[Senate Hearing 109-1081]
[From the U.S. Government Publishing Office]
S. Hrg. 109-1081
A REVIEW OF THE DEPARTMENT OF DEFENSE'S
REPORT ON PREDATORY LENDING PRACTICES
DIRECTED AT MEMBERS OF THE ARMED FORCES AND THEIR DEPENDENTS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
ON
UNFAIR OR ABUSIVE LOANS, CREDIT SALES TRANSACTIONS, AND COLLECTIONS
PRACTICES THAT ARE PARTICULARLY HARMFUL TO SERVICE MEMBERS AS IT
UNDERMINES MILTARY READINESS AND HARMS TROOP MORALE
----------
THURSDAY, SEPTEMBER 14, 2006
----------
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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senate05sh.html
----------
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UNFAIR OR ABUSIVE LOANS, CREDIT SALES TRANSACTIONS, AND COLLECTIONS
PRACTICES THAT ARE PARTICULARLY HARMFUL TO SERVICE MEMBERS AS IT
UNDERMINES MILTARY READINESS AND HARMS TROOP MORALE
S. Hrg. 109-1081
A REVIEW OF THE DEPARTMENT OF DEFENSE'S
REPORT ON PREDATORY LENDING PRACTICES
DIRECTED AT MEMBERS OF THE ARMED FORCES AND THEIR DEPENDENTS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
ON
UNFAIR OR ABUSIVE LOANS, CREDIT SALES TRANSACTIONS, AND COLLECTIONS
PRACTICES THAT ARE PARTICULARLY HARMFUL TO SERVICE MEMBERS AS IT
UNDERMINES MILTARY READINESS AND HARMS TROOP MORALE
__________
THURSDAY, SEPTEMBER 14, 2006
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.access.gpo.gov /congress /senate /
senate05sh.html
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky EVAN BAYH, Indiana
MIKE CRAPO, Idaho THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina ROBERT MENENDEZ, New Jersey
MEL MARTINEZ, Florida
William D. Duhnke, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Jonathon Gould, Counsel
Patience Singleton, Democratic Counsel
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
C O N T E N T S
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THURSDAY, SEPTEMBER 14, 2006
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Johnson.............................................. 2
Prepared statement....................................... 32
Senator Dole................................................. 3
Senator Reed................................................. 6
Senator Allard............................................... 6
Senator Schumer.............................................. 7
Senator Martinez............................................. 8
Senator Sarbanes............................................. 27
WITNESSES
David S.C. Chu, Under Secretary for Personnel and Readiness,
Department of Defense.......................................... 9
Prepared Statement........................................... 34
DoD Report on Predatory Lending Practices Directed at Members
of the Armed Forces and Their Dependents................... 41
Admiral Charles S. Abbot, Retired, President and Chief Executive
Officer, Navy-Marine Corps Relief Society...................... 19
Prepared Statement........................................... 133
Response to written questions of:
Senator Shelby........................................... 200
William O. Brown, Jr., Associate Professor, Department of
Accounting and Finance, Bryan School of Business and Economics,
University of North Carolina................................... 20
Prepared Statement........................................... 143
Response to written questions of:
Senator Shelby........................................... 200
Senator Crapo............................................ 201
Lynn Drysdale, Staff Attorney, Jacksonville Area Legal Aid....... 21
Prepared Statement........................................... 176
Response to written questions of:
Senator Shelby........................................... 201
Hilary B. Miller, President, Payday Loan Bar Association......... 24
Prepared Statement........................................... 182
Response to written questions of:
Senator Shelby and Senator Johnson....................... 204
Christopher L. Peterson, Assistant Professor of Law, Levin
College of Law, University of Florida.......................... 25
Prepared Statement........................................... 195
Response to written questions of:
Senator Shelby........................................... 216
Additional Material Supplied for the Record
Letter from Hilary B. Miller on behalf of Community Financial
Services Association of America................................ 398
A REVIEW OF THE DEPARTMENT OF DEFENSE'S REPORT ON PREDATORY LENDING
PRACTICES DIRECTED AT MEMBERS OF THE ARMED FORCES AND THEIR DEPENDENTS
----------
THURSDAY, SEPTEMBER 14, 2006
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:05 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Richard Shelby, presiding.
OPENING STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. The Committee will come to order.
This morning, the Committee will hear testimony on the
recently completed Department of Defense report on predatory
practices directed at members of the armed forces and their
dependents. The report draws attention to the problems of
predatory lending around military communities and the plight of
servicemen and women who are caught in what the report
describes as debt traps.
Although predatory lending schemes differ in their details,
they share certain characteristics. For example, some lenders
target financially inexperienced consumers and make loans
without regard to the consumers' ability to repay. The lending
products they offer also feature high interest rates and fees.
These lenders often count on the fact that borrowers will
be unable to pay the loan in full when it becomes due, forcing
borrowers to seek additional loans which generate more fees.
The end result is often the same: mounting debt, a
deteriorating credit rating, and reduced availability of credit
sources.
Unfortunately, military personnel and their families are
particularly attractive targets for this type of lending. They
are often young and financially inexperienced, sometimes
receiving their first steady paycheck. Because they fear
military sanctions, including the loss of security clearance,
servicemen and women are less likely to default entirely on
loans and, therefore, represent a low credit risk to lenders.
Finally, the fact that they are concentrated in large numbers
on and around military bases makes them a readily accessible
market for these types of loans.
In addition to describing the most prevalent forms of
predatory lending, the report that Secretary Chu will expound
on also offers concrete legislative recommendations to reduce
the impact and frequency of predatory lending. The Defense
Department, is to be applauded for the effort it has made to
promote financial literacy among service members and their
families, but education can only do so much.
As the Committee has learned in the cases and situations
involving certain mutual funds and insurance products aimed at
military personnel, stronger Congressional action may be
required. As long as certain unscrupulous lenders continue to
employ predatory practices, our servicemen and women suffer and
the toll on our readiness will increase.
I would like at this time to take a minute to commend
Senator Dole, for her work to initiate this important study. It
was through her efforts that this study was included in last
year's Defense Authorization Act, and she has been very, very
important to this cause.
On our first panel today, we will have Dr. David Chu, Under
Secretary of Defense for Personnel and Readiness; he will
discuss the department's report. Our second panel will consist
of: Admiral Charles S. Abbot, President and Chief Executive
Officer of the Navy-Marine Corps Relief Society; Dr. William O.
Brown, Associate Professor at the Bryan School of Business and
Economics at the University of North Carolina in Greensboro;
Ms. Lynn Drysdale, a staff attorney with the Jacksonville Area
Legal Aid; Mr. Hilary B. Miller, President of the Payday Loan
Bar Association; and Mr. Christopher L. Peterson, Assistant
Professor of Law at the Levin College of Law, University of
Florida.
STATEMENT OF SENATOR TIM JOHNSON
Senator Johnson. Well, thank you, Mr. Chairman, for this
hearing, and I appreciate the Committee is meeting today to
discuss an issue of critical importance.
Thousands of our military personnel are currently serving
in harm's way in defense of our country. In my State of South
Dakota, over 3800 military personnel and civilians are
stationed at Ellsworth Air Force Base, 300 of which recently
deployed in support of the Global War on Terror. As a father of
an active duty soldier, an enlisted man who served combat tours
in Iraq and Afghanistan, I am acutely aware of the very
personal and financial challenges facing our men and women in
uniform. I am proud of their courage and professionalism and am
grateful for their service to our country.
Financial stress can affect any soldier regardless of their
marital or deployment status, but in particular younger or
lower-ranked enlisted personnel. We all sympathize with the
soldier who incurs debt because he is blind-sided by unexpected
emergencies, auto repairs, personal or family illness, or is
just struggling with basic living expenses.
I share DoD's concern about service members falling into a
cycle of debt whether through inappropriate use of credit
cards, payday loans, or other forms of credit. I believe
Congress and DoD must work together to improve the financial
literacy of our service members and crack down on abusive and
truly predatory practices by any lender.
It is very clear that military personnel, like many other
consumers, have a real and legitimate need for short-term small
denomination credit products. According to the Federal Reserve,
payday loans typically total $500 or less with fees ranging
from $15 to $100. As the loans typically last for just 2 weeks,
however, the annualized interest rates tend to be high.
Now, one of the concerns that I have as we discuss this
issue is that there are various steps that the committee and
Congress could take relative to various sectors of the credit
industry, but the underlying problem remains, and that is the
problem of military personnel, particularly younger enlisted,
but others as well, who are not able to make ends meet; and
whatever we do with the various sources of credit, those
problems remain. Obviously, one of the reasons that payday
lenders have stepped into a vacuum is because the banking
industry and the credit union industry have chosen not to
pursue that level of lending with very much aggressiveness, and
as a result, a vacuum has occurred.
If we are to eliminate payday lending altogether and make
it unviable in this niche, then the question I have is who
fills then that niche, because the need remains. Do we then go
to increasing use of pawnshops? Internet lenders? Loan sharks
out of the back of their car? Where do we go next? That is one
of the concerns that I have, is that we not jump from the
frying pan literally into the fire in terms of abusive
practices toward our military personnel.
So I think we have some far-ranging questions that need to
be answered. I know that the military is aware of the need for
greater financial literacy, which is part of the problem. That
is a national problem, not simply a military, but it is a
national problem. We have got a long ways to go on that, but I
am concerned that the underlying problem remains and I want to
make sure that we don't have unintended consequences that are
worse than the current illness that we may have.
So as we continue to address the issue of predatory lending
to the military, the primary goal, I believe, should be to
develop meaningful solutions that will offer the greatest
protections to our service members while avoiding measures that
carry the potential for negative unintended consequences and
driving service members into potentially far more abusive and
more expensive and unregulated forms of credit. So, again, I
thank you, Mr. Chairman, for holding this hearing and I hope
that this leads us to a very constructive debate about how best
to serve the needs of our American military personnel.
STATEMENT OF SENATOR ELIZABETH DOLE
Senator Dole. Mr. Chairman, I thank you for your interest
in this subject and thank you for holding this hearing today.
Secretary Chu, thank you so much for your excellent report. I
appreciate the diligent efforts that have been made by those
who assisted you in this effort. I also want to thank the
witnesses who appear before us today in addition to Secretary
Chu. I look forward to hearing from all of you.
I have to say I am proud to have authored this legislation
that directed the Department of Defense to prepare the report
that we are focused on today, because this problem does provide
a real threat to our national defense in my view. It is a real
threat and it poses issues that need to be focused upon.
Predatory lenders are blatantly targeting our military
personnel, undermining their financial stability and tarnishing
their service records. This practice not only creates financial
problems for individual soldiers and their families, but also
weakens our military's operational readiness. Military conduct
codes stress financial solvency, and bad credit can prevent
service members from having the security clearances they need
to perform their duties. Unfortunately, all too many are
reluctant to seek help until it is too late, resulting in
disciplinary measures that can end a career.
Let me focus on testimony from a commanding officer
included in the DoD report, and I quote: ``Between 2000 and
2005, revoked or denied security clearances for sailors and
Marines due to financial problems have increased 1600
percent.'' I find it telling that the report also shows that in
the same time period, the number of payday lenders more than
doubled from 10,000 in the year 2000 to 23,000 in 2005.
Overall, predatory lending cost U.S. consumers more than
$25 billion a year, and these lenders profit from the most
vulnerable borrowers. As we see in this report, Mr. Chairman,
several factors make our men and women in uniform particularly
susceptible to this practice, as we have already heard this
morning. For starters, many are young, and like most young
Americans, they lack financial savvy and security. In fact, the
Defense Department is the largest employer of young adults in
the United States with nearly half of its enlisted members
under the age of 25.
In addition, service members have job security and steady
incomes, and they are fashioned by a military culture that
emphasizes financial responsibility and settling debts.
Borrowing can be an alluring option for a young soldier to get
cash fast and easy, but exorbitant interest rates can quickly
send an individual into a downward spiral of debt.
As the Pentagon's report mentions, my home State of North
Carolina has been aggressively cracking down on predatory
lenders, imposing a 36 percent small loan usury cap reinforced
by a strong bank regulator. Other States also are active in
combating this practice. While this is, indeed, encouraging,
the report also mentions States where the problem continues,
like Arkansas which has a low usury cap in its constitution,
but still allows lenders to charge triple-digit interest rates
to service members stationed at Little Rock.
We need national standards that ensure that all of our
courageous men and women in uniform are protected no matter
where they are based. The DoD report states that as many as one
in five service members are falling victim to predatory loan
operations. Still, there are some who question whether these
lenders are truly targeting our military even when many,
specifically military and installment lenders, market
themselves with names and logos that imply an official military
connection. For example, you see here ``Armed Force Loans'',
``Military Loans.com'', and ``Pioneer Military Lending''.
In addition, the geographic evidence speaks for itself. Let
us look at this February 2005 map of the State of North
Carolina. This was prepared by Dr. Steven Graves from
California State University, Northridge. Now, keep in mind that
this map was created at a time when North Carolina had 612
payday lenders. Today, because of our State's laws, these
lenders no longer operate in North Carolina.
This 2005 map shows us the most targeted ZIP Codes for
payday lending in North Carolina. We can see that the larger
population centers, like around Charlotte and Raleigh, have
high concentrations of payday lenders, as would be expected.
But look at the counties with the greatest number of payday
lenders. These are areas with significant military presence.
The county with the State's highest concentration was Wayne
County, home of Seymour Johnson Air Force Base. Cumberland
County, where Fort Bragg and Pope Air Force Base are located,
has the third-highest concentration, and Craven County, the
site of Marine Corps Air Station at Cherry Point, has the
fourth.
Let us specifically look at Fort Bragg and Pope Air Force
Base. In 2005, statewide, there were roughly four banks to one
payday lender, but in the entire three-mile zone surrounding
the perimeter of Bragg and Pope, the ratio was four banks to
every five payday lenders. Now let us look at the February 2000
map of just the eastern side of Bragg and Pope. This map shows
that seven of the thirty-six payday lenders in just this area,
or about 20 percent, were within one mile of the bases while
just five of the 68 banks are in the same area. And if we look
between one and two miles of the base, there are six additional
payday lenders and only one bank. In the two- to three-mile
zone, the ratio of payday lenders to banks gets closer to the
statewide average with three payday lenders and six banks.
In reviewing the DoD report and other maps produced by Dr.
Graves, it is apparent that some unscrupulous payday lenders
are clustering around military bases across the nation.
As a Senator representing more than 115,000 North Carolina-
based service members and as a member of both this committee
and the Senate Armed Services Committee, this issue is one of
my top priorities. With my support, the Senate approved an
amendment to the Fiscal Year 2007 defense authorization
sponsored by Senator Jim Talent to enact a 36 percent annual
interest rate cap on abusive loans to service members. Last
year, Mr. Chairman, you will remember I proposed a similar
amendment to the Defense Authorization Bill, but I encountered
jurisdictional objections.
The interest rate cap provision now awaits consideration by
a House Senate Conference Committee. I am hopeful that a
provision on predatory lending that includes the rate cap as
well as additional recommendations from the Pentagon report
will be included in the final legislation. Should the
conference report not properly address this problem, I will
introduce legislation that incorporates recommendations made in
the report.
Supporting our service members means more than providing
the equipment and training necessary for fighting the War on
Terror, Mr. Chairman. We should also support their livelihood
and their families, and predatory lending can seriously harm
both.
I look forward to working with this committee as we strive
to put a stop to this egregious practice. Thank you, Mr.
Chairman.
STATEMENT OF SENATOR JACK REED
Senator Reed. Well, thank you very much, Mr. Chairman. I
commend you for holding this hearing and I commend Senator Dole
for her efforts in this regard, and I don't represent North
Carolina, but I used to command a parachute company in
Fayetteville, North Carolina at Fort Bragg in the 504th
Parachute Infantry Regiment, and I have seen young soldiers at
payday who are financially strapped and willing to sign
anything to get a few dollars, and I think this behavior, if it
is targeted to exploit soldiers is absolutely reprehensible. We
owe them a lot more than that.
This is a command responsibility. I am glad the Secretary
of Defense and the Defense Department are taking steps with
this report. The commander at that base and every base in the
country have to work hard to educate their soldiers. The
community leaders of the Fayettevilles and all the other
military towns had to step up to the box too, and we have to do
our part.
The provision that Senator Dole talked about, a 36 percent
cap, I think is more than reasonable. Some of these loans have
average annual percent rates of 470 percent. One of the
advantages I had back in the 1970's commanding a company is
most States had usury laws capping interest rates at 21 percent
or so. That is a thing of the past now. We didn't have to
worry, at least, in licensed agencies like this having soldiers
pay a 470 percent interest rate.
So I think we have to do more. I hope we can keep this
provision in the bill, and I will not, I think, be here to ask
questions. I have to go to the Armed Services Committee, I
think along with Senator Dole, because of the military tribunal
issue; but I would ask every witness to give their position
with respect to that 36 percent cap, starting with Secretary
Chu.
Thank you, Mr. Chairman.
STATEMENT OF SENATOR WAYNE ALLARD
Senator Allard. Thank you, Mr. Chairman, for holding this
hearing to examine the ``Department of Defense's Report on
Predatory Lending Practices Directed at Members of the Armed
Forces and Their Dependents''. I am proud to represent a State
with a significant military presence, and I am looking forward
to the opportunity to learn more about this matter.
We owe our military personnel a great debt. They
volunteered to risk their lives to protect freedom and
democracy; therefore, it is only reasonable to expect that we
would protect them against predatory lending. Predatory lending
is an abhorrent practice, especially when it takes advantage of
our men and women in uniform.
Earlier this year, I was pleased to support Senate Bill
418, the Military Personnel Financial Services Protection Act.
This is one way in which we can help prevent predatory
practices aimed at those in uniform. During our hearings on
that bill, it became obvious that financial literacy is key to
preventing predatory practices and the Department of Defense
has a serious need to fill regarding financial education.
Unfortunately, too many people today lack basic financial
literacy and skills, and military personnel face the same
challenges. Therefore, it is important that the DoD help
provide financial education that will enable personnel to make
appropriate financial decisions.
The DoD report includes information on their strategy to
educate members of the armed forces and their families
regarding predatory lending as well as programs to reduce or
eliminate predatory lending. This is particularly important for
my home State of Colorado where military personnel are four
times more likely than civilians to have taken a payday loan.
Military personnel make up 1.1 percent of the adult population,
but they account for 4.6 percent of payday loan customers.
While not all payday loans are necessarily predatory, these
numbers do raise important concerns. First, why do military
personnel account for a disproportionate share of payday loans?
The second, do the personnel have other options? And third, do
members of the armed forces understand the implications of the
different alternatives?
I am eager to learn more about these issues as we delve
into the report. I would like to thank the witnesses for being
here today. Their testimony will provide us with a better
understanding of the issues. I look forward to their testimony.
Thank you, Mr. Chairman.
STATEMENT OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Well, thank you, Mr. Chairman. Thank you
for holding this timely hearing, and I want to praise my
colleague, Senator Dole, for getting this report done and into
the Defense Authorization Act. We may be at loggerheads on
certain things outside the Capitol, but we can work well
together inside the Capitol.
Senator Dole. Thank you.
Senator Schumer. Now, this is a topic that has been of
great concern to me for a long time. I have heard of so many
bad stories in New York State by Fort Drum near Watertown, our
largest military installation, one of the largest in the
country, in the capital region in Albany by Watervliet near the
Stratton Air Force Base, and in western New York by Niagra Air
Force Base. We are in a funny situation in New York. We have
pretty strict usury laws. So you would think that payday
lending wouldn't occur, these loans as high as 800 percent,
just absolutely disgusting, ripping off service men and women
and their families; but the banks find ways around so that at
first, we had New York processing the loans through, say,
Delaware or other banks, and we worked with the FDIC, and they
finally shut that down.
But in this new information society, the internet,
newspapers, etc., still hold the service men and women, who we
are so proud of in New York, they are holding us victim.
So here, and I would like to point this to Secretary Chu's
attention, the ``Army Times'', and you have fast cash, Force
One lending from Albuquerque, New Mexico. A soldier in Fort
Drum can read that, go on line, or whatever. ``Need a loan?''
This is one in Nevada.
So unless we have a national law, we are not going to stop
this no matter what we do at the State level, no matter what we
do in terms of the FDIC, and one thing, Mr. Secretary, I would
urge you to do is--I don't know if there is a way you can, but
could you prohibit ads like this in the ``Army Times''? Maybe
you will talk about that when you come before us and the other
kinds of newspapers that DoD has a real hand in putting out and
helping. There is freedom of speech, but I don't think if they
put an ad, you know, join a bank robber, come join Joe Smith
Bank Robbery Team, you would put that in. Well, this is sort of
the same thing. So I would urge you to look into that.
And I would ask unanimous consent that the rest of my
statement be put in the record. I want to thank you, Mr.
Chairman.
Senator Shelby. Without objection, it will be made part of
the hearing record.
Senator Schumer. Thank you, Mr. Chairman, for the good work
you have done with the Military Personnel Financial Services
Protection act which we passed in June, and that did a good job
about abusive sales practices. We need to do the same good job
about abusive lending practices, and I know that we decided
against including those lending practices in this bill so DoD
would conduct a review, and now we don't have to wait. So I
want to join with you and all of my colleagues to make sure we
shut this down once and for all.
STATEMENT OF SENATOR MEL MARTINEZ
Senator Martinez. Mr. Chairman, thank you very much. I
would ask again, likewise, that my entire statement be made
part of the record.
Senator Shelby. Without objection, your entire opening
statement will be made part of the record.
Senator Martinez. Thank you. Also, a letter from Daniel
Mica, President and CEO of CUNA, be made part of the record.
Senator Shelby. It will be made part of the record. He is
head of the credit union.
Senator Martinez. Correct.
Mr. Chairman, I would just comment along the lines of what
Senator Schumer said, that this is an egregious practice. It is
a terrible plight upon the lives of our service men and women
and really to all people who fall prey to this kind of lending.
When I was Mayor of Orange County in Orlando, Florida, we had a
problem with payday loans, a very similar problem, more
afflicting the civilian population, but nonetheless where they
would take the security, a vehicle, and then people get a bunch
of cash. Within 6 months after they have paid off a car, they
no longer have a car. It has been repossessed from them. This
is the kind of practices that take place.
As the chairman well knows, during my time at HUD, we did a
lot to try to work against predatory lending in home lending,
which is a first cousin to this problem. So let me just commend
you for holding the hearing and commend Senator Dole for her
leadership on this issue, and I share my full support for
whatever we can move forward to ensure that this egregious
practice, particularly the plight upon our servicemen and women
comes to a stop.
Senator Shelby. Thank you, Senator Martinez.
Secretary Chu, your written statement will be made part of
the hearing record in its entirety. You can proceed as you
wish. We appreciate your work in doing this report. Thank you
very much.
STATEMENT OF DAVID S.C. CHU, UNDER SECRETARY FOR PERSONNEL AND
READINESS, DEPARTMENT OF DEFENSE
Secretary Chu. Thank you, Mr. Chairman, members of the
Committee. It is a privilege to be here this morning to testify
on the report that we rendered at the direction of the Congress
on this issue of predatory lending practices directed at
military personnel. It certainly is a special privilege to be
here with Senator Dole whose actions led to that direction and
to which we were delighted to respond.
Financial readiness in our judgment equates to mission
readiness. It was my privilege in May of 2003 to join with the
Treasury Department in launching our broader financial
readiness campaign. That campaign encourages service members to
achieve good credit standing and to save on a regular basis for
emergencies, to watch their borrowing practices, including the
interest rates they accept, to take advantage of the Thrift
Savings Plan and the Service Members and Veterans Group Life
Insurance Program. Through these diverse efforts, we focus on
the issue of personal financial stability. We hope to develop a
culture that focuses on sound financial decisions by our
military personnel. That culture will encourage service members
to reduce reliance on credit cards, to implement short-term and
long-term savings plans, and to resist predatory lenders.
The department, as we reported, is concerned about
predatory lending because it is detrimental to mission
readiness and because it can have disastrous consequences on
the quality of life and for the careers of service members. It
is one of the reasons that we have made this issue, predatory
lending, one of the 10 key issues the department and the
Secretary of Defense is addressing with the Governors of our
Nation and other State officials to seek their assistance as
well.
We do recognize that it is the first responsibility of the
Department of Defense to prepare our service members through
education and counseling, and as the report indicates, the
military services have devoted considerable time and talent to
educating service members and, to the extent possible, their
spouses so that they do, indeed, become better stewards of
their finances. To enhance the educational capability of the
military services, several prestigious nonprofit agencies and
members of the Federal Financial Literacy Commission have
joined our financial readiness campaign, and they will help us
increase awareness, understanding, and knowledge of the
assistance that is available to our military personnel.
Commanders at every echelon, from the Chiefs of Staff down
to the unit commanders, as Senator Reed testified, have been
involved in emphasizing this important message to our troops.
It was my privilege this week to invite the service department
secretaries to endorse a campaign that we will be initiating
next February called ``Military Saves'', which asks everyone
associated with the Department of Defense to consider reducing
his or her debt, and save for the future. This campaign is part
of ``America Saves'', which has been endorsed by the Chairman
of the Federal Reserve Board.
It is through these diverse efforts, we believe, that we
will keep our current focus on the issue of personal finance in
place and develop the intended culture within the military that
encourages service members to seek assistance when they need it
rather than burying their financial concerns in additional
debt. The report we provided to Congress gives an overview of
the efforts within the department to educate, inform, and
influence service members and their families to take control of
their finances, to build wealth, and to escape the cycle of
debt for their own well-being and to enhance their military
readiness.
The department has, indeed, recommended--specifically to
Senator Schumer's question, the department has recommended
establishing an interest rate cap of 36 percent for service
members and their families. The department believes service
members who acquire loans with interest rates above 36 percent
should seek assistance and not consider further debt load. The
36 percent limit creates a barrier for installment lenders to
refrain from packing fees and premiums--and others have alluded
to this this morning--onto the base interest rate that is
charged for a loan. The limit of 36 percent is considered
appropriate since it mirrors the limitations found in several
States, actually a majority of States, for their small loan
products. It is an amount that has been proven reasonable for
consumers and the industries that serve them.
To accelerate this process, we have recommended in our
report to the Congress that limits be placed on the credit
opportunities that do not consider service members' ability to
repay their debt, and that is the subject you mentioned, Mr.
Chairman. We want service members to take the tough steps
necessary to get themselves out of debt rather than the quick
cash solutions that lead them to much worse circumstances. It
is our job to give them the tools they need to resolve their
debt. We are continuing to improve the already substantial
system of support available to them, but we need your
assistance in limiting the availability of loans that fail to
consider the ability of the borrower to repay so that service
members can and will consider other alternatives.
As long as these options are legal, we have little to no
control over how much and how often service members access
these options. By the time commanders are aware of their
troops' financial problems, that damage is done.
Service members inherently understand that limits on
interest rates are appropriate even if these limits will
decrease the ability of credit. When asked in a recent survey,
74 percent of service members agreed with the statement, and I
quote it, The Government should limit the interest rates that
lenders can charge even if it means fewer people will be able
to get credit, end quote.
Service members are in agreement that there should be
limits. Commanders have made their positions known that limits
should be established. The department sees this as an important
issue as part of our compact with our commanders, service
members, and their families for their well-being and in support
of military readiness. The department asks for your assistance
in adopting the statutory steps necessary to establish more
effective limits.
I am very grateful for this opportunity to appear, Mr.
Chairman, to share our concerns with you and the members of the
Committee. The department is ready to assistant your committee
in developing effective limits on predatory lending that
affects military readiness. Thank you, sir.
Senator Shelby. Senator Dole, you are the leader here. We
will recognize you first.
Senator Dole. Thank you, Mr. Chairman.
Secretary Chu, I thank you very much for your testimony
this morning.
In a June article in ``Sea Power Magazine'', Master Chief
Petty Officer of the Navy Terry Scott is quoted as saying:
``The No. 1 reason our sailors are forced from one job to
another is because they lose their security clearance, and the
No. 1 reason they lose their security clearance is because of
financial difficulties.'' Do you know this statement to be
accurate and are these financial difficulties due to predatory
lending?
Secretary Chu. Ma'am, my understanding is that Master Chief
Scott's statement is based on an internal Navy analysis and,
therefore, I would accept it as a good description of the
challenge we face in this arena. And, yes, an important part of
that problem is the result of predatory lending.
Senator Dole. Now, in your report, you included testimony
from a commanding officer stating that revoked or denied
security clearances for sailor and Marines due to financial
problems have increased 1600 percent between the year 2000 and
the year 2005. Is predatory military lending a leading cause of
these financial problems and do you expect this trend to
continue without legislative action?
Secretary Chu. We need legislative action, to get to the
bottom line, because without it, and I think members of this
committee have spoken to that, we cannot curtail the migration
of this set of predatory practices to other products. The
advantage, I think, of the Senate amendment that you co-
sponsored is that it does shut it off. It shuts it off by
including fees within the cap. It shuts it off by making
internet-based loans unenforceable across State lines. So even
if State A fails to curb the internet lender, the contract is
null and void across the country. You can't enforce it if you
are a military person.
So, yes, ma'am, we do need legislative assistance to curb
this problem. We do think we are making progress in the
awareness of our people about their situation and how they
should conduct themselves, but education and preparation alone
are not enough given the practices that you so eloquently
described with the maps that you showed just a few moments ago.
Senator Dole. Now, you reported the strong actions--I think
this is page 47 of your report--that North Carolina has taken
to combat predatory lending. Can you tell the committee how
this has affected personnel who are stationed at bases in North
Carolina? Have the actions taken by North Carolina eliminated
the threat of predatory lending or are there further actions
the State should take?
Secretary Chu. First of all, I want to commend North
Carolina for its actions. They have had a dramatic affect. They
have substantially reduced the problem. At least that is what
our commanders tell us at the important bases in that State.
They do not--this gets to your issue, ma'am, of do we need
national legislation. Our view is, yes, it would be very
beneficial, and I particularly value the provisions in the
Senate amendment you co-sponsored because of their effect in
curbing the internet interstate lending operation by making
those contracts unenforceable. That is a key provision.
Moreover, it helps us in other States. I don't want to in
any way denigrate what North Carolina has done, but we need
national action on this as far as military personnel are
concerned.
Senator Dole. You cite a Center for Responsible Lending
report as follows: ``Active duty personnel are three times more
likely than civilians to have taken out a payday loan and that
predatory payday lending costs military families over $80
million in abusive fees every year.'' Do you believe this
analysis is correct, Secretary Chu?
Secretary Chu. We have done our internal estimates. They
are not precisely the same, but they are in the same ballpark.
You would get similar results from other methodologies. Yes,
ma'am.
Senator Dole. And the report on page 14 states that: ``The
Uniform Code of Military Justice penalizes service members for
deliberately writing a check not covered by funds on deposit.''
Can you describe the penalties that the service members are
subjected to?
Secretary Chu. First, let me emphasize the important
provision of the Code, because it makes personal financial
responsibility something that is governed by our military
justice system, and so it calls it to the attention of all our
personnel. What the penalties are depends, of course, upon the
seriousness of the offense, and as you appreciate, ma'am, we
administer it on a decentralized basis where commanders decide
the immediate courts-martial, or other administrative
authorities decide what the penalties should be. So there will
be a range of penalties depending upon the seriousness of the
infraction.
Senator Dole. Thank you.
The final question, Mr. Chairman, the report states:
``Lenders who only lend to nonresident military personnel in
about half the States have either been granted formal exemption
from State regulation or have not been required to be licensed
or supervised by State regulators under a variety of legal
arguments.'' Secretary Chu, can you describe in greater detail
how these lenders circumvent regulation and are they able to do
this in North Carolina?
Secretary Chu. As you suggest, ma'am, and this is another
reason for national legislation, a number of States have taken
the position that if you are lending to a non-State resident,
the State law does not apply. We do not like that rule. We are
advocating the States to change that position, but it is
essential, I think, to have national legislation. That is also
an issue in North Carolina, I would acknowledge.
