The Financial Frontier: Financial Freedom, Payday Lending, & “Operation Choke Point” [Fourth Branch]
Articles,  Blog

The Financial Frontier: Financial Freedom, Payday Lending, & “Operation Choke Point” [Fourth Branch]

Can the government target legitimate businesses simply because it doesn’t approve of the industry? Payday loans, pornography, surveillance equipment, tobacco sales. There are unlawful businesses listed there. Operation Choke Point. Operation Choke Point. Operation Choke Point. Over the course of Operation Choke Point, we lost 21 banking relationships. This label — “Operation Choke Point” — was taken wildly out of context. The government was trying to do its job. Payday loans are very controversial but what is the borrower’s next best option? There are worse things than a payday loan and the borrower always has the choice to not take a loan. Payday loans are very controversial. While they are legal in many states and so, by definition, a lawful payday lender is abiding by the law, even the lawful loans are controversial because some people believe that these loans are inherently harmful to the borrower. What has happened is that payday lending has evolved into a derogatory term. Unfortunately, what our critics fail to do is to distinguish between regulated payday lending and unregulated payday lending. Payday lending, which is short-term small-dollar lending, is primarily regulated at the state level. There are some federal laws that affect payday lending, as well. So, there’s a statute called the Truth in Lending Act and this statute requires some price disclosures that characterize what the interest rate on the loan is. The lender is required to disclose it as an APR or an annual percentage rate. I think that the key thing to start with with payday loans is that they are extremely expensive loans. The average interest rate on payday loans is around 400%, and that price is the critical feature to understand its historical context. Payday lending is a small denomination small-dollar form of credit that is provided to consumers who have some type of financial shortfall, whether it’s the washing machine they use to clean their clothes breaks down or the car they use to get back and forth to work breaks down or they have some type of unexpected childcare expense. It’s really a form of credit that’s designed to meet the varying needs for millions of American consumers. These types of loans have an ancient pedigree. The very first recorded comprehensive law was the Code of Hammurabi from about 1750 BCE. This ancient law had a number of different rules but one thing it had was an interest rate cap: 22% for loans that were made in silver and a 33% interest rate cap for loans made in grain. So, long before we invented money, we figured out that we needed interest rate caps. There is a very robust debate about whether or not payday lending does harm consumers or is inherently harmful to consumers, and I think a lot of it is going to depend on the individual circumstances of the borrower. In some states, it’s prohibited because there are still interest rate caps — New York, for example. But it’s not just the eastern seaboard liberal states. In the last few elections, ballot measures in states like South Dakota, Montana, and maybe a swing state like Colorado, the public has voted to reestablish traditional interest rate caps of about 36%. When folks on Capitol Hill or regulators are talking about the importance of financial regulation, they’re talking about complicated products. They’re talking about higher denomination and rarely do they sit down and try to understand the needs of everyday Americans and what they have in terms of a need for a daily small-dollar-type product. So, Operation Choke Point was nominally to combat fraud. It was to combat fraud by denying fraudsters access to banks’ services, particularly a payment system. Fraudsters would partner with a bank to transfer money. When I first learned of Operation Choke Point, I was talking to a reporter from The Wall Street Journal who asked about an Operation Choke Point program that was designed to eradicate fraud in the banking system and was focusing on certain types of illegal lending activity. If you’re in a risky business, then it might make sense that a bank will want to charge you a higher price for dealing with the problems that are going on in that industry and that’s not because anybody is being targeted in that business that’s operating legally, it’s just because banks have to take time to distinguish between who the legal operators are and who the illegal operators are, and that could be complicated. Part of why reputational risk has come up in the context of payday lending is that there are people who believe that a bank doing business with a payday lender, not offering the payday loans themselves, but just providing payments or depository services to the lender, is enabling the payday lender to do an inherently abusive act and, therefore, the bank should be stigmatized or punished for engaging in that behavior even if it’s legal. I think that this label — “Operation Choke Point” — was taken wildly out of context and has been used to mischaracterize what the government was actually doing. The government was trying to do its job to try and help make sure that banks were doing reasonable due diligence to screen out illegal activity from the banking industry. What does seem to have occurred, whether intentionally or unintentionally, is banks got the message from their regulator that, “Hey, it isn’t worth it to do business with entities within these industries.” We, over the course of Operation Choke Point, lost 21 banking relationships. And these, again, were simple basic Treasury services relationships: allowing our centers to take a bank deposit at night to the nearest branch. If you’re a grocery store, the bank knows what your business is. It’s a pretty transparent business and doesn’t require the same level of scrutiny as a company that might be engaged in potentially problematic activity that is completely illegal in some states and illegal in almost every state if you don’t have the right license. I think reputational risk is used as a weapon against companies like Advance America, which are heavily regulated in the marketplace. And as regulators were going in to enforce Operation Choke Point, using the personal disfavor that they found against the entire industry, they were using regulatory risk as a tool to try to force these banks from exiting the relationship. The challenge for financial institutions in dealing with payday lending is to distinguish between who’s doing it appropriately, legally and who’s not, and that’s complicated and it takes some time and effort to make those distinctions. If you think payday lending is bad, if you honestly think it’s abusive, Choke Point looks consumer protective to you because payday lending is bad, Choke Point helped curtail payday lending, at least at the margin. So, there is a good outcome there. Well, the way that I define success for regulating banks is to try and get things to work the best that they can for both the bank and the financial institution and also for the consumers. We can certainly have a debate about whether or not payday lending is good and if we wanted to we could outlaw payday lending, but we would have to go through elected officials, there’d have to be votes, there’d be a challenge in court, and everything would be overt and out in the open. Well, what we hope for the future is that there is an opportunity to continue serving the customers who we have served for over 21 years who have a need for access to credit and do so in a way that continues to meet to their expectations and their needs. Look, the federal government could do better on some things and needs to continue to try to reform itself just like any business or any individual does. You have to keep on working to get better. But, the government is trying to do that and I think by having further dialogue with industry and also working to protect consumers, they’re going to continue to be in a place that facilitates reasonable consumer protections while maintaining a vibrant economy.


  • David Grover

    Operation Choke Point hobbled my business From at least 2013 driving up our costs and killing our opportunities costing at least $50,000 and ultimately caused us to close.

  • Tom Smith

    In the name of capitalism and free enterprise, there should be a place for such "services". As a long time user, they are both a blessing and a curse for those ignorant, uninformed, and undisciplined about personal financial stability, as I had been thru most of my life. In a perfect world, each child around age 10-12 would start to receive education on how "money" works. Ideally, no person would need these loans as savings would be the consumer's answer to overcome life's hiccups. The young should be encouraged to work, learn to budget & save. As one who had for most of his years, living the life of revolving credit is a counterproductive one.

Leave a Reply

Your email address will not be published. Required fields are marked *