Curbing payday lending is a fool's errand
As the ethical debate around ‘payday loans’ continues, local councils have begun to rally against these lenders. Plymouth Council recently became the first local authority in Britain to ban payday companies from advertising across their billboards and bus shelters, while other councils are looking at following suit. Councils such as Plymouth City, Newcastle, Dundee and Cheshire East have also already blocked access to the top 50 payday loan websites across their public networks of buildings, libraries and community centers.
This is partially a response to the Office of Fair Trading’s (OFT) report citing widespread regulatory non-compliance throughout the industry, including a prevalence of irresponsible lending. Whilst the new Financial Conduct Authority is soon to start a consultation over beefing-up industry regulation, the OFT has also instructed the Competition Commission (CC) to look for evidence of any prevention, restriction or distortion of competition within the industry. Last week, the CC announced they would be studying the market for evidence of “impediments to customer’s ability to search, switch and identify the best value product” and any “significant barriers to [firm’s] successful entry or expansion”.
The CC is probably expecting any anti-competitive behavior to stem from firm’s actions or the market’s structure. However, by restricting consumer’s access to information and erecting new barriers to entry, local councils are themselves making the market anti-competitive.
Blocking payday websites in public buildings means that those needing public internet to research loans are prevented from exploring the range of options open to them. These are generally the people most likely to benefit from discovering lower rates of repayment and flexible deals — and the kind of vulnerable people the council’s actions are designed to protect. Furthermore, banning advertising is simply likely to entrench the market share of current top providers who have an established image — regardless of the merits of other companies. The FCA is currently contemplating a cigarette-style nationwide ban on payday loan advertising , which would further compound this problem. Council’s actions may be designed to hurt the loan companies, but they end up harming consumers too.
It is interesting to see what, if anything, the CC will say about this impediment to effective competition. Given current public opinion it seems likely that any action taken to obstruct the publically-defined ‘predatory’ loan companies is here to stay, even if it were to negatively impact on the most vulnerable.
Instead of banning adverts and adding tighter regulation — both of which are designed to make it harder for these payday companies to operate — there are more effective ways to address the rise of payday loans.
Whilst currently only a small source of finance Credit Unions provide a viable and ethical alternative to payday lenders. However, they currently face a monthly interest cap of 2% and are often a loss-making venture. Easing the restrictions on Credit Unions would better allow them to make profits, grow in scope and effectively compete with payday companies.
Secondly, making the benefits system simpler would provide some with greater financial certainty and could eliminate some of the reasons for resorting to a quick loan. A benefits system better at tracking changes in people’s situations would reduce the delays people face to get the correct benefits and would reduce the number of people having to pay back over- payments. Similarly, tapering the withdrawal rate of benefits in a gradual way would ensure that people entering work aren’t suddenly hit with unexpected surprises and bills.
Tackling what we deem a worrying trend in society doesn’t always require bans and regulation. It is possible to create alternatives to payday loans and reduce the need to use them without demonizing or blaming the lenders themselves.
As I've been saying for 15 years now about the euro
Not long ago I undertook the challenge to try and find the oldest thing I'd written that could still be found on the internet. It turned out to be (without a really, really, thorough search) something from 1999 in sci.econ. On the subject of how the euro was most unlikely to work as well as the US $ did simply because the eurozone was much less of an optimal currency area than the US was. Well, lookee here:
The euro zone is (to no one's surprise) a less developed currency zone than America. In economic jargon, America: “...is more likely than the eurozone to satisfy the three Mundell-style optimal currency area criteria regarding the integration of product markets, symmetry of shocks, and labor mobility, as well as [the] criterion regarding the ability of a central fiscal authority to smooth shocks across regions.”
The effect of all of this is substantial:
For the sample of American regions, the difference between the desired and the actual policy rates was usually between 0 and 200 basis points. In other words, many areas received an interest rate that was perfect for their economy, and almost none received one that was more than two percentage points off. The euro area is a different story. The desired interest rate for peripheral countries (such as Greece and Portugal) was usually 300 basis points above the actual rate—before the crisis. After the crisis, the target was a massive 500-700 basis points below the actual rate.
Imagine how much you must have to hate people to insist upon interest rates that are that far out of line with local needs? And further imagine how appalling things would be here in the UK if we had joined. Interest rates 300 bp below what they actually were during the Brown Boom. And right now those hundreds of points above what they should be? And no possibility at all of doing QE of course, that correct monetary response to being at the zero lower bound for nominal interest rates.
You will all know that my innate bias is that we're well out of the whole thing. But it's not actually an innate bias: it's a considered response to having viewed the evidence. As I've been saying on this here internet for 15 years or so by now. Europe just ain't an optimal currency area. Therefore it should not have one currency.