Senator Dole. Thank you very much.
Thank you, Mr. Chairman.
Senator Shelby. Senator Johnson.
Senator Johnson. Thank you, Secretary Chu.
I think it is easy for us to sit here in a committee room
and say that, Well, these military personnel should just forego
getting credit; they have a funeral to go to; they have no
cash; the heck with them. That isn't a very satisfactory answer
and I don't think it is very realistic either. I think that
they are going to continue to seek credit for low denomination
short-term debt. I think that is a given.
The question is if we eliminate--if we place a 36 percent
cap, that means you cannot borrow $250 for airfare for a $25
fee because that would, annualize, exceed the cap. Where do you
suggest these guys go? What should they do?
It seems to me that it's saying, Well, just don't borrow
money. That is a good thing to say, but these needs do arise.
They have arisen, and that is the reason we have this vacuum
that has been filled by this particular industry, because the
credit unions, the banks have not stepped in. And so I just
wonder what do you say to that young soldier. He wants to go to
his mother's funeral. What are you going to do?
Secretary Chu. Nothing we propose, Senator, and nothing
that has been advanced is about broadly denying credit to
military personnel. Many, if not most, military personnel have
credit cards to help them pay for airline tickets, not cash.
Cash: I believe the Transportation Security Agency views it as
a signal that perhaps you are not a person we want on our
airlines.
So I don't think that is the issue, Senator. The issue is
predatory lending, getting people in over their heads, and the
maps Senator Dole displayed, are, in fact, the indictment of
this practice and the reason we need to curb it. These people
are taking military people into a debt load that they cannot
sustain. It is not about the airline ticket to a funeral.
For that purpose specifically, if a military person has a
pressing need, that is why we have and why we encourage the
Military Aid Societies. I have talked with every military
service about this. They have energetic programs to make sure
that if there is a legitimate emergency, the Military Society
is there to step forward, is eager to step forward. A major
fraction of what they do these days is make sure that those
kinds of needs are covered. We are also talking with the credit
unions and other agencies of that type that offer regular
banking products to be sure that they are responsive to these
needs as well.
So I don't think the example that you offered, sir, is, in
fact, the situation. That is not what we are confronting here.
We are confronting people in over their heads on a long-term
basis. This is the rollover issue.
Senator Johnson. Well, that is somewhat my point, is that
it seems to me the problem here is not so much a fee on a
particular low denomination loan as it is the rollover problem
and how many rollovers are going to go on, and it seems to me
that that is the larger issue than a fee that a credit card
company charges or a bank charges for an overdraft and so on.
It is how deep you go and how long you stretch out the loan, it
seems to me, the greater problem than the 36 percent issue.
But in any event, I appreciate your observations. It just
seems to me that the need for low denomination short-term loans
is not going to go away. I hope that there are mechanisms to
deal with it.
One of other points that it has brought out to me that I
think we need to have some discussion as this goes forward is
that two of the lenders that Senator Dole has focused on would
not be affected by the 36 percent rate cap because their fees
are not subject to the Truth-in-Lending Act. So I think we have
some other issues that we need to work together on as well as
we go forward with this.
But I want to see all of our soldiers treated fairly, and I
think we are all on the same page with that. The only
reservations I raise are we are going to wind up denying short-
term credit for people who have a legitimate need that is not
rolled over time and time and time again and are we going to
wind up putting a lot of our military personnel in a uniquely
difficult circumstance that the other citizens of America don't
have. So that is the issue I raise. I think we all are in good
faith trying to do what is right for our men and women in
uniform, but these are things I think we need to talk through
in the committee.
Secretary Chu. If I may, Senator, respond very briefly to
two important points you made, first of all, we agree that you
need a broad set of legislative restrictions. That is why we
like the Talent-Nelson amendment to the Senate Defense
Authorization Bill. It accomplishes that purpose in our
judgment.
The second issue of need for cash on an emergency basis,
that is one of the reasons we have emphasized in our financial
readiness campaign the importance of saving; you need to start
setting the money aside. We pay adequately in the military
these days. It is not the Army of 30 years ago. So one of the
points is you need to start setting aside some money yourself
for a rainy day.
Senator Johnson. Well, I would say that we on the
Congressional side think some of our enlisted personnel would
maybe disagree with you that the military, particularly if they
have children, is paying at a level that doesn't occasionally
cause some financial stress; but one last question, and I know
nothing about this proposal myself. It was called to my
attention that the CFSA has made a proposal to DoD relative to
an alternative approach to managing these loans. Have you had
any opportunity to review that at all?
Secretary Chu. We have the proposal from them. We will look
at their proposal. I think our preliminary assessment is it
doesn't fully deal with the issues at hand. I think, again, we
believe that the Senate Authorization Bill, Section 666, if I
recall, Senator, correctly does do a good job in that regard.
Senator Johnson. Well, thank you for testimony.
Secretary Chu. Thank you, sir.
Senator Shelby. Senator Martinez.
Secretary Chu. Good morning.
Senator Martinez. Good morning. How are you, sir?
Secretary Chu. Fine. Thank you.
Senator Martinez. We had the pleasure to work together a
little bit on some of these issues, frankly, relating to our
servicemen and women when we began this war. We worked at
little bit on the Sailors and Seamen's Relief Act, which I
think is a very good thing, and I appreciate your working with
me at that time.
Mr. Chairman, I am pleased that there are some Floridians
on the second panel today: Lynn Drysdale, Staff Attorney with
the Jacksonville Area Legal Aid, and Christopher Peterson,
Associate Professor of Law at the University of Florida. I
don't know if I will be here, but I want to make sure the
Committee will issue a welcome to them from myself.
The issue of rollover has come up, and I wanted to ask you
whether you thought a prohibition of these rollovers and loan
flipping would address many of the practices that we see as the
most egregious.
Secretary Chu. That type of prohibition would, indeed, be
helpful, sir, because that is part of the problem, people
taking one loan. Then when it comes due, they can only pay it
off by taking the next loan, and, of course, the fees and the
interest rate build on that total. That is partly how you get
these high numbers and you get people in a kind of trouble
which they find tough to extricate themselves from.
Senator Martinez. One of the things that I notice in your
report is that this industry particularly advertises and preys
upon our military personnel. Why is that? And if you can
explain and articulate that, what is it that causes our folks
in the military to be so vulnerable and at the same time to be
such a target of these unscrupulous lenders?
Secretary Chu. It is a very important question, sir. I
agree. I think there are several reasons. First of all, as
Senator Dole brought out, we insist people pay their debts. So
you have got the power of our leadership behind making good on
the loan eventually.
Second, they have a steady paycheck, and so as you know,
many payday loans are, indeed--just as the name implies, they
predate a check. They know, unlike perhaps might be true in the
private sector where sometimes you get paid--sometimes you
don't get paid--they know that paycheck is going to show up in
the bank account the first of the month. They are certain to
get the money back.
Second, or third I should say, our people have started to
accumulate assets. Some have cars. So another version of this
is the car title. They have an asset that can secure the loan.
So our people do have collateral often, and they,
unfortunately, for whatever reason, give it up for what is
really a terrible financial deal. Of course, that is an
educational issue for us, to make sure they understand, no, you
really shouldn't go there; that is not the way to handle your
situation; come to one of the other possible sources of
assistance instead.
Senator Martinez. I understand that at times people may
have an emergency and they need short-term financial
assistance. Is there not a network of assistance to our
military families and the personnel in the event of a family
death or bereavement sort of trip, things of that nature that
can be available to them through governmental and
nongovernmental sources?
Secretary Chu. I think this is another example of the great
volunteer spirit in our nation. We have a set of military aid
societies, essentially one per military department. They have
made it a priority to devote a substantial fraction of their
resources to this issue of short-term cash needs. As Senator
Johnson indicated, we need to lecture people and encourage them
to save, but if you do get to the point where you need the
cash, we ask that you come to the military aid society. That is
why they are there. I reviewed with them just very recently
what fraction of their portfolios are they devoting to this,
and it is a high number in each case.
They are trying to do that job. They are willing to do more
if that is necessary. So there is a safety net out there. We
are also asking our credit unions--we have credit unions on our
military installations--to be sure they offer appropriate small
loan products to our personnel as well.
So I think there are several avenues of assistance.
Ultimately what is needed is the military member or family
member needs to get control of their finances, whatever pressed
them to the wall.
Senator Martinez. Financial literacy, in other words.
Secretary Chu. Right. The loan is a Band-Aid. It is not a
solution.
Senator Martinez. I understand payday loans are now
available on the internet from off-shore lenders, and if
Congress acts to curb unethical lending practices at home, what
more can we do to protect the Nation's military personnel from
online lenders outside the country?
Secretary Chu. Well, I think the important provision that
is in this, as I understand the Senate Authorization Amendment,
is to make internet contracts as far as military personnel are
concerned unenforceable, and that means we can go--I am not
trying to encourage inappropriate behavior, but if we
faithfully execute that provision as Congress might desire, it
will essentially make it unattractive for any internet lender
to lend to a military person.
Senator Martinez. Often times, subprime lending,
particularly longer-term loans, can be confused with predatory
lending. There is a difference between the two, is there not?
There can be people with a credit rating that may not be as
worthy as another or their loan might be at a higher interest
rate, still within the law, still within reason, but a higher
interest rate. That is not what we are talking about here
today, is it?
Secretary Chu. You are absolutely correct, sir. That is not
what we are talking about. That is why we have endorsed the 36
percent limit. That is a high number. It is a high number, but
we think it allows for subprime lending. It does cutoff a
source of credit that might be important to people. It is
consistent with the laws of a majority of States of our nation.
Senator Martinez. Speaking of State laws, in 2001,
partially in reaction to what Orange County had done in
Florida, the State passed a very comprehensive law to prohibit
the abuse of payday loans and by both licensed providers and
consumers, and some say that the Florida laws are some of the
strictest in the country. Are there aspects, if you are
familiar with Florida law, that you believe would be a good
basis for a national model? And perhaps our next panel might be
better to answer this question, but I wanted to put it before
you.
Secretary Chu. Thank you, sir. I should probably turn to
them. I am not an expert on Florida law, but I do know that
across the board, Florida has been a leader in trying to
support our military families in this area and in several other
arenas as well.
Senator Martinez. Thank you, Mr. Chairman.
Senator Shelby. Thank you, Senator Martinez.
Dr. Chu, it is my understanding that the Armed Forces
Disciplinary Control Board can place commercial entities off
limits to military personnel. Can you explain why this
mechanism is not being used more frequently to ban specific
predatory lenders from accessing military personnel? First, it
that true? Can the Armed Forces Disciplinary Control Board
place commercial entities off limits to military personnel?
Secretary Chu. Yes, sir, it can.
Senator Shelby. Have you done that? Has the Pentagon done
any? If not, why not or do you plan to?
Secretary Chu. It is a responsibility at the local level,
installation level, as you can appreciate, sir.
Senator Shelby. Is that by commander?
Secretary Chu. By commanders. The difficulty, as I believe
you are aware, is that as a matter of law, and I am not a
lawyer, but as I understand the situation, basically, the way
they place them off limits is because the establishment is
violating the law. Of course, that is the essence of the issue
here. These practices in many States are not illegal. We have
looked at using this mechanism. Our counsels, plural, advise it
is legally problematic to do that for this and other reasons.
So in our judgment, the Disciplinary Control Board
mechanism placing establishments off limits, at least under the
present statutory construct, will not be effective for this
purpose.
Senator Shelby. For this purpose, but it could help, could
it not?
Secretary Chu. It is doubted by our legal staff that we can
get very far with that instrument.
Senator Shelby. In other words, the base commander can to
some extent restrict who is coming on that base. Is that right?
Secretary Chu. That is a different statement, sir, but in
terms of patronizing off-base establishments--
Senator Shelby. Off base.
Secretary Chu. He is, as I appreciate the law and I ought
to let the lawyers speak to this, he is restricted to those
establishments that are violating a law. If the product is
legal, and that is our central problem, if the product is
legal, however much we may find it distasteful, that
establishment is not violating the law and he can't reach it
with this mechanism.
Senator Shelby. I believe Senator Dole said something to
the effect that over half of the service people are under 25
years of age. A lot of them are 18 and 19 years of age.
Secretary Chu. Yes, sir, and some of their spouses are
younger.
Senator Shelby. Do you know what percentage are 18 or 19
years of age?
Secretary Chu. Not of the top of my head, sir. I can get
those numbers for you.
Senator Shelby. Could you do that for the record?
Secretary Chu. I would be delighted to, sir.
Senator Shelby. I just believe that we should, working with
you and the Administration, do everything we can to protect the
young soldiers because they are highly vulnerable, are they
not?
Secretary Chu. We agree, sir. They are early in their
careers. Our nation's educational establishments, I think you
and others noted this morning, do not give a large amount of
education on financial management. That is something that is
worth looking at, I think as a country, but, of course, people
come to us with the preparation that our country gives them,
and they often don't have the preparation. That is why we are
investing in their preparation starting in basic training, but
it does take time for those lessons to sink in.
So yes, sir. We would appreciate the kinds of steps that
Congress is considering to put temptation aside.
Senator Shelby. Most of these young people, most of them or
a great percentage of them, this is their first steady
paycheck. I believe Senator Dole mentioned that I, as well
Senator Martinez. Is that correct?
Secretary Chu. Yes, sir. That is true.
Senator Shelby. So people know that they have got a steady
paycheck. So they know where the potential is often times for
exploitation.
Secretary Chu. Yes, sir.
Senator Shelby. Does the report that you are talking about
today indicate any trends concerning the prevalence and the
impact of predatory lending on our service members? I think it
does, but I would like to hear from you.
Secretary Chu. Yes, sir. We have seen a growth, and Senator
Dole's maps are eloquent in the North Carolina case, a growth
in predatory lending institutions near military bases. I was
struck just yesterday that a citizen with no connection to the
problem, unaware that the department had done a survey, raised
with me why when he was in the White Sands Missile Base did he
see a clustering of these kinds of payday lenders right outside
the gate. He thought that was shameful and a blot on our
national reputation.
Senator Shelby. Your report makes clear that loopholes and
State laws or exemptions granted by State authorities are often
abused by predatory lenders to avoid interest rates caps,
disclosure requirements, and other consumer protections. Has
the Defense Department approached the States with its concerns,
with your concerns, and if so, what kind of response have you
seen from the States in this regard?
Secretary Chu. Yes, sir, we have. As I indicated, it is one
of the issues the Secretary is personally engaging the
Governors on, and as a broad matter, we are pleased with the
Governors' willingness to listen to us. That does not, of
course, always mean they can get the necessary legislation
enacted in their States. That is why I think all of us pulling
together can make a difference here, and I think national
legislation will send a strong signal to every State that this
is where the country wants us to be.
Senator Shelby. Dr. Chu, we appreciate your work as the
Under Secretary of Defense for Personnel and Readiness and
especially in this issue. We will continue to work with you to
try to resolve a real problem that we have on the bases. Thank
you very much.
Secretary Chu. Thank you, Mr. Chairman. Thank you for the
opportunity. Thank you for your questions.
Senator Shelby. I am going to call up now our second panel:
Admiral Charles S. Abbot, Retired, President and Chief
Executive Officer, Navy-Marine Corps Relief Society; Dr.
William O. Brown, Jr., Associate Professor, Department of
Accounting and Finance, Bryan School of Business and Economics,
University of North Carolina; Ms. Lynn Drysdale, Staff
Attorney, Jacksonville Area Legal Aid; Mr. Hilary Miller,
President of the Payday Loan Bar Association; Mr. Christopher
Peterson, Assistant Professor of Law, Levin College of Law,
University of Florida.
If you will all take your seats.
Senator Shelby. All of your written testimony, as I have
previously said, will be made part of the hearing record in its
entirety, and what we would like to do, because we are going to
have a vote on the floor in a little bit and we will have to
move on, is let you sum up your top points that you want to
make orally as fast as you can.
Admiral Abbot, we will start with you. Welcome to the
Committee.
STATEMENT OF ADMIRAL CHARLES S. ABBOT, RETIRED, PRESIDENT AND
CHIEF EXECUTIVE OFFICER, NAVY-MARINE CORPS RELIEF SOCIETY
Admiral Abbot. Mr. Chairman, members of the Committee,
thank you very much.
I am grateful for the opportunity to appear here and to
comment on the Department of Defense report, and I will
abbreviate my remarks to leave the entirety as a part of the
record, but as the President of the Navy-Marine Corps Relief
Society, I am a head of a military charity, one of the four
that Secretary Chu mentioned, and for a hundred years, we have
been providing support to sailors and Marines and their
families. I would like to say that as I look at the history of
our organization, this problem with predatory lending, with
payday lending, is the most serious single financial problem
that we have encountered in that hundred years, and we know
that the industry has said that they don't, in fact, target
military personnel, but certainly our experience, we see it at
the suffering end of these individuals that they are, in fact,
a direct target.
And I echo Senator Schumer's comment about the ``Navy
Times' and other similar publications having ads in them where
the lending organizations state that, in fact, they are
purposefully organized to target military personnel. We see
every day in our offices around the country individuals who
have come in and have fallen into the venus fly trap of the
payday lending problem, and it has literally destroyed their
lives, and we provided cases to the Department of Defense for
them to use in their report and we see additional ones every
day which are contained in my draft comments to you.
I believe that it is a growing problem. Every year, we see
more of these individuals coming in the door at our offices,
and over the last 5 years, it has been in excess of 5,000
individuals in more than two and a half million dollars, and we
also see the growing problem of the internet payday lending
business and the effect that that is having on the problem more
broadly.
So we enthusiastically support the recommendations of the
DoD report. I do believe that in addition to the interest rate
limitation, that flipping of the loans is, in fact, one of the
serious problems. It is, in fact, what causes the individuals
to get caught in the trap. There aren't very many who simply
get a single loan and that is the last time they were ever
seen. There are statistics which show that the average number
of loans is usually as high as about five for an individual,
and it destroys lives. It destroys families.
Senator Shelby. It doesn't help readiness either, does it?
Admiral Abbot. It does not, sir. We see that effect as the
individuals come to us and they are removed from their duties
to be able to deal with these problems, and then some, as Dr.
Chu describes, in fact, lose their clearance and are unable to
continue to serve in their assigned billets.
So I thank you very much for the opportunity to appear
before the Committee.
Senator Shelby. Thank you.
Dr. Brown.
STATEMENT OF WILLIAM O. BROWN, JR., ASSOCIATE PROFESSOR,
DEPARTMENT OF ACCOUNTING AND FINANCE, BRYAN SCHOOL OF BUSINESS
AND ECONOMICS, UNIVERSITY OF NORTH CAROLINA
Mr. Brown. Yes. I will shorten my remarks that are in my
statement, as you wish. I have conducted some research on
payday lending and on payday lending in the military.
Senator Shelby. Have you published in that area too?
Mr. Brown. I have not published academic journal articles,
but hopefully I will at some point.
This research has focused on trying to figure out why it is
that military personnel use payday loans and why payday loans
are used by the broader sort of population and student
population as well. As noted here, this business has expanded
greatly in the last 10 years. It almost went from a business
that didn't exist to a business that now has over 20,000
outlets. So I will summarize some of our key factors that
found.
We surveyed a list of personnel in the four service
branches regarding their attitudes toward and uses of the
short-term credit, including payday loans. Our analysis is
based on the empirical data that we collected through a random
sample of people who live on the military bases.
The first finding is that a small percentage of enlisted
personnel use payday loans. We found that roughly 13 percent of
the 460 enlisted personnel that lived around the military bases
that responded to our survey indicated that they had used a
payday loan in the previous year. That number, I mean, 13
percent to some extent may seem high, but this is just enlisted
personnel, which you already noted the people are often times
18, 19 years old. If you compare that to a similar group of
population among the general population, you will find that
that number is not out of line with people that are 18, 19
years old in terms of what they are doing with payday loans as
well.
Military borrowers report that they use payday loans for
the same things as civilian borrowers do. They are paying bills
that they otherwise can't afford. They have unexpected
automobile, home repairs, those kinds of things, and so they
are reporting that they are using it for those purposes.
Despite this admonition that they should save, you know,
spending a lot of time around young people, these admonitions
don't go very far. Right? You should also study for your exams.
Right? With students, sometimes it takes a while to learn that.
Right? So it is only after failing on occasion that sometimes
you learn and stuff hits.
So I think just admonishing them to save and not actually
giving them the ability to fail in small steps--now, you want
to prevent these serious egregious things that happen which you
can make sure that you give people the ability to learn from
their mistakes in some cases as well.
What we also found is that the military enlisted personnel
look much different from civilians using payday loans in that
they tend to pay them back more quickly. We don't see the same
rollover problem that you see with the civilian users and the
military of payday loans. Forty-nine percent of the military
payday loans, borrowers had two or fewer loans in the last 12
years. I mean the last 12 months. So it is not an indication
that they are rolling these things over or rolling them over
continuously.
Again, there is a small group in the sample that do roll
these over, and you should be concerned about those people and
find better education for them, but given the overall low
default rate on these loans to begin with, given the military
personnel and the small fraction that are using them, and given
that most of them aren't using them and don't have these
serious rollover issues and are only using them once or twice a
year, we indicate that there is not really a threat to military
preparedness, and there is nothing in the DoD report that
suggests, that gives anything other than this anecdotal
evidence that these sometimes create problems. There is no
large scale statistical evidence that this is a problem.
Senator Shelby. Ms. Drysdale.
STATEMENT OF LYNN DRYSDALE, STAFF ATTORNEY, JACKSONVILLE AREA
LEGAL AID
Ms. Drysdale. Thank you, Honorable Chairman and Committee
Members.
I am a legal services attorney in Jacksonville, Florida,
home of Naval Air Station Jacksonville and Mayport Naval
Station. Based upon the increasing number of clients I
represent and the military people I talk to, the DoD report is
right on target, and I urge you to adopt the recommendations
for statutory changes.
In brief, the payday loans I see are generally short-term
2-week loans with interest rates ranging from 390 percent to
well over 900 percent. If I don't have $300 today, it is
unlikely that I am going to have $300 today plus 900 percent
interest 2 weeks later. So they are destined to fail.
Why do people sign these loans? Because even your
mainstream payday lenders explain away the interest rate. They
say, Well, the APR is 390 percent, but it is only a 2-week loan
rather than a year loan, so don't worry about the interest
rate. Others use loan disguises. I am going to reference just a
few.
Senator Shelby. How much do you say the APR was?
Ms. Drysdale. Anywhere from 390 percent.
Senator Shelby. 390 percent?
Ms. Drysdale. 390 percent up to--the most recent I have
seen is 906 percent. The lenders which do this get around
Florida law by using loan disguises. I will describe very
briefly several of my clients, and some of them I will have to
refer by an initial. Please keep in mind that these are only
representative of dozens of other clients with the same
problems.
Mr. B went to a payday lender which disguised its loan as
rebates. In other words, he was getting not a loan, but a
rebate in return for his paying for the right to use the
internet on the small computer they had in their office that
was not plugged in. When he could not repay the loan at a 400
percent interest rate, they took the loan amount plus hundreds
of dollars directly out of his bank account, meaning that he
did not have enough money to pay rent. He also not have enough
money to put groceries on the table and not enough money to pay
for diapers for the family's small children. When this company
had taken all of the money out of the bank account, they sent
him an unauthorized letter on State Attorney letterhead
threatening criminal prosecution if he didn't pay the debt.
Not only do these lenders illegally try to use our State
Attorney's Office for a law enforcement arm, but they also use
the military chain of command as a collection enforcement tool.
Because the members of the military are governed by the Uniform
Code of Military Justice, the payday lenders contact the
service members to harass them and they also contact their
chain of command.
You may have seen the Hubbells, a family represented in an
ABC News story who started out by taking out one payday loan
because Ms. Hubbell was stricken with a very aggressive form of
breast cancer. They were both in the military, but she was
forced to quit work. They took out a payday loan to address
some of the financial stress involved with her illness. Over
the years, they have borrowed about $10,000 in payday loans,
most of which did not benefit them, but went to rollovers. They
have paid tens of thousands of dollars back and still owe
$12,2000.
Mr. Hubbell once got a call when he was at work. He was an
E-6 air traffic controller and got a call at work from a payday
lender threatening and harassing him to pay. He told them he
had an attorney, and so the call ended. Twenty-five minutes
later, his superior officer called Mr. Hubbell and said, I have
already had two phone calls from the same gentleman harassing
me, ordering me to give him the name of your commanding officer
so he could call him. Mr. Hubbell was terrified he was going to
lose his security clearance, he was going to lose rank, he was
going to lose pay and maybe even his job.
Mr. G sent me an E-mail. He was stationed out in the middle
of the Mediterranean in an undisclosed location. He was
terrified because his wife had E-mailed him telling him that a
payday lender was threatening to put her in jail which would
mean their two children would not have a parent at home.
Mr. Kahne was so frightened by all of these types of
collection techniques that he spent his entire day off going
from payday lender to payday lender, rolling over loans with
nine different companies so that he would not bounce a check.
Mr. Wall sued Military Financial Network because they
debited his account 11 times in 1 day, creating hundreds of
dollars in bounced check fees with his financial institution.
The lender also added additional fees and charges. Military
Financial Network also put a clause in Mr. Wall's contract that
if he didn't pay the debt, he would be subject to a court-
martial, imprisonment, and dishonorable discharge. Also, if Mr.
Wall wanted to sue this company because of all of these illegal
actions, he was precluded from doing so even though this
company had all rights of enforcement. They put a clause in his
contract that if he didn't like the way they were operating, he
could not go to court; he had to go through expensive
arbitration in Delaware despite the fact that he was located in
Florida when he signed the loan.
You will hear that the pay day lenders' organization, the
CFSA, has best practices that all of its members are required
to follow. Well, let me comment on a women I started
representing 2 weeks ago. She is a Navy wife who has taken out
a loan with one of this industry organization's founding
members. In Florida, there is a prohibition to rollovers, but
this company and other companies get around it by requiring the
borrow to wait 24 hours before getting the rollover loan.
Florida also allows a grace period with no additional
penalties or fines or interest if you seek credit counseling.
Ms. Griffin went to pay off her loan and was told that she
needed to roll it over because she was $45 short, which she
did. The next time she went back, she had obtained the required
credit counseling from the Navy-Marine Corps Relief Society,
which is an authorized credit counseling agency for the
purposes of getting the grace period. They still refused the
grace period, and ironically, in their contract, the lender
stated it was a member of the CFSA and followed the best
practices.
The Director of the Navy-Marine Corps Relief Society,
Retired Captain Dave Faraldo, called this company and said,
``You are required to give her the grace period.'' The employee
said, ``No, we don't have to give her the grace period and, in
fact, I have been a trainer of employees for 8 years and we
have never had to give the grace period.'' She refused to speak
to him anymore, and would only speak to her attorney.
I called them as her attorney. They refused to speak to me
even if I did provide a written release. I said, I would like
to speak to your supervisor. She said, I can't give you the
name or the number of that person, but I will have them call
you. That is 2 weeks ago. I haven't heard a word from them.
And the real shame in this is that all of these people I
have mentioned would have the alternative of the Navy-Marine
Corps Relief Society, and even my credit union offers a similar
short term loan for emergencies. They did a study and
determined they could provide a similar product and they could
feasibly do it at 14 percent APR. There is also a savings
component in with the loan as well as credit counseling. My
credit union is responsible to me to make sure it is making
financially sound decisions.
I have filed lawsuits against the internet lenders and am
presently pursuing those cases, and also there have been
enforcement actions by other States against the internet
lenders so they would not be immune to the type of legislation
that has been proposed.
Senator Shelby. Thank you.
Mr. Miller.
STATEMENT OF HILARY B. MILLER, PRESIDENT, PAYDAY LOAN BAR
ASSOCIATION
Mr. Miller. Thank you, Mr. Chairman and Members of the
Committee. It is a pleasure and honor to be here today. My name
is Hilary Miller and I am here both as an expert on subprime
lending and also on behalf of the payday advance industry's
national trade association, the Community Financial Services
Association of America or CFSA.
Both the Payday Loan Bar Association, of which I am
President, and CFSA subscribe to the highest principles of
ethical and fair treatment of borrowers. CFSA represents the
owners of approximately half of the estimated 22,000 payday
advance retail outlets in the United States. CFSA has and,
importantly, enforces among its members responsible industry
practices and appropriate consumer rights and protections,
including special protections for the benefit of military
personnel.
There are serious flaws in the Defense Department's report.
Those flaws involve both fundamental matters of methodology and
policy. We think that decisions involving potentially far-
reaching implications regarding the cost and availability of
consumer credit should be reached only after a careful
gathering of data from a variety of sources and even-handed
analysis of such data. By failing to synthesize information
from balanced sources and by systematically excluding any input
from independent economists, from consumer credit experts, or
from the industry itself, the DoD report presents the views
only of opponents of the kind of lending that is discussed in
the report. The result is a biased, inaccurate, and incomplete
picture of the market for such credit.
Our industry, contrary to some of the discussion of the
ability-to-repay issue, has a vital interest in making sure
that military borrowers can repay their loans, and for one
simple reason: as lenders, we only make money when our
borrowers repay us. If they do not pay, not only do we fail to
collect their finance charges, which the DoD criticizes, but we
also lose many times those finance charges in loan principal.
In short, it is contrary to our interests to have service
members get into trouble with their loans.
The reason we lend to military borrowers at all is that the
entirety of the available scientific data suggests that only a
tiny percentage of military borrowers actually do get into
trouble with payday loans. Anecdotes derived from a non-
representative sample of this small group are now being used to
drive public policy for the much larger numbers of military
borrowers who use payday loans for their intended purpose and
who repay their loans on time and without financial difficulty.
There are serious flaws that I have mentioned, and here are
some of them, in the report: First, the DoD report determines
that payday loans are predatory solely by uncritically adopting
eight factors used by an opponent of the industry, the Center
for Responsible Lending, without making the independent
determination that such loans are unfair or abusive as required
by the applicable statute. No other recognized authority has
used these factors.
Second, according to DoD's own internal data, fewer than 5
percent of service members have had a payday loan. That is not
indicative of a problem from my standpoint, and because fewer
than 6 percent of payday loans ultimately default, at most 6
percent of that 5 percent, or 0.3 percent, of all service
members have experienced financial difficulty with a payday
loan. In other words, 99.7 percent of service members have
either not had a payday loan or have not had financial
difficulty with payday loans. There is simply no statistical
evidence that payday loans contribute to military readiness
problems to any measurable degree.
Now, although some service members with financial problems
have taken out payday loans, DoD data do not support the
conclusion that payday loans cause financial problems. It is
purely a correlation-is-causation argument in their report.
Payday loans are intended to solve financial problems and the
overwhelming majority of users employ them in that manner.
DoD's data regarding the asserted hardship related to
payday loans consists of a mere 12 anecdotes drawn from the
experience of 1,400,000 active-duty military personnel. We did
a sample of service members who had a variety of different
kinds of debts and who went into bankruptcy, which is the
ultimate example of financial failure. Now, we looked at not
only what kind of payday loans they had, but what all of their
other loans were, and our experience was that the payday loans
were the last loans that they got. They were not the first
loans that they got. Most of those borrowers had mountains of
credit card debt. They had automobile loans. They had student
loans. They were not going ``belly-up'' because of payday
loans.
DoD's principal recommendation is to reduce the maximum
permissible charge on loans to 36 percent, which is below the
lender's marginal cost of producing the type of credit that the
payday advance industry provides. The effect of that cap would
be to drive legitimate regulated lenders out of the market and
to compel borrowers to deal with illegal lenders such as
overseas lenders. Those lenders will just as likely pursue
illegal collection methods when the time comes to collect the
loan.
There are many other approaches to dealing with it. Our
trade association, the CFSA, has proposed alternative
approaches to the DoD, and for the most part, we have been
spurned, but we look forward to having a dialog with the
Defense Department and to working these matters out.
