Carl Packman\’s not thinking this through

Taking me to task over credit unions, Wonga and all the rest. It\’s worth quoting at length here:

I’ve seen a report that Goodwill (think charity shops) tried this in the US and found that APR was well over 130% without even charging interest, let alone trying to make a profit. So I wish the CoE all the luck in trying to compete in this payday loans market. But I do think that they’re not going to get very far. Simply because the costs of lending small sums for short time periods are inherently high.

He forgets one or two things. Firstly credit unions already lend at smaller sums than payday lenders. He’s right to say focusing on APRs are misleading, but in pounds and pence while a payday lender can charge around £25-35 per loan of £100 over 28 days, a credit union will charge about a pound.

Secondly financial institutions often cross-subsidise from more profitable bits of their operation to ensure loss-making activity can stay. Banks do it to fund “free” current accounts. This is why there was the need to make credit unions more than just lenders, attracting middle class savers back in the early nineties to make it easier to lend to low income families.

Though Timmy neglects to mention that more work on attracting more money can make the CoE’s plans on credit unions workable, his main crime was in not reminding us how necessary this intervention is. Even if credit unions do not make profit from lending to low income people or state subsidy is called upon (such as the DWP fund of £38m), this is vital to save the public purse in the long run.

If additional resources and support from outside isn’t given to credit unions, in the form of funding, shop-fronts, equipment, and advertising, then many consumers will have to rely on high cost credit from payday lenders. To this end personal debt profiles will rise, less money will be circulated on the high streets, more of it will line the pockets of fringe bank bigwigs, consumers will be less able to shield themselves from unseen financial shocks and the whole debt cycle starts again. That, Tim, is just not sensible.

Umm, Carl. Changing who pays the heavy expense of lending small sums for short terms doesn\’t change the fact that it is a heavy expense. It\’s still a very costly thing to do whether it is cross subsidised from other parts of the business (banks do this because they make large profits off the float on those \”free\” current accounts. That presumably wouldn\’t be there if we\’re talking about banking for the poor who won\’t be leaving those sums in accounts to be used as a float), whether it\’s subsidised from the tax payments of everyone else or anything else you might want to try and think up. Where the money comes from doesn\’t change the fact that money needs to be there to cover those costs.

So, no, I\’m not confused in the slightest, nor committing any kind of crime. It simply is expensive to lend small sums for short periods of time. Because there is a discrete and fixed cost to lending any amount of money at all. Which, as a percentage, will be higher the smaller the sum of money. How that cost is covered doesn\’t change the fact that it has to be.

34 thoughts on “Carl Packman\’s not thinking this through”

  1. It’s more than this – the cost of the loan isn’t just the more or less fixed cost of setting up a loan (cross-subsidised or otherwise) but the premium that comes with lending small sums to risky customers. Unless the credit unions have some magic method of eliminating default then the only way to reduce the cost is to reduce the risk. Which means not lending to a lot of people who currently borrow from the likes of Wonga.

    I wrote the other day that the church would be better suited to reducing the need for people to use payday loans as a distress purchase:

    “This little headline grabbing initiative is great PR, brilliant politics and poor business. If the church wants to do something to reduce the need for lenders like Wonga the way to do this is to help reduce the reasons why vulnerable people use them. And to do this the Church should build on the work already being done out there by organisations such as Christians Against Poverty – working in local neighbourhoods to advise people on how to avoid debt, how to budget and how to get out of the mess once you’re in it. And, while credit unions have a role in all this, they really aren’t the solution.

    If every church had a debt advisor or two plus a little relief fund, the chances are that thousands of people might be guided away from the risks of short-term borrowing. Rather than compete, the Church should simply remove Wonga’s market.”

  2. Didn’t say it wasn’t expensive, just saying that the expense is worth it overall for the public purse. Efforts to expand credit unions and the ability for them to lend to lower income households is better than the alternative – that is, the proliferation of credit that is charged at a high cost to the consumer. Call me a statist if you wish to but this statist wants to see more consumers able to save money and have enough left over to spend trying get our economy back on track.