Kick the 'wise men' out of the Bank of England
In today's City AM, newly-minted ASI fellow Lars Christensen (aka The Market Monetarist) writes on the 'Carney rule'. The Carney announcement is a tiny step in the right direction, he says, but as long as the 'wise men' of the Monetary Policy Committee are running monetary policy, policy will be erratic and unpredictable, preventing adequate planning by firms and adding to market panic in economic downturns. Instead, we should have a strict rules-based system of nominal GDP targeting:
A much better rule would have been to commit to stabilising the level of nominal GDP (NGDP), a measure of aggregate demand, keeping market expectations of NGDP growth on a 4 or 5 per cent growth path. This should be combined with an open-ended commitment to expanding the money base to hit this target. This would avoid the nitty-gritty of the Carney Rule and be clearer and easier to communicate to markets.
Monetary policy based on the discretion of “wise men” leads to market uncertainty and panicky jolts as investors react to tiny changes in central bankers’ pronouncements. Replacing the MPC with rules-based policy would bring discipline and predictability to the Bank of England far beyond what was outlined yesterday.
I would prefer to have no Bank of England at all, with money emerging from the market as outlined by Hayek in 1976. Having said that, perfect is not the enemy of good — replacing the discretion of 'experts' with predictable, market-led rules would be a huge step in the right direction. If Carney's new rule fails, it may come on to the agenda sooner than we think.
Holy Credit!
So Archbishop of Canterbury Justin Welby wants to make the Church of England’s property available for Credit Unions so they can wipe out those dastardly payday loan sharks. This is a brilliant idea with wide-ranging opportunities for both entrepreneurial clerics and banks.
Just consider the convenience for consumers of banking and praying at the same time. After the queue for communion, you simply shuffle over to the bank teller next to the altar to pick up your loan or maybe deposit whatever spare change you have after passing the collection box.
Meanwhile, over in the confessional, the priest can follow up an absolution prayer with a financial product pitch – “Have you considered insurance for seven years of drought?”
Recruitment of young folk into the priesthood has become a real problem for the Church but Credit Unions on site offer an added attraction in the area of branch security. Wearing body armour under cassocks, learning a martial art or designing bank vaults disguised as crypts will broaden the profession’s appeal.
Of course, established banks won’t be sitting still against this new competition on the High Street. Many branches surely have space available for any number of religious sects to set up shop.
What depositor with a bag full of cash could resist first lighting a candle in the hopes his deposits won’t attract the attentions of the taxman? Impatient couples could stop off at the on-site wedding chapel before opening a joint bank account.
Imam calling for midday prayers while you’re stuck in the queue behind the old lady counting out thousands of pennies? No problem – step aside to our prayer rug area and we’ll hold your place in the line.
And what customer wouldn’t appreciate an evangelical choir lifting the spirits before meeting the bank manager about those persistent overdrafts?
Keep those ideas coming, Mr Welby!
The Wonga delusion
The Church of England’s plan to drive payday lenders like Wonga out of business by competing with them is wonderful. After years of politicians demanding ‘action’ on the payday loan industry, an organization has finally decided to tackle this perceived social evil by giving people a better alternative, not trying to legislate problems away.
Critics of payday lenders quote the loans’ astronomical APRs — Wonga’s representative APR is 5853%. But this is extremely misleading. Representative APR is designed to show interest-on-interest compounding over a year, and is an inappropriate measure to use for a loan whose term is a month or so. A Wonga loan does not and cannot compound for longer than 60 days beyond the initially agreed loan period (which can be between 1 and 46 days).
Borrowing £200 over 46 days accrues £100.03 in interest and fees, an effective interest rate of 50% over this period. After this point, interest only continues to accrue for 60 days, after which point it stops. It simply does not make sense to look at representative APR for a short-term product that does not keep compounding for long enough for anything like that APR to ever apply.
No Wonga borrower can end up with a 5853% interest rate – the existence of this number is just an quirk of our financial regulations which require all lenders to express their rates in annualized terms. Journalists and politicians who report this 5853% APR figure as the ‘standard’ Wonga rate are mistaken and are misleading the public.
The real problem is that people are poor enough to have to rely on these sorts of lenders. Wonga et al only exist because their customers have no better alternative. Before the emergence of the formal payday loan sector, people had to rely on tattooed guys with a Rottweiler who’d happily break your legs to recover their investment. Nobody wants to borrow from a firm like Wonga, but they're a damn sight better than the existing alternatives.
The Archbishop of Canterbury appears to recognise this. Giving people more choices by offering a cheaper alternative is the sensible way to help payday borrowers.