Thank you very much for your time and for your patience. I
look forward to answering your questions.
Senator Shelby. Thank you, Mr. Miller.
Professor Peterson.
STATEMENT OF CHRISTOPHER L. PETERSON, ASSISTANT PROFESSOR OF
LAW, LEVIN COLLEGE OF LAW, UNIVERSITY OF FLORIDA
Mr. Peterson. Thank you, Mr. Chairman, Ranking Member
Sarbanes, and other members of the Committee. It is a real
honor and a privilege for me to get to come and share some
thoughts about this with you today.
I spent a significant chunk of my life writing this study
that Senator Dole showed some maps from along with my co-
author, Professor Graves, and what we did is we looked at 109
military bases around the country and the State that those
bases were in, and we analyzed every location of every payday
lender in all of those States and every bank location in all of
those States.
Senator Shelby. Do we have the study? Have you furnished
that to the staff?
Mr. Peterson. Sure. Yes. I believe I have, but it is
around. It is right here in the Ohio State Law Journal. Go
Buckeyes.
What we looked at were all the counties and all the ZIP
Codes, and what we came up with was I think pretty irrefutable
statistical evidence suggesting that payday lenders cluster
around military bases, targeting military personnel. There are
a lot of reasons for that. I think some of them Admiral Abbot
and Dr. Chu explained, but I really don't think there is any
doubt about that.
The one State that we didn't find that, which was really
sort of troubling to me when I realized it, was New York. Fort
Drum in upstate New York, when we started trying to get the
data, we couldn't find any payday lenders up there. It troubled
me so much that in the middle of January, I got on an airplane
and flew all the way up there to the Canadian border, which is
tough for a Florida boy.
I drove around the entire base, every street to make sure
that our data was right on this, and there were a couple that
had sort of snuck up and were disguising it, but the Attorney
General is shutting them down. The reason, clearly, was because
New York had stuck by their guns in their traditional interest
cap of 25 percent.
That brings me to a historical point that I would like to
make, that predatory lending to military personnel is nothing
new. I have done a lot of reading of history, and it has
happened in the Chinese Empire, in the Roman Empire. The first
succession from the Roman Republic was a riot that spread all
throughout the Roman society over abusive loans to military
veterans. The Romans figured that out. Their emblems are here
still adorning our room, and they put a 12 percent interest
rate cap on.
They were the first to do it. The very first comprehensive
law in the history of our species, the Code of Hammurabi from
1750 B.C., the legend was that Hummurabi ascended the mountain
where Shamash, the god of justice gave him this comprehensive
code and they chiseled in on a rock, and we still have it. It
is in the Louvre in Paris. It has an interest rate cap in it of
20 percent for loans made in bulk silver and 30 percent for
loans in grain. This is before we figured out how to coin
money.
And it actually, if you translate it, it is almost exactly
the same as the 18 percent interest rate cap that happens to
still be on the books, although not enforced particularly well,
in the great State of Florida. So the first law in still in the
State of Florida now, but we have fallen away from that.
Throughout the history of our country, our republic, we have
always had interest rate caps. Thomas Jefferson and George
Washington would have been pretty upset if there were lenders
lending at 500 percent to the Continental Army. They would not
have tolerated that, those guys.
And I don't think General Eisenhower would have in World
War II. Throughout the Great Depression and World War II, this
was an illegal practice. We would not tolerate that. It is only
in the past 15 years or so, for the first time in the history
of our republic, that we have come to the point where we could
say something along the lines that the Congress will not stand
up and stop 500 percent loans to the Marine Corps. Well, that
is a very peculiar and troubling thing to me.
And last, an economic point: I note that there is a
profound difference between market competition, of which I
believe in--free market is very important, but there is a
difference between market competition and market anarchy. We
don't allow unregulated markets in any market. If somebody
wants to sell weapons-grade plutonium, we won't tolerate that.
If they want to sell child pornography, we don't tolerate that.
If they want to sell 500 percent interest rate, loans to the
Marine Corps, I don't think that we should tolerate that. I
think it is a bad idea for our national security and it is a
bad idea for ourselves in our own moral sense of who we want to
be as a country.
So with respect, I would strongly urge the Committee and
Senators to support providing some national limit to what I
think is a tragedy. These soldiers are going over to Iraq and
they are bleeding out on the desert floor, and the Congress
can't come up with a cap for the loans that they are being
charged? It is time for us to do something about it.
Thank you.
Senator Shelby. Thank you, Professor.
I have a number of questions that I am going to submit them
for the record to all of you, because we have just now been
notified we have a vote on the floor and we are going to have
to leave here in just a few minutes.
I want to recognize Senator Sarbanes. He has been in
another meeting.
STATEMENT OF SENATOR PAUL S. SARBANES
Senator Sarbanes. Thank you very much, Mr. Chairman. I will
be very brief. I just want to make some comments.
First of all, I want to thank the panel for their
contributions. I want to commend Chairman Shelby for holding
this hearing on the ''Defense Department's Report on Predatory
Lending Practices Directed at Members of the Armed Forces and
Their Dependents``. In my view, it portrays clearly
unacceptable practices on the part of a number of short-term
lenders.
This report is a result of an amendment that Senator Dole
included in the National Defense Authorization Act mandating a
study on predatory lending. I think it provides a disturbing
insight into how predatory lenders target military personnel.
It details the disastrous effects of high-cost predatory
lending on our military and outlines actions taken by the
military to address predatory lending and makes recommendation
for further statutory protection.
There are approximately 1.3 million members of the U.S.
Armed Forces. Even 10 percent of those would be 130,000 people.
These men and women play an important role in our defense,
obviously, and the view that a number of these practices are
directed at them in a whole range of ways, I think is a matter
for the considerable concern.
The DoD report cites a study showing that service members
are three to four times more likely, actually, to have payday
loan than are civilians. They are not typically based on the
borrower's ability to pay. I was interested in Mr. Miller's
comment that this is the loan of last resort, that they have
been through all these other things showing a weakened
financial condition and everything else. Why are you making
this loan to someone who has got that kind of financial
trouble?
They carry annualized interest rates often of more than 400
percent, often extended through rollovers, which, of course,
include additional high fees, no payment of the principal.
Service members get trapped in the seemingly never ending cycle
of debt.
I have some examples here, but due to the shortage of time,
I won't put those in the record. I do want to commend the
military for its efforts to address these predatory lending
practices. I don't think there is sufficient protection for
service members.
And, Mr. Chairman, I hope that we will be able to take a
very careful look at the recommendations of the DoD report and
other proposals that have been put forward in order to try to
get this situation under control. Our men and women in the
armed forces deserve better than this. Thank you.
Senator Shelby. Senator Martinez. I know you have a
Floridian here.
Senator Martinez. I know, and I want to just welcome both
of my Floridian friends here and commend both of you for your
testimony. I know Senator Dole wanted me to welcome you.
Senator Shelby. Floridians. I said one.
Senator Martinez. There are two, actually.
Senator Shelby. You stacked the panel, didn't you? No, you
didn't.
Senator Martinez. Well, we are concerned about this in
Florida, sir. We have got Mayport and NAS in Jacksonville. They
are very important to our national defense, and I know we have
got to go vote. So I will be very brief, but I just can't help
but ask Mr. Miller.
I just want you to know that I am not impressed that you
are only destroying the financial lives of a small percentage
of our service members; but understanding that, this agreement,
what is the average percentage rate of your lenders in this
business of average payday loans? I believe we heard a 390
percent to 906 percent. Do you dispute those figures?
Mr. Miller. I think there are probably relatively few
operators who are in the 900 percent range.
Senator Martinez. Where would most of them be? Five hundred
or so?
Mr. Miller. Standard pricing for a payday loan would be a
finance charge of approximately $15 for a 2-week, $100 loan.
Senator Martinez. Just do it in a percentage, in an APR.
What would be the APR rate? We are all grown-ups and know what
that means.
Mr. Miller. That would be equivalent to a 398 percent APR
or 390 percent APR.
Senator Martinez. What is your evidence that the cost of
lending that--that is before they get in trouble, by the way,
and could escalate then further with penalties and fees and so
forth, but what is the financial basis for a 390 percent
lending rate? Is there a sound basis that you can say these
loans are so risky that we have to charge that high a rate?
Because you on the other hand were telling us that very few
actually are bad loans, that most of them are not bad loans.
Mr. Miller. Senator, that is a very good question, and I am
happy to respond to it. The principal costs associated with
making payday loans are real estate and personnel costs. They
are not credit-related costs. The costs of keeping stores open
generally on a 24-7 basis in some of the larger areas, of
processing numerous very small transactions that involve a
tremendous amount of back office activity is what generates the
costs associated with this business, and there is a study done
by two researchers at the FDIC that substantiates that the
costs are primarily office-related costs rather than credit-
related costs.
Senator Martinez. But you wouldn't disagree that a 390
percent loan is unconscionable?
Mr. Miller. I would disagree with you.
Senator Martinez. You would disagree with me? That is a
fair rate of lending and that that is not going to drive
someone to financial ruin if they are paying that kind of an
interest rate, particularly when they are working in a fairly
modest salary scale in the first place?
Mr. Miller. Well, I respectfully disagree with you.
Senator Martinez. Do you think an 18-year-old taking a loan
at 390 percent is conscionable? You can look at me with a
straight face and tell me that that is, in fact, what you
believe?
Mr. Miller. I believe that used for its intended short-term
purpose, that loan can be very helpful to bridge a financial
problem that an 18-year-old might have.
Senator Martinez. Have you ever gone through a credit
counseling place where people counsel folks on credit
counseling and how to avoid financial difficulties such as
that? Do you think anyone ever in a credit counseling session
would recommend someone to go get yourself a loan with a 390
percent?
Mr. Miller. I don't know. I am not familiar with how credit
counseling operations act.
Senator Martinez. You should become familiar. Your
organization should become familiar, because our servicemen and
women need to be become familiar, and part of avoiding this
kind of unconscionable problem is for them to be better
informed on issues of financial literacy, and I think that is
one of the areas we really show focus, but I also don't
understand how a credible organization purporting to serve the
public interest could suggest that loans at those rates of
interest are really in the best interest of our servicemen and
women.
Thank you.
Senator Shelby. Senator Carper.
Senator Carper. Thank you, Mr. Chairman.
I spent some time at some of those bases that Senator
mentioned, Jacksonville, Mayport, those places. I was in the
Navy for 23 years and active in the Reserves, and one of the
things I was struck by in the training that I had and I suspect
the training that given to our enlisted personnel down in
Orlando and other places around the country, that apparently we
don't do a very good job of literacy training, financial
literacy training, for the officers that were coming up and I
am sure for enlisted men and women as well.
Let me just ask our friends here from the DoD and maybe
Admiral Abbot your own thoughts on the kind of financial
literacy training we are providing to people that are in the
armed services, especially with the enlisted ranks.
Admiral Abbot. Senator, the Navy and I believe all the
services are doing a job good job at financial literacy
training and it is getting better. It starts at boot camp and
it continues on into the specialty schools afterwards. They
have to start off at square one. As has been mentioned before,
a lot of these young people haven't ever had a paycheck,
haven't had a checking account. They are required to have a
checking account in order to have their pay deposited. You have
to start off by teaching them how to read an earning statement
and how to balance a checkbook, and then they move on in
subsequent sessions to give them more of an education on
handling the basics of life, of buying an automobile and
housing and paying for groceries and dealing with the family;
but it requires a continuum of education and repetition, and
the Navy and the Marine Corps I know are focused on that and
getting better.
Senator Carper. Good. I know when I got to the Naval Air
Station in Pensacola when I was a brand new enlisted man, one
of the first things I did was I opened up an account at the
Navy Federal Credit Union right there in Pensacola and used
that to buy a car, and I know a lot of my colleagues did the
same kind of thing. We have Federal Credit Unions. We have
banks all over the country as well. The access to credit unions
on the military base is pretty good, and the idea is that an
enlisted man or woman or an officer can go into a credit union
or a local community bank and get access to pretty low rates,
especially in those credit unions. I am not sure why that are
not better used.
The other thing I would say--Senator Martinez has gone.
What I find especially objectionable and concerning with
respect to the kinds of loans that we are talking about here
today is not so much they are paying $15 to get a loan for a
transaction cost. The real problem is when the loans roll over
and over and over and extend beyond a week or two. That is
where the real problem lies and that is where I hope that we
will focus our attention and the industry will focus its
attention.
The other thing is, Mr. Chairman, my hope is that when we
go to the next year that we can come back and revisit this
issue in the context of predatory lending in a broader sense
that is going on in this country. I am very concerned, and I
know you are in Alabama and other States, and this is one that
we need to just keep our eye on the ball and do something
responsible and soon.
Thank you.
Senator Shelby. We have a vote. We have got to conclude the
panel. We thank you for your contribution. We appreciate what
you are doing. This is something that I believe we have to
address.
Thank you very much.
The Committee is adjourned.
[Whereupon, at 11:43 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF SENATOR TIM JOHNSON
Thank you, Mr. Chairman and Ranking Member Sarbanes. I appreciate
that the Committee is meeting today to address this issue of critical
importance.
Thousands of our military personnel are currently serving in harm's
way in defense of this country. In South Dakota, over 3,800 military
personnel and civilians are stationed at Ellsworth Air Force Base, 300
of which recently deployed in support of the Global War on Terror.
As the father of an active-duty soldier who has served combat tours
in Iraq and Afghanistan, I am acutely aware of the very personal
challenges facing our men and women in uniform. I am proud of their
courage and professionalism, and grateful for their service to our
country.
Congress has an obligation to ensure each soldier is combat ready
before deployment. This includes equipping our troops with body armor,
up-armored Humvees, night vision goggles, and other essential life-
saving equipment. But our commitment to our servicemembers does not
just involve protecting their personal safety. I hear much too often
that our military personnel and their families are not equipped with
the tools to adequately manage their personal finances.
Financial stress can affect any soldier regardless of their marital
or deployment status--in particular, younger or lower-ranked enlisted
personnel. We all sympathize with the soldier who incurs debt because
he was blindsided by unexpected emergencies, auto repairs, personal or
family illness or is just struggling with basic living expenses.
To ensure our servicemembers are capable of addressing their
financial needs, we must first provide them with adequate compensation.
To that end, I have consistently supported robust pay raises each year
in the defense appropriations bill.
At the same time, we must help our soldiers exercise financial
responsibility. This has proven to be a challenge for many Americans
and financial literacy remains a critical issue of importance.
I share DoD's concern about servicemembers falling into a ``cycle
of debt'' whether through inappropriate use of credit cards, payday
loans, or other forms of credit, and I believe Congress and DoD must
work together to improve the financial literacy of our servicemembers,
and crack down on abusive and predatory practices by any lender.
It is essential that military personnel and their families have
access to information and assistance and that DoD's commitment to
financial readiness extends from the top down and is consistent
throughout all branches. I am concerned that DoD's Financial Readiness
Campaign that began in 2003 has not been fully embraced by all of the
services.
I look forward to hearing from our witnesses today, and I am
especially interested in hearing from Secretary Chu regarding the
report's findings and recommendations. I am concerned that DoD is
recommending a federal ceiling on the cost of credit to military
borrowers and their families, capping the APR at 36%. This would, in
effect, ban short term, high APR loans, but would do nothing to address
predatory lending by ``military lenders'' that specifically target 100%
of their loans to servicemembers, DoD employees, and retired
servicemembers.While well intentioned, I am not convinced that this
approach would solve the larger problem.
It is very clear that military personnel like many other consumers
have a real and legitimate need for short-term, small denomination
credit products. And we must remain mindful of that fact as we address
the issue of predatory lending. There are clear differences of opinion
as to how those products should be structured, and how they should be
delivered. I have a real concern that if these types of financial
services products are pushed outside of a regulated environment or
banned outright, it will open the door for abuse and inevitably result
in less consumer protection. There is something to be said for striking
the right balance between regulation, consumer protection, and
effectively meeting consumers' credit needs especially those of our
service men and women.
Our servicemembers, like all other consumers, should be afforded
the benefit and opportunity to choose the financial services and
products that best suit their needs. Additionally, the financial
services industry must continue to develop and offer meaningful
products, including short term credit products that will meet the needs
of the military while also protecting all consumers, including
servicemembers, from potentially abusive and predatory practices by
lenders. And it is equally critical that the regulatory agencies foster
a regulatory environment that supports short-term credit products and
one in which such products can thrive while providing the greatest
benefit to the consumer.
As we continue to address the issue of predatory lending to the
military, the primary goal should be to develop meaningful solutions
that will offer the greatest protections to our servicemembers, while
avoiding measures that carry the potential for the unintended
consequence of driving servicemembers into potentially abusive, and far
more expensive forms of credit.
Mr. Chairman, I would like to include with my statement a cost
comparison chart of payday loan alternatives.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Consumer groups and academic researchers comment on the cost of payday
advance versus its alternatives:
``We find that fixed operating costs and loan losses justify a
large part of the high APR charged on payday advance loans . . . These
operating costs lie in the range of [payday] advance fees, suggesting
that payday loans may not necessarily yield extraordinary profits.''--
Payday Lending: Do the Costs Justify the Price, Center for Financial
Research, Federal Deposit Insurance Corporation, 2005
``Critics also contend that [overdraft] bounce protection fees, as
high as $37 per transaction, are little more than high-priced credit.
`If a bank lends you $100 and charges you a $20 fee--and then you pay
the money back in two weeks--that's an annualized interest rate of
520%,' notes Jean Ann Fox, director for consumer protection at the
Consumer Federation of America in Washington. `It's worse than a payday
loan'.''--Business Week, May 2, 2005
``Unlike payday lending programs, the extraordinarily high APRs in
fee-based overdraft programs are never disclosed as such, and none of
the other consumer protections are provided. Moreover, fee-based
overdraft programs are aimed at the very same customers that payday
lenders are seeking . . . and the costs rival or exceed those of payday
lending.''--Comment letter to Board of Governors of the Federal Reserve
System from 90 consumer group organizational signators, January 27,
2003
``Interviews and industry survey indicate that payday loan
customers do make a cost analysis in comparing the price of a payday
loan with the alternative costs of bouncing a check and/or incurring
late fees . . . When used on a recurring basis for small amounts, the
annualized percentage rate for fee-based bounce protection far exceeds
the APRs associated with payday loans.''--Low-Cost Payday Loans:
Opportunities and Obstacles, Annie Casey Foundation Report, June 2005
``Courtesy pay is not marketed as an alternative to a payday loan,
but it serves a similar function when used as credit. Credit unions
charge fees ranging from $15 to $35 to cover an overdraft.''--Credit
Union Payday Loan Alternatives, National Association of Community
Credit Unions, December 2005
______
PREPARED STATEMENT OF DAVID S.C. CHU
Under Secretary for Personnel and Readiness, Department of Defense
September 14, 2006
Mr. Chairman and members of the committee, it is a privilege to
testify on the predatory lending DoD report. This report, required by
Section 579 of the Fiscal Year 2006 National Defense Authorization Act,
reviews the impact of lending practices that prey on Service members
and their families, the efforts of the Department to ameliorate those
impacts, and recommendations for legislative remedies to assist our
military families.
This Administration recognizes personal finance as a primary aspect
of ``quality of life'' for Service members and their families. It has
included payday lending as one of ten key issues requiring the
assistance of state governments to protect their well-being. Permit me
to summarize how we reached this conclusion as context for the report.
Social Compact
In 2001, the President directed the Secretary of Defense to
``undertake a review of measures for improving the quality of life for
our military personnel.'' We collaborated with the Military Services to
develop a ``Social Compact'' that describes the reciprocal nature of
the commitments among Service members (to the defense of the nation),
their families (to being part of that commitment) and the Department of
Defense (to caring for their well-being). This bottom-up review
articulated the linkage between quality of life programs as a human
capital management tool and the strategic goal of the Department--
military readiness.
The Social Compact lays out long term strategic-level plans for key
aspects of quality of life, of which financial readiness is one. The
long-term vision for financial readiness is to develop a military
culture that values financial competency and responsible financial
behavior. Financial readiness is equally important as other military
skills and attributes.
Financially ready Service members seek out information to be
proficient, and seek assistance when they encounter difficulty.
Financially ready Service members would not seek to hide their
financial problems by continuing to build debt to the point of
destroying their finances, adversely impacting their family life and
jeopardizing their military careers.
The goals associated with this strategic plan focus on the benefits
of financial readiness to the individual and to the Department. We seek
to:
Reduce the stresses related to financial problems--
the stress of out-of-control debt that can impact the
performance of Service members and their family's quality of
life.
Increase savings--a personal and family goal of
motivated Service members to control their finances and plan
and prepare for their futures.
Decrease dependence on high interest rate or
unsecured debt--the vulnerability associated with living from
paycheck to paycheck.
Decrease the prevalence of predatory practices--
protection from financial practices that seek to deceive
Service members or that take advantage of them at a moment of
vulnerability.
These goals establish an environment and culture in which Service
members can feel secure about their finances and are ready to engage in
the military mission. To accomplish these goals, Service members need
to be competent in dealing with finances, protected from financial
predators and motivated to achieve financial readiness. The Department
uses awareness media, education programs and assistance through
counseling to help Service members conform their behavior to the goals.
But these tools do not protect them from predators as they develop
their financial competency.
Financial Education Policy and Metrics
The Military Services are expected to provide instruction and
information to meet the needs of Service members and their families. To
this end, the Department published in November 2004: DoD Instruction
1342.27, Personal Financial Management Programs for Service Member.
As outlined in the Government Accountability Office Report 05-348,
each Military Service tailors its programs for training first-term
Service members on the basics of personal finance. These programs vary
in terms of venue and duration, but all Military Service programs must
cover the same core topics to the level of competency necessary for
first-term Service members to achieve financial readiness. The
Department monitors the ability of Service members to pay their bills
on time, as a reflection of their financial competency and ability to
apply basic financial principles. The Department has tracked the
performance of the first four enlisted ranks as a leading indicator for
the rest of the force. Since 2002, these Service members' self-reported
assessments indicate they are paying better attention to keeping up
with their monthly payments (graph at Table 1).
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The Department is adding another indicator this year to the
performance measure for personal finance: enrollment in the Thrift
Savings Plan.
I review these metrics quarterly along with metrics that measure
other important aspects of Service member and family quality of life.
The Department is developing an evaluation tool that measures
first-term Service members' ability to apply basic principles to
scenarios they may encounter. This tool will standardize the evaluation
process throughout the Military Services and will help ensure that
Service members can apply the instruction they receive.
Financial Readiness Campaign
To assist the Military Services in delivering financial messages,
the Department established the Financial Readiness Campaign in May
2003. It is now supported by 26 nonprofit organizations and federal
agencies. In the past three years, Service members have benefited from
the materials and assistance from:
Air Force Aid Society (AFAS)--provides financial
counseling and emergency monetary support for airmen in need.
American Savings Education Council (ASEC)--provides
over 60 award winning public service announcements that have
been shown on American Forces Radio and Television Service
(AFRTS).
Army Emergency Relief (AER)--provides counseling,
education programs and emergency financial relief to soldiers.
Consumer Federation of America (CFA)--established
the ``Military Saves Campaign'' as part of the CFA ``America
Saves'' initiative, to encourage Service members to establish
emergency savings and invest in the Thrift Savings Program.
Association of Military Banks of America (AMBA)--
AMBA members provide educational programs to supplement
programs offered by the Military Services, as part of the
responsibility for residing on military installations.
Additionally, AMBA assists the CFA in deploying the Military
Saves Campaign.
Council of Better Business Bureaus--works with the
Military Services to assist Service members and their families
with a variety of consumer-related issues, along with providing
education programs upon request.
Defense Credit Union Council (DCUC)--members of
DCUC provide education programs to supplement programs offered
by the Military Services, and assist in the deployment of
Military Saves.
Federal Deposit Insurance Corporation (FDIC)--made
available their ``Money Smart'' curriculum and train-the-
trainer program to the Military Services, as well as AMBA and
DCUC members.
Federal Reserve Board--studies the impact of the
AER sponsored education course conducted at Fort Bliss, TX, to
determine the effect of training on financial behavior.
Federal Trade Commission (FTC)--provides most
widely disseminated materials available outside of DoD, on
various topics concerning consumer protection.
Financial Literacy and Education Commission
(FLEC)--consolidates the materials available through the
federal agencies via the ``www.mymoney.gov'' website, and
accompanying toll-free number. It is widely advertised and
linked to DoD and Military Service websites concerning personal
finance.
InCharge Institute--provides access to credit
counseling/debt management, and publishes a quarterly magazine
``Military Money'' in partnership with the National Military
Family Association (NMFA). The magazine is designed primarily
to reach out to military spouses on a variety of financial,
spouse and family life topics. To accompany the magazine,
InCharge also provides public service announcements called the
``Military Money Minute,'' on AFRTS, covering helpful financial
tips on military pay, deployment preparation, etc.
Institute for Consumer Financial Education--helps
individuals and counselors with credit questions and
understanding credit reports.
Moneywise with Kelvin Boston--provides access to
his syndicated television program for broadcast on AFRTS.
National Association for Credit Counseling--
partners with military installations to provide educational
classes and credit counseling services.
National Association of Securities Dealers (NASD)
Foundation--funds a multi-year awareness and education program
to supplement the programs provided by the Military Services.
Included in the program are multimedia public service
announcements (through sources such as AFRTS, Military Times
magazines and local radio); an interactive website; sponsorship
of a scholarship program for military spouses (through
partnership with NMFA) to accredit them as Financial Counselors
in return for volunteer hours in military communities; and
education for Military Service Financial Counselors and
Educators.
National Endowment for Financial Education (NEFE)--
provides access to its ``Project for Financial Independence,''
to severely injured Service members, members of the Guard and
Reserve, and their families. The Project for Financial
Independence connects Certified Financial Planners with Service
members (geographically separated from an active duty military
installation where they can obtain financial counseling) to
accomplish pro bono financial planning.
National Military Family Association (NMFA)--
partners with several other organizations to facilitate
reaching military spouses, a primary target of the Financial
Readiness Campaign.
Navy-Marine Corps Relief Society--provides
education, counseling and emergency financial support for
sailors and Marines in need.
Securities and Exchange Commission--provides
seminars at military installations, along with investor
education materials in libraries on military installations.
These partnerships allow the Military Services to choose the
programs that can best supplement the education, awareness and
counseling services they provide.
Education and Predatory Lending
Predatory lending practices are covered as topics in initial
financial education training and in refresher courses offered at the
military installations. As described in the report, the Military
Services have provided over 11,800 classes and trained over 324,000
Service members (approximately 24 percent of the force), as well as
19,400 family members.
In addition to these classes, Financial Readiness Campaign partner
organizations conducted 1,300 classes for a total of 60,600 Service
members and family members. These classes were primarily provided by
the staff of banks and credit unions located on military installations.
These institutions provide these classes as part of their
responsibilities outlined in the DoD Financial Management Regulation.
Other organizations involved include local Credit Counseling Agencies,
state financial regulatory agencies, the InCharge Institute and the
NASD Foundation.
The Military Service financial educators, along with partner
organizations, have also distributed over 223,000 brochures and
pamphlets, with the Military Services and Federal Trade Commission the
primary provider of these products. In addition, Military Money
Magazine has run several articles, including two cover article
editions, on predatory lending. The free distribution of the magazine
is through military commissaries, family support centers, other service
agencies on the installation. The magazine is sent to residents on the
military installations and home addresses off the installation upon
request. Approximately 250,000 copies are distributed per quarter.
Predatory Lending Practices Considered
The lending practices covered in education programs parallel those
covered in the report: payday loans, Internet loans, military
installment loans, tax refund anticipation loans and rent-to-own
programs. Education programs also cover budgeting, the appropriate use
of credit, credit cards, and other financial services.
The loans covered in the report include those with high interest
rates, little or no responsible underwriting, loan flipping or repeat
renewals that ensure profit without significant payment of principal,
loan packing with high cost ancillary products whose cost is not
included in computing interest rates, a non-mortgage loan structure or
terms that transform these loans into the equivalent of highly secured
transactions; and loans that involve fraud or deception, waiver of
meaningful legal redress, or operation outside of state usury or small
loan protection law or regulation. These characteristics strip earnings
or savings from the borrower, place the borrower's key assets at undue
risk, potentially deepen the borrower's financial shortfall and trap
the borrower in a cycle of debt. These loans take advantage of the
borrower's lack of understanding, vulnerability or both.
The types of loans included in the report were chosen as a result
of feedback from military financial counselors and legal assistance
attorneys who have provided counsel to Service members with financial
problems. The Military Services and Military Aid Societies provided
3,393 case studies providing information about incidents where Service
members have requested assistance with their lending problems. These
case studies showed that the typical scenario involved indebtedness
resulting from a lack of financial control, a financial emergency, or
both. Many of these cases involved military borrowers who owed money to
installment lenders and payday lenders that created a cycle of debt.
Efforts to Curb the Prevalence and Impact of Predatory Loans
The Department has attempted to use the processes and resources
available within the Department to curb the prevalence of payday
lenders. But the Armed Forces Disciplinary Control Board (AFDCB) and
command policy are not adequate to address the issue. The AFDCB is
designed to address commercial entities providing services that are a
detriment to good order and discipline, and in violation of federal or
state statute. Without appropriate statute, commanders and AFDCBs have
difficulty citing payday lenders as the focus of remedial action.
Moreover, in states that authorize payday lending, AFDCBs must
establish their own local guidelines in addition to the provisions of
state law, ensure all affected businesses are aware of these new rules,
and then require these businesses to comply. The Department has
considered establishing guidelines that would ameliorate the concerns
posed by lenders characterized above, but establishing these policies
within DoD poses legal problems and raises the potential for
troublesome litigation against the Department. There is no established
authority for DoD to make rules governing off-base private business
dealings.
Military installment companies have also attempted to evade state
usury limits and oversight. In 2005, the California Department of
Corporations considered a complaint filed against one such company,
alleging it operates without a license, charges usurious interest,
collects prepaid finance charges which are not permitted in California,
contracts for excessive dishonored check fees, and automatically adds
various forms of credit insurance to loan agreements (98 percent of
contracts include ``voluntary'' insurance purchases).
Internet lenders claim jurisdiction in states with lax protections
and unlimited rates and often attempt to bypass the state credit, usury
or payday loan laws of the state where the borrower receives the loan.
All military installment lenders cited in the report listed Nevada as
their home state. State regulators have successfully enforced home-
state law against Internet payday lenders making loans to consumers in
their states in Colorado, New York, Massachusetts, Kansas, Pennsylvania
and the District of Columbia.
The scope and methods of payday, military installment and Internet
lenders are outside the capability of the Department to place ``off
limits'' as a way of dealing with good order and discipline concerns
associated with these lenders' practices. It is also unrealistic to
believe that the Department can adequately control these concerns
through education alone. The recent survey accomplished by the Consumer
Credit Research Foundation stated that the primary reason Service
members choose payday loans is because they are convenient. Certainly,
obtaining ``fast cash'' from a payday lender is far more convenient
than debt counseling or addressing inherent overspending that creates
situations where sub-prime loans are needed. The Department seeks your
assistance in helping Service members find convenient, less costly
options that build their financial future.
Alternatives
The Department would prefer Service members and their families seek
out the alternatives available through Military Aid Societies, military
banks and defense credit unions. These institutions have established
programs and products designed to help Service members and their
families resolve their financial crises, rebuild their credit and
establish savings.
The Military Aid Societies are strong advocates for limiting the
cost associated with credit and for developing alternative products by
financial institutions for Service members who cannot otherwise qualify
for loans. Within their own resources they provided $87.3 million in
no-cost loans and grants to Service members and their families in 2005.
As described in the report, many military banks and defense credit
unions have developed products and services to assist Service members
recover from their financial problems. These alternative programs
require Service members to commit to changing their financial behavior.
The Department is seeking this outcome in its awareness campaigns,
education programs, and the counseling services it offers, and supports
reasonable alternative programs that help Service members recover their
financial well-being.
