected a subtle undermining of consumer protections, from a lack of enforcement if nothing else. But Noreika, a hired gun passing through the halls of a federal regulator before scrambling back to big bank clients, has done far more damage here. He’s empowered banks to engage in reckless abuse of their customers at a time when we’ve seen Wells Fargo in particular revealed as eager to do so. And he may not even be in office legally.
Financiers relentlessly built a business model based on tricking people instead of helping them, and they’ll stop at nothing to preserve and expand it. The only thing consumer protection advocates have going for them is the extreme unpopularity of such schemes. Now that efforts to police short-term loan abuses may lead to even more of them, Democrats—led by Warren, perhaps—should pounce on the issue to explain how the party plans to build broad enough prosperity that fewer Americans need to drown in debt.