Despite its problems, QE might be right
John Butler has a great piece in yesterday's City A.M. making the case against central bank interest rate interference. He uses the devastating insights of Ludwig von Mises and Friedrich Hayek to show why central planning cannot work rationally for basic epistemic reasons. His example is of the Soviet shoe industry, constantly providing surfeits of boots in summer and sandals during winter.
Absent a pricing mechanism to match supply and demand, there was invariably either a glut or a shortage. And even when there was a glut, there were plenty of summer shoes, but a shortage of winter boots. By contrast, the largely capitalist West, responding to real price signals in real markets, did a pretty good job at producing, in sufficient quantities, a range of shoes that customers wanted, that fit, that they could afford.
Butler argues that in the significantly more important financial markets, which coordinate plans about saving and investment, together determining the future's capital structure, the same rules apply. We need real prices to convey information and organise society into a rational economic order. He claims the monetary policies of many countries—cutting headline interest rates and buying hundreds of millions of bonds—distort market interest rates (the most important prices in the economy) and thereby drive capital to be used in suboptimal ways.
I think there's a problem with his approach. Going with the title of this post—isn't it possible that the free market interest rate is below zero? German bund yields have fallen below zero several times during the Euro crisis, despite no central bank engaging in any major programme to buy them up. In times with few good investment opportunities, lots of funds (saving rates have boomed during the bust), and lots of worrying risky areas, it makes sense that some safe assets would see crashing rates. Bond yields can fall below zero even in a zero inflation or deflationary environment, but that's not true for many of the myriad interest rates in a modern economy. There is a zero lower bound on most rates, that is, no one would accept a nominal rate less than zero, as they could usually change the money into cash and put it under their mattress. But quantitative easing raises inflation expectations (and inflation), allowing real rates to go below zero, potentially clearing some otherwise stuck markets.
Now this isn't necessarily telling on Butler's argument. It might be that sometimes rates need to fall below zero, potentially justifying inflation above zero, but the QE needed to achieve this inflation distorts markets in general more than it benefits in these cases. Other things being equal, the extra demand from bond purchases means higher prices and lower yields on those bonds, and this would be expected to hit all substitute assets. This seems to hold even if the other effects of extra QE (higher inflation and demand growth (NGDP growth) expectations) work in the other direction, or even exactly balance out the demand effect of QE. Compared to the hypothetical situation where the central bank boosts growth expectations without buying up bonds, assets will be more expensive, or yield less.
Funds will look cheaper to firms than they "actually are" in the sense of their social cost as approximated by the information that would have been contained in the relevant market interest rates. Firms will tie up slightly more productive capital in improving capacity when society as a whole would seem to prefer slightly more devoted to consumption. This mispricing of loanable funds seems like it would have distortionary effects, with the size of the efficiency loss depending on the responsiveness of the supply of deposits and the demand for investment to their prices.
Before this starts to sounds one-sided against QE, there is one (big) consideration to take into account—the extra inflation and demand growth expectations that asset purchases create don't just help some interest rates adjust, but also create the space for a vast number of relative price moves. Labour markets tend not to clear after demand shocks because wages take a long time to adjust downwards. The price of avoiding any interference could be deep, ongoing recessions. So a prudent central banker may need to risk some misallocation of resources into investment if they wish to avoid the probably worse cost of punishing unemployment and slashed living standards.
Welcome Mark Carney, now here's what you need to do
Today Mark Carney becomes the new governor of the Bank of England, gaining oversight not only of UK monetary policy, but also financial regulation, as part of the Bank's newly-expanded responsibilites. When George Osborne revealed he had managed to persuade Carney to take on the role there was great fanfare and excitement. This was firstly because the Canadian economy has performed relatively well through the recession and secondly because Carney has shown himself open to innovations in central banking, though he has not implemented any in his time at the helm of the Bank of Canada.
Carney talked up the benefits of targeting the level of demand in the economy—though only for exceptional times—in a recent speech. And one would expect that the chancellor, for the £870,000 he has agreed to pay Carney, is open to significant change, notwithstanding the insignificance of the minuscule changes he himself made to the BoE's remit in the budget. Put together, these facts give cause for some optimism for someone like me, who supports targeting the level of demand.