Legislative Recommendations
For the reasons outlined above, the Department is requesting the
Congress' assistance in establishing limits that will help Service
members seek out alternatives capable of motivating them to change
their financial behavior. The report outlines several recommendations
that are designed to curb the corrosive nature of predatory loans. Each
recommendation seeks to limit the abuses articulated in the report:
Require that unambiguous and uniform price
disclosures be given to all Service members and family members
with regard to any extension of credit (excluding mortgage
lending). All fees, charges, insurance premiums and ancillary
products sold with any extension of credit should be included
within the definition of finance charge for the computation and
disclosure of the annual percentage rate (APR) for all loans
made to military borrowers. As stated in the report, some loan
companies pack loans with additional fees not included in the
APR calculation. Additionally, many Internet lenders do not
disclose their interest rates and fees on their websites, and
are only disclosed after the borrower has committed to taking
the loan.
Require a federal ceiling on the cost of credit to
military borrowers, capping the APR to prevent any lenders from
imposing usurious rates. Lenders should be prohibited from
directly or indirectly imposing, charging, or collecting rates
in excess of 36 percent APR with regard to extensions of credit
made to Service members. This APR is expected to cover all cost
elements associated with the extension of credit. This
limitation is expected to affect all lenders referenced in the
report (payday, installment, Internet, tax refund anticipation,
and rent-to-own). This limit may affect payday lenders, but by
their own statistics, the military represent only one to four
percent of their market. True, a 36 percent APR may preclude
some Service members from obtaining credit. The Department
believes Service members who require loans with interest rates
above 36 percent APR should seek assistance and not consider
further increasing their debt load. The 36 percent APR limit
creates a barrier for installment lenders to refrain from
packing fees and premiums onto the base interest rate they
charge for a loan. The limit of 36 percent APR is considered
appropriate, since it mirrors the limitations found in several
states for their small loan products. For those states where
the cap is lower than 36 percent, the state limit and consumer
protections would apply.
Prohibit lenders from extending credit to Service
members and family members without due regard for the Service
member's ability to repay. Perhaps the most important limit
that can be applied is assuring Service members are not
provided loans they cannot repay in a timely manner. If they
are in situations that require them to take loans to meet
short-term obligations without considering their short- and
long-term ability to repay, then they should be obtaining
counseling and assistance to restructure their debt and develop
long-term budgets that can help them recover from their
financial concerns. Such a prohibition would also limit the use
of high interest credit to make impulse and unnecessary
purchases, since these outlays push Service members and their
families deeper into debt. Lenders that require checks, access
to bank accounts or car titles to secure obligations consider
these essential assets to mitigate their risk and do not
consider the ability of the borrower to repay the loan. Lenders
that require allotments to repay loans deliver their products
under the same expectations. Access to essential assets places
the borrower in a position of undue duress, with no options but
to pay according to the schedule, even if the borrower has no
capability of doing so. Again, this is not of concern to the
lender holding these assets. If this restriction precludes some
Service members from obtaining credit, then they may consider
the alternatives--counseling, assistance and a change in
financial behavior.
Prohibit provisions in loan contracts that require
Service members and family members to waive their rights to
take legal action. Service members should maintain full legal
recourse against unscrupulous lenders. Loan contracts to
Service members should not include mandatory arbitration
clauses or onerous notice provisions, and should not require
the Service member to waive his or her right of recourse, such
as the right to participate in a plaintiff class. Waiver is not
a matter of ``choice'' in take-it-or-leave-it contracts of
adhesion. To the contrary, Service members should be given the
opportunity to hold lenders accountable for situations where
they have violated their rights.
Prohibit contract clauses that require Service
members to waive any special legal protections afforded to
them. These proposed protections, and those provided to Service
members through the Servicemembers Civil Relief Act, were
intended to strengthen our national defense by enabling Service
members to devote their entire energy to the defense needs of
the Nation. In the interest of our national defense, such
protections should not be subjected to waiver (other than in
circumstances stated in the Servicemembers Civil Relief Act),
in writing or otherwise.
Prohibit states from discriminating against Service
members and family members stationed within their borders, and
prohibit lenders from making loans to Service members that
violate consumer protections of the state in which their base
is located. States should be prohibited from discriminating
against Service members stationed within their borders and
should be required to assure that such Service members are
entitled to and receive the benefit of all protections offered
to citizens of the state, including regulation of lenders
located in the state or that provide loans via the Internet to
Service members stationed there. States have a vested interest
in assuring the financial safety and stability of Service
members stationed within their borders. States should be
prohibited from authorizing predatory lenders to treat ``non-
resident'' Service members stationed within the state's borders
differently than the state would permit that lender to treat
in-state residents. Lenders should be prohibited from charging
Service members stationed within a state an APR higher than the
legal limit for residents of the state, and should also be
prohibited from violating any other consumer lending
protections for residents of the state in which the base is
located.
Conclusion
The Department appreciates the opportunity to report to the
Congress on the issue of predatory lending. The report outlines the
prevalence around military installations of payday lenders and the
overt marketing of some installment and Internet lenders. The report
and this testimony provide an overview of the efforts within the
Department to educate, inform and influence Service members and their
families to take control of their finances, build wealth and escape the
cycle of debt--for their own well-being and to enhance their military
readiness. The Department's strategic plan seeks to increase savings
and decrease dependence on debt. The strategic plan also focuses on
improving the protection afforded Service members and their families in
the market place--again to help assure their military readiness.
The vision for personal finance in the Department is to develop a
military culture that values financial competency and responsible
financial behavior, in other words, a system that values Service
members addressing their financial problems, rather than perpetuating
them through high interest loans. Service members inherently understand
that limits on interest rates are appropriate, even if these limits
would decrease the availability of credit. When asked in a recent
survey conducted by the Consumer Credit Research Foundation if Service
members strongly/somewhat agree or disagree with the statement: ``The
government should limit the interest rates that lenders can charge even
if it means fewer people will be able to get credit,'' over 74 percent
of the Service members surveyed agreed with the statement (with over 40
percent strongly agreeing). Similarly when asked their position on the
statement ``There is too much credit available today,'' 75 percent of
Service members not using payday loans and 63 percent of Service
members using payday loans agreed (with 51 percent of non-users
strongly agreeing).
Service members agree that there should be limits. Commanders have
made their positions known that limits should be established. This
issue is an important part of the Department's social compact with
commanders, Service members and their families, for their well-being
and in support of military readiness. The Department asks for your
assistance enacting the statutory language necessary to establish more
effective limits.
I thank you for this opportunity to share these concerns with you
and the committee. The Department stands ready to assist the committee
in developing effective limits on predatory lending.
______
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PREPARED STATEMENT OF ADMIRAL CHARLES S. ABBOT, RETIRED
President and Chief Executive Officer, Navy-Marine Corps Relief Society
September 14, 2006
Mr. Chairman, Senator Sarbanes, Members of the Committee on
Banking, Housing, and Urban Affairs: I am honored to have the
opportunity to testify this morning on the Department of Defense Report
on Predatory Lending Practices Directed at Members of the Armed Forces
and Their Dependents. The Navy-Marine Corps Relief Society was founded
by President Theodore Roosevelt in 1904 to provide emergency financial
assistance in the form of interest-free loans and grants to Sailors,
Marines and their families. Through the decades, our organization has
encountered various scams, but none as flagrant and serious as today's
predatory lending industry. As President of the Society, I have
personally witnessed the downward spiral of debt suffered by our
Sailors, Marines and their families who seek financial assistance from
predatory lenders. This industry says it does not target the military,
but pick up any edition of Army, Navy, Air Force or Marine Corps Times
and you'll see large, color advertisements with quotes like ``Our
entire focus is on the U.S. Military''; or ``We are dedicated
exclusively to military personnel.'' Instead of solving what may be
temporary cash flow problems, these military families become
overwhelmed and financially destroyed when they fall into the payday
loan trap. The resulting low morale and pre-occupation with personal
financial difficulties have a negative impact on military readiness.
Their stories are heartwrenching:
A 21-year-old Active Duty Sailor in Virginia Beach,
with four dependents was involved in payday loans for two
years. He started in March 2004 by taking out three payday
loans to take his family to visit his grandfather who was
diagnosed with cancer. By October 2005, he had four payday
loans totaling $2,300 that cost him $600 every month just to
roll over. To cover all of this, plus the bounced checks that
it caused, he also borrowed from his Thrift Savings Plan and
took out additional loans. He routinely paid late charges for
his rent and car payments.
An E-4 Active Duty Sailor with a wife and child in
the Pacific Northwest was assisted by the Society with payment
of 8 payday loans totaling $5,250 in July 2005. The service
member took out two payday loans to make a down payment on a
car. His two loans grew to four, six, then eight as he rolled
them over and continued to make up his budget deficit by taking
out additional payday loans. His electricity was cut off. The
family had to go and live with relatives. His car was
repossessed, sold at auction, and he currently owes $12,000 on
that automobile.
An E-6 Active Duty Sailor requested assistance in
paying one month's mortgage ($1,870.38) payment. The service
member stated he got behind on his mortgage when his wife's
father became ill in Japan and he had to send her home to
provide support. At that time, he turned to payday lenders. He
took out 10 payday loans. During some months, he needed two
payday loans to pay off earlier loans. He used his reenlistment
bonus check to pay off the lenders and refinanced his house to
pay off all of his other debts, but still required the
Society's assistance to catch up on his mortgage.
In Jacksonville, Florida, an E-5 Active Duty Sailor
with a wife and three children accumulated nine payday loans
totaling $5,409. The interest rate on these various loans
varied from 121% to 421%. Having no credit cards, this military
couple purchased furniture by using payday loans on the
occasion of a permanent change of station move. There was a
death in the family, followed by an ill relative. Each month
they rolled the loans over, paying a fee to take out additional
new loans. Finally, they sought assistance from our
organization.
These examples illustrate the ever-growing problem. Since August of
2001, the Society has assisted more than 5,500 Navy and Marine Corps
clients victimized by predatory lenders in the amount of $2,597,881.19.
The problem has been made more difficult to monitor and control now
that these loans are easily accessible on the Internet. The web sites
of these predators are as compelling as the neon signs that beckon
unsuspecting Soldiers, Sailors, Airmen and Marines at establishments
outside our military bases across the United States. If one reads the
not so fine print at these web sites, one can learn that:
At Checkmate, you can borrow $150 for three days
with a finance charge equivalent to an Annual Percentage Rate
(APR) of 3,220 percent;
At Northway Financial Corporation, you can borrow
$700 and the cost for your credit as a yearly rate is 758.08%
APR;
At ATMAdvance.com, you can borrow $170 for two
weeks and the finance charge is equivalent to 460.16% APR;
At Cashcall, you can borrow $5,000, and if you make
scheduled payments only (120 payments over ten years), you will
end up paying back more than $30,000.
It is a grim picture that is brought into sharp focus when
destitute military clients come to the military aid societies to ask
for help. The Department of Defense report does a commendable job of
documenting the problem and its impact on our military families.
Equally commendable is the Department's aggressive education program
designed to inform our military families about the perils of accepting
financial assistance from predatory lenders. Education, consisting of
effective personal financial management training, and an intensive,
sustained publicity campaign can reduce the problems resulting from
this legalized loan shark industry. It is an important first step, but
education alone is not enough.
Two additional requirements are critically important to solving
this serious problem: responsible alternative sources of short term
loans and, equally important, Federal legislation with teeth. There has
been some success fighting this battle on the state level; but Federal
legislation will be necessary that, at a minimum, provides the
following:
Caps the interest rate at 36% (to include all fees
and insurance).
Eliminates all loan roll overs or the ability for
individuals to take out another loan to payoff the first loan
which creates a vicious cycle of debt.
Requires all payday lending businesses to belong to
a PDL association that will serve as a clearing house to ensure
clients don't have outstanding payday loans from other payday
lenders, and allows monthly payment plans.
Regulates on-line payday loan transactions.
Thank you for focusing attention on this significant problem that
affects military readiness and the lives of our men and women in
uniform. I appreciate this opportunity to share my concerns with
members of this committee. I hope that Congress will take prompt and
effective action by drafting and passing effective anti-predatory
lending legislation.
I would be pleased to answer your questions.
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PREPARED STATEMENT OF WILLIAM O. BROWN, JR.
Associate Professor, Department of Accounting and Finance, Bryan School
of Business and Economics, University of North Carolina
September 14, 2006
Chairman Shelby, Senator Sarbanes and members of the Committee,
thank you for the opportunity to speak to you today about the
Department of Defense's report on lending practices directed at members
of the armed forces. I am currently an Associate Professor in the
Department of Accounting and Finance at the University of North
Carolina at Greensboro and an economist by training. Over the past two
years I have conducted research on payday lending, military
compensation and the use of payday loans by military personal. In June
of this year, I released a study with my colleague, Dr. Charles B.
Cushman, Jr. from The George Washington University, of payday loan
attitudes and usage among enlisted military personnel. Our results are
cited on several occasions in the Department of Defense Report.
I would like to take this opportunity to share with you some of our
key findings and then raise some of my concerns about the methodology
and analysis in the recent Department of Defense report. Our study
surveyed U.S. enlisted personnel in four branches of the armed service
regarding their attitudes toward, and usage of, short-term credit,
including payday loans. Our survey is the first systematic survey of
enlisted military personnel regarding their economic circumstances and
attitudes toward short-term credit. Our analysis is based on empirical
data that we collected through a random sample of enlisted military
personnel who live near military bases in the United States.
I want to briefly discuss some of our findings that I believe are
relevant to the discussion today. Our results indicate that 13% of the
460 enlisted personnel that lived around military bases and responded
to our survey had obtained payday loans in the previous year. It is
important to note that these numbers are only for enlisted personnel
and not all military personnel. It is suggested in the Department of
Defense report and elsewhere that our number indicates a higher
incidence of payday loan use by members of the military than the
general population. However, our results do not provide such a
comparison. One would need to compare enlisted personnel with a
civilian population of similar age and income in order to make such a
comparison. Otherwise, it is an apples to oranges comparison.
Military borrowers report that they use payday loans to help pay
bills, for auto and home repairs, family emergencies, relocations and
other short term cash flow disruptions. This usage is very similar to
that reported by civilian users of payday loans.
The military enlisted personnel who have had a payday loan repay
them more quickly than their civilian counterparts. Forty-nine percent
of military payday loan borrowers have had two or fewer loans in the
last 12 months, and 78% have had four or fewer loans. A 2001 study
indicated that only 35% of civilian payday loan users had fewer than
four loans. There is little evidence that military users of payday
loans use these loans as a substitute for longer term credit. Given the
relative low overall default rate for such loans in general, the claims
of some opponents to payday lending that payday loan are a threat to
military readiness appear unsupported.
Payday loans are but one form of short-term credit available to
military personnel. Bounced-check fees, late fees and utility reconnect
fees can be and are often more costly than a payday loan. The majority
of military survey respondents reported that they choose a payday loan
for convenience related reasons. In addition some military personnel
reported a lack of alternative options or lack of knowledge about
alternative sources of short term loans indicating that the military
may need to do a better job of educating enlisted personnel about short
term credit options.
As potential decisions regarding the cost and availability of
consumer credit by members of the armed services are considered today,
I sincerely believe that our comprehensive study, which I have only
briefly reviewed here today, would be a valuable body of information to
inform your views on this topic. For this reason, I am submitting a
copy of our full study for the record today.
As to the Department of Defense report, I have several points of
concern and disagreement with the conclusions drawn.
From anecdotes portrayed in the news media and mentioned in the
Department of Defense report, one could have the impression that the
majority of military personnel are deep in debt, the victims of
aggressive payday loan issuers. I am sure many on the anecdotal stories
are true. However, anecdotes only tell us what can happen in some
cases, they fail to give us a bigger picture view or tell us how often
these things happen. There is nothing in the Department of Defense
report to give any indication of the prevalence of problem borrowing by
military personnel.
There are certainly some military personnel with financial problems
and service members with financial problems may have obtained payday
loans, but there is no evidence that payday loans are the cause rather
than a symptom of these financial problems. This causation connection
is completely missing in the Department of Defense report.
Consumer make purchasing decisions based on a number of factors:
price, convenience and opportunity being chief among them. This
Department of Defense report fails to consider that service members
either choose payday loans either because of they lack a better
alternative or because they lack available information about better
alternatives. In either case, the Department of Defense needs to do a
better job of working with financial services firms to provide products
that meet the needs of military personnel and educating military
personnel about the availability and use of those products.
Finally, the Department of Defense's recommendation to reduce the
maximum permissible charge on payday loans to 36% would likely drive
lenders out of the market. The problem is that marginal cost of
providing small consumer loans is high. This is why so many banks and
financial service firms fail to provide such products. When you take
choices away from consumers, prices go up, not down. Again, members of
the military have a demonstrated need for access to short-term credit.
The likely impact of such a rule would be to make military personnel
with short term credit needs significantly worse off.
Mr. Chairman and members of this Committee, I thank you for the
opportunity to appear before you and will be happy to answer any
questions you may have.
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PREPARED STATEMENT OF LYNN DRYSDALE
Staff Attorney, Jacksonville Area Legal Aid
September 14, 2006
Introduction
Chairman and members of the Committee, thank you for the
opportunity to speak in support of the Department of Defense Report on
Predatory Lending Practices Directed at Members of the Armed Forces and
Their Dependents and to illustrate the problems and proposed solutions
in the report with the experiences of military families I represent in
Florida.
Since 1988, I have been a consumer protection attorney with
Jacksonville Area Legal Aid, Inc. and represent low income consumers in
Duval County. I am co-author of a law review article titled ``The Two-
Tiered Consumer Financial Services Marketplace: The Fringe Banking
System and its Challenge to Current Thinking About the Role of Usury
Laws in Today's Society,'' published in the South Carolina Law Review
in 2000. This widely quoted article covers the high cost loan products
detailed in the Department of Defense report to Congress. I serve on
the Jacksonville Bankruptcy Bar Association Board of Directors and have
been a trainer for Judge Advocates, legal officers and Senior
Leadership at Naval Air Station Jacksonville.
Duval County, FL is home to Jacksonville Naval Air Station and
Mayport Naval Station where about thirty thousand service members plus
their families and retirees live and work. Over the years I have
represented many of these Sailors and their dependents as well as
veterans who have fallen victim to the predatory loan practices
described in the DOD Report to Congress. Today I will use their stories
to put a face on the problems identified in the Department of Defense
report and to support the recommended solutions to those problems.
Why military consumers are ideal customers for quick cash lenders
Despite their moderate incomes, many Service members are young and
financially inexperienced, with young families and tight budgets. They
are attractive to lenders because their pay is certain, their residence
is easy to find and they live in concentrated areas. They have stable
and steady employment and, as members of the Armed Forces, unlike
civilian borrowers, they are easy to collect from because the lender
routinely contacts their employer pre-judgment. Service members must
comply with the Uniform Code of Military Justice and could lose rank,
miss opportunities for advancement in rank and pay, and could lose
their jobs for failure to honor their debts.
Military pay arrangements benefit lenders
Members of the Armed Forces are required to maintain bank accounts
in order to receive direct deposit of their federal pay. This makes
them attractive to payday lenders whose only qualifications for quick
cash loans are a steady source of income and an open bank account.
Because they must have a bank account, Service members have added
incentive to pay additional sums to renew loans in order to keep the
checks provided as security from being returned for insufficient funds.
The Uniform Code of Military Justice penalizes a service member's
failure to make good on a check drawn on his or her bank account. Many,
if not most, lenders can and do ask military borrowers to sign over
electronic access to their bank accounts to repay loans. Some lenders
require their loans to be repaid by allotment of military pay, which
means that funds are taken out of their pay and sent to creditors
before the Service member has an opportunity to use the money to pay
rent or utilities. This is a form of payment that is supposed to be
voluntary and a convenience to the Service member but has been turned
into a way to ensure that high cost lenders get paid before funds are
available to pay pressing bills or feed the family. A few lenders even
require borrowers to sign wage assignments to insure payment is made
timely, despite the federal prohibition on wage assignments in loans to
enlisted Service members.
While these Service members have unique features, such as needing
to prove financial responsibility, to strive for advancement in rank
and pay, and to preserve security clearances, their experiences with
predatory lending are replicated in low to moderate income families in
civilian life. The Department's report, in many ways, describes the
plight of all low to moderate income consumers who struggle to make
ends meet in a predatory lending environment.
In my testimony, I will highlight three main points:
1. Predatory loan products and services are expanding rapidly,
including quick cash loans offered in exchange for a personal check to
be deposited next payday, loans secured by the free and clear title to
the family vehicle, and installment loans repaid by military allotments
or electronic access to the bank accounts Service members are require
to have. All of these loans place important assets at risk, come at a
steep cost, and often trap borrowers in repeat borrowing or renewals.
These products also do not provide even the compliant consumer with a
credit history that helps them escape from this choice of borrowing.
High cost predatory lenders target service members by location,
affinity marketing, presence on the Internet, or because they are
widely available in the communities where military families reside.
2. Service members are not being protected by most states, either
because high cost lenders have been carved out of usury or loan laws,
or lenders claim that state credit laws do not protect nonresident
borrowers such as Service members stationed in the jurisdiction, or
because lenders have exploited every loophole to evade consumer
protections. High cost loan contracts are grossly one-sided and include
unilateral, mandatory arbitration clauses to deprive Service members of
their day in court and limit their remedies, both of which are the
cornerstones of the American justice system they fight to preserve.
Congress must step in to protect Service members.
3. Service members are disproportionately targeted and punished by
the products and practices of high cost lenders who harass them, their
families and those in their command and who threaten criminal
prosecution, court martial, loss of rank and pay, loss of security
clearance and dishonorable discharge. Service members fear the
consequences of failure to make good on checks used to get payday
loans, and facing automatic and electronic withdrawal of money from
their accounts are forced to juggle finances to stay afloat. They fear
the loss of the family car whose title is pledged for loans. They fear
the lender retaliation resulting from the cancelling of an allotment
given to a lender. This struggle leads to stress, to loss of morale and
impedes military readiness in addition to harsh financial consequences
felt by the entire family. The practices and problems described in the
DOD Report come alive in my clients' stories.
Mr. Hubbell and his wife are both service members.
You may have seen their story on a recent ABC News program. Due
to the costs of his wife's illness and her inability to work,
they took out a payday loan which led to thousands of dollars
in outstanding loans from both payday lenders and installment
loan companies. The more they paid, the more they owed and have
repaid tens of thousands of dollars. One loan led to another
because they had to keep borrowing more money to avoid the
threats of criminal prosecution and the consequences of the
lender contacting Mr. Hubbell's command. Over a five-year
period of time, they were forced to borrow just over $10,000
and still have a monthly payday loan debt of just over $3,500.
The Hubbells still owe over $12,000 on loans, most of which
only went to pay off other loans and provided no benefit to the
Hubbells except for digging them deeper into debt. Mr. Hubbell
is an air traffic controller and felt he had no option but to
stay on this debt treadmill because of his fear of the real
danger of losing his security clearance and his rank.
Another of my clients borrowed from a sham lender
who pretended to sell Internet access to cloak a criminally
usurious loan. When he was unable to keep up with payments, the
lender directly debited his account for more than the amounts
needed to pay off his loan. The lender also harassed him on his
ship and called his superior officers. He was faced with not
having enough money for groceries and rent for his family,
including three children.
Problems Identified in the DOD Report
1. Predatory loan practices and unsafe credit products are high risk
for military borrowers
The Report describes the same types of high-cost, high-risk loan
products that we addressed in the law journal article about the two-
tiered financial services market: Payday loans, rent to own, car title
loans, high cost installment loans, and refund anticipation loans. From
my experience helping low income and military consumers, I concur with
the Report's description of the lenders' extreme high costs and their
unsafe and unsound lending practices. I also concur with the
description of the risk to borrowers' assets. Lenders require borrowers
to grant them electronic access to their bank accounts as a condition
of getting a payday loan at a store or via the Internet or to borrow
from a military installment lender. As a result, consumers lose control
of their bank accounts and rack up multiple fees when lenders make
repeated efforts to collect on the loan by electronically accessing
their bank accounts multiple times in one day for just one loan.
Predatory lending is not committed only by one class of lenders.
Even banks have begun to join the fray of those lending at triple digit
rates. Two banks are offering ``account advances'' that work just like
a payday loans: the bank advances up to $500 for a short, typically two
week loan that must be paid back on the next payday, at annual rates up
to 500%. In North Little Rock, Arkansas, near Camp Robinson and Camp
Pike, ACE Cash Express partners with First Bank of Delaware to offer an
installment loan at a 390% APR rate. The bank can violate Arkansas'
constitutional 17% usury cap because banks are exempt from state
regulation.
The high risks to military borrowers who must maintain bank
accounts and who rely on their military pay are illustrated by a Navy
borrower I represented.
Mr. M had an installment loan through a
``military'' lender that required automatic access to his bank
account for electronic payment. When he did not make a timely
payment, the lender ``hit'' his bank account eleven times in
one day, causing hundreds of dollars in late fees, NSF fees and
other bank charges.
Lenders often require the borrower to sign a military allotment,
which permits the lender to be paid directly by the Department of
Defense out of the Service member's pay before funds are deposited in
the bank. Allotments to pay consumer debt are supposed to be a
convenience for the Sailor, payday and installment lenders turn this
convenience into a mandatory wage assignment which is prohibited by
federal law for enlisted personnel. The allotment becomes another
method used by the payday lender to put the Service member at risk.
Ms. W obtained a loan from a ``military'' lender
that was marketed online. The lender required her to pay them
through a military allotment check. They threatened to contact
her Command if the allotment was redirected. This put Ms. W in
a bind because the costs were so high for the loan that the
allotment took away money she needed for food, transportation
to and from work and utilities.
Deceptively marketed car title loans have also been problematic for
my clients. In these loans, borrowers sign over the free and clear
title to their vehicle to secure loans for a fraction of the vehicle's
value. Typically these loans must be repaid in full at the end of the
month to avoid repossession of the family's transportation. We had a
plague of title loan abuses in Florida until the Legislature finally
imposed a reasonable 30 percent interest rate cap on these secured
loans. Although Florida now caps these rates, the Report maps show that
title loan sales outlets are still located in Jacksonville to channel
customers to lenders across state lines in Georgia where title lenders
are permitted to charge 300 percent annual interest.
I represented several Sailors who were in constant
fear of losing the family's only means of transportation and
their only means of getting to work. In addition to being
responsible for sound financial decisions, Service members must
also be at work on time. The stress of a potential loss of
transportation left one aircraft mechanic constantly distracted
while trying to take care of Navy aircraft.
2. Predatory Lenders Target Military Borrowers
The Report includes a set of maps created by Professor Steve Graves
from California State University at Northridge, illustrating the
clustering of payday lenders, installment lenders and a few title loan
outlets around military bases in Duval County. In addition, payday
lenders that do not explicitly ``target'' the military have a big
presence in the commercial areas of Jacksonville. For example, the
largest national chain, Advance America has twenty-nine outlets in
Jacksonville, Orange Park, and Atlantic Beach yet stated that only
about five percent of its borrowers in Duval County are members of the
military or their spouses.
The Report also includes a brief survey of online lenders and notes
there are millions of ``hits'' representing companies that appear when
someone uses ``military'' and ``loans'' as their search terms. Some of
these sites are designed to appeal to Service members with photos of
Service people, flags, patriotic symbols, and military-sounding names.
Other online lenders that appear in searches market to the general
public but include ``military'' pages to attract more hits from Service
members.
The problems for military borrowers come from both lenders that
wrap themselves in the flag and those that market generally to cash-
strapped consumers either in communities where Service members and
reservists' families live or through websites available to Service
members anywhere around the world where they have access to the
Internet. The loans are just as expensive and risky for Service members
whether made by a lender with ``military'' in the title or by a
national chain marketing to the entire community.
My clients tell me that they are influenced by loan ads that
include military trappings. They think advertisements appearing in
local Navy papers have been approved by the military.
Mr. M and Ms. W are both in the Navy and are
stationed at NAS-Jax. They each responded to advertisements in
the local Navy newspaper and on the Internet by companies
called Loans 4 Military and Military Financial Network, Inc.
They both thought that the lenders were approved by the Navy
because of their names, their patriotic web sites and because
they were advertised in the Navy paper. The lender advertised a
much lower rate than that which was actually provided. As a
result, the borrowers were left with insufficient funds to pay
their bills because these lenders required repayment by
allotment. They had to take more loans to cover the bills that
were not being paid because of the allotments.
3. High cost loans, abusive collection practices, and the debt trap
The Defense Report describes the high and deceptively marketed
costs, illegal collection practices and repeat borrowing trap that
results from predatory lending to Service members.
The cost of payday loans for my clients over the
years has ranged from 390 percent to 906 percent.
One of my clients had an installment loan with a
disclosed interest rate of 17% while the true but undisclosed
interest rate was 102%.
Mr. N who is in the Navy obtained a title loan
deceptively marketed as the sale and buy back of his motor
vehicle. The lender hid the 300% rate charged because the
Florida Legislature had reduced the interest rates that title
lenders could charge from 264% to 30%.
I regularly see clients who have loans with an
installment lender which deceptively markets its products to
Service members and claims to provide low interest rates. For
example, the disclosed rate in one $1,000 loan was 19%. The
lender also required the borrower to pay $475.95 for insurance
that provided absolutely no real benefit for the borrower. The
insurance was actually additional interest disguised as a real
``insurance'' product.
The Department of Defense Report includes results of this year's
Defense Manpower survey and questions about payday loan use. Those
Service members who admitted to using payday loans reported an average
of 13 transactions last year (including new loans and loan roll-overs).
This loan use pattern is at the top of the range for average
transactions per borrower as reported by publicly-traded lenders and
state regulators who collect that data, as noted in the Report. If a
consumer pays for thirteen $350 two-week payday loans at a cost of $15
per $100, they would pay $682.50 in finance charges to use $350 for
twenty-six weeks of the year.
It isn't just the high cost of payday loans that springs the debt
trap. Failure to pay or renew a loan means that the check written to
secure the loan will bounce and set off a cascade of bounced check fees
charged by both the payday lender and the consumer's bank, not to
mention the adverse impact on the borrower's credit report as a result
of the perceived failure to maintain the bank account.
Mr. K spent his entire day off going from payday
lender to payday lender to keep from having his checks bounce.
At one time, he was trying to juggle nine loans. This is the
same experience that a witness reported to Senator Lieberman at
his 1999 forum on payday lending here in the Senate.
Coercive collections are made easy due to the terms included in
payday loans, car title loans and installment loans.
A payday lender sent one of my clients, who was
required to allow electronic access to his bank account in the
loan transaction collection, letters written by the lender on
State Attorney letterhead. In these unauthorized and illegal
collection letters, the lender threatened criminal prosecution
when he did not have sufficient money to pay the loan in full.
Mr. W borrowed from Military Financial Network
which included language in their documents threatening Court
Martial, imprisonment and a dishonorable discharge if he did
not pay.
Mr. G contacted me via email from an undisclosed
location at sea. He was worried about his wife and family
because of his outstanding payday loan debt. Due to threats she
had received, he was afraid that the payday lender would put
his wife in jail, leaving their two babies without a parent.
4. Service members sign away their rights in the credit market
Every contract I see includes a binding, unilateral pre-dispute
mandatory arbitration clause which is especially burdensome to military
borrowers who are not able to pay the costs associated with arbitration
or travel to participate in arbitration. For example, Mr. W, who had
the Military Financial Network loan while stationed in Florida, was
prohibited from suing MFN and, if he thought they acted illegally, was
required to arbitrate his dispute in Delaware. Therefore, he
effectively had no remedy when MFN debited his account eleven times in
one day, used a contract threatening Court Martial, and threatened him
while at work.
