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Designing a Targeted Regulatory Intervention for Payday Lending Mitigating Extended Use of Single-Payment Loans Without Eliminating Access

Rick Hackett Special Policy Consultant, Clarity Services

Topics

• Regulatory Context

• Fixing Flaws in Existing Statistical Analysis of Single-Pay Loans

• Building a Representative Longitudinal Sample

• Results from Longitudinal Sample

• Robustness of Sampling Method

• Designing a Targeted Intervention That Preserves Access

Theory of “harm” is triggered by cost of loan: “Fees eclipse loan amount.”

• “Cost” computation is rational – a “loan sequence” is renting the same dollars when no intervening income between loan.

• Limit is arbitrary (why not .5x or 2.0x loan amount?)

• Sounds like a loan cost limitation, but CFPB prohibited from setting usury caps

Essence of the CFPB’s Data Analysis

Essence of the CFPB’s Data Analysis

This presentation analyzes the “proof,” assuming that the theory is correct. CFPB “proof” has two basic flaws:

1. Prove “harm” with too short a sample

2. Prove “harm” without looking at evolution over time

(longitudinal) – using single-month cohorts

Fundamental Flaws in Published Analyses

• Truncation Effect on Studies Limited to 11 or 12 Months

• Sampling Bias in Selection of Cohorts for Study

Duration of “Life Cycle” of Payday Loan Use Number of Loans per Sequence; Summary Statistics

Behaviors Missed Due to Truncation

Sampling Bias: Oversampling Heavy Users

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greater than 7loans

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CFPB Sampling Method

Maximum Number of Loans in One Sequence per Borrower ("WorstCase")

Why is Sampling Method So Critical?

• Median sequence duration from all 6 sampling methods we tested was 2 loans (except 3 for CPFB method).

• But mean sequence duration ranged from 4.5 to 7.5 loans.

• There are outliers dragging the mean way above the median, and sampling methods determine the weighting of the outliers.

Visualizing the Tail on the Curve: Distribution of Percentage of Sequences Both Samples

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Percent-CFPB Sample

Visualizing the Tail on the Curve: Distribution of Percentage of Sequences CFPB Sample Method 4 years

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The Top 5%

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Visualizing the Tail on the Curve: Distribution of Sequence Counts-A Longitudinal Study

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Frequency of Sequences by Number of Loans Longitudinal Sample


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Percent-CFPB Sample

Building a Representative Longitudinal Sample

Data source: 100MM loans over 4.5 years (20% of market)

Sampling method: • 1,000 random-sampled borrowers January 2010

• Sample for 3.5 years; observe for 4.5 years

• When a borrower ends product use through sample period, replace with new random-sampled borrower not a user in prior month

Building a Representative Longitudinal Sample Result: • 1,211 new borrowers join the sample over the 3.5 year period

• All 2,211 followed through end of 4.5 years (limited truncation effect)


Olin when you do this slide add; Replacement N=1211 Replaced N=698 Persistent N=302 (legend below)

How Our Random Sample Evolves Ju

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Building a Representative Longitudinal Sample How Our Random Sample Evolves

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Out of 2,211 borrowers who make up a constant 1,000 per month:

• 302 are “persistent” throughout – CFPB sees

• 698 taper off – CFPB sees

• 1,211 are new replacements not seen by the CFPB – they are very different

Visualizing Truncation and Sampling Bias Mostly Persistent Borrowers and No Replacements

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Results from Longitudinal Sample (CFPB sees mean sequence = 7.25 loans)

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Predominance of Sequences 6 Loans or Less

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Takeaway

When the CFPB looks at a single cohort packed with heavy users, over a short time, it finds a large percentage of long sequences.

When you look at the behavior of a longitudinal sample (new borrowers joining all the time) over a longer period, the percentage of long sequences drops radically.

Takeaway

Better Worst Case Scenarios Distribution of Borrowers’ Maximum Loan Sequence 49.8% of Borrowers Never Experience “CFPB Harm”

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Takeaway

• 49.8% of borrowers never have a sequence longer than six loans.

• This analysis includes sequences using multiple lenders.

• Only the “persistent” borrowers have high percentage of long “worst case.” These are CFPB’s white paper borrowers.

If There Is a Single “Debt Trap,” Are There Many? NO

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Replacement

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Percentage of Other Sequences for Borrowers With Maximum Loan Sequence of 10 Loans

No Harm by CFPB Definition

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Replacement Replaced Persistent Total

Are Borrowers With a Maximum Loan Sequence of 10 Loans Having Other Sequences Showing Harm? NO

Robustness: Are New Borrowers Really Different?

SEQUENCE DURATION STATISTICS FROM MULTIPLE SAMPLES

Is ANY Change Justified? Hackett Thinks So

90th Percentile (Top 0%)

Objectives for a Targeted Intervention

• Eliminate long sequences

• Limit additional cost of origination

• Speed and convenience

• Preserve access

Demand Side Considerations

Financial profiles and use cases vary: • Chronic cash flow shortage (cash flow insolvent)

• Income/expenditure asynchrony

• Temporary cash flow shortage (expense or income shock)

• Opportunity cost of denial will vary (loss of housing versus loss of cable tv)

• Only the first case is easy to legislate

Suggested Content of Intervention

• Automated and inexpensive screen for cash flow insolvency

• Screen for existing/recent small-dollar obligations to accurately detect sequences

• Rollover (sequence length) limit consistent with CFPB economic theory

Automated And Inexpensive Screen For Cash Flow Insolvency

• Consumer stated income (not more than 125% of zip+4/age median)

• Consumer stated housing expense (not less than 75% of zip+4/age median)

• Credit report-based other debt payments

Automated And Inexpensive Screen For Cash Flow Insolvency

• BLS-based (zip+4/age/income) proxy for living expenses

• Screen: Residual income ≥ loan fee + 1/6 loan amount

• Can be done in seconds for less than $1.00

Rollover Limit Consistent With CFPB Economic Theory

• Linked recent loans (within one pay period sequence) plus new loan cannot produce fees ≥ principal (or some % selected by CFPB).

• Will vary by state (Florida = 10 loans; Utah = 5 loans)

Rollover Limit Consistent With CFPB Economic Theory

• Once hit limit, lender must offer 4 pay period off ramp. If PIF, then 30-day cooling off period.

• Data to manage all of this is available from existing credit reporting systems.

Loan Volume Retained Under Alternative Restrictions

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