So instead of speculating on what the superstar economist actually will do, I will outline the basics of what Mark Carney should—and could do:
I. Target levels instead of rates—this means bygones are not expected to be treated as bygones, and market actors do not worry about worse-than-expected outcomes because the central bank has committed to sorting them out
II. Target NGDP (demand) instead of inflation—this means supply moves don’t lead to the wrong sorts of tightening or loosening of monetary policy, also means demand is stabilised directly, instead of an arbitrary part of the outcome of demand; stable demand means no recessions caused by nominal factors and no unsustainable booms
III. Target the forecast instead of the outcome—this is what matters for expectations, which are basically all that matters for employment contracts, loan/debt contracts, investment etc. etc. Expectations are the key, so it’s insane to ignore them
IV. Target market, not internal forecasts—set up an NGDP-linked bond, like the RPI-linked bond, and target the spread between the vanilla bond and the linked bond to get an objective idea of where to aim. Guesses where people have skin in the game are systematically better than the relatively costless estimates produced by private consultancies and the Bank’s internal team. But even if they’re wrong it doesn’t matter because expectations are all that count, and the spread between the bonds IS the market expectation. Driving that to a particular point is success, regardless of what happens.
In general the road ahead must be one of rules and discipline, not the translucent discretion of nine unelected barons.They must keep demand steady so we can focus on improving the supply capacity of the economy, and so there is no excuse for fiscal stimulus, with all its flaws. If you still need convincing, read Scott Sumner's 2011 Adam Smith Institute monograph "The Case for NGDP Targeting".
Putting bankers in jail cannot prevent mistakes
The Parliamentary Commission on Banking Standards has published its report on how to make bankers act less irresponsibly. Among other things, it recommends making bankers criminally liable for reckless professional conduct. “Too many bankers”, it says, “especially at the most senior levels, have operated in an environment with insufficient personal responsibility”.
The assumption here is that bankers acted recklessly because they were insulated from the negative consequences of their actions. I don’t know if that’s true. During the 2008 crisis, plenty of executives at failing financial institutions made the same mistakes that their firms made. AIG’s former CEO kept much of his net worth in AIG stock, most of which he lost. The CEO of Lehman Bros lost $1bn. Citigroup’s Sanford Weill lost $500m. Between them, Bear Stearns’ executives lost billions.
There are many other examples like these. If bankers had known that they were acting recklessly in business, they would not have done the same thing with their personal holdings. That so many executives' personal losses were so great suggests that they did not realise what they were doing. Their bad business moves were errors, not calculatedly reckless decisions.
Indeed, Jeffrey Friedman has shown that the real error was on the part of regulators. Financial regulations such as the Basel capital accords that were designed to make banks act more prudentially in fact did the opposite, incentivizing banks to load up on government-backed mortgage debt and, particularly in Europe, government bonds. And, unlike mistakes made by individual firms, these mistakes were compounded across the entire global financial system.
Making the punishment for failure harsher will only improve behaviour if the people affected already know that they’re doing wrong. If they’re simply mistaken – as I would imagine you’d have to be to lose billions of dollars of your own net worth – regulations like this will not have the effect we want them to.
But what about the ones who really did know what they’re doing? We used to have a mechanism for punishing reckless business practices — it was called bankruptcy. In banking, at least, this seems to have been abandoned in favour of unlimited bailouts. If we had let bad banks go bankrupt, as Iceland did, we might not be in such a bad situation today.
Throwing a few scapegoats in jail to satisfy an anti-banker mob ignores that the crisis was largely about regulators' and bankers' error. It is no replacement for letting bad firms go bust and punishing them the old-fashioned way.
That high frequency trading we need the financial transactions tax to save us from
One of the arguments put forward by hte Robin Hood, or financial transactions, tax people is that high frequency trading is the work of the very Devil and it needs to be curbed by that tax. HFT is that algorithmic trading that takes place in nanoseconds as computers and algobots play with each other.
And I will admit that there's not a huge deal of use to the activity. It provides liquidity, this is true, it makes the players a profit, this is also true. Those against it state that it doesn't serve any public purpose: which is of course entirely the wrong question to be asking. We're all allowed to do whatever it is that we wish as long as that doesn't create some public disservice: that's what those old standbys freedom and liberty mean. The test of whether you're allowed to do something is not that you need permission: it's whether there's any good reason why you should not.
But logic aside there's not really anything much to worry about as Craig Pirrong points out:
HFT has been a bugbear for several years now. The monster that would eat the equity markets, and then move onto derivatives for dessert. But HFT has apparently fallen on (relatively hard times). HFT volumes are down. HFT market shares are down. And most interestingly, HFT profits are down, by about 50 percent on a per share basis, more on a gross basis because volumes are down.
Pirrong points out that Schumpeter told us all about this. But it's there in Smith too. When a new method of making excess profits is found (excess being above the normal rate in this instance) then the opther capitalists will observe that excess profit being made. They will then direct their own capital into this new method: the competition from their doing so wearing away at the ability to make the excess profit. given that markets often overshoot there'll often be a period of less than normal profits in the field but over time we'll end up in a reasonably stable equilibrium where this new field, such an exciting opportunity only a few years ago, is now returning normal profits just like the rest of the economy. And everyone goes off to hunt for the next excess profits opportunity.