5. Consumer Protections are evaded, not enforced, or nonexistent
Thirty-nine states have carved payday lenders out of usury or small
loan rate caps or repealed their credit restrictions for all licensed
lenders. Half the states permit title lenders to make short term cash
loans at an average of 300% APR. In about half the states, installment
lenders claim that state credit code or rate caps do not apply to
nonresident service members stationed in that state. My home state of
Florida is now in Federal court over the claim that Pioneer Military
Lending is not licensed as a small loan company and does not comply
with Florida protections. Installment lenders that make loans to
military borrowers are not licensed or supervised in North Carolina or
Virginia. Just recently California regulators withdrew its licensing
waiver for one military lender, deciding that there was a public
interest in supervising these companies.
Over the years I have witnessed payday lenders use every trick in
the book to escape real protections.
Hiding behind the check cashing statute. In Florida, payday lenders
tried for years to operate under the state check cashing law to avoid
compliance with the state small loan law and credit protections.
Eventually, Florida allowed payday lenders a safe harbor, permitting
rates up to 390% APR for a $100 loan. Even with such generous rates,
some lenders have attempted to evade Florida law.
Rent-a-bank evasion of state limits were used by some of the
largest payday lenders until the Federal bank regulatory agencies
halted that tactic. Cash America, a publicly traded pawn and loan
chain, used a series of out of state banks as a partner, claiming that
they did not have to comply with Florida regulation. Jennafer Long
borrowed money from ACE Cash Express while it partnered with Goleta
National Bank to make loans at rates that exceeded Florida caps. The
company repeatedly debited her bank account and harassed her
supervising officers and threatened her with criminal prosecution when
she was unable to repay on the due date. We sued and got a favorable
ruling from the Federal court. Thankfully, the Comptroller of the
Currency, the Office of Thrift Supervision, the Federal Reserve and the
FDIC put a stop to the misuse of the charters of financial institutions
through strict guidelines, safety and soundness enforcement and close
examination of partner institutions.
Sham transactions to cloak loans: There is no limit to the lengths
some lenders will go to loan money to consumers at outrageous terms.
Mr. B, a low-ranking Navy member, entered into a loan transaction with
Florida Internet. The loan was characterized as the ``sale of the right
to use the Internet'' for hourly increments. The loan was cloaked as a
``rebate'' for buying Internet time. The lender required direct
electronic access to the borrower's bank account. This company was
hiding interest rates which exceeded 400%, which made the loans
criminally usurious and well above the 18% general loan rate in
Florida. The same lender used a ``catalogue'' sales model to avoid
Florida usury and payday loan law and was sanctioned by the State
Attorney in Pensacola, another Navy town. The lender has been convicted
of racketeering charges and is awaiting sentencing after decades of
predatory lending from Washington to New York's Fort Drum.
Claim to broker loans for other lenders under the credit service
organization model: Cash America is claiming to be a credit services
organization as a ruse to ``broker'' payday loans in Florida for an
Ohio-based finance company, which may be a Cash America subsidiary.
Cash America guarantees repayment of the loans to the Ohio company,
which should take them out of the definition of a credit services
organization and put them in the category of a loan guarantor. Cash
America's loans cost $18 per $100 for the ``broker fee,'' plus interest
charged by the purported lender. This makes Cash America loans even
more expensive than Florida's limits for payday loans. I believe that
this arrangement does not comply with Florida's Credit Services
Organization Act and is simply done to charge Florida borrowers higher
rates than even the state payday loan law allows.
Attempt to avoid state protections by doing business online
I recently filed a lawsuit against an Internet lender,
Sonicpayday.com. This lender is available only on the Internet and
charges interest rates as high as 900%. They do not allow the grace
period provided by Florida law and encourage rollover transactions
(paying off an outstanding loan with another more expensive loan).
Sonic also requires its borrowers to sign a ``voluntary'' wage
assignment. When my clients were unable to pay these high cost loans,
Sonic contacted their employers and demanded the employers pay Sonic
directly. They also contacted the Service member's chain of command
when he told them he could not pay on time. Sonic loans have a term of
two weeks or less. The short term makes the loan even harder to pay
back.
Noncompliance with protections. In July, Florida regulators took
EZPawn to court over its failure to get a license to make payday loans.
The Office of Financial Regulation alleged that EZPawn Florida, Inc.
unlawfully blocked examiners from inspecting its loan papers and other
records. This company, one of the large publicly traded payday loan and
pawn chains, has at least eighteen locations in Florida
The public record is replete with instances of large payday loan
companies violating state consumer protection laws. This summer the
Washington Department of Financial Institutions filed a case against
Check'n Go for continued violation of state rules for payday lenders.
Illinois Department of Financial Institutions fined Advance America
earlier this year for violating the new Illinois law. West Virginia's
Attorney General settled a case against Advance America for debt
collection tactics used by its Ohio stores with West Virginia
consumers. Arizona's Attorney General brought a case against a payday
lender for threatening criminal prosecution for nonpayment. The
Colorado Attorney General settled a case against an Internet payday
lender that failed to comply with Colorado law. The North Carolina
Banking Commissioner ruled that Advance America violated its small loan
law while brokering loans through a series of out-of-state banks.
Industry ``best practices'' voluntary codes fail to protect
consumers
Trade group ``best practices'' codes of conduct are more public
relations than consumer protection. The CFSA ``Best Practices'' do not
call on their members to cap interest rates, to stop enticing consumers
to write checks without money in the bank, to consider ability to repay
in extending credit, or to provide affordable repayment terms for their
loans. Instead, the trade group's voluntary guidelines call for lenders
to obey the Truth in Lending Act and state law relating to disclosures,
to refrain from threatening criminal prosecution if a check used to get
a loan is returned unpaid, and calls for a 24-hour right to cancel the
loan by returning the amount borrowed. Even where the guidelines appear
to offer the protection of a four roll-overs limit (unless state law
requires less), these companies do not consider back-to-back loans as
roll-overs restricted by this limit. Their Best Practices call for
borrower responsibility but says nothing about lender responsibility to
make appropriate loans.
One of my clients had a bad experience with a payday lender which
bragged about being a member of CFSA in its contract and claimed that
it followed CFSA's Best Practices:
Ms. Griffin is a Navy wife who has a payday loan
with Advance America in Florida, which, as stated above, is a
state that requires licensed lenders to grant at least a 60-day
grace period with no additional fees, charges or costs if a
borrower seeks credit counseling. Despite the grace period and
a prohibition on ``roll-overs'' in her contract, she was
required to roll over her loan when she could not pay. When she
went to pay it off, she was $45 short, not realizing that she
would be charged another fee to roll over the loan. Advance
America refused the grace period even after she told them she
already had the counseling at the Navy Marine Corps Relief
Society, an authorized State of Florida Deferred Presentment
Provider counseling agency. The director of NAS Jax NMCRS, Ret.
Capt. Dave Faraldo, called the lender only to be told they did
not have to talk to him and did not have to provide the grace
period. You might think this was a matter of an inexperienced
employee; however, the Advance America employee said she had
been an employee trainer for eight years and they never had to
provide the grace period. When I provided a signed release that
I was Ms. Griffin's attorney, the Advance America staffer
refused to speak to me about the legally-required grace period
on her account.
The organization also promotes its ``military best practices'' as
all the protection military borrowers need. A close examination reveals
no cap on interest rates; no ban on check holding or electronic access
to bank accounts; no prohibition on mandatory arbitration clauses, and
no ban on waiver of rights or access to the courts. Instead, the code
prohibits after-the-loan practices that are already largely addressed
by Department of Defense rules, the Servicemembers Civil Relief Act, or
are promises that sound good but deliver little. Payday lenders use the
borrowers' automatic access to bank accounts and checks to collect, not
garnishment, in most cases. Federal law provides significant
protections against garnishment of wages for enlisted personnel.
Officers are directed by DOD not to assist creditors in collecting
``exorbitant'' debts. The other weak provisions of the CFSA Military
Best Practices, adopted in 2004, call for honoring repayment agreements
negotiated by credit counselors, providing educational materials
including a brochure, and maintaining a web site. Since these
guidelines have been in effect for over two years, it is obvious their
application did not prevent the serious problems identified by the
Department of Defense in last month's report.
Solutions Needed
I agree with the reforms urged by the Department of Defense to
protect military borrowers and believe these protections are needed by
all consumers struggling to make ends meet.
1. Rate cap which the Senate has already enacted as part of the
2007 Defense Authorization bill, now in conference with the House. DOD
calls for a 36% APR cap to include all fees, premiums, other charges.
This is the typical state small loan rate cap and is double the federal
interest rate cap for Federal credit unions. It is six times the
interest rate for loans held by Service members prior to joining the
military. The Talent-Nelson amendment places a federal ceiling on
interest rates (helpful for those states that neglect to protect
nonresident Service members who live in their states) but permits
states to provide more protection.
2. Loans should not be based on key assets for families. This puts
too much risk into borrowing, fosters coercive collection tactics, and
encourages consumers to take desperate steps to avoid losing those
assets. S. 1878, introduced by Senator Akaka, would prohibit lending
based on solicitation of unfunded checks or electronic access to bank
accounts. It is already illegal for lenders to require consumers to pay
debts through periodic electronic payments. This protection should be
extended to single payment payday loans. No lender should be permitted
to require a Service member to sign an allotment to military pay,
providing a de facto wage assignment to lenders.
3. Service members deserve to have the full range of American
rights when dealing with creditors. They should not be asked to waive
their rights under state and federal law or be forced to accept
binding, unilateral mandatory arbitration. No one should have to sign
that they will not sue a lender for illegal practices and will not join
a class action lawsuit. Often class litigation is the most efficient
means for both parties to litigate illegal practices relating to
hundreds of cases involving relatively small sums. Also, no one should
be required to agree to pay the lender's expenses to remove them from a
class or promise they will not file for bankruptcy in the future. I
agree with DOD that ``waiver is not a matter of `choice' in take-it-or-
leave-it contracts of adhesion.''
______
PREPARED STATEMENT OF HILARY B. MILLER
President, Payday Loan Bar Association
September 14, 2006
Mr. Chairman and members of the Committee, it is a distinct honor
to appear before you today. My name is Hilary Miller, and I am
president of the Payday Loan Bar Association. I am here today as an
expert in subprime lending, and I appear on behalf of the payday-
advance industry's national trade association, the Community Financial
Services Association of America (``CFSA'').
Our bar association and CFSA both subscribe to the highest
principles of ethical and fair treatment of borrowers. CFSA represents
owners of approximately half of the estimated 22,000 payday-advance
retail outlets in the United States. CFSA has established--and,
critically, enforces among its members--responsible industry practices
and appropriate consumer rights and protections, including special
protections for the benefit of military personnel.\1\
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\1\ These protections and information resources for service
members, which include prohibitions on garnishment and contacting the
chain of command for collection assistance, can be viewed in their
entirety at http://www.cfsa.net/genfo/MilBestPractie.html (visited
September 2, 2006).
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There are serious flaws in the Defense Department's recent Report
on Predatory Lending Practices Directed at Members of the Armed Forces
and Their Dependents (the ``DoD Report'').\2\ Those flaws involve
fundamental matters of both methodology and policy.
---------------------------------------------------------------------------
\2\ A copy of the report is available at http://
www.defenselink.mil/pubs/pdfs/Report_to_Congress_final.pdf.
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Decisions having potentially far-reaching implications regarding
the cost and availability of consumer credit used by members of the
Armed Forces must be reached only after careful gathering of data from
a variety of sources and even-handed analysis of such data.
By failing to synthesize information from balanced sources--and by
systematically excluding any input from independent economists,
consumer-credit experts or the industry itself--the DoD Report presents
the views only of opponents of the kinds of lending discussed.\3\ The
result is a biased, inaccurate and incomplete picture of the market for
such credit, of the industry's practices and, most importantly, of the
likely impact on military consumers were the DoD Report's
recommendations to be adopted.
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\3\ A flawed report was perhaps predictable in light of the
original directive of Congress that the Secretary of Defense consult
with ``representatives of military charity organizations and consumer
organizations'' but not with industry representatives, economists or
consumer-credit experts. Section 579 of the National Defense
Authorization Act for Fiscal Year 2006, P.L. 109-163, 119 Stat. 3276-77
(the ``2006 Act'').
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The language of the report reveals the author's bias. Instead of
providing an objective explanation of his findings, the author
frequently employs normative and emotionally charged terms to describe
subprime lending, thereby suggesting--without a basis in research--that
such lending is a societal evil.
Our industry has a vital interest in making sure that military
borrowers can repay their loans, for one simple reason: as lenders, we
only make money when our borrowers repay us. If they do not pay, not
only do we fail to collect their finance charges--which the DoD
criticizes--but we also lose many times those charges in loan
principal. In short, it is contrary to our interests to have service
members get into trouble with their loans. And the reason we lend to
military borrowers at all is that the entirety of the available
scientific data suggest that only a tiny percentage of military
borrowers actually do get into trouble with payday loans. Anecdotes
derived from a non-representative sample of this small group are now
being used to drive public policy for the much larger numbers of
military borrowers who use payday loans for their intended purpose and
who repay their loans on time.
Here are some of the DoD Report's principal flaws:
The DoD report determines that payday loans are
``predatory'' solely by uncritically adopting eight factors
used by a vociferous opponent of the industry, the Center for
Responsible Lending, without making an independent
determination that such loans are ``unfair'' or ``abusive'' as
required by the applicable statute. No other recognized
authority has adopted these factors.
According to DoD's own internal data, fewer than 5%
of service members have had a payday loan.
Because fewer than 6% of payday loans ultimately
default, at most 6% of that 5%, or 0.3%, of all service members
have experienced financial difficulty with a payday loan. In
other words, 99.7% of service members have either not had a
payday loan or experience no financial difficulties with payday
loans. There is simply no statistical evidence that payday
loans contribute to military readiness problems to any
measurable degree.
Although some service members with financial
problems have taken out payday loans, DoD has presented no data
showing that payday loans cause financial problems. Payday
loans are intended to solve short-term financial problems, and
the overwhelming majority of users employ them in that manner.
DoD's data regarding asserted hardship relating to
payday loans consist of a mere 12 anecdotes drawn from the
experiences of 1,400,000 or more service members.
For a sample of service members with payday loans
who have experienced bankruptcy, payday loans account for less
than 4% of their total liabilities, and the financial
difficulties suffered by such service members manifestly relate
to preexisting (i.e., non-payday-loan) factors.
DoD's data regarding ``targeting'' of service
members by payday lenders are flawed because they do not
control for demographics and fail to include tests of
statistical significance. The ``targeting'' argument assumes,
in defiance of logic, that the industry would commit
disproportionate resources to customers who account for only 1%
of revenues.
Service members appreciate the convenience and ease
of obtaining a payday loan; 78% of service members with payday
loans agree that ``most people benefit from the use of
credit.''
DoD's principal recommendation is to reduce the
maximum permissible charge on such loans to 36%, which is below
lenders' marginal cost--thereby driving legitimate, regulated
lenders out of the market and compelling borrowers to deal with
illegal lenders. Those lenders would just as likely pursue
illegal collection methods.
A 36% rate cap is not the only possible approach to
addressing the needs of overburdened service members. The
industry has suggested allowing service members a longer
repayment plan similar to that offered by the banks highlighted
in the DoD Report. Our proposal to DOD was to allow service
members to repay their defaulted loans over a term of six
months or longer, and to limit interest rates to 36% in the
post-default period. It is hard to understand why the bank
program is embraced by DoD and the payday-advance industry's
proposal is ignored.
Ironically, payday lending competes with bank and
credit union overdraft charges and service fees and is often
less expensive for the consumer. For example, if a service
member is a Pentagon Federal Credit Union member, the charge
for a $100 overdraft is $25; our industry typically charges
only $15 for a $100 advance. Similarly, Pentagon Federal's late
charge on a credit card is $39, which explains why more than
70% of our customers use payday advances to avoid late fees.
In a comprehensive submission attached to these remarks, we discuss
the DoD Report as it addresses payday lending. However, many of our
criticisms of the DoD Report are equally applicable to the other forms
of credit addressed in the DoD Report.
The DoD Report should be rejected, and the subjects raised by the
report should be given appropriately balanced further study and
analytical reflection by qualified experts.
Thank you for your interest. I will be pleased to take any
questions.
Analysis
I. Payday Loans Are Not ``Predatory''
The DoD Report adopts wholesale, and without critical analysis, a
set of eight criteria promulgated by a vociferous opponent of the
industry, the Center for Responsible Lending (``CRL'') , for
determining whether a payday loan is ``predatory.'' \4\ No political,
regulatory or academic authority has adopted CRL's criteria. There
exists no principled rationale for the use of these criteria to the
exclusion of more established notions of what constitutes a
``predatory'' loan.\5\
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\4\ DoD Report at pp. 13-14.
\5\ A standard definition is an unsuitable loan designed to exploit
vulnerable and unsophisticated borrowers. A predatory loan has one or
more of the following features: charges more in interest and fees than
is required to cover the added risk or cost of lending to borrowers
with credit imperfections, contains abusive terms and conditions that
surprise or trap borrowers and lead to increased indebtedness, does not
take into account the borrower's ability to repay the loan, or violates
fair lending laws by targeting women, minorities and communities of
color. Payday loans meet none of these criteria. See, generally, U.S.
Dep't of Treasury/U.S. Dep't of Housing and Urban Development, Joint
Report on Recommendations to Curb Predatory Home Mortgage Lending
(2000), available at http://www.hud.gov/library/bookshelf12/pressre1/
treasrpt.pdf (visited August 29, 2006).
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Although not clear from the DoD Report, it appears that both CRL
and the author of the DoD Report believe that the CRL criteria should
be applied disjunctively; i.e., that a loan that possesses any one of
the eight criteria is ``predatory.'' Since all payday loans possess at
least two of the CRL criteria (``high'' cost and the use of a check-
repayment mechanism), the DoD Report effectively classifies all payday
lending as ``predatory''--without making an independent determination,
as required by Congress, of how payday loans are ``unfair or abusive''
(within the meaning of the 2006 Act).\6\ By circularly defining payday
loans to be ``predatory,'' the result of the DoD Report is a political
statement, not science.
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\6\ Section 576(c)(2) of the 2006 Act defines a ``predatory lending
practice'' as ``an unfair or abusive loan or credit sale transaction or
collection practice.''
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We discuss these eight factors individually.
Interest Rate
The DoD Report's principal objection to all of the types of loans
it criticizes is their ``high cost.'' \7\ Yet no other authoritative
source has classified any form of consumer lending as ``predatory''
based solely on pricing.\8\
---------------------------------------------------------------------------
\7\ DoD Report at pp. 13, 16-20.
\8\ As a general matter, consumer credit experts understand the
term ``predatory'' to be rooted in deceptive and/or illegal practices
to coerce borrowers into unfavorable agreements. Stephen C. Bourassa,
Predatory Lending in Jefferson County. University of Louisville 2003,
http://www.lul.org/?foreclosed.htm (visited August 29, 2006). See also,
Remarks by Governor Edward M. Gramlich at the Housing Bureau for
Seniors Conference, Ann Arbor, Michigan (2002):
In understanding the problem, it is particularly important to
distinguish predatory lending from generally beneficial subprime
lending. Predatory lending refers to activities and practices just
cited--asset-based lending, loan flipping, packing of unnecessary fees
and insurance, fraudulent or deceptive practices. Subprime lending, on
the other hand, refers to entirely appropriate and legal lending to
borrowers who do not qualify for prime rates, those rates reserved for
borrowers with virtually blemish-free credit histories. Premiums for
extending credit to these borrowers compensate lenders for the
increased risk that they incur and range several percentage points over
rates charged on prime loans. Although some have argued that these
premiums are excessive, market forces should eliminate inappropriate
spreads over time.http://www.federalreserve.gov/boarddocs/speeches/
2002/20020118/default.htm (visited August 29, 2006) (emphasis added).
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In the case of payday loans, the cost of credit, standing alone, is
neither ``unfair'' nor ``abusive,'' even though the interest rates on
such loans (expressed as an annual rate) are nearly universally in the
triple digits. Rather, such pricing has been found to be justified by
the fixed costs of keeping stores open and the relatively high initial
default rates on such loans. To the extent that CRL--and the author of
the DoD Report, by unquestioningly adopting CRL's political views--
claim otherwise, their views are inconsistent with the research of
federal consumer credit regulators.\9\
---------------------------------------------------------------------------
\9\ Mark Flannery and Katherine Samolyk, Payday Lending: Do the
Costs Justify the Price? FDIC Center for Financial Research Working
Paper No. 2005-09. http://www.fdic.gov/bank/analytical/cfr/
workingpapers.html#payday (visited August 29, 2006).
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In large measure, the perceived high cost of payday lending is
driven by the small dollar amount of each loan, the high cost of
maintaining stores in operation (both during and outside of traditional
business hours), and the costs of marketing, originating and collecting
such loans. Payday loans are thus ``expensive'' for the same reason
that, for example, small quantities of food, available on a 24/7 basis
from 7-Eleven, cost more than the same items purchased in bulk from
Sam's Club during regular business hours. Likewise, so-called ``low-
documentation'' mortgage loans have higher default rates and are more
expensive than those based on more time-consuming credit
investigations.\10\ Consumers who buy in small quantity and want it
``right now'' and with no ``hassle'' pay higher prices for those
privileges. This is not an unfair or deceptive business practice; it is
part of the American system of freedom of economic choice.
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\10\ Roberto G. Quercia, Michael A. Stegman and Walter R. Davis,
The Impact of Predatory Loan Terms on Subprime Foreclosures: The
Special Case of Prepayment Penalties and Balloon Payments (2005),
Center for Community Capitalism, University of North Carolina. http://
www.kenan-flagler.unc.edu/assets/documents/foreclosurepaper.pdf
(visited September 29, 2006).
---------------------------------------------------------------------------
There is no evidence that payday-loan pricing causes economic harm.
Indeed, borrowers' economic welfare is generally enhanced, rather than
reduced, as a result of such borrowing. Any analysis of the cost of
payday-loan credit must take into account the cost to the borrower of
not obtaining such credit. For example, a consumer with limited credit
alternatives may write a check drawn on insufficient funds. Even if the
depository bank pays the overdraft, the cost of such credit is
substantial, because the consumer is charged a service charge of $18 to
$25 (or more) for the overdraft.\11\ But in most cases, middle-income
consumers do not find that their banks are willing to pay overdrafts;
rather, the checks are returned unpaid. When the check ``bounces,'' not
only does the consumer's bank impose its service charge, but the
consumer is also subjected to a returned-check fee by the merchant to
whom the check had been written--generally another $25 or more. Thus,
the total cost of ``bouncing'' a check, which may provide a consumer
with a few days or weeks of credit until the check is paid is often $45
or more. Alternatively, a consumer with limited credit alternatives may
engage in self-help to obtain an extension of credit in the form of a
deferred payment of rent, a utility bill, or an installment due on a
mortgage or a car loan. Such late payments will generally subject the
consumer to late fees--penalties charged by the landlord or creditor
which are very substantial relative to the true amount of temporary
credit of which the consumer has availed himself. If the payment is
made to a utility, often the consumer is subject to disconnect and/or
reconnect fees. These charges have also risen to the point that
consumers will almost always find it less expensive to employ a payday
advance instead. Academic literature supports this welfare-enhancing
view of payday lending.\12\
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\11\ The cost of overdraft-protection credit can be astronomical
and generally exceeds the cost of comparable payday-loan credit. Banks
are not required to disclose these costs as an annual rate. For unknown
reasons, the DoD Report does not address them.
\12\ Samuel Hanson and Donald P. Morgan, Predatory Lending? Federal
Reserve Bank of New York working paper (2005), available at http://
www.consumercreditresearchfoundation.org/_files/
FRB_Morgan_Hanson_5_2005.pdf (visited August 29, 2006) (no evidence
that payday lending is ``predatory'').
The notion that the borrower engages in his own welfare-enhancement
calculus is likewise suggested by Thomas E. Lehman of Indiana Wesleyan
University:
In all likelihood, the borrower cares not what the ``effective
APR'' is on the loan. The real price signal to which the borrower
responds is the flat fee that is charged to hold the postdated check.
If the value attached by the borrower to the immediate cash advance
exceeds the value of the [principal] plus the fee one or two weeks
hence, then the borrower will undertake the transaction . . . .
``In Defense of Payday Lending,'' The Free Market, Ludwig von Mises
Institute, Vol. 23, No. 9 (2003).
See also, James J. White, ``The Usury Trompe L'Oeil,'' 51 S.C. L.
Rev. 445, 466 (2000) (``Contrary to those who claim to befriend the
impecunious consumer, . . . even the poorest consumers are quite savvy.
They understand the alternatives and make choices about borrowing that
are wise for them even when the decisions seem foolish or wasteful to
middle-class observers'').
---------------------------------------------------------------------------
The pricing of payday loans is thus not ``unfair'' because, among
other reasons, given the costs of providing credit, such pricing does
not result in a grossly disproportionate exchange of value with the
consumer or excess profitability to the lender.
A recent study by Karlan and Zinman (2006) provides the best and
most complete scientific answer to the question, ``Do high-interest
short-term loans harm consumers?'' The authors used a lender to conduct
a large-scale, randomized trial in which marginal borrowers who would
not ordinarily receive access to short-term loans were granted loans.
Those who received these loans were, one year later, less likely to be
poor, unemployed or hungry.\13\ There is no comparably rigorous study
showing a contradictory result.
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\13\ Dean S. Karlin and Jonathan Zinman, Expanding Credit Access:
Using Randomized Supply Decisions to Estimate the Impacts (2006).
http://www.dartmouth.edujzinman/Papers/
Karlan&Zinman%20Consumer%20Credit%20Impacts.pdf (visited August 29,
2006).
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Both Hanson and Morgan (2005), fn. 12, and Bond, Musto and Yilmaz
(2006) \14\ conclude that predatory lending is effectively eliminated
through robust competition.\15\ There can be no more perfectly
competitive industry than the payday-loan business.\16\
---------------------------------------------------------------------------
\14\ Philip Bond, David K. Musto and Bilge Yilmaz, Predatory
Lending in a Rational World, Federal Reserve Bank of Philadelphia
Working Paper No. 06-092 (2006). http://ideas.repec.org/p/fip/fedpwp/
06-2.html (visited August 29, 2006).
\15\ See also, ``Let competition curb payday lending excesses,''
Crain's Chicago Business (May 17, 2004).
\16\ See, generally, Banking on the fringe, Federal Reserve Bank of
Minneapolis (July 2004), http://minneapolisfed.org/pubs/fedgaz/04-07/
banking.cfm (visited August 29, 2006).
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In summary, there is no authoritative or theoretical support for
the DoD Report's conclusion that the ``high'' interest rates
traditionally charged on payday loans, without more, render them
``predatory.''
--Short Minimum Loan Term
The DoD Report asserts--again adopting, without analysis or
question, the CRL view--that the short-term nature of the loan, without
more, renders a payday loan ``predatory.'' \17\
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\17\ ``The letters from the regulators recognize that a practice
that can be abusive in some contexts can also--in absence of fraud or
deception--be highly beneficial to consumers.'' Report of the Staff to
Chairman Gramm, Committee on Banking, Housing and Urban Affairs,
Predatory Lending Practices: Staff Analysis of Regulators' Responses
(August 23, 2000) available at http://banking.senate.gov/docs/reports/
predlend/predlend.htm (visited August 29, 2006).
---------------------------------------------------------------------------
The sole support for this claim is the unsubstantiated statement
that ``75% of payday customers are unable to repay their loan within
two weeks.'' There is no factual basis for this statement.
Both CRL (and the author of the DoD Report) assume, without factual
basis, that the reason all payday loans that have been renewed, or
``rolled over,'' is that the borrowers were unable to repay them. This
conclusion is but one of many possible conclusions why borrowers may
choose to extend the maturity of their loans. None of the academic
literature in this field addresses the reason for ``rollovers.''
Even assuming that the average number of rollovers cited for non-
military users were correct, the rate of repeat usage of payday loans
among military borrowers is known to be much lower. In a recent
independent study, 49% of military enlisted payday-loan borrowers
reported they have used a payday loan no more than twice in the last
year (compared to 16% of the general population of payday borrowers);
79% said they had no more than four loans in the last year (compared to
65% of the general population).\18\
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\18\ William O. Brown, Jr. and Charles B. Cushman, Payday Loan
Attitudes and Usage Among Enlisted Military Personnel (2006). Available
at http://www.consumercreditresearchfoundation.org/_files/
060628MilitaryPDLSurvey.pdf (visited August 29, 2006).
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Finally, there is no theoretical support for the supposition that a
loan, the duration and cost of which are fully disclosed to the
consumer, and which (as noted in the preceding paragraph) military
borrowers actually repay in accordance with the original schedule, is
``predatory'' within the meaning of the 2006 Act. The cost of renewal
credit is neither ``unfair'' nor ``abusive'' for the same reasons
(supra, pp. 2-4) that the cost of the original loan is not predatory.
The mere fact that a minority of military borrowers may find it
necessary to renew their loans likewise does not render such loans
``unfair'' or ``abusive'' because the consequences of renewal do not
result in either a meaningful reduction in consumer economic welfare
nor excess profits to the lender.
--Single Balloon Payment
The DoD Report again incorporates, without examination, a CRL
criterion for ``predatory'' lending that the entire balance of a
consumer loan is repayable in a single balloon payment.\19\ The report
incorrectly states that payday loans do not allow for partial
installment payments to be made during the loan term; in fact, nearly
all payday lenders permit partial payments, and such prepayments are
required to be accepted under the laws of many states.\20\
---------------------------------------------------------------------------
\19\ Many ``mainstream'' forms of consumer credit are payable in a
single balloon payment, such as the currently popular interest-only
home mortgages and certain home equity lines of credit. The DoD Report
fails to explain how, if at all, these credit vehicles are
distinguishable in predation from payday loans.
\20\ E.g., Nevada, Utah, Louisiana and Virginia.
---------------------------------------------------------------------------
The DoD Report fails to set forth any principled reason why a
requirement for repayment in a single balloon payment is evidence of
predation. As with the ``short minimum loan term'' issue discussed
above, the nature and terms of the loan are fully disclosed to, and
understood by, the borrower at the time the loan is entered into--
perhaps more than any other aspect of any loan's terms. There is no
fraud or deception regarding the consequences to the consumer of being
unable to make partial repayments or of failure to make the single
required repayment. There is no material economic difference to the
borrower, ceteris paribus, in being required to make a single payment
in two weeks instead of two payments at one-week intervals; indeed,
because payday loans generally have a ``bullet'' maturity date at or
immediately after the borrower's next payday, the single-installment
nature of the loan benefits the borrower by allowing payment coincident
with his employer's payroll practices.
--Loan ``Flipping''
The DoD Report adopts the CRL terminology of ``loan flipping'' to
refer to ``rollovers,'' or loan renewals. Neither CRL nor the DoD
Report correctly utilizes the term ``flipping,'' although use of the
term gives the issue more of a political charge, as CRL hopes and
expects; and in this respect, the author of the DoD Report is likely an
unwitting dupee.
``Loan flipping'' is a ``predatory'' practice by mortgage lenders
where the lender induces the borrower to refinance an existing,
favorable mortgage (often serially) by falsely representing the
benefits of the new loan, and ultimately providing little or no
economic benefit for the consumer because the manifest benefit is
consumed by additional loan points, loan fees, prepayment penalties and
fees from financing the sale of credit-related products such as life
and disability insurance.\21\ For example, some homeowners are
pressured by lenders into refinancing existing subsidized mortgage
loans in exchange for commercial loans at higher interest rates, but
with slightly lower monthly payments and substantial fees rolled into
an increased principal balance. These tactics, because the consumer is
actively deceived into believing that the transaction produces a net
economic benefit for him, are clearly ``abusive'' within the meaning of
the 2006 Act.
---------------------------------------------------------------------------
\21\ See, Comptroller of the Currency, Guidelines for National
Banks to Guard Against Predatory and Abusive Lending Practices, O.C.C.
Advisory Letter 2003-2, available at http://www.occ.treas.gov/ftp/
advisory/2003-2.doc (visited August 29, 2006).