  3. I like your idea, Simon, about having a debt adviser in every church. In fact the church likes that idea, too. So much so that that’s exactly what they’re going to do.

    ps where is the rest of your post published?

  4. “Call me a statist if you wish to but this statist wants to see more consumers able to save money and have enough left over to spend trying get our economy back on track.”

    But you’ve taken money from consumers to fund your Credit Union, haven’t you?

  5. If anything, you can say payday lenders are *more* honest about this than others. You see, upfront, the actual cost of your loan. None of that cost is hidden by cross-subsidies.

  6. Tim/Carl

    I hesitate to offer an opinion; you both clearly don’t need any help. However Carl:
    No Tim hasn’t forgotten a couple of things, unless failing to compare apples and pears is being forgetful.
    And no, Tim’s charge is way off the mark, you have thought it through. I just don’t like your thoughts here. How on earth is gov’t spending its money (or not) to cover loans to the impecunious a good idea?
    However, I personally think this little debate has missed the economic and moral elephant in the room. I think Simon Cooke has hit the nail on the head. We are talking here about loans that should never be advanced to people who should never be borrowing. The face of modern poverty isn’t Want the Urchin; it’s the mother of said Urchin, who made sure she and Urchin got all the latest gear but has no idea how she is going to pay for it.
    I would also say that Justin Welsby is proving to be a far smarter, far more challenging Archbishop than any for past half century. He might often be wrong, but he is offering a challenge that is based in the real world.

  7. Artificially and by government intervention making it cheaper and easier for the poor to borrow money without collateral – can’t for the life of me think of what could go wrong with that …

  8. Micro credit works… sort of. (At least the bloke who started it got a Nobel.)
    How does it work? No doubt from the incentive to borrow more.
    Just like us then.
    It also works because the bank officers are paid peanuts. Now there’s a thought.

  9. No, No, NO.

    Credit unions are never going to be a substitute for Wonga. They are too small and far too labour intensive. It’s not a solution. Someone needing an emergency loan cannot suddenly turn up at a credit union and expect to receive funding. Credit unions are about fostering relationships and substituting relationship capital for security. If my oven blows up today, I cannot turn up at the credit union and ask for 500 quid to replace it if I have never been there before.

    One needs to understand something about payday loans (which is what Wonga is). All research (basically US, but just as true here) shows two effects:

    1) The availability of payday loans increases the chances of financial distress including bankruptcy, denial of banking service. If you ban payday lenders, this reduces financial distress events.

    2) Payday loans help to alleviate cashflow difficulties after natural disasters. This reduces the rate of mortgage defaults.

    The first is a general and large effect. People who are bad with money get access to credit and end up in greater difficulty. But the second reflects the reality that the poor do not have access to financial services and when there is a crisis, the availability of credit via payday loans helps out those who are poor, but good with money.

    If we were to ban Wonga, this would mean more people would go to loansharks, but that events of financial distress would decline (because some people who want to borrow, and are willing to borrow from Wonga, will not borrow from a loan shark). But a corollary is that some “good borrowers” will enter financial distress because they cannot access credit.

    The reason why Wonga works is that it assumes a high default rate, taps a really big market and relies on getting enough “good borrowers” who pay the high APRs to make it worthwhile. The credit unions are not competitors in this instant cash market – they literally cannot compete since they rely on building trust and are manpower intensive. So they can charge lower rates, but this isnt going to work for most people.

    The only way in which Wonga could be competed away, is to match them online. This is the idea behind this firm in the US:

    lendup.com

    Note that when you initially apply, interest rates are roughly Wonga like. At higher levels on the lendup ladder, interest rates become far more reasonable. This has some credit union like characteristics (builds information and relationship via repeated transactions and through education), but is online. If His Grace wants to compete Wonga away, he should give up the bricks and mortar approach and approach lendup. (It wouldnt take much social finance to damage Wonga’s business model, because removing the best borrowers online would make the business far riskier).

  10. Agammamon

    The studies of payday loans in the US show that the effective APRs of being a poor person dealing with a regular bank in the US can have payday-like costs – bouncing cheques, penalty fees for being overdrawn etc. This can mean that people prefer to go to a payday loan firm rather than a bank for precisely the reason you describe. Banks do not want to deal with poor people and charge them heavily – this is one of the cross-subsidies – from the poor to the wealthy.

