I usually begin my blogs out with quotes from various sources. Today, however, I am quoting a famous mythological event painted by Nicolas Poussin in 1634. The story is that shortly after the founding of Rome a competing tribe, the Sabines, prevented their women, by regulation, from marrying Roman men. This angered Romulus, one of the mythological founders of Rome and his men. As a result they said the heck with Sabine regulations, we’ll just take them. Being of stronger force the Romans then set about attacking the Sabines and taking their women.
The Trump administration is intent on reducing government regulation and without question that has the potential to benefit many parts of the American economy IF it is exercised with care. One of our readers shared a piece written by Ray Dalio, a very successful and smart hedge fund manager. He writes, “The question is whether this administration will be a) aggressive and thoughtful or b) aggressive and reckless. The interactions between Trump, his heavy-weight advisors, and them with each other will likely determine the answer to this question.”
Last week the Wall Street Journal wrote an editorial entitled, “Government Payday Choke Hold.” In it they say, “that the Obama Administration has spent years targeting entire industries merely because the left dislikes them. Case in point is the onslaught against payday lenders….” After years of fighting the payday lenders on a variety of fronts in 2013 the Administration sought to pressure banks from doing business with payday lenders through a program entitled Operation Choke Point. The Journal notes that, “Payday lenders provide credit to people who have few options beyond loans sharks,” which is pretty accurate. They go on to say that, “state governments have gone a long way to police bad actors. The Trump Administration should end Choke Point, another example of regulatory abuse that has defined the Obama era.”
To which I say baloney! The Wall Street Journal editorial board has fabricated their facts out of thin air! Thirty-two states continue to permit payday lenders to charge anywhere between 154 and 652% (annual percentage rate (APR)) depending upon the state. That is simply unconscionable! Especially when you consider that these are Americans who are already in financial trouble. Further the payday lender’s net profit, that is, their return on assets is in excess of 100% according to an FDIC study done in 2005. That figure is not a typo. Payday lenders net earnings are fifty to one hundred times that of high performing banks. While dated, the situation remains the same in most of those 32 states despite what the Journal has written.
Payday lending is not a small business. Pew Research reports that this past year saw 12 million Americans borrow from payday lenders and they paid $9 billion in loan fees in 2016 alone. Courtesy of the Center for Responsible Lending the following chart shows the maximum interest rates (APR) allowed by State as of May 2016.
Clearly the Journal did little, if any, homework before writing their editorial. One suspects that the Payday lending lobbyists did an outstanding job of getting the editorial staff to do their bidding.
The truth is, other than not breaking someone’s bones, what is the difference between a loan shark and a legalized business that charges 400 or 500 or even 600% interest rates? Not very much.
In yellow above you will find states with no interest rate shown. They are the States that have controlled payday lending. Georgia has outlawed payday lending completely under its racketeering laws! Six other states also prohibit payday lending. Eleven states have capped the interest rate at 36% or less which has resulted in payday lenders leaving those States in large numbers.
Unfortunately for the Journal’s editorial reputation, however, many, if not all, of the 32 remaining states have APR caps that are, to be polite, usurious. Thus, to make the statement that, “state governments have gone a long way to police bad actors,” is pure fiction. The fact is that the majority of states have not done so. But, as egregious as that is I present this story to serve a larger point.
As the new Administration comes to power seeking to deregulate a number of areas we, as Mr. Dalio points out so effectively, need to focus on whether those reductions in oversight are done intelligently or recklessly. One serves to benefit the majority of Americans, the other does not.
Mr. Dalio writes regarding the President elect and his cabinet choices that, “…the people he chose are bold and hell-bent on playing hardball to make big changes happen in economics and in foreign policy (as well as other areas such as education, environmental policies, etc.)…. This new administration hates weak, unproductive, socialist people and policies, and it admires strong, can-do, profit makers. It wants to, and probably will, shift the environment from one that makes profit makers villains with limited power to one that makes them heroes with significant power.”
Certainly the vast majority of profit makers are not evil nor however are they heroes. They are simply business leaders who made a lot of money. That isn’t heroism. Nor does it, as the Obama Administration sought to do, make them the enemy of the State either.
The use of artificial synonymic descriptors is not relevant to whether or not more or less regulation is properly administered. While it is great press to write, “that the Obama Administration has spent years targeting entire industries merely because the left dislikes them,” that it is simply political rhetoric. But, to make policy or regulation requires evidentiary material and decision-making that is disciplined if we are to come to the best conclusions. That is true whether we are creating new regulations or deregulating old ones.
