An Ounce of Rescission is Worth a Pound of Cure: The Proper Treatment for Texas Payday Lending

As a native Texan, I make an effort to stay current on the latest happenings in my home state. And even though the announcement by the Consumer Financial Protection Bureau that it will reconsider new federal rules that would regulate payday lending is national in scope, the nature of the affected industry means that the particular impact will inevitably vary from state to state. Accordingly, the recently published editorial by the San Antonio Express-News addressing the topic calls for a state-specific response.

The Editorial Board must have viewed its argument as a common sense, self-evident proposal: in order to cure the payday malady, we need more laws! But the argument that “Texas lawmakers need to step up their game next session” in the event these federal regulations are rescinded gets it exactly backward; what Texas needs is not more fix-one-problem-while-causing-two-more statutes. Instead, an epinephrine injection of vigorously enforcing good laws should be combined with the surgical removal of bad ones.

Texas has gone down the “just pass another law and fix it” road before on this issue, and this approach has consistently made things worse, not better. After the passage of the federal Fair Credit Reporting Act in 1970, an industry offering “debt repair” services emerged. Unfortunately, many debt repair organizations engaged in disreputable practices and, in order to combat the excesses of this industry, the Texas Credit Services Organizations Act was enacted in 1987. But the organizations (“CSO’s”) created and defined under this Act not only included businesses paid to improve a consumer’s credit rating, but also those involved in “obtaining an extension of consumer credit for a consumer.” After the FDIC issued new guidelines on payday lending in 2005, Texas payday lenders sought to avoid these and other restrictions by registering and operating as CSO’s. And now, in an effort to fix the problem caused by the CSO statute, which itself was designed to fix a supposed problem in the Fair Credit Reporting Act, we are told that yet another statute must be passed. Who is actually gullible enough to think that this new “fix” will not again create at least as many new problems as it supposedly solves? It’s deja vu all over again.

No legislative body, no matter how powerful or well-intentioned, can repeal the laws of economics. In 2008, congressional mandates for Freddie and Fannie combined with the passage of the Community Reinvestment Act to mandate lending to those who could not afford to pay the loans back, thereby injecting systemic risk into the market. Similarly, the unintended consequences of severely restricting or eliminating the ability of desperate people facing financial emergencies to take out payday loans will only drive the market underground, resulting in less competition and more harm to consumers.

The real problem is not the existence of payday loans per se, but rather the unseemly entanglement of government enforcers with payday lenders. When borrowers default on credit cards or fail to pay back a signature loan from their bank, they face a denial of future credit from that institution, negative credit reporting making it more difficult to obtain credit with other institutions, and execution on civil judgments that can be satisfied against their nonexempt assets. These consequences work well to both constrain irresponsible behavior by consumers and allow institutions to properly assess the risk of lending. But the payday lending industry commonly eschews such reasonable remedial measures in favor of employing state actors to do their dirty work.

The process goes something like this. A payday lender requires the borrower to provide a post-dated check in order to receive the loan. Unsurprisingly, on the appointed date these checks often bounce due to insufficient funds. Lenders then take advantage of unsophisticated borrowers by threatening prosecution for check fraud unless they either pay up or roll over the loan. If these threats don’t do the trick, the lenders then refer the matter to the local district attorney’s office for potential prosecution.

These threats from collectors are not legally supportable under any fair interpretation of the penal code, and thus should constitute a violation of the Texas Debt Collection Act’s provisions against falsely accusing consumers of crimes or threatening them with arrest. Unfortunately, not only are such collection actions rarely punished, but many district attorney’s offices are often all too willing to countenance such charges. In fact, some district attorneys not only send out legally required notices on behalf of merchants using official government letterhead, but they have also established fast-filing programs that allow these lenders to expedite the process.

Taking a ding on your credit report is one thing; facing jail time is quite another. It is true that these pseudo-crimes are rarely prosecuted (presumably, because many recipients are suitably terrified into immediate payment), and that claims of modern-day debtors’ prisons lurking just around the corner are a bit hyperbolic. Even so, hijacking the government—the entity that by definition has a monopoly on the legitimate use of force—by transforming prosecutors into private debt collecting muscle is simply unconscionable.

Rather than pass another statute, the Texas Legislature should start by repealing the wrongheaded provisions of the CSO that allow payday lenders to avoid the laws intended to regulate their industry. The Consumer Protection Division of the Texas Attorney General’s Office should more vigorously enforce provisions of the Texas Debt Collection Act prohibiting fraudulent collection practices. And prosecutors should cease threatening to break borrower’s financial legs unless they pay up. These are the sort of solutions needed to combat the most pernicious aspects of the industry.

Payday lending, as currently constituted, is indeed a boil on the skin of the financial system. But the “medicine” of passing a new state statute that significantly limits these loans will not only fail to cure the patient, it will both exacerbate the current illness and produce a whole litany of unwanted side effects. The Texas Legislature should observe the Hippocratic Oath instead; first, do no harm.