    Emil
    In the US, this was called the Community Reinvestment Act. Blamed by some for contributing to the Financial Crisis.

  11. The person who is financially solvent, has a short-term emergency for which he requires money, and gets himself into a spiral of Wonga debt as a result is, as far as I can tell, almost entirely mythical.

    There are certainly people who get themselves into difficulties, but they are people whose weekly or monthly expenditure regularly exceeds their income. You can’t fix that with a loan, however cheap you make the interest rate.

  12. Emil has it.

    Carl is basically arguing that if wonga’s competitors get some of their costs (funding, shopfronts, equipment and advertising) met by someone else then those competitors can charge less than wonga and stay in business.

    Well, duh.

  13. The APR’s qoted for Wonga and by Wonga are Bizzare.
    Going by their website, if a person cold borrow £1 for 365 days
    they would pay £1 plus £365 interest plus the arrangement fee. How does calling that an APR of 3000 illustrate anything.

  14. Why not look at this problem – and the cost of finance for poor people is undoubtedly a problem – from the right end? The reason it costs so much to lend to the poor is that they are pretty likely to decide not to pay it back, to flee the loan. The obvious reason there is that they’re responding to the incentives they have, and they have little to lose by failing to repay.

    Clearly, the solution to the PDL problem is to make it less easy, and so likely, for borrowers to default. That might be by criminalising failure to repay, although that’s rather harsh.

  15. I guess if you aren’t a super-high credit risk you will borrow elsewhere anyway. If you’re a super-high credit risk of course Wonga have to charge such that the good payers cover the losses to the bad. I guess it’s also not worth their while suing for bad debts of £100 or so – especially given the marginal chance of getting it back, or at best an attachment at 50p a week, or some such.

    Wonga is clearly for people whose best buddies won’t sub them a tenner ’till the end of the month.

  16. Not even for a month! Have had unexpected bills before payday before – central heating boiler problem and car repair being most recent ones for me. Could have chosen to use payday lenders in each case, for 7 days or so. Thats where they come into their own – short term loan where a longer loan is not wanted or required and where speed is of the essence.

  17. where does the 3000 percent come from. Is compound interest being incorrectly applied.

    If the arrangement feefor 1 month is £25 and the loan is £100. At one percent interest,

    Wonga website says they don’t charge compound interest.

    Rolled over 12 times that is £350 charges plus £365 interest

    = £715 = 715 percent

  18. Dave

    The penalty for not repaying is pretty terrifying – a black mark on your credit history. No mortgage, no credit card. Access only to iffy legal lenders and to loan sharks. The penalty is pretty severe, the main problem with those who access Wonga and enter financial distress is that they don’t have a good grasp of the difficulties. Yes, they are foolish, but many people are. No amount of greater threats is going to change this, No Wonga would probably reduce the number of defaults since as I noted above some who borrow from Wonga will not borrow from loansharks.

  19. The CoE is NOT trying to compete in payday lending. The idea is that it helps reduce fixed costs of credit unions (low/zero rents, volunteers, such as retired bank managers, reducing staff costs) so that people can borrow cheaply when hit by an unexpected cost (car or washing machine repair or …) and thereby avoid falling into the debt spiral that leads them to wonga and its competitors.
    The cost of credit checks will be much lower for CoE parish-based credit unions – you know whether or not Joe works for Farmer Giles or Mr Bun, the Baker, and while you won’t know his income a big lie would be obvious.
    So, I reckon Justin Welby is far from stupid. He *can* reduce the fixed cost of lending small sums and thereby boost credit unions and reduce the demand for payday lenders. I do not expect him to put wonga out of business (though I should be glad if he did), but his initiative will relieve the pain of poverty for some, hopefully many, of those hit by an unexpected cost. That’s part of his job description

  20. john77

    The cost of credit checks will be lower for some, but hardly for many. Attendance at church is estimated at between 6-15% of the population. And also the ratio of those who do attend tends to be skewed towards the AB social classes, groups that are not the typical borrowers from the payday lenders. Credit unions are not the answer to Wonga, and church assisted credit unions will be a minor palliative, and will no doubt see the CoE being caned when some mother in debt claims it is all of their fault.