Which leads us to two observations: the first being that markets here are doing their thing about providing information. In this instance that capital should flow into this field with the excess profits. Then when there aren't such excess profits no more should enter this field.
The second is that markets have, clearly and obviously, moved much faster than the regulators or the taxmen. We don't need to tax the activity as it's already contracting having exploited that excess profits possibility. As so often, even if it really is a problem, a market left alone to get on with things has sorted out said problem.
The Fault, Dear Barclays, Lies in Yourselves
Over the last three years, the caseload of the Financial Ombudsman Service FOS) has soared. The fault lies not with building societies, or insurers, or financial advisers, but with the big banks.
Few complaints come in about Building Societies and those are mostly not supported by the Financial Ombudsman. The Building Societies are good at dealing with their own complaints.
Not so with the big banks, which generate 74% of Ombudsman complaints, most of which are upheld. Clearly the banks’ internal complaint procedures do not work. And market forces do not work either because consumers think the banks are all the same so there is no point in switching. Or most of them: when frustrated by Barclays’ incompetence and failure to deal with complaints, I moved to First Direct and the sky is blue again.
No customer is more loyal than one whose complaint has been well handled. I complained about my breakfast on British Airways once and got a personal letter from Colin Marshall, then the CEO. How can we get banks to satisfy their own customers like that?
Properly managed internal complaints systems would be better for consumers, better for FOS, better for the country at large and better for the banks themselves. The banks cannot win public trust unless, like the building societies, they cut complaints to the FOS to a trickle and lose few FOS judgements.
What can FOS do about it? If they charged the banks thumping fines for their poor complaints handling, FOS would be accused of bias, imposing fines just to raise revenue. Handing the fines over to HM Treasury might mitigate that but maybe not enough.
The big banks are more of a club than a competitive market. The FSA has to take the rap for that. By trying to standardise everything, making entry difficult, disallowing failure and fining them all together in an effort to be fair, the regulator has done no service to the consumer. The new Financial Conduct Authority talks competition but nobody has any idea of how that will be achieved. Maybe the FCA has no idea either. The FOS could make a start by singling out and publishing the best and the worst performer of the month so that the odium can be targeted, not shared equally.
The FCA should be closed down immediately and these matters left to the FOS. That would deal with the boundary issues between them. The suggestion that regulators look forward but the FOS looks back is nonsense: for ten years the regulators have lagged far behind the FOS – which at least has its ear to real customers in the real world.
Over the last three years, the caseload of the Financial Ombudsman Service FOS) has soared. The fault lies not with building societies, or insurers, or financial advisers, but with the big banks.
Few complaints come in about Building Societies and those are mostly not supported by the Financial Ombudsman. The Building Societies are good at dealing with their own complaints.
Not so with the big banks, which generate 74% of Ombudsman complaints, most of which are upheld. Clearly the banks’ internal complaint procedures do not work. And market forces do not work either because consumers think the banks are all the same so there is no point in switching. Or most of them: when frustrated by Barclays’ incompetence and failure to deal with complaints, I moved to First Direct and the sky is blue again.
No customer is more loyal than one whose complaint has been well handled. I complained about my breakfast on British Airways once and got a personal letter from Colin Marshall, then the CEO. How can we get banks to satisfy their own customers like that?
Properly managed internal complaints systems would be better for consumers, better for FOS, better for the country at large and better for the banks themselves. The banks cannot win public trust unless, like the building societies, they cut complaints to the FOS to a trickle and lose few FOS judgements.
What can FOS do about it? If they charged the banks thumping fines for their poor complaints handling, FOS would be accused of bias, imposing fines just to raise revenue. Handing the fines over to HM Treasury might mitigate that but maybe not enough.
The big banks are more of a club than a competitive market. The FSA has to take the rap for that. By trying to standardise everything, making entry difficult, disallowing failure and fining them all together in an effort to be fair, the regulator has done no service to the consumer. The new Financial Conduct Authority talks competition but nobody has any idea of how that will be achieved. Maybe the FCA has no idea either. The FOS could make a start by singling out and publishing the best and the worst performer of the month so that the odium can be targeted, not shared equally.
The FCA should be closed down immediately and these matters left to the FOS. That would deal with the boundary issues between them. The suggestion that regulators look forward but the FOS looks back is nonsense: for ten years the regulators have lagged far behind the FOS – which at least has its ear to real customers in the real world.