---------------------------------------------------------------------------
In contrast, renewals of payday loans are initiated not by the
lender but rather by the borrower. The borrower fully understands at
the outset of the original loan and of any renewal loan what the costs
and benefits are to him of repayment or renewal. Pricing of a payday
loan is straightforward and does not involve complex computations to
determine the cost of credit. There is no opportunity for the lender to
conceal costs or to confuse the borrower regarding the economic
benefits of extension.
The payday lender's ``default setting'' is that the loan must be
repaid in full on the original due date. Because payday-loan renewals
are initiated by the borrower, the harms sought to be avoided by
federal and state anti-``flipping'' regulations are simply absent from
this arena.
Under the Best Practices for the Industry of the CFSA, CFSA members
limit payday-loan renewals to the lesser of four or the number
permitted by applicable state law.\22\ Applicable state laws in Arizona
(for military borrowers), California, District of Columbia, Florida,
Hawaii, Illinois, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota,
Mississippi, Montana, Nebraska, New Hampshire, Ohio, Oklahoma, South
Carolina, Tennessee, Virginia, Washington and Wyoming proscribe all
rollovers whatsoever. State laws in Alabama, Colorado, North Dakota and
Rhode Island limit the permissible number of rollovers to one. Laws in
the other 12 states which permit payday lending have variable limits on
the number of rollovers permitted.
---------------------------------------------------------------------------
\22\ Community Financial Services Association, Best Practices for
the Industry, http://www.cfsa.net/genfo/egeninf.html (visited August
29, 2006).
---------------------------------------------------------------------------
There is no factual or authoritative support for the DoD Report's
conclusion that merely permitting rollovers, to the very limited extent
allowed by law or by CFSA's Best Practices, is a predatory practice.
--Simultaneous Borrowing from Multiple Lenders
It is theoretically possible for a borrower to incur substantial
amounts of debt by contracting simultaneously with multiple payday
lenders--just as a borrower may have multiple credit cards, mortgages,
car loans and doctors' bills. Neither CRL nor the author of the DoD
Report explains how this possibility is the result of a predatory
practice by lenders. Virtually any consumer good or service holds risks
if it is over-consumed. To the extent that a borrower can become
indebted to multiple lenders simultaneously, consumer activists like
CRL (and, by wholesale adoption, the author of the DoD Report) appear
to expect lenders to protect borrowers not from predation by lenders
but rather from the results of the borrowers' own improvident financial
decisions.
It is ironic that the proponents of such protections expect sellers
of credit services to ascertain whether the buyers have relationships
with competitors, and, if so, to refrain from doing business with those
buyers. In any other field of endeavor, the Sherman Act would be loudly
invoked, and the Justice Department would be vitally concerned about
the anticompetitive nature of these behaviors.
Once again, the author of the DoD Report does not explain how it is
``unfair'' or ``abusive'' for a lender to extend credit to a borrower
who has existing credit relationships with others--especially, as is
usually the case, if the lender is unaware of those relationships.\23\
---------------------------------------------------------------------------
\23\ Alabama, Florida, Illinois, Indiana, Michigan, North Dakota
and Oklahoma have state ``database'' requirements that limit or
proscribe multiple loans to a single borrower from multiple payday
lenders and provide for an electronic means to determine the existence
of an outstanding loan from a competitor.
---------------------------------------------------------------------------
--No Consideration of the Borrower's Ability to Repay
CRL's language, which is once again adopted unquestioningly and
verbatim by the DoD report, asserts that ``payday lenders encourage
consumers to borrow the maximum allowed, regardless of their credit
history.'' The notion that payday lenders extend credit regardless of
the likelihood of repayment by borrowers is preposterous and reveals
the utter ignorance of the DoD Report's author regarding how the
industry operates.
Every payday lender employs a credit-scoring system to make credit
decisions regarding individual borrowers. Such systems are ubiquitous
in the consumer credit industry and are employed equally for credit
cards, car loans, store credit and mortgages; the models vary from
lender to lender and by type of loan. The largest and most
sophisticated payday lenders employ computer-based models that are
tested against large databases of actual experience and that are
continually refined over time. Smaller lenders often use paper-based
``check the box'' systems to ensure that borrowers meet their credit
criteria. The systems take into account such factors as whether the
borrower has a telephone at his residence, whether he has a steady
source of income, his prior credit history with the lender and others,
and his legal ability to contract. The factors vary by lender.
All of these systems have one goal, and one goal only: to screen
out borrowers who are unlikely to repay their payday loans.
Lenders make money only if borrowers pay them; if they do not
repay, lenders go out of business. It is beyond silly to suggest that
lenders are unconcerned about the possibility that a borrower will
default.
--Deferred Check Mechanism
A universal feature of a payday loan is that the borrower gives the
lender a check or other authorization to debit the borrower's checking
account on the maturity date of the loan. If the borrower has not
prepaid the loan in cash or otherwise, on the maturity date, the lender
deposits the check. If the check is returned unpaid, the borrower may
be subjected to a service charge by his bank because the borrower
failed to arrange to have sufficient funds in his checking account at
loan maturity.
Once again, the DoD Report fails to explain how it could be
predatory from the standpoint of the lender when a third party charges
the borrower for returning a check unpaid. The lender does not control
such charges and is a stranger to the relationship between the borrower
and his depository bank. The borrower, but not the lender, had the
power to avoid the charge by assuring that adequate funds were in the
borrower's account.
Automatic charges to the borrower's checking account are a routine
feature of many ``mainstream'' forms of consumer credit. The DoD does
not suggest how a lender's right to initiate such charges, standing
alone, is ``unfair'' or ``abusive.''
The DoD Report also improperly suggests that a borrower ``may fear
criminal prosecution'' for such returned checks. Any such fears are
unfounded. CFSA, through its Best Practices (supra, fn. 22), forbids
its members from threatening or pursuing criminal action against a
borrower as a result of the borrower's check being returned unpaid.
This proscription is codified in most of the state laws that permit
payday lending.\24\
---------------------------------------------------------------------------
\24\ See, e.g., Cal. Fin. Code Sec. Sec. 23035(c)(3) and (d)(1).
---------------------------------------------------------------------------
--Mandatory Arbitration Clauses
Many consumer and non-consumer contracts contain arbitration
clauses. Parties to arbitration clauses do not waive their substantive
rights or, as the DoD Report erroneously states, eliminate the
borrower's right to sue for abusive lending practices.\25\ Congress
enacted the Federal Arbitration Act to promote the expeditious and
inexpensive resolution of both contractual disputes and statutory
claims. Longstanding federal public policy strongly supports
arbitration of disputes. As the U.S. Supreme Court has held:
---------------------------------------------------------------------------
\25\ The DoD Report incorrectly states (at p. 21) that the Federal
Arbitration Act ``eliminates the borrowers' opportunity to obtain legal
recourse'' and improperly suggests that arbitrators ``paid for by the
lender'' will be biased in favor of the lender. These statements are
patently false.
By agreeing to arbitrate a statutory claim, a party does not
forgo the substantive rights afforded by the statute; it only
submits to their resolution in an arbitral, rather than a
judicial, forum. It trades the procedures and opportunity for
review of the courtroom for the simplicity, informality, and
expedition of arbitration.\26\
---------------------------------------------------------------------------
\26\ Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473
U.S. 614, 629, 105 S.Ct. 3345, 87 L.Ed.2d 444 (1985).
Arbitration permits the vindication of consumer claims for abusive
and other improper lending practices. An analysis of actual awards and
results suggests that consumers fare better in arbitration than in the
judicial system and are satisfied with the results.\27\
---------------------------------------------------------------------------
\27\ Michael T. Burr, The Truth About ADR, 14 Corporate Legal Times
44, 45 (2004); Ernst & Young, Outcomes of Arbitration--An Empirical
Study of Consumer Lending Cases (2004), http://www.adrforum.com/
rcontrol/documents/ResearchStudiesAndStatistics/2005ErnstAndYoung.pdf
(visited August 29, 2006).
---------------------------------------------------------------------------
The DoD Report's statements regarding arbitration are simply
unfounded.
II. The DoD Report Fails to Demonstrate the Existence of a Problem
Warranting Legislative Action
The DoD Report presents what is at best a confused, inconsistent
and anecdotal picture regarding the prevalence of payday-loan use among
service members. It is impossible to draw any conclusion from the
report regarding (a) what percentage of military borrowers have
experienced extreme financial difficulties while having payday loans
outstanding, or (b) whether, and in what percentage of cases, payday
loans were themselves a material factor in causing or contributing to
the financial difficulties. Without such information, Congress cannot
make an informed decision regarding the legislative action, if any, to
be taken. It may indeed be the case that some change is warranted, but
it is impossible to draw any conclusions from the haphazard
presentation of data contained in the DoD Report.
--No Meaningful Percentage of Service Members Appear to be ``In
Trouble'' with Payday Loans
The author's methodology in drafting the DoD Report is highly
problematic. Although a quantitative survey of military personnel was
undertaken to determine what actual percentage of service members make
use of payday loans, that study was not used as a vehicle to determine
how such loans have contributed to (or deterred) the service members'
economic welfare. Instead, the Defense Department now discredits its
own survey and substitutes, for quantitative data, a number of ``case
studies'' culled from reports by ``financial counselors and legal
assistance attorneys'' in instances where assistance had been rendered
to service members after ``being trapped in high interest loans.'' \28\
---------------------------------------------------------------------------
\28\ DoD Report at p. 39.
---------------------------------------------------------------------------
These ``case studies'' were not chosen at random from all
financial-assistance files.\29\ The ``case studies'' are not asserted
to be a representative cross-section of all military families, of all
military payday-loan users, or, indeed, of all users of military
financial counseling. Rather, they are the product of the author's
attempt to extract the most sympathetic (and possibly most egregious)
examples of personal financial mismanagement by service members and
then to hold them out as the ``evidence'' of the need for legislative
relief.
---------------------------------------------------------------------------
\29\ The DoD Report does not disclose how the ``financial
counselors and legal assistance attorneys'' were instructed to select
the ``case studies.''
---------------------------------------------------------------------------
It is impossible to determine the prevalence of personal financial
problems from the anecdotes presented in the DoD Report. Assuming, in
the light most favorable to the DoD Report's author, that the 3,393
``case studies'' are drawn only from a single short time period, they
represent a mere 0.2% of the 1,379,879 active duty personnel; \30\ if
the ``case studies'' were collected over a longer period, possibly of
years--during which the armed forces experienced considerable
turnover--then the incidence of such ``cases'' is much lower than 0.2%.
The DoD Report simply does not disclose enough information to be able
to fix the proper denominator.
---------------------------------------------------------------------------
\30\ Department of Defense, Directorate for Information Operations
and Reports (2006). Military Personnel Statistics. http://
www.dior.whs.mil/mmid/military/rg0601.pdf (visited August 30, 2006).
---------------------------------------------------------------------------
The ``case studies'' were distilled into 17 anecdotes in the DoD
Report. A mere 12 of these anecdotes involved payday loans.\31\ Twelve
anecdotes should not be deemed sufficient evidence to warrant
extraordinary legislative action.
---------------------------------------------------------------------------
\31\ DoD Report at pp. 39-42.
---------------------------------------------------------------------------
The best evidence of the absence of a ``problem'' is contained in
other, inconsistent aspects of the DoD Report itself:
First, according to the Defense Department's own data, only 5% of
service members use payday loans at all.\32\
---------------------------------------------------------------------------
\32\ DoD Report at p. 13. The author of the DoD Report insists that
his own data must be incorrect because such data are is inconsistent
with a study by the Consumer Credit Research Foundation (fn. 18, supra)
that found the incidence of payday-loan use by enlisted military
personnel at 13%. But the Foundation only surveyed personnel who live
on and in the immediate vicinity of military bases in the continental
United States; if deployed and otherwise stationed personnel --who
generally will not have access to payday loans at retail locations--
were included in the denominator, the result would likely be much lower
and consistent with the DoD Report's 5% figure.
---------------------------------------------------------------------------
Second, the DoD Report states that ``payday loans carry very low
risk of loss''; \33\ in other words, the default rate--the best proxy
for the rate at which payday-loan borrowers ``get in trouble''--is low.
CRL claims the default rate to be 6%.\34\ Assuming this rate to be
accurate, or even in the ballpark, the percentage of all service
members who ``get into trouble'' while having payday loans outstanding
is about 6% of 5%, or 0.3%. In other words, 99.7% of service members
either do not use payday loans or are unaffected by ``troubled'' payday
loans.
---------------------------------------------------------------------------
\33\ Id.
\34\ Center for Responsible Lending, Fact v. Fiction: The Truth
about Payday Lending Industry Claims. http://
www.responsiblelending.org/issues/payday/briefs/
page.jsp?itemID=29557872 (visited August 30, 2006).
---------------------------------------------------------------------------
Finally, the DoD Report itself suggests that the ``problem,'' if
one exists at all, is diminishing substantially without legislative
action--a 20% decline from 2004 to 2006--through, among other things,
education and command attention.\35\
---------------------------------------------------------------------------
\35\ DoD Report at pp. 37-38.
---------------------------------------------------------------------------
A problem which is not experienced by 99.7% of all service members,
and where usage is declining to immaterial levels, cannot be said to be
worthy of immediate legislative action.
--There Is No Evidence That Payday Loans Cause Financial Hardship or
Affect Military Readiness
As noted above, in a very small percentage of cases--0.3% of all
service members--there is a default or ``trouble'' with a payday loan.
The data do not show whether payday loans caused the service
members' financial difficulty, or whether--as is far more likely--the
payday loan was merely an unsuccessful attempt to find a solution to a
preexisting financial problem.
The 12 anecdotes presented in the DoD Report involving payday loans
fail to present, in a balanced way, the totality of the financial
circumstances of the borrowers. It is impossible to determine from
those anecdotes how the service members fell on hard times, whether
they sought payday loans before or after experiencing other financial
reversals, the other obligations they had outstanding, and why they
were ultimately unable to repay their debts.
The author of the DoD Report wishes readers to believe that payday
loans were the cause of the service members' difficulties in those
cases where the service members (a) had outstanding payday loans, and
(b) experienced financial difficulties. In other words, he concludes
that the mere coincidence of payday loans and financial difficulties
means that payday loans must be the cause of the financial
difficulties. This post hoc, ergo propter hoc reasoning--that
correlation is causation--is a tempting logical fallacy for an author
whose conclusion had been reached before the research began.
Such an explanation is not supported by DoD Report's data and, more
importantly, is inconsistent with what is known generally about how
consumers behave with payday-loan borrowings. Although the vast
majority of payday-loan borrowers use such credit responsibly, for its
intended short-term purpose and under circumstances where repayment is
likely, a small minority of borrowers seek payday loans when they are
already in serious financial difficulty and when their repayment
prospects are poor. Such borrowers may hold a good-faith expectation
that their circumstances will improve if they can temporize, or they
may simply seek to postpone the day of reckoning. Either way, this
small minority of borrowers is generally operating under an enormous
debt load before incurring payday-loan debt. Often, the debts have been
caused by circumstances beyond the borrower's control, such as
unforeseen medical expenses (medical expenses are a factor in
approximately half of all personal bankruptcies, even among fully
insured debtors \36\). In such circumstances, a payday loan will have
postponed, but ultimately made little difference to, the debtor's
financial failure.
---------------------------------------------------------------------------
\36\ See, generally, ``MarketWatch: Illness And Injury As
Contributors To Bankruptcy,'' Health Affairs (February 2, 2005)
(available at http://content.healthaffairs.org/cgi/content/full/
hlthaff.w5.63/DC1 [visited August 31, 2006]).
---------------------------------------------------------------------------
This analysis is borne out by a random sample conducted by CFSA of
service members' bankruptcy petitions in cases where payday loans were
discharged, which provide the details of their debts on a creditor-by-
creditor basis.\37\ Payday-loan debt comprises less than 4% of such
bankrupt service members' total liabilities. Perhaps more interesting
is that none of such petitions reveals either a judgment or garnishment
for payday-loan debt, while such judgments and garnishments for other
debts were commonplace.
---------------------------------------------------------------------------
\37\ Details available on request.
---------------------------------------------------------------------------
It is likewise difficult, because of the lack quantitative data, to
accept at face value the DoD Report's implicit (and unexamined and
unexplained) conclusion that high-interest-rate lending, without more,
adversely affects military readiness. While being ``in financial
trouble'' may result in loss of a security clearance, there is no
logical causation chain that connects merely having access to payday
loans to being ``in trouble.'' As noted above, the vast majority of
payday-loan borrowers repay their loans without ``trouble.'' To the
extent that these borrowers are ``in trouble,'' the data available show
that they were universally ``in trouble'' before obtaining payday-loan
credit. In the vast majority of cases, payday loans are a solution to a
problem, not the problem--and there is no objective evidence to the
contrary.
Finally, if it is assumed--as CRL posits--that some military
borrowers make use of multiple payday loans, the total amount they pay
in interest is extremely unlikely, without more, to give rise to a
``readiness'' problem. A borrower with ten loans over a two-year period
who pays $600 in interest will have paid less in payday-loan interest
than the cost of a twice-weekly cup of coffee from Starbucks.
In summary, the DoD Report fails to set forth any evidence from
which Congress may logically conclude that payday loans cause or
contribute to financial difficulties for service members. To the
contrary, the data suggest that the vast majority of borrowers repay
their payday loans without difficulty, as intended, and use them as the
short-term ``bridge'' for which they are designed.
--Alleged ``Targeting'' of Military Customers is Not Meaningful to this
Analysis
The DoD Report cites at length a study (Graves and Peterson, 2005)
\38\ purporting to show that payday lenders concentrate their retail
locations near military institutions in order to ``target'' potential
military borrowers. Even assuming the correctness of this analysis,
such putative ``targeting'' is irrelevant if (a) payday loans are not
``predatory'' (within the meaning of the 2006 Act), or (b) payday loans
do not materially cause or contribute to a decrease in economic welfare
for borrowers. As noted above, the DoD Report sheds heat, but no light,
on these matters.
---------------------------------------------------------------------------
\38\ ``Predatory Lending and the Military: The Law and Geography of
`Payday' Loans in Military Towns.'' 66 Oh. St. Law Rev. 653 (2005).
---------------------------------------------------------------------------
Moreover, even if the concentration data are credited, there are
innocent as well as sinister explanations for such concentration. For
example, areas around military bases universally contain large numbers
of support businesses, the employees of which are often more squarely
within the demographic profile of payday-loan users than service
members themselves.
Graves and Peterson also assume that demographics alone explain
retailers' store- location decisions. They do not consider, and thus do
not include in their analysis, other factors that may explain these
decisions. For example, rental costs, payroll costs, zoning regulations
and proximity to other retail outlets (``agglomeration effects,'' in
economic terms) are all factors in store-location strategy.\39\
---------------------------------------------------------------------------
\39\ Graves and Peterson's study does not follow customary social
science protocols by controlling for, for example, characteristics of
the nearby non-military populations such as income, unemployment, home
ownership and education levels. Their paper implicitly assumes that all
those characteristics are distributed equally across each state, and
that military bases are placed in random locations. Graves and Peterson
calculate the ``predicted'' number of payday lenders by calculating a
statewide number of payday outlets per person and multiplying that
number by the population in the military installation's ZIP Code. Their
theory assumes, effectively, that Detroit and Grosse Point should have
the same number of payday lenders per person. They fail to provide t-
statistics from which a reader can determine whether the difference
between the ``predicted'' and ``actual'' number of lenders is
statistically significant. For these reasons, the study cannot be
accorded any scientific weight.
---------------------------------------------------------------------------
The ``targeting'' argument also defies common sense. Military
customers account for a very small percentage of all users of payday
loans.\40\ It is illogical that payday-loan companies would devote
disproportionate resources to marketing to such a small percentage of
their customer base.
---------------------------------------------------------------------------
\40\ Letter from Penn, Schoen & Berland Associates, Inc., Results
of Poll Determination Payday Loan Usage Among Active Duty Members of
the US Military (January 2005), available at http://www.cfsa.net/genfo/
Military-Polling-Results-Memo.pdf (visited September 5, 2006).
---------------------------------------------------------------------------
Finally, the unspoken message of both the DoD Report and of Graves
and Peterson is that it is somehow wrongful for businesses to address
their services directly to groups of their potential customers. Yet
military borrowers have legitimate needs for short-term credit, based
on their age, their stage in the economic lifecycle and the high value
to them of immediate consumption of certain kinds of goods and
services:
While military compensation tends to be stable, the household
cash expenditures of military enlisted personnel can be
irregular because of features of the military lifestyle and
rules governing service. Enlisted personnel, because of their
young age, general standard of living and historical low
incomes, are not likely to have amassed significant
precautionary savings to address these issues. However, they
are able to smooth these irregularities in cash outflows by
taking on debt, and they can repay that indebtedness through
their stable incomes.
Because of their youth, military enlisted personnel tend to
be at the stage in life where the acquisition of durable goods
can provide a stream of perceived economic benefits that
substantially exceeds the cost of consumer credit.\41\
\41\ William O. Brown, Jr. and Charles B. Cushman, Compensation and
Short-Term
Credit Needs of U.S. Military Enlisted Personnel (2006).
http://www.consumercreditresearchfoundation.org/_files/
060427MilitaryCredit.pdf (visited August 31, 2006).
In the final analysis, however, there is simply no analog for
Graves and Peterson's ``targeting'' analysis in any other field of
endeavor. Public policy regarding the services offered by fast-food
stores, convenience stores, gasoline stations, supermarkets, liquor
stores or casinos is not derived from studies of the concentration of
their outlets around military bases. Rather, an objective and
quantitative determination must be made regarding the nature of the
services offered and their value to society. The DoD Study fails to
provide a scientific and factual basis for such a determination.
III. The DoD Report's Conclusions Are Not Supported by Economic Theory
or Sound Public Policy
The DoD Report fails to provide quantitative and scientific
evidence to demonstrate the existence of a ``problem'' requiring a
legislative solution. But even if the DoD Report's deeply flawed
analysis were credited, the principal recommendations of its author
find little theoretical support in economic literature or public
policy. Although apparently well intentioned, implementation of the
author's recommendations will not provide a meaningful benefit to
service members and will materially diminish the economic choices
available to military personnel, while creating unintended consequences
and problems. These recommendations should therefore be rejected.
--36% APR Ceiling
The DoD Report's principal and most dramatic recommendation is a
36% across-the-board federal interest-rate ceiling on all lending to
military borrowers. If this interest rate were to be applied to payday
lending, it would fix the consumer price below the lenders' marginal
costs and well below the lenders' average costs (Flannery and Samolyk,
2005, fn. 9). The practical effect of such a rate cap would be to
eliminate the legitimate market for such lending altogether.
The economic effects of price controls of any kind are notorious.
While affordability and consumer protection are generally cited as the
goals of price ceilings, price controls invariably become a wealth-
redistribution mechanism. This mechanism evolves into a system of
implicit subsidies, under which some rates are maintained at levels
that are artificially high so that others can be restrained. Usury
ceilings erode service quality, as lenders reduce the expenses of their
operations and weed out all but the most creditworthy borrowers;
pricing to the most desirable customers is invariably increased so that
the least desirable customers can be subsidized, if they are served at
all. The distortion of market forces that occurs with rate caps will
deprive the most desperate of borrowers of the opportunity to borrow
from legitimate, regulated lenders and instead compel marginal
borrowers to deal with lenders who are willing to lend illegally\42\
and who, more likely than not, will pursue just as illegal collection
practices when the loans come due.
---------------------------------------------------------------------------
\42\ Rationing and under-the-table payments are common results of
statutory price ceilings. ``Loan sharking'' is the most prevalent
result of artificially low usury ceilings.
---------------------------------------------------------------------------
The DoD Report assumes, without any theoretical or practical
foundation, that: (a) payday loans will continue to be available in a
legitimate market, even if rates are fixed below lenders' costs; or (b)
if such loans are unavailable, borrowers will behave in a manner deemed
more ``responsible'' financially.
History teaches that Congress has vast powers, but it cannot
suspend the laws of economics; needy borrowers will obtain the credit
that they need, even if they can only do so illegally.
The effect of a legitimate and regulated market for payday loans
has been salutary. As noted above, CRL claims that at least 94% of
payday-loan borrowers repay their loans without default; approximately
99.7% of all service members appear to be unaffected by payday-loan
defaults. There is no meaningful black market for military credit, so
that the opportunities for a wide range of criminal behaviors simply do
not exist--yet.
Consumer credit experts, even those who favor usury ceilings,
recognize the bluntness of usury as a tool for regulating consumer
credit policy.\43\ Other tools, while less direct, may have a consumer-
friendly effect while allowing the market itself to create the proper
pricing. For example, liberalized bankruptcy exemptions and
restrictions on creditor remedies (such as on garnishment and
collection) force lenders to internalize the costs of improvident
credit decisions while not restraining prices artificially. Likewise,
as the DoD Report recommends, enhanced disclosures may be useful to
promote informed shopping and to eliminate the effects of unintended
transactions. Finally, there are a variety of approaches that are
gaining popularity in Europe but have not been attempted in the United
States, such as requiring lenders to give advice regarding appropriate
forms of credit and so-called ``responsible lending'' rules.\44\ (The
CFSA Best Practices, fn. 22, are a form of ``responsible lending''
principles.) There is thus sound scholarly support for the notion that
usury regulations should be the last resort, not the first, in
regulating credit markets. Evidence of need for such crude re-
regulation is simply absent from the DoD Report.
---------------------------------------------------------------------------
\43\ Steven M. Crafton, An Empirical Test of the Effect of Usury
Laws, 23 J.L. & Econ. 135, 145 (1980); James E. McNulty, A
Reexamination of the Problem of State Usury Ceilings: The Impact in the
Mortgage Market, 20 Q. Rev. Econ. & Bus. 16, 26-27 (1980); Loretta J.
Mester, Why Are Credit Card Rates Sticky?, 4 Econ. Theory 505, 505, 521
(1994); Usury Laws: The Bad Side of Town, Economist, Nov. 28, 1998, at
30.
\44\ See, e.g., Commission of the European Communities, Proposed
Directive on Consumer Credit Agreements (2005), available at http://
ec.europa.eu/consumers/con_int/fina_serv/cons_directive/
2ndproposal_en.pdf (visited August 31, 2006).
---------------------------------------------------------------------------
The DoD Report proposes to reverse years of enlightened
deregulation of credit markets. This deregulation has resulted in
unprecedented access to credit for low-income borrowers.\45\ Moreover,
deregulation has caused the average cost of credit to existing
borrowers todecline.\ 46\
---------------------------------------------------------------------------
\45\ See, generally, Baxter, W.F., ``Section 85 of the National
Bank Act and Consumer Welfare,'' 1995 Utah L. Rev. 1009, 1023:
``Finally, notwithstanding the familiar populist politics of usury
laws, the greatest gains from federal preemption are likely to accrue
to the least well-off consumers in society. Regulatory restrictions in
credit markets hurt highest-risk borrowers the most. Based on a review
of the empirical literature estimating the impact of restrictive
interest rate ceilings before Marquette, one study concludes that
`lower-income families and families headed by younger persons would
seem to be among those most likely to be denied credit as a result of
such [interest rate] ceilings.' [footnote omitted] In credit card
markets in particular, both the Credit Research Center survey data and
a New York State study echo this result. These studies indicate that
pre-Marquette rate ceilings affected the probability that a low-income
or lower-middle-income family would hold a credit card but did not
affect the probability of cardholding for higher-income families.''
\ 46\ Id. at 1022.
---------------------------------------------------------------------------
Service members obviously appreciate the convenience and ease of
obtaining a payday loan; 78% of service members agree that ``most
people benefit from the use of credit.'' \ 47\ Other authorities are in
accord.\48\
---------------------------------------------------------------------------
\ 47\ DoD Report at p. 44.
\ 48\ ``Payday lenders have grown dramatically in the past few
years precisely because they are meeting both a need and a service
banks and credit unions have failed to provide--convenient, small loans
on a short-term basis . . . Payday lenders are fast, friendly and have
convenient hours; they are open until 6 p.m. and on Saturdays . . .
They have a good business model; they fill a need and provide a service
that people want.'' National Association of Community Credit Unions,
Credit Union Alternatives to Payday Lending (January 2006), available
at
http://www.naccu.coop/white_papers.html (visited August 29, 2006).
---------------------------------------------------------------------------
The state legislatures of 37 states have performed this calculus
and reached conclusions that are directly contrary to those of the
author of the DoD Report. Recognizing that it is better to have a
robust and competitive but regulated market for the kinds of credit
that borrowers actually demand, these states have, after careful study,
both enabled such lending and set interest-rate ceilings at levels that
exceed lenders' costs. The DoD Report discounts the decisions of these
state legislatures entirely.
Throughout, the DoD Report notes that many borrowers turn to payday
lending because they already have bad credit. The DoD Report's
``solution'' is to eliminate a borrowing option when the damage (i.e.,
bad credit) has already been done. The most appropriate and effective
policy response would be one that addresses the root cause, not one
that eliminates a possible, albeit temporary, solution. Education and
the fostering of sound personal finances would create more financial
options for households than any other solution.
The DoD Report gives no attention to the possible harm caused by
eliminating lawful access to payday-loan credit for the 99.7% of
service members who either do not payday loans at all, or who use them
responsibly and for their intended purpose. Further study of this issue
is warranted prior to material legislative change.
--Ability to Repay
As noted above, the DoD Report discusses the extension of credit
without regard to ability to repay. Payday lenders never extend credit
without consideration of the borrower's ability to repay. An essential
feature of any positive credit decision is that the borrower has a
steady source of income, and that income can be used to make loan
payments. This is the same criterion that is employed by providers of
both secured and unsecured credit of virtually every kind (with the
possible exception of pawn lending).
The overarching unique feature of a payday loan is that the
borrower provides the lender with a check for the aggregate of the loan
principal and finance charge at the inception of the relationship; the
lender knows that the check is likely to be honored because the
borrower's checking account is periodically replenished by the
borrower's employer. It is this very check that provides the lender
with the borrower's assurance of repayment. The DoD Report stands logic
on its head by recommending that this check be dispensed with, thereby
eliminating the lender's assurance of the borrower's ability to repay.
If taking the borrower's check were proscribed, a payday loan would
have very different economic characteristics, because the lender's
collection costs and overall credit experience would be dramatically
and adversely affected. Elimination of the check would drive lenders'
costs up to the point were it would no longer be economic to extend
credit at current market rates; such credit would be unthinkable at the
proposed ceiling rates.
--Arbitration
The DoD Report recommends that arbitration clauses in loan
contracts with military borrowers be forbidden. As noted earlier in
this letter, there is no evidence of a ``problem'' to which this
``solution'' purports to be responsive. Overall complaint rates to
regulators regarding payday loans are extremely low: on the order of
magnitude of one complaint per million loans. Other than litigation
involving the now-defunct ``bank model,'' there have been only a
handful of reported cases relating to the payday-loan industry.
As noted above, agreeing to arbitration does not amount to the
waiver of any substantive rights. By agreeing to arbitrate, a consumer
submits his claims to an impartial tribunal that is authorized to award
any remedy that a court might award, including injunctive relief,
attorneys' fees and costs. Arbitration is more expeditious and less
expensive than litigation and produces results with which consumers are
nearly universally satisfied.
This recommendation is inconsistent with federal public policy that
encourages non-judicial resolution of disputes and should be rejected.
--Other Recommendations
CFSA takes no position regarding the remaining recommendations of
the DoD Report.
Although the report makes the uncontroversial suggestion that
uniform cost-of-credit disclosures be given to military borrowers, in
fact such disclosures are already being made to all payday-loan
borrowers because they are required under the Truth in Lending Act, 15
U.S.C. Sec. 1601 et seq., and the Federal Reserve Board's implementing
Regulation Z, 12 C.F.R. Part 226. The requirement for such disclosures
is likewise incorporated in many of the state-law provisions that
enable payday lending. It is unclear whether this recommendation is
intended to remedy a perceived deficiency in payday lending or in some
other form of credit.
