More than a decade after the 2008 financial crisis, subprime lending is coming back into the political spotlight.
The US financial services sector enjoyed four years of restrained enforcement and supervision during Donald Trump’s presidency. Under Joe Biden, though, the pendulum is swinging back — even as Republicans try to prevent it from swinging too far.
The ideological tensions are vividly illustrated by the debate over subprime lending: how far should regulation seek to protect consumers — mostly working-class Americans — from risk?
Biden has nominated Rohit Chopra, an administrator favoured by his party’s leftwing, to run the Consumer Financial Protection Bureau. The CFPB has broad powers to regulate non-bank consumer lenders and Chopra, a federal trade commissioner, has spoken out strongly against what he sees as predatory lending practices, in areas from education finance to payday loans. If confirmed, he will probably be under pressure to take bold action, soon.
One potential target: instalment lenders, who provide loans of a few hundred to a few thousand dollars to borrowers who lack the credit rating needed to secure a credit card. Companies such as World Acceptance, Curo, Enova and OneMain provide credit to people banks won’t touch, for a price.
Consider World Acceptance, one of the largest and most controversial in the group. Its average loan is for about $1,200, runs for 16 months, and has an interest rate of more than 50 per cent. In its last fiscal year, almost a fifth of its loans had annual interest rates of more than 90 per cent.
This puts many of World Acceptance’s loans well above the rate that recent pieces of legislation have treated as unacceptably usurious: 36 per cent. That is the level, for example, above which the Military Lending Act forbids interest rates on most loans to members of the military, and the rate cap on all consumer loans the Illinois legislature passed this month.
Much of the controversy around World Acceptance (it was investigated by the CFPB before the regulator dropped its probe in 2018) focuses on how its business model is driven by loan refinancing. Once customers have made several payments, the company offers to provide another cash payment and renew the loan at a higher level. The result, critics say, is that the customer regresses to paying mostly interest each month, and the principal becomes effectively permanent. Almost 80 per cent of the company’s loans originated through refinancings.
World’s rates may seem excessive. But remember that about 15 per cent of its loans are written off, and then there is the cost of running branch networks, and the cost of financing. The company’s return on equity has averaged in the low teens in recent years. It is not a wildly profitable business. More than 20 per cent of the company’s publicly traded shares have been sold short — meaning that traders are betting on them to fall.
“It’s very clear from an enforcement perspective that [the CFPB] is going to take a more aggressive approach,” said John Hecht, an analyst at Jefferies.
Should the CFPB and the Biden administration come down hard?
The concern is that “the lenders don’t look at borrowers’ ability to pay — they just make sure there is money coming in”, says Lisa Stifler, director of state policy at the non profit Center for Responsible Lending. The refinancings “lead to a permanent debt overhang, with other financial consequences, such as bank overdraft fees and even bankruptcy”.
There is little doubt that instalment loans land some borrowers in trouble. The harder thing to determine is whether there are offsetting benefits.
Jeremy Rosenblum, a lawyer at Ballard Spahr, who has represented instalment lenders (but not World Acceptance) sums up the other side: “People are getting credit who simply cannot qualify at a rate under 36 per cent. The question really is: who knows best? The consumer or government officials in entirely different financial circumstances?”
“There are people who urgently need money — their car is broken, they have a medical bill, they are in danger of having their utilities disconnected — and these loans can keep them afloat.”
The debate is not simple, but this much is clear: it will be played out directly on top of the faultline that divides Americans’ attitudes towards business, regulation, inequality and free markets. How it is resolved will tell us a great deal about where America stands as a nation.