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Creola Johnson

For complete article see: Creola Johnson, Congress Protected the Troops: Can the New CFBP Protect Civilians from Payday Lending?, 69 Washington and Lee Law Review 649 (Spring, 2012)(394 footnotes)


In the summer of 2003, Navy Petty Officer 2nd Class Jason Withrow, stationed at a naval base in Georgia, obtained a $300 payday loan. When the loan became due, he had to borrow from another lender to pay back that loan because he could not repay the original $300 loan in a single payment, as required by the contract. By February 2004, he had paid $5,000 in interest and fees on payday loans totaling $1,800 from four different lenders. If Petty Officer Withrow were in need of a short-term loan today, he would not have to settle for the typical payday loan, which carries a tripledigit interest rate and has to be repaid in a single balloon payment in a short time frame (e.g., two weeks).

For military personnel in need of quick cash, the financial landscape has dramatically changed for the better. Persuaded by testimony that payday loans trap soldiers like Petty Officer Withrow in debt and interfere with their military preparedness, Congress passed in 2006 a federal law, commonly referred to as the Military Lending Act (MLA). It protects not only combat soldiers but all active-duty military personnel and their dependents from usurious loans by capping interest rates on several types of short-term loans, including payday loans, at 36% annual percentage rate (APR). Since the passage of the MLA, the number of loans offered by payday lenders to military families has drastically decreased. However, this decrease did not leave military families without access to short-term credit. Military relief societies--non-profit organizations established to help military families--expanded their personal finance education outreach and began offering several interest-free loan products to help military families avoid payday loans. Similarly, many credit unions and banks challenged the payday loan industry's assertion that triple-digit-interest loans are necessary by offering military personnel loans with APRs below 36% and on terms resulting in successful loan repayment. Because of this, military families now have access to--and are increasingly using--safe, affordable short-term loans.

In contrast, the financial landscape for civilians seeking short-term loans was already bad and has become increasingly worse, due in part to online lending and other tactics by payday lenders. For example, in 2007, the same year the MLA took effect to protect military families, Bonnie Bernhardt, a civilian single mother from Wisconsin, borrowed $300 from a Delaware-based online payday lender. Two weeks later, when she could not repay it, the lender debited her bank account for $90 to roll over--extend the due date--on the loan. After the lender debited Ms. Bernhardt's account for a total of $810 in rollover fees, it still insisted that she owed the original $300 loan. Her case reflects a common debt trap for civilians borrowing online.

Payday lenders are cleverly expanding their payday loan business to civilian consumers. For instance, an online payday loan company purportedly operating out of the Cheyenne River Reservation in South Dakota is fighting a cease-and-desist order issued by Maryland financial regulators and is claiming to have the right under tribal sovereign immunity to issue to Maryland residents loans with interest rates as high as 1,800%. Although several states have passed statutes in the last four years imposing greater restrictions on payday lending and capping APRs at 36% or less, payday lenders are routinely ignoring these laws and are developing more schemes to claim they are not subject to these laws.

While state legislators have been wrangling over how to prevent payday lenders from circumventing state laws, major banks, such as U.S. Bancorp, Wells Fargo, and Fifth Third Bank--all three recipients of taxpayer bailout funds --have been stealthily creating their own payday loan products, cleverly labeled as direct deposit advances. These loans have triple-digit APRs, exceeding 100%, have short maturity dates, and require single balloon payments, just like payday loans. Moreover, although credit unions largely have a reputation for offering consumers low-cost loans, a few of them have been accused of issuing loans that are similar to payday loans and also carry triple-digit APRs.

The outlook for civilian borrowers like Ms. Bernhardt, at first glance, appears bleak. However, this Great Recession, which originated in irresponsible subprime mortgage lending, has a silver lining: enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Title X of the Dodd--Frank Act is titled the Consumer Financial Protection Act of 2010 (CFPA), and it created the Bureau of Consumer Financial Protection (CFPB). The CFPB is empowered to enforce existing federal consumer laws as well as adopt new regulations for enforcement. The CFPB can become the champion for civilian borrowers by taking on America's financial institutions to combat predatory short-term loans.

Part II of this Article describes the predatory characteristics of payday loans. It also analyzes provisions of the MLA that prohibit some payday loan practices, including prohibiting rollovers and interest rates higher than 36%. Part II also explains how the enactment of the MLA eventually led to a dramatic decrease in payday lending to military personnel and a substantial increase in safe affordable loans to military families.