The report also makes the recommendation that lenders be precluded
from contracting for waivers of the protections provided by the
Servicemembers' Civil Relief Act.\49\ Such waivers are unenforceable in
any event, and it is once again not clear what wrong is sought to be
remedied by the author's recommendation.
---------------------------------------------------------------------------
\49\ This law protects not only those on active duty but also
Reservists and activated members of the National Guard. 50 U.S.C. App.
Sec. 501 et seq. The U.S. Supreme Court has said that the predecessor
statute should be read ``with an eye friendly to those who dropped
their affairs to answer their country's call,'' Le Maistre v. Leffers,
333 U.S. 1, 6 (1948), and its provisions are generally considered to be
non-waivable.
---------------------------------------------------------------------------
Conclusion
The DoD Report is biased, unscientific and fails to follow the
routine social-science protocols that enable policy makers to reach
informed decisions regarding consumer-credit law. The report makes
recommendations that are unsound from a policy standpoint, and those
recommendations are intended to address problems that have not been
proven to exist with any demonstrated rate of incidence. The
overwhelming evidence is that payday loans are employed by borrowers
for their intended short-term purpose, and nearly all borrowers repay
them as agreed, without financial distress.
The DoD Report should be rejected in its entirety.
______
PREPARED STATEMENT OF CHRISTOPHER L. PETERSON
Assistant Professor of Law, Levin College of Law, University of Florida
September 14, 2006
It is an honor to appear today before this Committee. Thank you for
the opportunity to share some thoughts on predatory lending practices
directed at military personnel and their dependents. My name is
Christopher Peterson and I am a law professor at the University of
Florida where I teach commercial law and consumer law classes. I
commend you, Mr. Chairman, Senator Sarbanes, and other members of the
Committee for organizing these hearings and for providing an
opportunity to discuss this important and timely national issue.
As you know, the Department of Defense recently released a large
report on predatory lending to military personnel. I have been asked to
share my reactions to this report. In short, I believe that deceptive
and onerous credit is a significant problem for both the military and
for many middle and lower income Americans. The Department of Defense's
report does an excellent job of compiling the various predatory lending
threats to its personnel and in recommending an appropriate policy
response. In this testimony, I will briefly discuss some historical,
economic, geographic, and legal considerations which may be of
assistance to you in deliberating on the meaning and significance of
this report.
Military Personnel Have Historically Been Vulnerable to Oppressive
Credit
Predatory lending is not a new phenomenon either in American or
world history. Since humanity's earliest recorded history, some
creditors have always been willing to take advantage of desperate,
incautious, or naive borrowers by making loans with ruinous interest
rates and remedies. While today's borrowers wonder whether they will
have sufficient funds in their account to cover a check post-dated two
weeks in advance, ancient debtors dreaded ``the end of the moon'' when
their high cost loans came due.
Moreover, government and religious leaders of virtually all complex
civilizations have tried to limit the harsh consequences these
contracts can have both for borrowers and for their communities and
institutions. It is no coincidence that humanity's very first recorded
comprehensive legal system, the Code of Hammurabi (c.1750 B.C.E.),
includes aggressive consumer protection rules. According to legend, the
Babylonian Emperor Hammurabi ascended a mountain where Shamash, the
Babylonian God of Justice gave him a comprehensive code which was used
to govern that civilization for over a thousand years. Included in the
statute was a usury law that limited interest rates to 20% per annum
for loans of silver and 33% on loans of grain. The text of the code
bears a remarkable similarity to interest rate caps adopted thousands
of years later, including the interest rate cap purporting to limit
interest rates to 18%, which is still in the State code in my home
state of Florida. Ironically, the loans offered by companies that
surround virtually all of our military bases would have been illegal in
ancient Babylon.
History books are full of evidence suggesting military personnel
have tended to be especially vulnerable to oppressive moneylenders. For
example, violent riots broke out in the early Roman Republic (before
they adopted a usury law) when the public learned of an oppressive
credit contract between a military veteran and a money lender. When the
veteran was unable to pay his debt the moneylender took his farm and
imprisoned him. The resulting riots, usually called the ``First
Secession'' by Roman historians, threatened to undermine the entire
emerging Roman Republic. Public resentment of oppressive credit
contracts was stabilized when the government adopted an interest rate
cap in the twelve tables, a law which served as the foundation of Roman
law and still influences civil legal systems in Europe and the state of
Louisiana. Throughout most of the Roman Empire and eventually the
Byzantine Empire, the government capped interest rates at 12% per
annum.
All throughout our national history--with the exception of the past
decade or two--we have attempted to protect military and non-military
borrowers alike with usury laws. The founding fathers brought over
English interest rate caps when they arrived in America. When the U.S.
Constitution was ratified, low usury ceilings and a frontier thrift
ethic were nearly universally agreed upon by America's first leaders.
It is extraordinarily unlikely that George Washington, Thomas
Jefferson, or Alexander Hamilton would have tolerated 500 percent
interest rate loans to members of the Continental army. Certainly
Benjamin Franklin, who frequently wrote on the subject and was a strong
proponent of usury law, would have been outraged at today's military
loans.\1\
---------------------------------------------------------------------------
\ 1.\ ``For example, Franklin once wrote: Think what you do when
you run in Debt; You give to another Power over your Liberty. If you
cannot pay at the Time, you will be ashamed to see your Creditor; you
will be in Fear when you speak to him; you will make poor pitiful
sneaking Excuses, and by Degrees come to lose your Veracity, and sink
into base downright lying; for, as Poor Richard says, The second Vice
is Lying, the first is running in Debt. . . . Poverty often deprives a
Man of all Spirit and Virtue: Tis hard for an empty Bag to stand
upright . . . . The Borrower is a Slave to the Lender, and the Debtor
to the Creditor, disdain the Chain, preserve your Freedom; and maintain
your independency: Be industrious and free; be frugal and free.'' David
M. Tucker, the Decline of Thrift in America: Our Cultural Shift From
Saving to Spending 9-10 (1991); 7 The Papers of Benjamin Franklin 342-
49 (Leonard W. Labaree ed., 1963).
---------------------------------------------------------------------------
During America's rise to international power in the twentieth
century federal and state governments relied on usury laws to deter,
educate, and exercise symbolic moral leadership on predatory lending.
During the years when so-called ``greatest generation'' governed our
country, very few states or leaders were willing to depart from our
traditional usury laws. Our military, along with our allies (all of
which, incidentally, did not tolerate predatory lending to their troops
either), managed to win the Second World War without the assistance of
triple digit interest rate loans in whatever form those loans might
take. In the economic boom years following the war, our country became
more comfortable with using credit to finance a middle class lifestyle.
But it was not until much later that loopholes in our law, including
the Supreme Court's historically dubious interpretation of the National
Bank Act, allowed lenders to begin marketing loans with terms that in
past generations would have been associated with illegal loansharks.
A long term historical perspective suggests that the Department of
Defense's recent report on predatory lending is actually quite
conservative in substance and modest in proposals. Any responsible look
at our national history reveals that at no other time would the
Pentagon have been forced to implore the Congress to protect its
personnel from triple digit interest rate loans. In every previous
American generation, the Department of Defense's substantive legal
recommendations would have been accepted with little or no debate.
The Department of Defense Report is Economically Sound
Free and competitive enterprise is one of the backbones of American
society. And, no institution is more responsible for preserving our
freedom to conduct business than the Department of Defense. However, I
would respectfully counsel the Senate to recall the great difference
between a competitive market and market anarchy.
In a competitive market, self-interested, autonomous commercial
behavior creates better policy outcomes than government intervention,
because each individual can be trusted to make their own resource
allocation decisions. As each individual makes decisions about where to
invest their time, services, and funds, competitive markets naturally
evolve into a result that is better than could have been achieved had
government intervened. Adam Smith famously compared this process of
individual, self-interested decision making to an ``invisible hand''
that guides social policy to the optimal outcome.
Unfortunately, sometimes the invisible hand alone does not work.
Responsible leaders uniformly agree that the government must intervene
in the market for some goods and services. We can all agree that the
U.S. government should ban free markets for weapons grade plutonium,
child pornography, or heroin. These products have characteristics
associated with them that make an unregulated market unacceptable. The
sale of plutonium to terrorists would likely impose the highest
externalities on those killed by a bomb made as a result of the
contract. We ban child pornography because contracts to purchase it
create an incentive to assault our children, and because we refuse to
recognize economic demand for that product as morally legitimate. We
ban the sale of heroin because buyers of this product tend to make non-
rational decisions by virtue of the product's addictive
characteristics. Our ancient (and only recently relaxed) laws against
predatory loans are evidence of analogous market imperfections
associated with credit contracts.
At least three market imperfections prevent the market for high
cost short term loans from resolving to an efficient equilibrium: (1)
imperfect information, (2) behavioral distortion, and (3)
externalities. First, consumers have great difficulty comparing the
prices of credit. Despite the best efforts of our educational system,
many people in our society still have (and likely will always have)
difficulty learning to read or make simple mathematical calculations.
The ``invisible hand'' cannot create efficient outcomes when individual
borrowers do not compare the price of a loan to its opportunity cost.
In markets that are targeted by predatory lenders, it is likely that a
large percent of the served population have little or no idea how to
compare credit prices. Moreover, because creditors can hide and obscure
those prices through inaccurate disclosure, hidden fees (including
contingent charges such as late fees, over-the-limit fees, attorney
fees, etc.), and worthless add-on products that even rational borrowers
will not attempt to shop, since doing so is likely to be an
unproductive use of time.\2\
---------------------------------------------------------------------------
\ 2.\ Although the government has attempted to assist in this
respect by passing the Truth in Lending Act, most people agree that
there are serious problems with this statute as it is currently
written. TILA disclosures are difficult to understand, come far too
late in negotiations (after a loan applicant has already decided to
borrow), and are riddled with exceptions that distort the usefulness of
disclosures. Moreover, inflation has outdated the dollar limits to the
scope of the statute and the remedial damage awards that deter non-
compliance. Besides, predatory lenders consistently disregard and
obscure TILA disclosure rules anyway. See generally Christopher L.
Peterson, Taming the Sharks: Towards a Cure for the High Cost Credit
Market (U. Akron Press, 20034)
---------------------------------------------------------------------------
Second, Consumers, including military personnel, do not always make
economically rational decisions. As the nobel prize winning research of
Daniel Kahneman and Vernon Smith demonstrates, people often fail to
match their estimation of the value of the a product to the utility
they actually receive from it. For example, consumers often
unreasonably discount the value of future income. Sometimes, for better
or worse, people want today, what they should wait for until tomorrow.
That is why it is difficult to save for retirement and it is one reason
why many people borrow more money than they should. Similarly,
consumers tend to overestimate their own ability to control financial
outcomes and underestimate factors outside their control, such as
unexpected car repairs, illness, payroll mistakes, job loss, etc. This
common tendency leads borrowers into believing they can quickly repay
high cost loans, when in reality, they cannot. Predatory lenders
understand how these behavioral distortions operate in the credit
market, and intentionally exploit them. This is why advertisements for
``fast cash'' or ``easy credit'' can tempt people, including soldiers,
sailors, airmen, and marines, into making unreasonable financial
decisions.
Third, predatory loans have significant costs--usually referred to
as externalities--born by those not privy to the contract. For example,
when a predatory loan does not only hurt the borrower, it can also lead
to deprivation of resources that would have otherwise gone to the
borrower's children or other dependents. Neighborhoods that host
predatory lenders often suffer from lower property values. Utilities,
hospitals, land lords, and mainstream financial service providers all
have greater difficulty obtaining timely payment from consumers who
become mired in high cost debt. Because they tend to be more aggressive
than other creditors, predatory lenders frequently skip to the head of
the line obtaining payment before others with less questionable debts.
The Department of Defense report should be seen as an emphatic
example of the externalities associated with predatory loans. Military
leaders are speaking out, explaining that predatory lending is eroding
the military readiness of our armed forces. Who better to know whether
this is true than the Pentagon along with the many generals, admirals,
and other officers who have spoken out on this issue? By trapping
military borrowers in high cost predatory loans, lenders are disrupting
the family lives and emotional well being of those who are protecting
us in a complex and dangerous world. The evidence cited by the Pentagon
on the thousands of service members who have suffered revoked security
clearances as a result of predatory lending should be seen as concrete,
unimpeachable evidence of a market distorting externatility associated
with high cost consumer loans.
The Department of Defense Report is Empirically Sound
A previous study conducted by Professor Stephen Graves, of
California State University, Northridge, and myself examined the
location patterns of one type of predatory lender in relation to
military installations around the country.\3\ In our study we examined
20 states, 1,516 counties, 13,253 ZIP codes, nearly 15,000 payday
lenders, and 109 military bases. We found high concentrations of
predatory lending businesses in counties, zip codes, and neighborhoods
in close proximity to military bases. Our study controlled our
observations by comparing the density of payday lender locations in
military areas to statewide averages and also by comparing payday
lender locations to bank locations. We could find no statistically
reasonable explanation for these location patterns except for the
presence of military personnel living on or in close proximity to
military bases.
---------------------------------------------------------------------------
\ 3\ Steven M. Graves & Christopher L. Peterson, Predatory Lending
and the Military: The Law and Geography of ``Payday'' Loans in Military
Towns, 66 Ohio St. L.J. 653-832 (2006).
---------------------------------------------------------------------------
This pattern existed in every state we looked at, except for New
York, which had consistently and aggressively enforced its 25 percent
per annum interest rate cap. Unlike every other major military
installation we studied, Ft. Drum (home to the Army's 10th Mountain
Division) in upstate New York was not surrounded by payday loan
outlets. While other credit options were available, including finance
companies, credit unions, banks, thrifts, and pawnshops, there was not
a large on the ground force of triple digit interest rate lenders
surrounding the base. In contrast, voluntary trade association
guidelines, or so-called ``best practices'' agreements, did not create
any demonstrable influence on the geographic patterns associated with
payday lenders and military installations. Similarly, a variety of
ancillary state consumer protection rules, such as rollover
limitations, internet databases, and licensing requirements, did not
deter payday lender clustering around military bases. We concluded that
usury laws--the time tested, conservative, historical American response
to predatory lending--appeared to be the best legal tool for addressing
concerns about predatory lending to military personnel.
The Department of Defense report further corroborates our findings.
It uses a variety of quantitative and qualitative data to establish the
existence of a significant predatory lending problem. The report makes
realistic estimates of the percent of service members using payday
loans. The report also accurately summarizes a variety of other
potentially predatory credit products used by military personnel. The
report accurately describes Department of Defense financial education
efforts, as well as the inherent limitations to this approach. The
report accurately summarizes the many better alternatives to predatory
loans available to military borrowers, and pragmatically explains that
these alternatives are not likely to prevent service members from
falling into predatory debt traps. The report persuasively presents
compelling qualitative narratives of service members and their families
who have suffered real personal, financial, emotional, and professional
lossses as a result of predatory lending. And the report compiles a
useful list of suggestions for policy reform--all of which would
meaningfully improve the lives of military service members.
In conclusion, I do have one reservation with the Department of
Defense report. I am afraid the comprehensive nature of the report
might be used as a tool to prevent immediate reform of credit laws.
While I believe comprehensive reform is necessary, reestablishing our
traditional, time-tested usury law should be a necessary first step on
the path to comprehensive reform. Accordingly, I strongly urge Congress
to take the opportunity presented by the Talent-Nelson amendment to
this year's defense authorization bill. This amendment reasonably re-
establishes a cap on allowable interest rates charged to military
personnel at a generous 36 percent per annum. Loans in excess of this
amount have proven historically dangerous, economically inefficient,
and geographically targeted at the military. For additional information
on these issues I invite the Committee members and their staff to
review my prior published writing.\4\
---------------------------------------------------------------------------
\ 4\ A bibliography of my research is available at http://
www.law.ufl.edu/faculty/peterson/..
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM ADM.
CHARLES S. ABBOT (RET.)
Q.1. While military relief societies seem to present a means to
help soldiers in financial distress, a recent Washington Post
article claimed that these societies have cumbersome procedures
and require referrals from a ranking officer prior to obtaining
financial assistance. Do these procedures create obstacles for
service members and if so, what can be done to reduce or
eliminate them?
A.1. The mission and charter of each service's Military Aide
Society (MAS) are designed to best support the requirements of
the service. Each provides a different level and variety of
services to their clients. All the MAS have an agreement that
allows them to provide assistance to service members and
families from the other military services.
The Navy-Marine Corps Relief Society was established in
1904 and has been dedicated to the financial health and welfare
of Sailors, Marines and families since. Though a private non-
profit, volunteer service organization, we work in partnership
with the Navy and Marine Corps to support the financial
readiness of the service member and family. With 53 full
service offices on Navy and Marine installations around the
world, we provide financial, educational and other assistance
to those in need. The majority of our assistance is provided
for basic living expenses, vehicle repair, and emergency
travel.
As a charity supported by the generosity of active duty and
retired Sailors and Marines, the Society has a responsibility
to provide assistance based on valid needs. In every case, we
require verification of eligibility, and in non-emergency cases
we verify financial need. Our caseworkers are well trained,
case management records are automated, and our procedures well
refined and efficient. We require no referral by the service
member's chain of command. Many of our clients are ``walk-ins''
at our offices. Every client's case is thoroughly reviewed by a
qualified caseworker.
We have a policy of confidentiality and do not involve the
clients command unless there is misconduct or criminal
activity. If a client's request is denied at the local level,
the client may decide to involve the command and request an
appeal from the Society's leadership.
I am proud to say that during our most recent (2006) client
satisfaction survey, the Society received a 98% satisfaction
rate.
------
RESPONSE TO WRITTEN QUESTION OF SENATOR SHELBY FROM WILLIAM O.
BROWN, Jr.
Q.1. You criticize the Department of Defense Report methodology
on several grounds. One of these grounds is that the Report
fails to show how payday loans cause financial problems, rather
than being a mere symptom of larger financial problems. Could
you explain this lack of causation argument?
A.1. The Department of Defense Report only provides anecdotes
of military members that had financial difficulties and
acquired payday loans. The Department of Defense does not
conduct a study of bankruptcy filings by military personnel in
order to determine if there is any systematic relationship
between payday lending and bankruptcy. The Report provides no
evidence that financial problems among military personnel are
caused by their usage of payday loans. Payday loans are small
denomination loans intended to solve short-term financial
problems and my research indicates that most members of the
military use them for that purpose. The rate of default on
payday loans is in the neighborhood of 5% indicating that few
individuals with payday loans have larger financial problems
that would prevent the repayment of the loans. Most individuals
that declare bankruptcy or experience severe financial problems
have a variety of financial problems caused by unexpected
negative life events or overspending. These problems are
usually far larger in scale than the amount borrowed through
payday lending. To the extent that those with severe financial
problems use payday loans, they already have these problems
when they obtain the payday loans and using them as a last
attempt to pay off other creditors.
------
RESPONSE TO WRITTEN QUESTION OF SENATOR CRAPO FROM WILLIAM O.
BROWN, Jr.
Q.1. What would be the potential unintended consequences of
price caps on individuals seeking access to the growing demand
for short-term, small denomination credit?
A.1. There was a study in 2005 by two economists at the FDIC
that found that the current price of payday loans just cover
the cost of providing this service. If prices are capped, then
the industry will no longer be able to profitably provide these
loans and legitimate providers will no longer offer them. There
is a demonstrated need for such products by military personnel.
These military personnel will no longer be able to use what
they consider as a valuable source of short-term credit and
will likely turn to alternative sources for their short term
borrowing needs. These may include legal lenders such as pawn
shops where borrowers risk forfeiting personal possessions or
credit cards where borrowers are more likely to carry an
ongoing credit balance. Some former payday loan customers will
almost certainly turn to lenders that are willing to violate
both the legal interest rate cap and legal collection practices
when dealing with borrowers. Studies indicate that countries
with more stringent interest rate caps on consumer loans have
larger and more active illegal lending markets. As a result,
the price caps may have the ultimate result of sending military
borrowers to legal credit products that are less well fit for
their needs or illegal credit products that come with much
higher costs than the existing legal products. A combined
program of encouraging more competition in the market for
short-term loan products and better education about financial
products among military personnel would be more beneficial than
the proposed interest rate caps.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM LYNN
DRYSDALE
Q.1. The Report discusses coercive actions that are often
employed by lenders to collect on debts, such as garnishment of
wages or attempting to collect when a customer has been
deployed. The Report also mentions that many loan contracts
require borrowers to waive their rights to legal action or any
special legal protections afforded to them. What evidence have
you seen of either coercive collections actions or mandatory
waivers of important legal rights?
A.1. In Florida payday lenders are called deferred presentment
providers. I see many varieties of coercive collection
practices and all lenders include clauses in their contracts
prohibiting consumers from filing lawsuits against the lenders
and cutting off other consumer rights. These contracts and
practices are particularly harmful in these high cost, short-
term loans because the loans are almost impossible to timely
pay and are deceptively marketed. I have seen coercive
collection techniques lead to the payment of payday loans
before other essential household bills exacerbating rather than
alleviating financial emergencies. Also, the coercion leads to
stress which affects individuals and their families.
Representative samples of coercive collection techniques
and mandatory waivers of important legal rights follow:
Mr. Hubbell and his wife are both service members.
Due to the costs of his wife's illness and her inability to
work, they took out a payday loan which eventually led to
thousands of dollars in outstanding loans from both payday
lenders and installment loan companies. Over a five year
period, the more they paid, the more they owed. They have
repaid tens of thousands of dollars and still owe over $12,000,
a monthly payday loan debt of just over $3,500. Most of the
repaid sums went to pay off other loans and provided no benefit
to the Hubbells except for digging them deeper into debt.
Mr. Hubbell is an air traffic controller. Therefore, he
felt he had no option but to stay on the debt treadmill because
of the fear created by threats of criminal prosecution and the
inevitable consequence of lenders' contacts to Mr. Hubbell's
command which would lead to loss of his security clearance and
his rank. Lenders were harassing him on base and at home. One
day a lender called him while on the ship, cussed at him and
threatened him. Mr. Hubbell told the collector to contact his
attorney. Twenty-five minutes later his superior officer called
and said the lender had called him twice in the short period of
time since he hung up from speaking with Mr. Hubbell. The
collector harassed the superior officer and demanded the name
and number of the base Commanding Officer.
Each of the lenders required either payment by allotment or
electronic assess to his bank account as additional security,
required him to allow them to debit his account more than once
in one day, and one required him to sign an illegal wage
assignment. See Exhibit ``A'' attached.
Each of the loan contracts contained a unilateral,
mandatory arbitration clause. The required arbitration was
expensive and prevented Mr. Hubbell from suing them for illegal
actions while the lenders retained the right to take money
directly from his account without prior notice.
Mr. Bartholomew borrowed from a sham lender who
pretended to provide ``rebates'' instead of loans when a person
purportedly purchased Internet access. The disguise was used so
the lender could hide criminally usurious loans, ignore the
Florida anti-rollover laws and ignore Mr. Bartholomew's right
to a grace period.
This lender required electronic access to his account as
additional security for his loan. When he was unable to keep up
with payments, the lender directly debited his account for more
than the amounts needed to pay off his loan. The lender also
harassed him on his ship and called his superior officers. He
was faced with not having enough money for groceries and rent
for his family, including three small children; they debited
his account multiple times in one day. When he closed the
account because the lender's actions rendered the account
overdrawn, the lender sent him a letter which was copied on to
the official letterhead from our local State Attorney's Office
threatening to put him in jail for failing to pay the loan.
Mr. Bartholomew's contract also contained a unilateral,
mandatory arbitration clause. The arbitration required was
expensive and attempted to prevent Mr. Bartholomew from suing
them for illegal actions while the lender retained the right to
take money directly from his account. The clause contained in
his contract also limited the remedies he could seek in
arbitration. See Exhibits ``B'' (Loan Document) and ``C''
(unauthorized letter using State Attorney letterhead) attached.
Mr. Wall had an installment loan through a
``military'' lender that required automatic access to his bank
account for electronic payment and required him to allow
multiple debits in one day for a single loan. When he did not
make a timely payment, the lender ``hit'' his bank account
eleven times in one day. The lender then charged him $525.00 in
late and bad check fees and his credit union charged him
$275.00 in NSF charges. See Exhibit ``D'' attached.
The lender also included provisions in his contract
preventing him from suing the lender for illegal actions and
requiring him to take all claims to an expensive arbitration
process in Delaware even though he was solicited and signed the
loan in Florida. Lastly, his contract contained the following
phrase: ``I understand that persuant (sic) to Art 134 and Art
123a of the Uniform Code of Military Justice that failure to
comply with the terms of this agreement may result in a maximum
penalty of a bad conduct discharge, 6 months confinement and
forfeiture (sic) of all pay and allowances.'' See Exhibit ``E''
attached.
Ms. Worrow obtained a loan from a ``military''
lender that was marketed online. The lender required her to pay
through a military allotment check. They threatened to contact
her Command if the allotment was redirected. This put Ms. W in
a bind because the costs were so high for the loan that the
allotment took away money she needed for food, transportation
to and from work and utilities. See Exhibit ``F'' attached.
Her lender also prevented her from suing them for illegal
practices and required her to sign a unilateral, mandatory
arbitration clause. Therefore, she could not sue them but they
could take money directly from her pay check or bank account.
Mr. K spent his entire day off going from payday
lender to payday lender to keep from having his checks bounce.
At one time, he was trying to juggle nine loans. Each time a
payday loan became due he felt compelled to take out another,
more expensive loan because the lenders were harassing him with
illegal threats of criminal prosecution. They also contacted
his superiors at work and required him to agree to automatic
withdrawal from his bank account.
Mr. G contacted me via email from an undisclosed
location at sea. He was worried about his wife and family
because of his outstanding payday loan debt. Due to threats she
had received, he was afraid that the payday lender would put
his wife in jail, leaving their two babies without a parent.
Ms. Griffin is a Navy wife who has a payday loan
with Advance America in Florida. In its contract, Advance
America claimed it was a member of the Community Financial
Services Association, a payday lender trade association. It
also claimed it followed the Best Practices of this association
published on its Web site such as promises to follow state law.
Florida law requires lenders to grant at least a 60-day grace
period with no additional fees, charges or costs if a borrower
seeks credit counseling and prohibits ``roll-overs.'' Instead
of providing the grace period, Advance America required her to
roll over her loan when she could not pay. When she went to pay
it off, she was $45 short, because of the ``roll over'' fee.
Advance America refused the grace period even after she
told them she already had the counseling at the Navy Marine
Corps Relief Society, an authorized State of Florida Deferred
Presentment Provider counseling agency. The director of NAS Jax
NMCRS, Ret. Capt. Dave Faraldo, called the lender only to be
told they did not have to talk to him and did not have to
provide the grace period. The Advance America employee added
she had been an employee trainer for eight years and they never
had to provide the grace period. When I contacted Advance
America as Ms. Griffin's attorney and provided a signed
release, the employee refused to speak to me about the legally-
required grace period on her account.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATORS SHELBY AND JOHNSON
FROM HILARY B. MILLER
Q.1. Although the Report acknowledges that many payday lenders
voluntarily adopt a set of best practices, it criticizes the
lack of a mechanism to monitor and enforce them. Is there more
the industry could be doing to make sure lenders are complying
with these best practices?
A.1. The industry's principal trade association, Community
Financial Services Association of America (``CFSA''), seeks to
enforce its Best Practices by causing them to be enacted into
positive state law and by assuring that state regulators have
appropriate information, authority and enforcement powers. To
date, CFSA member companies have dedicated millions of dollars
to this activity, and 37 states and the District of Columbia
have enacted laws that incorporate CFSA's Best Practices in
some part. Compliance with CFSA's Best Practices is also
mandatory for CFSA's members, and the association investigates
and takes appropriate enforcement steps with respect to
violations. Because of both the transparency and simplicity of
loan terms, consumers are highly unlikely to be misled by non-
compliant lenders. The industry continues to work with
legislators and regulators to assure consistent and, to the
greatest extent possible, uniform regulation of these loan
products.
Q.2. In your testimony you state that it is contrary to the
interests of the payday lending industry to have service
members get into trouble with their loans. But if borrowers can
not pay in full when the loan is due and choose to roll over
the current loan into another, larger loan, don't lenders
benefit from the additional fees that result? How frequently
are loans rolled over?
A.2. As noted in my prepared statement, a recent independent
study showed that 49% of military enlisted payday-loan
borrowers have used a payday loan no more than twice in the
last year, and 79% had had no more than four loans in the last
year.\1\ Of the 38 states that have permitted payday lending,
36 have strict statutory limitations on rollovers, and there is
an outright ban in 22 of those states. CFSA's Best Practices
ban rollovers unless they are allowed by state law, in which
case rollovers are limited to the lesser of four or the state-
law limit. While rollovers are frequently mentioned as an issue
with payday loans, the reality is that military borrowers very
rarely experience repayment problems with their loans and, as a
group, are in debt for much shorter periods than their civilian
counterparts. Payday lenders do not earn more in fees from a
loan rollover than from a new loan. While payday lenders charge
a fee for rollovers, every lender (including bank overdraft
lenders, as well as mortgage lenders, credit card lenders and
auto lenders) benefits to some extent when a borrower pays a
fee for the privilege of paying late. This is the inherent
nature of consumer lending, and it is not fundamentally
wrongful or misleading. Moreover, the consequences to a
borrower of not being able to extend--on a limited and
responsible basis--the maturity of a payday loan may often be
more costly to the borrower than the small extra fee for this
service; those consequences may include adverse credit-bureau
entries, bounced checks, overdraft fees, late-payment fees and
other vendor charges.
---------------------------------------------------------------------------
\1\ William O. Brown, Jr. and Charles B. Cushman, Payday Loan
Attitudes and Usage Among Enlisted Military Personnel (2006). Available
at http://www.consumercreditresearchfoundation.org/_files/
060628MilitaryPDLSurvey.pdf (visited August 29, 2006).
---------------------------------------------------------------------------
Q.3. Did your industry seek to work with DoD and give it input
on this study? What, if anything, has the industry proposed to
DoD to stop specific abusive practices that may occur when
payday loans are made?
A.3. CFSA made repeated good faith attempts to work with DoD,
but DoD clearly had no interest in doing so. First, over a year
ago before the study was prepared, CFSA representatives met
with key DoD representatives--including some whom we understand
were directly involved in preparing the report--and requested
that DoD work with CFSA to address concerns with respect to
payday lending to military personnel. These DoD officials
showed no interest in working with CFSA and failed to follow up
with any further contact. Then, while the study was being
conducted, CFSA became concerned that DoD had not contacted the
association or its members for information or input.
Accordingly, CFSA made a number of requests for meetings with
relevant DoD officials; DoD staff would schedule meetings with
CFSA but subsequently cancel those meetings. Finally, again at
CFSA's initiative and request, about a week before the study
was released, Dr. Chu and several of his associates met with
CFSA representatives. During the meeting, CFSA sought to
educate DoD regarding the fundamental fallacies of certain
arguments and factual assertions by opponents of the industry
like the Center for Responsible Lending (``CRL''). CFSA also
proposed amending federal law to include over a dozen
additional safeguards for military borrowers, including a total
ban on rollovers and a payment plan, but DoD had no interest in
these proposals and proceeded to issue its report a few days
later. I am attaching a separate memorandum summarizing CFSA's
proposals to DoD. I trust that you and other Committee members
will see from this memorandum that CFSA was proposing tough
measures that would have prevented abuses while at the same
time preserving payday loans as a credit option for service
members. DoD unfortunately had no interest in adopting such
responsible measures and instead continued to follow its course
of blindly accepting erroneous CRL contentions and flawed
studies and of recommending unwarranted measures.
Q.4. Wouldn't the use of a properly constructed payment plan
resolve most of the ``cycle of debt'' problems some military
customers may have in repaying their loans? If so, will
industry support such a plan?
