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The Debate Room: Stop Fleecing Poor Americans

Tyler Cowen, Nouriel Roubini

May 11, 2007

BusinessWeek

The U.S. government should place greater restrictions on car sellers, pay-day lenders, and tax preparers who offer the working poor cash or credit with high fees and interest rates. Pro or con?

Pro: Exploitation, Plain and Simple

by Nouriel Roubini

Most poor households lack financial literacy and are at risk of falling prey to exploitative lending. In the case of subprime mortgages, for example, economically disadvantaged borrowers have accepted teaser rates without realizing they can ill afford the much higher rates they'll see down the line. Other forms of lending to low-income borrowers present similar dangers.

These vulnerable Americans often end up in debt traps, with unclear and exorbitant interest rates or fees on car, payday, or tax-preparation loans. Borrowers with inadequate financial education and meager finances often fail to realize the imprudence of such loans until it's much too late.

The government must intervene to prevent such arrangements from occurring in the first place.

Yes, lawmakers' restrictions may make it harder for those in need of quick cash to obtain it. But on a larger scale, these limits will produce a better outcome than leaving millions of households crushed under the weight of monies owed-and forced into bankruptcy.

The carnage and ruin caused by the subprime meltdown serves as a lesson in what can happen when credit markets balloon without the benefit of appropriate supervision and regulation. The subprime fiasco threatens to cause a generalized crunch in consumer credit that will lead to a hard landing, and possibly a recession, for the entire U.S. economy.

Let's learn from our mistakes and ask government to do its job by protecting economically disadvantaged Americans.

Con: Treat Borrowers Like Adults

by Tyler Cowen

"Life, liberty, and the pursuit of happiness" should include the right to borrow money without coercive interference from government.

The Americans who pay high interest rates to pay-day, car-loan, and other lenders fall into two broad categories. The first consists of people who genuinely need the money now. They need to pay a doctor's bill, move into a new house, or buy an engagement ring. Yes, the lenders charge a high rate of interest, but most of these people qualify as potentially bad or unknown credit risks. There are hundreds or thousands of lenders competing to give borrowers the best deal possible. These borrowers have decided to pay the price for up-front money, and no one has any business trying to stop them.

The second category comprises Americans who are simply desperate. They borrow because they have irrational impulses and cannot resist temptation. Even with these people, it may backfire to have the government restrict lending. If a hard-up individual can't get a legal pay-day loan, he or she may go to the local loan shark. The rate of interest there is even higher, and nonpayment may result in broken bones or worse.

Or the desperate may look to gambling, legal or not, or perhaps hock treasured possessions in a pawnshop. Government cannot protect us from every possible form of our own stupidity, and it's often counter-productive for it to try.

On the issue of loan markets, the main business of government is to ensure transparency of terms and protect against fraud. No one can judge how high an interest rate is too high for another person.

Finally, over-borrowed Americans do deserve a second chance. If we have to tinker with bankruptcy laws, so be it, but don't assume that government can or should manage loan markets.