Not All Birds of a Feather Flock Together: DOD takes Aggressive Pro-consumer Stance on Loans to Soldiers

By Emma Coleman Jordan

Recently, the Department of Defense took the unusual position of urging aggressive pro-consumer protections for predatory loans extended to service men and women.  In a new report, link here, DOD called for drastic federal restrictions on the types of loans that can be made to military personnel. 

The DOD study documents the fact that some lenders have concentrated their  predatory practices, which I have discussed in an earlier post, in the areas near military bases.  The Defense Department argues that our fighting men and women cannot protect themselves against predatory practices such as payday loans, car title loans, income tax refund anticipation loans, and imprudent loans made to servicemen and women whose income could not possibly support repayment.

A virtually fixed point of division between libertarian economic thinkers and their progressive critics is the disagreement about the role that government should play in regulating consumer credit.  For many years, before risk-based pricing became firmly installed in the market, libertarians argued against interest rate ceilings and direct government control of the terms of consumer credit, beyond disclosure.

The libertarian economic view, exemplified in the work of economists Milton Friedman and Gary Becker, is that price regulation of credit works to the disadvantage of the least creditworthy borrowers.   They argue that if you try to cap interest rates to protect borrowers with poor collateral or bad credit histories from the exhorbitant rates charged by creditors who would otherwise serve the riskiest end of the market; these creditors will simply withdraw and thus reduce the amount of legal credit available to borrowers who need it the most.  This will in turn push these borrowers into the illegal markets run by loan sharks and organized crime. 

The other side of this argument has been made by pro-consumer moderates and progressives alike.  They argue that borrowers who have nowhere else to turn, should not be subject to predatory terms.  So,  progressives, like me, have long supported government regulation of interest rate ceilings, invalidation of contractual waivers of legal rights, and direct limits on the enforceability of loans made to borrowers who the creditor reasonably knows have no ability to repay the loan.  These are just and even required.  In a market economy in which the model of arms length bargaining simply does not apply for those with the least bargaining power; government serves to provide a necessary restraint on the imbalances of economic bargaining power common between creditors serving the poorest niche and their customers.

Now, the DOD joins the pro consumer side of this argument with its view that “a clear, unambiguous rate ceiling is justified given the high fees, interest and other charges associated with loans to Service members reviewed in this report, and the impact of those predatory loans on military readiness and troop morale."  In addition, it urges that car title loans, payday loans using postdated checks written on bank accounts should be prohibited per se.

DOD calls for the following federal legislative reforms:
□ Interest rate cap of 36% for all military borrowers
□ Uniform price disclosure for all loans, except mortgages
□ Prohibit lenders from using checks, access to bank accounts and car title pawns as security for obligations
□  Prohibit provisions in loan contracts that require Service members and family members to waive their rights to take legal action.

□   "Waiver is not a matter of 'choice' in take-it-or-leave-it contracts of adhesion. "

So, the DOD must be given credit for recognizing that the very least  men and women who are willing to die for their country deserve in recognition of their sacrifice is to have the government protect them from predatory lending practices. 

Now the only question I have is, if this is good for soldiers, which it is, then why isn't it also good in  general for the poor who are not soldiers?  Why rely upon military exceptionalism for soldiers who are mostly poor, and not provide the same protection for their poor relatives back home?

Comments

[Rebecca Tushnet]

Very interesting post. What interests me about the rhetoric of these discussions is that pro-regulators have become adept at using the language of economics, specifically behavioral economics, to explain why such offers are deceptive in ways that mere disclosures can't correct. If you deregulate for economic efficiency, you have to be open to the possibility of regulating for economic efficiency -- or you're really not after efficiency at all.

[Sofia]

You call the regulatory side "pro-consumer," but if the libertarians are right that these policies will drive marginal borrowers into the arms of organized crime, it's not really pro-consumer at all. You argue that "borrowers who have nowhere else to turn, [sic] should not be subject to predatory terms." But they are subject to such terms whether they are borrowing from legal or illegal businesses. Is there any more to your argument than "libertarians are meanies"? Do you have a real solution?

[Emma Coleman Jordan]

Thanks for the comments, this site is coming to life.

A quick response:

1. The key question is whether the claim that the only alternatives are completely unregulated consumer loans or extensive price and term regulation.

The evidence suggests that conventional lenders are able to operate successfully in a price regulated environment. The introduction of new financial instruments that permit calibrated risk-based pricing makes it possible to refine pricing structures within the interest rate limits set by government.

Experience suggests that some forms of the most extreme arguments for completely unregulated consumer lending markets are based on hyperbole and a determined preference for markets over government.

2. You miss a large component of what the argument is about. The non-price terms have been as important as the price (interest rate) issues. Libertarians oppose regulation in both categories.

3. Protecting borrowers with limited bargaining power from economic predation on both price and non price terms is a normative good, if your belief system permits consideration of norms other than efficiency. Reducing economic unfairness by restricting waivers and the use of inappropriate collateral advances the norm of fair participation in markets.

4. As I said in the post, I agree with the DOD proposals. This is a reasonable use of government intervention in a market that suggests that niche players are not truly competing on price and other terms.
5. No, Sophia, libertarians are not "meanies" and progressives are not stupid. Newsflash: the Lochner era is over.

[Emma Coleman Jordan]

Rebecca makes a great comment about the inconsistency of those who have elevated efficiency to the uberprinciple for evaluating human commercial exchange.

If efficiency justifies non-intervention in markets, then the efficiency adherents ought to be just as pleased,
(but they rarely are) with strong regulation to improve efficiency.

This proposal does indeed provide a test of fidelity to the efficiency principle. The DOD proposals can, in fact, be strongly justified on efficiency grounds.

For example, within the Navy, predatory lending contributed to an increase in the number of security revocations and denials for financial reasons.

These security revocations or denials increased from 212 in 2002, to 1,999 in 2005 (representing 80 percent of all revocations and denials for that year).

The report details the role that debt accumulated from predatory lending practices played in impairing soldiers' personal readiness, and in tarnishing their careers.

Our armed forces have encountered difficulty in recruiting (ironically, there are allegations that some recruiters have engaged in predatory recruiting tactics to meet quotas) and in maintaining troop levels. Thus, the regulations proposed can be justified as improving efficient administration of our military preparedness.

Nice point Rebecca.

[David Nieporent]

5. No, Sophia, libertarians are not "meanies" and progressives are not stupid.

You seem to take umbrage at the latter accusation (although Sofia did not make such an argument), but the underlying premise of your position is that poor people are stupid.

You dress it up in language about "lack of bargaining power," but of course that's not the case; they have the same bargaining power as everyone else: the ability to take their business to another service provider (in this case, lender). If they're nonetheless choosing these "predatory" terms over better ones, then the only conclusion we can come to is that they're stupid.

You might respond by arguing that they don't have bargaining power because they can't shop around, because there simply aren't any lenders out there willing to offer better terms. But in that case, outlawing the so-called "predatory" terms doesn't help them at all; all it does is remove their ability to borrow. Unless, that is, your assertion is that it's better to have no loan at all than a 37% loan (using the DOD's proposed cutoff, for the sake of discussion). But apparently, the people actually taking out the 37% loans disagree. So we're again back to the implication that they're stupid.