A.4. Absolutely. The industry supports such plans and would
support them for military borrowers. In states where payment
plans have been required by law, such plans have enabled tens
of thousands of customers to defer payment in accordance with a
plan that meets their individualized cash-flow requirements.
Such plans give borrowers options rather than, as the DoD
report urges, taking them away. As noted above, CFSA proposed
banning rollovers and requiring an extended payment plan. The
effect of such a plan would be to provide military borrowers
with an interest-free, long-term principal-reduction plan that
would make it just as easy to repay a payday loan as it is to
obtain one.
Q.5. On pages 14 and 15, the report states as a fact that the
two-week loan cited by payday lenders ``is virtually
nonexistent.'' It then says that Center for Responsible Lending
research shows that only 1% of loans go to borrowers who take
out only 1 loan a year and 91% of payday loans go to borrowers
with 5 or more loan transactions per year. It says that it is
the rule, not the exception, that payday loans catch the
borrower in a debt trap with the average borrower paying back
$834 for a $339 loan. Are these statements accurate?
A.5. No. Unfortunately, the Center for Responsible Lending
generally is not responsible or accurate when making most of
its contentions regarding payday lending. It repeatedly puts
forth erroneous ``facts'' and reaches unsupportable and
misleading conclusions based on faulty and biased analyses. To
date, there have been only a handful of legitimate academic
studies regarding the rate of repeat payday loan usage, and
these studies do not support CRL's assertions with respect to
military borrowers. Among service members--which is the only
relevant population for purposes of the DoD Report, not the
general population--the correct facts are as set forth on page
2 above. DoD's own statistics show that the rate of usage,
including repeat usage, of payday loans among military
borrowers is extremely low. These low rates of usage and repeat
usage were not demonstrated to be sufficiently problematic to
warrant extraordinary legislative action. DoD proceeded to
reject its own data and disregarded other readily available
information--including independent third-party data--contrary
to CRL's positions, and adopted CRL's inaccurate contentions
and inappropriate ``solutions'' without critical or responsible
analysis.
ATTACHMENT
A Case Against Prohibition of Regulated Storefront Payday Lenders as a
Short-term Credit Option for Military Personnel
Most public policy debates revolve around a perceived
problem and a proposed solution.
In this case, the Department of Defense (``the
Department'', or ``DOD'') has determined that an increasing
number of military personnel have become sufficiently concerned
about their domestic financial obligations, to cause an adverse
effect on military readiness. In response to this problem, the
DOD has recommended, as one primary solution, that Congress
prohibit the offering of payday advances that charge a fee
exceeding 36% when annualized over 365 days (``APR'').
The Community Financial Services Association of America
(``CFSA'') does not question the DOD's analysis of its
military's state of readiness to defend our country. In fact,
no fair-minded critic of the payday advance industry has ever
suggested that the owners and employees of this industry do not
unequivocally support our military and the DOD's duty to
protect the men and women who serve our nation.
The focus of this discourse is not on the problem, but
instead, on the proposed solution. It is our intention only to
illustrate the inherent flaws in the proposed 36% APR cap,
which would effectively apply to just one small segment of the
short-term, unsecured consumer credit market and, most
certainly have unintended consequences to the very ones it is
intended to protect.
A DISPASSIONATE ANALYSIS OF THIS SHORT-TERM, UNSECURED CREDIT MARKET
INDICATES THAT PROHIBITION OF ONE SEGMENT WILL LIKELY
EXACERBATE, NOT REMEDY, THE PROBLEM.
Virtually every commentator who has opined upon the payday
advance issue, has agreed upon at least one fact--there is an
enormous demand for short-term access to money in small
denominations. Consumers define short-term to mean until their
next influx of cash, typically occurring on their next payday.
The market satisfying this demand is estimated at
approximately $100 billion and is supplied by a number of
financial and quasi-financial services, none of which are
traditional loan products. All of the diverse providers in this
short-term, unsecured credit market offer the same end
product--the ability of a consumer to access credit by entering
into a fee transaction to be ``settled up'' at the customer's
next receipt of income. In decreasing order by size, this
market volume is composed of the following credit products:
1. Late fees--paying one creditor, or funding an
immediate cash need, by delaying a payment to another
creditor;
2. Bank non-sufficient funds fees--using an unfunded
check, either unintentionally or intentionally, to pay
a creditor by forcing your bank to ``front'' the
payment until funds are available to replenish your
account;
3. Courtesy overdraft, or ``bounce'', protection
fees--using your bank's permission to overdraw your
account, thereby creating immediate cash funds;
4. Payday advance fees at storefront lenders--using
regulated payday advance lenders to ``cover'' your
unfunded check until payday;
5. Payday advance fees at offshore Internet lending
sites or from other subterfuge products--satisfying
your need for short-term cash through lenders who are
immune to state or federal regulation.
A common mistake when evaluating the cost of a payday
advance is to compare it to traditional loan products. Such a
comparison serves no useful purpose, since the comparison would
be of products that occupy very different segments of the
financial services market and, accordingly, fill very different
needs of consumers. A fair analysis of the payday advance
service must be made in the context of the actual products and
services with which it competes, and with an understanding of
the real alternatives available to its customers. Below is a
comparison of the costs and the total fee volumes for these
market segments.
COSTS AND MARKET FEE VOLUME OF CONSUMERS' SHORT-TERM UNSECURED CREDIT OPTIONS
----------------------------------------------------------------------------------------------------------------
Cost per $100 loan or
Credit option Occurrence Total fee volume State Regulation
----------------------------------------------------------------------------------------------------------------
Storefront Payday Advance $15 $6 billion 38 States
Offshore Internet Payday Advance $10-$40 Unknown None
Bounced Check Fees $54 $22 billion NSF None
+ Unknown Merchant Fees
Overdraft Protection Fees $27 $10 billion None
Late Fees (credit card, landlord, $39 $57 billion None
utilities, etc.)
----------------------------------------------------------------------------------------------------------------
THE DOD'S PROPOSED 36% APR CAP WILL ELIMINATE ONLY THE SMALLEST SEGMENT
OF SHORT-TERM CREDIT OPTIONS AVAILABLE TO MILITARY PERSONNEL.
A payday advance cannot be offered at a 36% APR. The
typical payday advance customer is charged $15 for a $100, 14-
day advance, resulting in an annualized rate of 391% (use of
the APR assumes the customer takes out the loan every two weeks
for 52 weeks--in reality, this virtually never occurs as most
states prohibit such constant rollovers, as do our mandatory
industry Best Practices). At a 36% APR, the total fee charged
for that same $100 advance would be $1.38, representing a 91%
reduction in gross revenue. The public filings of publicly
traded payday advance companies indicate that the average net
profit, after taxes, is between 10%-20% of gross revenue, well
in line with, and often below, other financial services
companies. No serious policy maker believes that the payday
advance product can be offered with a 36% APR, a belief shared
by thoughtful commentators as exhibited in this excerpt from an
August 14, 2006 editorial in the St. Louis Post Dispatch:
--``Sen. Talent's proposal, tacked on as an amendment
to a defense bill (SB 2766), would limit the annual
percentage rate to 36% percent for military members and
dependents. That works out to about $1.38 on a two-week
loan of $100. Payday lenders argue that's less than it
costs to service such loans, and that the industry
couldn't stay in business at rates that low. There's
truth to that argument, and payday loans--if they're
[not] allowed to snowball out of control--do serve a
legitimate purpose. While the Talent/Nelson amendment
has the support of the Center for Responsible Lending,
a nonpartisan research center in Washington, and the
Consumer Federation of America, there are other
approaches. Mr. Talent might take a look at the new
reforms in Illinois.''
Economists, academicians and state policy makers have
substantiated the fact that this restrictive APR would not be
feasible for payday advance lenders. Researchers representing
many of the nation's credit unions and the Federal Deposit
Insurance Corporation (FDIC), neither of which are advocates
for the payday advance product, have studied the issue of cost
and profitability and come to the conclusion that the costs
largely justify the price. Below are two references from such
studies.
The Economics of Payday Lending, John P. Caskey, Filene
Research Institute & The Center for Credit Union
Research, Madison, WI, 2002.
--``Another possible approach to the rise of payday
lending would be for credit unions to undercut payday
lenders by offering low-cost small-value loans to
payday loan customers. But this approach is unlikely to
be successful. If a credit union were to find good loan
candidates and charge them its top loan rate of 18% APR
for a short-term small-value loan, this would not cover
its costs.''
--``For example, a $200 two-week loan at 18% APR would
generate $1.38 in interest, not enough to cover even
the origination cost. In other words, the high cost of
payday loans substantially reflects the high cost of
making small-value, short-term loans.''
Payday Lending: Do the costs justify the price?, Mark
J. Flannery and Katherine Samolyk, for the Center for
Financial Research, FDIC, 2005.
--``The payday advance product's structure makes it
costly to originate these short-term loans, whose
default rates substantially exceed the customary credit
losses at mainstream financial institutions.''
--. . .``an important reason why advance fees are high
is that the loan is short-term and non-amortizing.''
--``We find that fixed operating costs and loan losses
justify a large part of the high APR charged on payday
advance loans . . . These operating costs lie in the
range of [payday] advance fees, suggesting that payday
loans may not necessarily yield extraordinary
profits.''
--``These APRs substantially exceed the rates
associated with mainstream consumer credit products,
although some mainstream services (e.g., overdraft
protection fees or credit card late payment fees) might
translate into similar APRs if providers were required
to report such information.''
Additionally, policy makers in 37 states (plus D.C.) have
studied the rate issue and passed legislation allowing an
average fee of $17.50 per $100. In fact, Indiana, Kansas and
Rhode Island, having previously enacted restrictive fees
averaging about $12.50 per $100, repealed those rates in favor
of a $15 per $100 fee. Policymakers in these states found that
rates below $15 per $100 had restricted competition and forced
consumers to more expensive, less desirable and even
unregulated alternatives.
AVAILABILITY OF MARKET ALTERNATIVES MAKES IT UNLIKELY THAT ELIMINATION
OF THE STOREFRONT PAYDAY ADVANCE OPTION FOR SERVICEMEMBERS WILL
DECREASE THE READINESS PROBLEM.
On the surface, it might seem reasonable to assume that
reducing the annual percentage rate (from 391% to 36%) paid by
military personnel for a storefront payday advance might
correspondingly reduce the DOD's military readiness problem.
Given the current market short-term credit alternatives
discussed previously, the reality must be that it will either
have no effect, or intensify the problem. What is clear is that
the expected result of lowering the APR of a storefront payday
advance to 36% will not occur--but the unintended result of
forcing the military to more expensive, or more dangerous
alternatives, surely will.
As noted earlier, there exists a $100 billion demand for
financial services that provide immediate access to needed
money or credit. Storefront payday advances comprise about 6%
of the supply side of that market. The remaining 94% of the
market will not be subject to the 36% rate cap. Since
prohibition of the storefront payday advance service option
will not eradicate the demand for the service by the 6% of
customers in the market that currently use it, those customers
will simply shift to one of the other alternative products
available.
Case studies of consumers who had unfortunate, and
sometimes dire, experiences with these other sources of higher
cost credit are plentiful. Consider just these few recent
examples.
-- Mark Keil, of Dayton, OH, stopped at a convenience
store for $19.45 worth of cigarettes. The expense
cleared his debit card, along with several others over
the next several days, but he didn't know his bank had
automatically covered these overdrafts. He paid $198 to
his bank for covering $59 in overdrafts. Six months
later he had amassed $1,194 in overdraft fees. (AARP
Magazine, September & October 2006)
-- Carolyn Russell, of Fort Worth, TX and living on a
fixed income, called her bank and was told she had
$2.32 available in her checking account. She
immediately bought that amount of gas for her car.
Eight days later she received a notice from her bank
that she was overdrawn by two cents and required to pay
a $36 fee. After calling to inquire, she went to the
bank the next day to pay the overdraft, which by then
had grown to more than $70, due to daily penalties.
(Star Telegram, July 7, 2006)
-- Unidentified customer from Bristol, TN, signed up
for a payday loan on the Internet and it ``turned into
a nightmare. They were debiting my bank account, so
months later I was still getting deductions from my
bank account . . . On the whole run I lost about three
or four hundred dollars.'' (Briston Herald Courier,
January 4, 2006)
-- Fatemeh Hosseini, of Sunnyvale, CA, worked a
second job to try to keep up with her credit card
payments. Although she had stopped using her cards to
buy anything, in two years her debt nearly doubled.
``That's because Hosseini's payments sometimes were
tardy, triggering late fees ranging from $25 to $50 and
doubling interest rates.'' She eventually filed for
bankruptcy. (The Washington Post, March 6, 2005)
These readily available alternatives have raised the ire of
consumer advocates, credit union officials and state regulators
of financial services:
-- Paying overdraft fees ``can be as costly as payday
loans . . . $80 one week overdraft loan with a $26.90
fee equals 1,753% interest.'' (Center for Responsible
Lending issue paper on bank overdraft fees, April 2006)
-- ``Critics also contend that bounce-protection
fees, as high as $37 per transaction, are little more
than high-priced credit. ``If a bank lends you $100 and
charges you a $20 fee--and then you pay the money back
in two weeks--that's an annualized interest rate of
520%,'' notes Jean Ann Fox, director for consumer
protection at the Consumer Federation of America in
Washington. ``It's worse than a payday loan.''
(Business Week, May 2, 2005)
-- ``These products [overdraft ``bounce'' protection]
are worse than payday loans. With payday loans at least
you get a disclosure, which is required by federal law,
so you know how much they're gouging you,'' says Chi
Chi Wu with the National Consumer Law Center. (AARP
Magazine, September & October 2006)
-- ``About 80% of our members are using courtesy pay
the way it was intended just a few times a year here
and there,'' explained First Financial Federal Credit
Union CEO Rob Windsor. ``But 20% were paying us a lot
more than they should be . . . Our courtesy pay fee is
$15, which is pretty low, but even with that low fee,
we see people who are paying thousands in courtesy pay
fees.'' (Banking Wire, March 2, 2006)
-- ``A common complaint against online payday lenders
is that the customer is required to give banking
information, whereas if they walk into a payday lender
store they give them a postdated check. But what's
happening online is the payday lender uses the bank
information to make unauthorized withdrawals from the
consumer's account. They say they're collecting funds
owed to them. They can make these withdrawals in a way
they can't with a postdated check,'' said Karolyn
Klohe, financial legal examiner, WA Department of
Financial Institutions. (Bankrate.com, September 12,
2005)
-- ``People who use online payday lenders risk losing
money, paying excessive fees and having their
identities stolen, the Nebraska Department of Banking
and Finance warned Tuesday. `Using the Internet for
this type of transaction puts the borrower back into an
unregulated electronic alley, possibly dealing with
lenders from foreign countries,' said John Munn,
director. (Omaha World-Herald, April 12, 2006)
The previously discussed alternative short-term credit
products each fill a niche and may be, depending on the
circumstances, a better or worse choice for a consumer than a
payday advance. But no one can deny that, if a consumer is
seeking a payday advance from a storefront lender, it will in
many cases be:
1. less expensive than NSF/merchant fees, overdraft
protection fees, most internet lending fees and some
late fees;
2. safer than a transaction with an internet lender
located overseas;
3. void of any negative impact on the customer's
credit score, unlike NSF or late fees.
It is ironic that storefront payday advances represent
-- the smallest segment of a distinct market
-- often the least expensive supplier in that market
-- an industry that fully discloses all costs
associated with the transaction and seeks responsible
regulation from state policy makers
. . . and, yet, is the only significant supplier in the market
subject to prohibition by the DOD proposed 36% rate cap.
TRADITIONAL, LOWER COST ALTERNATIVES TO PAYDAY ADVANCE LOANS, BOUNCED
CHECK FEES AND LATE BILL PAYMENTS CANNOT FILL THE DEMAND FOR
THIS SHORT-TERM, LOW DENOMINATION CREDIT.
Even with the best intentions and advocacy efforts, the DOD
and other organizations are not equipped to provide enough
alternative financial resources to eliminate the $100 billion
short-term credit market in the foreseeable future. Given the
level of consumer demand, if business enterprises could offer
them at 36% APR, traditional financial institutions would
already be doing so. Even non-profit entities--with well-funded
operating resources, tax-exempt status and a mission to provide
affordable financial aide to those in need--have found it
difficult, if not impossible, to offer low-cost alternatives to
payday advances.
While a number of institutions have talked about providing
low cost alternatives to payday advance loans, there has been
little real progress made in offering similar, viable products
that are attractive to consumers. In fact, there is one school
of thought that traditional financial institutions may have
little incentive to do so.
The Annie E. Casey Foundation has recently released a
report, authored by former Assistant Secretary of the U.S.
Department of the Treasury and current Chairman of the FDIC
Sheila Bair, entitled, ``Low-Cost Payday Loans: Opportunities
and Obstacles.'' (http://www.aecf.org) The report underscores
the importance of small-denomination, short-term loans and
encourages banks and credit unions to offer lower cost payday
loan alternatives to their customers. But the report points out
that banks and credit unions may be reluctant to do so, saying:
--``Though depository institutions have the means to
offer low-cost payday loan alternatives, the
proliferation of fee-based bounce protection programs
represents a significant impediment to competition.''
--``. . . fee-based bounce protection programs are
functionally equivalent to payday loans when used by
customers as a form of credit. When used on a recurring
basis for small amounts, the annualized percentage rate
for fee-based bounce protection far exceeds the APRs
associated with payday loans.''
--``To the extent so many depository institutions
are relying on bounce protection for significant fee
income, they may view it as against their own interests
to cannibalize profits through development of other,
lower-cost forms of small dollar credit.''
The report goes on to say that payday loans can be the
lowest-cost option available to some consumers:
--``Interviews and industry survey indicate that
payday loan customers do make a cost analysis in
comparing the price of a payday loan with the
alternative costs of bouncing a check and/or incurring
late fees.''
--``When used on a recurring basis for small
amounts, the annualized percentage rate for fee-based
bounce protection far exceeds the APRs associated with
payday loans.''
--``. . . APR disclosure of fee-based bounce
protection might help payday loan vendors, since for
some consumers, their product will be less expensive.''
CFSA supports the exploration and encouragement of payday
advance alternatives. The entry of traditional financial
institutions into the payday advance market would accelerate
overall acceptance of the service and provide more consumer
choices--both having positive effects on consumers and the
industry. In the interim, consumers need to have viable and
safe credit options. And while a payday advance isn't the best
choice for consumers in every situation, increasing evidence
shows it is often the lower cost, more desirable alternative.
THE CFSA PROPOSAL
CFSA has continually worked with legislators, regulators,
policymakers, customers and critics around the country to
resolve concerns about the payday advance product. To that end,
37 states have passed legislation that balances consumer
protections with the consumer's right to continued access to
the product. After passage of such legislation, it is common to
see the number of complaints filed with the state regulator,
statistically disappear.
It is also important to note that, while thousands of
legislators have participated in hundreds of hearings in which
the rate issue has been debated and votes have been taken, no
legislature has passed a fee cap that results in a 36% APR for
payday advances. There are two reasons that such attempts at
36% APR caps fail.
First, it is understood that such a cap is implicit
prohibition of the product, thereby taking a choice away from
consumers instead of empowering the consumer with options.
Legislators' sentiments seem to echo remarks made by Jeffrey M.
Lacker, president ofthe Federal Reserve Bank of Richmond, at
the Conference of State Bank Supervisors May 18, 2006:
--``Much of the popular response to consumer credit
expansion and its byproducts has been less about
prudential supervision, however, and more about
consumer protection. Many proposals amount to calls for
lending restrictions or the outright prohibition of
some lending practices. This strikes me as a dangerous
approach. In the long run, it would tend to slow
innovation and constrain the availability of financial
products to a broad range of consumers in order to
protect the relatively few who use a credit product
inappropriately or unadvisedly.''
Second, nearly all policy informed makers understand that
rate is not the issue on which to focus.
The first reason serves as the basis for why a 36% rate
will not help the DOD solve its problem. The second reason
forms the foundation of CFSA's proposal to help do so.
It is not a $15 fee that causes some consumers to struggle
with a payday advance, but, rather, the repayment of the $100
principal amount--which is a common issue for all the products
serving this market. While customers are able to repay a $15
payday advance fee, or the $25 overdraft fee or even the $39
late fee, some will have difficulty repaying the underlying
principal balance. It is those customers that need a safety net
to help them manage their obligations, without making their
situation any worse.
CFSA would be willing to discuss a payment plan option that
would allow military customers to repay their principal balance
due, over many months, without the accumulation of any interest
or charges. A military customer would be eligible for the plan
under either of two conditions:
1. the customer has completed a DOD-approved
financial readiness program; or
2. the customer has entered into 4 or more
consecutive payday advances.
Under either condition, the customer would be able to
unilaterally convert his payday advance into a longer term,
less expensive installment loan, which, when adding in the
initial payday advance fee, would result in an overall APR of
36% or less. The dual conditions would require payday advance
companies to provide this special assistance to those members
of the military who have either chosen to help themselves
through financial readiness programs or have exhibited the need
to be helped by their demonstrated repeated use of the service.
At the same time, however, DOD would be allowing continued
access to the product for all others, who neither seek nor need
such assistance.
CFSA Is Willing to Discuss a Number of Consumer Protections for the
Military, Many of Which Have Been Promoted and Implemented in
Various States:
Provide military customers the unfettered
opportunity to convert payday advance transactions into
longer term, cost-free payment plans (resulting in a
36% APR), if either of the following events occur:
The customer completes a DOD-
approved financial readiness program; or
The customer enters into 4 or more
consecutive payday advance transactions.
Prohibit the rollover of payday advances by
military customers.
Require unambiguous and uniform price and term
disclosures.
Require payday advance companies to provide
information to the military customer concerning
appropriate use of the service, counseling options and
alternative programs and products available to the
customer.
Prohibit prepayment penalties and require the
rebate of unearned fees.
Prohibit mandatory arbitration clauses which
are unconscionable, oppressive, unfair or substantially
in derogation of the rights of the military customers.
Prohibit the garnishment, or allotment, of
military wages.
Prohibit the payday advance company from
contacting, or threatening to contact, the customer's
commanding officer or any other person in the
customer's military chain of command, in effort to
collect on an advance.
Prohibit the waiver of a military customer's
rights under the Servicemembers Civil Relief Act or
under any other federal or state law.
Prohibit the use of any representations or
symbols that suggest, give the appearance of, or
provide reasonable cause to believe, that any component
of the Armed Forces, the Department of Defense, or any
other federal entity sponsors or endorses the payday
advance company.
Require payday advance companies to defer all
collection activity and halt the accrual of interest or
any other fees, upon the deployment of a military
customer to a combat, combat support or combat service
support posting.
Provide military customers the right to
rescind a payday advance, without cost, within 2
business days of entering into the transaction.
Prohibit payday advance companies from
threatening or pursuing criminal action against a
military customer as a result of the customer's check
being returned unpaid or the customer's account not
being paid.
Consider the use of payday advance locations
as platforms for the dissemination of DOD approved
financial readiness materials.
Conclusion
The Department of Defense has voiced its concern--the
financial obligations of our military men and women should not
escalate into a distraction from their duties, nor should it
impair the country's military readiness. In addressing this
concern, the Department may:
1. Attempt to eliminate the storefront payday
advance option, and naively hope that its personnel
choose not to use the unrestricted alternative
products, or
2. Allow CFSA to work with the Department in
designing and implementing real, effective solutions
regarding payday loans for the military personnel who
need assistance.
We are prepared to offer you a list of references from
across the country that will confirm that CFSA has successfully
resolved the concerns of many of its critics and, in doing so,
has demonstrated its integrity and good faith. We respectfully
request the opportunity to enter into such discussions with the
Department of Defense.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM CHRISTOPHER L. PETERSON
Q.1. It is my understanding that you conducted a study that
found that payday lenders were disproportionately located near
military installations. How many locations did you examine as
part of your study and what do you think are the implications
of these findings?
A.1. Steven Graves, a Geography Professor at the University of
California at Northridge, and I recently published a study on
predatory lending to military personnel. The full citation to
the study is Steven M. Graves & Christopher L. Peterson,
Predatory Lending and the Military: The Law and Geography of
``Payday'' Loans in Military Towns, 66 OHIO STATE LAW JOURNAL
653-832 (2005). It should be available in the Library of
Congress and any other law library around the country.
Moreover, a copy of the study accompanies this correspondence.
We would be honored to have the study or any portion thereof
accompany the written record of this hearing.
In conducting our study, we examined 20 states, 1,516
counties, 13,253 ZIP codes, nearly 15,000 payday lenders, and
109 military installations. Our study found high concentrations
of payday lending businesses in counties, ZIP codes, and
neighborhoods in close proximity to military bases. In order to
assure that this pattern of ``clustering'' around military
bases was not caused by factors unrelated to the presence of
military personnel, we controlled our observations by comparing
the density of payday lender locations to that of bank
locations. Even when accounting for commercial development
patterns and zoning ordinances with bank locations, payday
lender location patterns unambiguously show greater
concentrations per capita near military populations. We believe
our findings stand as conclusive proof that the payday lending
industry targets members of the armed forces and their
families.
In addition to our empirical findings, our research
included an extensive discussion of sociological and historical
literature on the financial well being of military families. We
concluded that clustering of payday lenders around military
installations was the most recent incarnation of an ancient
history of predatory lending to military personnel both in our
country and around the world. Payday loans, which typically
have interest rates of between 300 and 900 percent, are
extremely dangerous financial products that can trap consumers
with modest income in a ruinous cycle of high cost borrowing.
Our study recommended reestablishing the traditional
American response to predatory lending: usury law. For the
great majority of the past century, the American government
protected service members from high-cost predatory loans with
usury laws limiting interest rates to between 18% and 42% per
annum. Through federal preemption and state legislative change,
these laws have given way to an environment in which service
members are literally surrounded by lenders clamoring to charge
annual rates averaging around 450%. Military personnel both in
ancient history and contemporary America have chronic financial
vulnerabilities owing to their demanding and semi-nomadic
lifestyles. Inevitably, many struggling military personnel and
their families find the temptation of short term financial
quick fixes advertised as ``easy,'' ``no hassles,'' ``no credit
check,'' or ``quick cash'' too difficult to pass up.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Additional Material Submitted for the Record
Hilary B. Miller, Attorney at Law
Greenwich, CT, September 20, 2006
Hon. Melquiades R. Martinez,
317 Hart Senate Office Building
Washington, DC.
Re: Predatory Lending Practices Directed At Members of the Armed Forces
and Their Dependents
Dear Senator Martinez:
In the limited time available for last Thursday's hearing, it was
not possible to provide complete information regarding the finance
charges applicable to payday advances. On behalf of Community Financial
Services Association of America, I write to supplement my responses at
the hearing.
The finance charge for a payday advance is largely a function of
the lender's costs (principally occupancy and personnel expenses). An
FDIC study cited in my prepared remarks estimates that the these costs
are approximately $13-$14 per $100 of loan principal advanced.\ 1\
Thus, a finance charge of $15 per $100 to the consumer is, to use your
term, entirely ``conscionable'' and results in a very normal profit
margin to the lender.
---------------------------------------------------------------------------
\ 1\ Mark Flannery and Katherine Samolyk, Payday Lending: Do the
Costs Justify the Price? FDIC Center for Financial Research Working
Paper No. 2005-09. http://www.fdic.gov/bank/analytical/cfr/
workingpapers.html#payday (visited August 29, 2006).
---------------------------------------------------------------------------
There is considerable evidence that the industry's margins are not
exorbitant, insofar as most of the largest operators are public
companies and have readily ascertainable, audited profit figures. The
absence of inappropriate profits makes sense when you consider that,
unlike an installment or mortgage lender--which is able to recoup its
costs through finance charges collected over a period of three, five or
even thirty years--a payday lender must recover its entire costs of
origination and servicing over the initial two-week typical loan term.
Moreover, the industry is nearly perfectly competitive. With over
22,000 retail outlets (and innumerable Internet-based providers), and
very low barriers to entry, prices would be expected to converge toward
lenders' marginal costs--and indeed that is precisely what has
occurred. To phrase it differently, if the payday lending business were
``unconscionably'' profitable, lenders would be expected to flood the
market and drive interest rates down.
Consumers can (and do) readily comparison shop because the industry
universally quotes pricing both as a finance charge in dollars and as
an annual percentage rate (as required by the Truth In Lending Act).
Finally, you asked why it might be appropriate for a young service
member to borrow at the seemingly high annual percentage rates charged
by payday lenders. Just as commuters understand that taxicabs are
valuable and convenient when used for short-term travel needs but too
expensive for extended trips, consumers understand that payday advances
are useful when utilized for short-term needs but inappropriate for
long-term borrowings. To America's working middle class, the payday-
advance product serves as a dignified, discreet and cost-efficient
``financial taxi'' to tide the borrower over to his next payday when
faced with an unexpected cash need.
Although it is tempting to cite high annualized interest rates as
problematic, the use of annualized rates is inappropriate when
comparing extremely short-term credit options. The vast majority of
military borrowers have payday-loan credit outstanding for only a few
weeks per year.\2\
---------------------------------------------------------------------------
\ 2\ William O. Brown, Jr. and Charles B. Cushman, Payday Loan
Attitudes and Usage Among Enlisted Military Personnel (2006). Available
at http://www.consumercreditresearchfoundation.org/files/
060628MilitaryPDLSurvey.pdf (visited August 29, 2006).
---------------------------------------------------------------------------
Rollovers were mentioned at the hearing as a potential problem, but
36 of the 38 states that permit payday lending have strict statutory
limitations on rollovers. For example, Florida forbids all rollovers.
Fla. Stat. Ann. Sec. 560.404(18). In contrast to this reality, the
technical APR computation requires an assumption that the loan will be
rolled over 25 times (even though the permitted number of rollovers is
zero). The actual interest rate on the loan is 15%, but the theoretical
APR figure is 391%. Thus, I am sure that you can understand how we
believe that focusing on the APR is extremely misleading and typically
presents a distorted picture of the real cost of payday loans.
As noted in my prepared remarks, analysis of the cost of payday-
advance credit must take into account the cost to the borrower of not
obtaining such credit. Faced with the alternative of writing a check
that may ``bounce'' or of a utility disconnect--often with implicit
annualized costs in excess of 1,400% when expressed in APR terms for
purposes of comparison--or being unable to afford repairs to a car
needed for commuting to work, the modest cost of a short-term payday
advance will almost always represent a good tradeoff for the
borrower.\3\
---------------------------------------------------------------------------
\3\ ``Critics also contend that [overdraft] bounce protection fees,
as high as $37 per transaction, are little more than high-priced
credit. `If a bank lends you $100 and charges you a $20 fee--and then
you pay the money back in two weeks--that's an annualized rate of
520%,' notes Jean Ann Fox, director for consumer protection at the
Consumer Federation of America in Washington. `It's worse than a payday
loan.' ''--Business Week, May 2, 2005.
---------------------------------------------------------------------------
The following table shows how a payday loan may be advantageous
when compared with other forms of credit that a middle-income military
consumer may choose:
--------------------------------------------------------------------------------------------------------------------------------------------------------
Credit card Late/Disconnect $100 Bounced
Credit alternative $100 Payday $100 Overdraft late fee on fee on $100 check NSF/
advance protection $100 bill utility bill merchant
--------------------------------------------------------------------------------------------------------------------------------------------------------
Fee................................................................ $15.00 $26.90 $32.61 $46.16 $53.68
Effective APR...................................................... 391% 701% 850% 1,203% 1,400%
--------------------------------------------------------------------------------------------------------------------------------------------------------
Against this backdrop, a payday loan may be a very wise choice for
a service member.
We respectfully urge you that there are two sides to this issue,
and the DoD report contains only one of them. We will work diligently
with you and your staff to make sure that you can make an informed and
principled decision regarding this matter.
Thank you for you courtesies at the hearing and for your efforts on
behalf of our service members and our nation.
Very truly yours,
/s/ Hilary B. Miller