Part III describes the arguments used to pass a federal law that protects only military families from payday lending. Applying these same arguments to the civilian borrower, Part III makes a compelling case as to why civilian families need federal laws protecting them from payday lending. Payday lenders issue to civilians the same predatory loans they did to soldiers; however, the financial situation for the average civilian is worse, thereby making the civilian borrower more susceptible to the payday loan trap. Because of the sacrifices of military members in volunteering to protect America, we rightfully reward military families with a strong social safety net, which is comprised of numerous benefits, including free healthcare services, free public higher education, and subsidized housing. In contrast, the average low-to-moderate-income civilian worker lacks these benefits and is in a precarious situation due to continuing high unemployment rates and an evershrinking benefits package. If military families, who enjoy a strong safety net, need protection from payday loans, then unquestionably civilian families, who are largely left to fend for themselves, deserve the same protection. Both groups of consumers are lacking in financial sophistication and are no match for the $40 billion payday loan industry or Wall Street titans like Wells Fargo and other banks engaged in payday lending.

Part IV discusses failed attempts by federal lawmakers to pass laws directly regulating payday loans. The need for federal regulation continues to grow as payday lenders and their affiliates devise new schemes to circumvent laws passed by several states to protect civilians from predatory payday loans. Part IV also explains why, in the absence of actions taken by the CFPB, mainstream financial institutions alone cannot be relied on to offer nationwide safe, affordable loans to civilians. While prudential regulators of nationally chartered banks and federal credit unions have taken measures to try to get these institutions to offer alternatives to payday loans, many so-called alternatives are nothing more than payday loans by another name.

Part V discusses the emergence of the CFPB as a watchdog to protect civilian borrowers from payday lending. It asserts that the CFPB has rulemaking authority to prohibit many payday loan practices as unfair, deceptive, or abusive, as well as authority to issue a guide warning bank and nonbank lenders what practices it considers unfair, deceptive, and abusive. Because the guideline-making process can be much shorter than the rule-making process and has other advantages over the rule-making process, the author proposes in Part V that the CFPB issue guidelines for financial institutions offering payday loans (CFPB's Guide for Payday Loan Providers) to deter their proliferation. This guide should be soundly rooted in provisions of the MLA and actions taken by state law makers and federal banking regulators, and should warn lenders that the CFPB considers common payday lending practices, such as those described above, unfair, deceptive, and abusive. The author also proposes that the CFPB should use its authority to issue a policy statement to create a zone of safety for loan products that meet criteria for affordable low-cost loans (Policy Statement for Safe Low-Cost Loans). The statement would be meant to encourage responsible lenders to develop loan products that can truly be considered low-cost alternatives to payday loans.

Having used its authority to issue the proposed Guide for Payday Loan Providers and the proposed Policy Statement for Safe Low-Cost Loans, the CFPB, as discussed in Part IV, can use its Office of Financial Education to fulfill its educational mandate to provide consumers with timely and understandable information to make responsible decisions about financial transactions. Because the possibility exists that the CFPB's funding will be substantially reduced, the CFPB has to become adept at effectively using its funding for education outreach. Rather than the CFPB relying primarily on a web page with a wealth of information the CFPB hopes consumers will visit and learn from, the author proposes that the Office of Financial Education launch a public service education campaign using a strategy that harnesses the power of social media, consumer-generated advertising, and wireless technology. Part V.C sets forth the author's proposed six-step strategy that includes the CFPB (1) increasing the number of fans on its social networking sites; (2) conducting a contest for the creation of consumer-generated advertising promoting safe, affordable loans; (3) utilizing crowdsourcing to select the best advertisements; (4) securing the agreement of banks and credit unions in every state to supply safe, affordable loans; (5) starting a public service campaign to increase consumer awareness; and (6) developing an electronic application that consumers can download to make it easy for consumers to find these loans. This would nudge consumers in the right direction and enable them to select appropriate loans, thus freeing them from their bounded rationality.

By taking the above actions, the CFPB will foster the expansion of affordable small-dollar loan programs and cause them to emerge as a viable alternative to the typical payday loan. As a result, the CFPB will afford ordinary Americans protections from payday lending similar to those extended to military families.

[a1] . Creola Johnson (This email address is being protected from spambots. You need JavaScript enabled to view it.), Professor of Law, The Ohio State University, Michael E. Moritz College of Law.