From the Nimble rabbit, to the loan shark, to the vulture funds that have just gobbled up the Australian consumer arm of GE Capital, consumer finance is capitalism at it most raw.
Those with funds to spare, lending to often desperate borrowers at interest rates that would have been called usury in the Middle Ages and even banned for Catholics until the mid-19th Century.
Consumer finance is forever a battle between those who are “unfortunate” or “feckless”, depending on your ideological perspective, against those who are “greedy” or “thrifty”, again a philosophical judgement. The battle will rage forever - each time an avenue for excess lending, and admittedly borrowing, is closed, a new one opens up. This week ABC’s Four Corners showed how adept payday lenders are at bypassing regulation.
The news that whitegoods leasing company Radio Rentals is receiving a large chunk of its revenues directly from Centrelink highlights the problem - yet again. People, who are on Centrelink benefits can, like other regular bills, have their payments for rentals of furniture and whitegoods, automatically deducted from their benefit.
Moral outrage on this news has ranged from accusations that taxpayers are subsidising “dole bludgers” to watch big screen TVs, to anger over government money flowing directly to large corporations that charge the poor up to 500% interest per annum on necessary whitegoods such as refrigerators.
There is, of course, at least a modicum of truth in both of these perspectives.
Conventional economics does not have a solution to bridging these differences. Interest rates are interest rates after all, determined by the market and that is it, full stop! The fact that interest rates are unconscionable or alternatively accurately reflect the risks being taken, is purely an opinion and nothing to do with economics.
But markets can be (and often are) constrained. While claiming strict adherence to market principles, our largest “too big to fail” financial institutions are quite content to have the market constrained by taxpayer support when things go badly. For example, some of the largest US banks have just exited the “payday lending” business because of adverse publicity. Many claimed they were never in the “payday loan” business but did instead offer so-called “deposit advance” facilities. Unfortunately, as Four Corners reported, not all Australian banks have got that message yet.
The role of regulators
To its credit, ASIC is very active in constraining payday lending having just fined one of the largest of such lenders and issued a new report on how payday lending will be regulated in future. This follows similar actions by regulators in the UK and USA.
But regulating consumer finance is like holding a jellyfish, it keeps slipping through your fingers. Try as they can, ASIC finds payday lenders are more nimble than they are.
Everyone agrees that getting people into a spiral of debt which they cannot repay is counterproductive. Changes to Australian regulation in 2009 placed limits on the amount that borrowers are required to repay for a short-term loan (20% fee plus 4% interest per month) and how often they can take out and roll-over such loans (not more than two in 90 days). However, these terms, though outwardly stringent, were watered down in favour of lenders during the parliamentary debates.
ASIC is definitely on the payday lending case, but given all of the other financial sector scandals currently on its plate, this is problematic. ASIC is not only responsible for registering financial services licenses and supervising licensed firms, but also for consumer education, which it does via its MoneySmart initiative. Can it focus effectively on both of these responsibilities at the same time? As Four Corners shows, payday lenders are very adept at skirting the rules.
In other jurisdictions, regulatory bodies have been created to focus not only on consumer protection, but also on financial literacy. In the UK, it is the Money Advice Service (MAS) and in the USA, the Consumer Financial Protection Bureau (CFPB).
Both of these new regulators, along with the new Financial Conduct Authority (FCA) in the UK have recognised consumers sometime make dumb (called “irrational”) decisions about money. After all, who in their right mind would willingly pay interest at an annual percentage rate of over 400%?
Behavioural economics can help
These regulators, much to the distaste of traditional economists, have turned to the discipline of behavioural economics for insights. In rather dry language, the Financial System Inquiry agreed that people are often really irresponsible about financial matters and that new insights are needed:
“Behavioural economists highlight that individuals are prone to making systematic errors in decisions that involve assessing risk and uncertainty, such as when making insurance or investment decisions.”
In his first speech as head of the new UK Financial Conduct Authority, Martin Wheatley, emphasised the importance of behavioural economics to regulation and the Authority has issued a number of papers on related topics such as how investors “significantly and systematically” overestimated the returns from structured deposits, a type of complex investment product.
And from the outset, led by Senator Elizabeth Warren, the new CFPB has shown its support of behavioural economics for consumer finance regulation.
ASIC has, in the past, reviewed the use of these new economic techniques but implementation is still at the trial phase in narrow segments.
The time is now right to look at what other jurisdictions do, focusing on the end consumer rather than the intermediary financier.