Over regulation is ridiculously expensive both for American business as well as the consumer. The Consumer Financial Protection Bureau, in its quest to demonize banks for their part in the 2008 financial meltdown, spent millions of dollars rewriting the mortgage lending rules. If I had to guess, the implementation of those rules likely runs into the billions of dollars for the financial institutions and the consumers who must live with those rules.
Did we need new regulation after the 2008 crash? Yes. Unbridled capitalism doesn’t work any better than unbridled socialism or communism.
But in reality, we could have revised the lending rules and regulations quite literally on one piece of paper! We needed to set maximum levels of indebtedness i.e. debt ratios that also take into consideration whether a loan rate is fixed or variable and we needed to mandate proper income verification. That’s it! Every other piece of regulatory language and control was unnecessary.
How do we know that? Because, for decades when there were sound underwriting criteria the system worked extraordinarily well. It only broke when those principles of sound lending were violated. This is not rocket science. Nor did it require reams of regulation to fix the problem. It was bureaucracy at its worst.
Thus, I believe that Mr. Dalio is right when he suggests that we must wait and see whether the new administration will be thoughtful or reckless. Leaders, almost by definition, tend to be aggressive. What defines their success is how well or poorly they control their aggression as they go to execute their strategies.
It’s not about heroism. It is about disciplined focus that takes into consideration both risk and reward and does so after a thorough vetting of the strategic issues at hand.
Shortly after the election a statement was posted on the official transition website that said the Administration financial services team, “…will be working to dismantle the Dodd-Frank Act and replace it with new policies ….” That is all well and good as far as the statement goes. It’s even better that Mr. Icahn, President elect Trump’s special advisor on regulatory reform was recently quoted on CNBC as saying, “he is not against regulation as he would not want to repeal Dodd-Frank.” Good decision- making requires multiple points of view. Thus, when Mr. Mnuchin, the presumptive Treasury Secretary, says, “…we want to strip back parts of Dodd-Frank and that will be the number one priority on the regulatory side,” we can be hopeful that the Administration is looking at all sides of the coin and being thoughtful.
Dodd-Frank is complicated as will be virtually every issue the President will have to consider. If President Trump is to be successful he is going to have to be consistently thoughtful as his Administration works through deregulating banks, energy and any other area they may deem appropriate. Absent that, we cannot have any certainty that, in the long term, Americans will be better off.
Regulation, be it more or less, requires a balanced assessment of the societal costs and benefits for most Americans, not just the rich or the poor. They are the outliers. What matters is how regulation impacts the majority of Americans.
I chose the payday lending issue specifically for that reason. The Journal’s fake facts starkly demonstrate how regulatory changes should not be made. The owners of payday lending firms are not heroes for having financially raped Americans in need. Nor are they heroes for the size of their profits.
At the same time, during the mortgage fiasco of 2008 borrowers who used no document loans and lied about their income to obtain homes they couldn’t afford were not blameless either.
Regulations shouldn’t be written to benefit the extremes. Rather, they need to maximize the benefit for most Americans while impeding our economic progress as little as possible while insuring that we are safe and sound at all times. That definition applies to any form of regulation be it financial or otherwise. Leaning too far one way or the other places the majority of Americans at risk solely to benefit one extreme or the other. In the long run that creates societal damage for everyone.
The Journal’s position regarding the Choke Hold program is reckless. It would only benefit the executives and stock holders of payday loan companies. Had they taken the time to truly understand the issue they would likely have seen a better way.
In 2007 Congress and the President (Bush) passed and signed into law the Military Lending Act. It limited the APR for all lenders, to include payday lenders, to 36% for active duty military personnel.
They did so because the Department of Defense reported to Congress that payday lending was predatory and “…undermines military readiness, harms the morale of troops and their families and adds to the cost of fielding an all volunteer force.”
This was ground breaking legislation. “For the first time in modern history,” according to the Consumer Federation of America, “Congress set a national usury cap for credit and banned risky features of credit products….” There was significant bi partisan support in Congress. This was not an act of the left simply disliking the payday lending industry.
Applying the lending act to all Americans, not simply active duty military personnel, would enable us to aggressively and thoughtfully change regulation for the better for the vast majority of Americans. At the same time it would render the need for the Choke Hold program mute. That would be an act of both positive new regulation as well as one of deregulation.
We must all hope that the new Administration will be thoughtful rather than reckless for as the military often says, “Prior planning prevents piss poor performance!”