  21. @ ken
    In a small community recognition is not limited to church attenders: I knew the employment of a higher proportion of the running club I belonged to before I tore a hamstring than of church members. In my previous parish I knew the principal interests for more than one-third of the local residents. So yes, it will be for for many.
    While church members are less likely to borrow from payday lenders that is not down to social class. A few get into trouble because they do not want to tell others that they have a financial problem, so they will be helped by a credit union but you seem to have overlooked the definition of the CoE as “the only body whose purpose is to help those who are not members”

  22. john77

    Extrapolation from personal experience is not evidence, it’s akin to “I feel” type statements and I could give counter anecdotes, but the data is more eloquent.

    You’ve misunderstood what I was saying about the AB social groups. By definition, they are less likely to get into financial difficulty of the sort that requires Wonga and yes a few will, but here we’re talking about absolute numbers. The CoE may be there to help non members (I’d note the requirement to give alms is one that is enjoined on Muslims, without a requirement that the beneficiaries need not be co-religionists, but leaving that aside) my point was merely that on average church attendance was low (and lower still amongst the social classes that will need access to informal credit) and information would be poor on most of the population and thus would not help with credit checks. At the margin it will have an effect, but given the need for instant cash, a lack of relationship building, a mistrust of standard institutions, thepayday lenders will remain – especially online, and unless they are challenged online, I see no hope for significant progress.

  23. Pingback: Tim Worstall says I’m not thinking things through ← Carl Packman

  24. John77

    The etymology of the word evidence might be linked to sight, but in the modern world we no longer trust to anecdata as anything more than a case study. Numbers on church attendance and social class are several orders of magnitude more compelling than personal experience. Indeed evidence is what is obvious and correct, and the data outweighs personal experience.

  25. @ ken
    You seem not to know the difference between assumptions, hearsay and evidence. You treat hearsay as evidence and evidence as anecdote. I was citing my personal experience as just an example of the fact that in most small communities (and the large majority of parishes*are* small communities – if a parish gets too big for the Vicar to know his parishioners it needs to be split), people know each other, not as the basis of all knowledge – I am not quite so arrogant as to imagine the whole world revolves round me!
    In a recession anyone can get into debt if they fall ill or lose their job or, for the self-employed, when business drops off. I think that it is not social class so much as listening to dozens of sermons on the Prodigal Son from the age of four upwards that leads to fewer church members getting into debt. Since the A & B social classes are a minority of churchgoers in the UK, and the D and E social classes are heavily represented (it is C1 and C2 that are heavily underrepresented), your assumption that because A & B are a higher %age of church members than of the general population, church members are unlikely to get into debt is a bit of a non sequitur, since it is the D & E classes who are (i) more likely to get into debt and (ii) more likely to seek a PayDay lender than an overdraft.. Obviously I cannot prove my opinion, but the data you cite disproves yours.
    By the way, data does NOT outweigh personal experience when personal experience proves that the reported data is wrong. You read Tim’s blog so you see dozens of examples where official reports in allegedly respectable newspapers are blatantly wrong: last month I slated misreporting by the BBC (and the firm published it: not a dicky-bird from the BBC in response); also last month I objected to a report that a team which only had three eligible guys had come second in a relay race …

  26. john77

    BTW where do I cite hearsay as evidence?

    I assume that you will admit that you are wrong:

    1) ABs are 43% of regular churchgoers.
    2) C12s are 27% of regular churchgoers.
    3) DEs are 28% of regular churchgoers.

    “and the D and E social classes are heavily represented” er… Since 34% of the population is DE vs. 28% of regular churchgoers – so less than ABs and less than their representation in the population.

    http://www.whychurch.org.uk/welloff.php

  27. @ ken
    Firstly you are citing third party reports “Numbers on church attendance and social class are several orders of magnitude more compelling than personal experience” – that is hearsay. Even if you had census data it would still be hearsay, as was the official race result.
    I usually admit that I am wrong *when* I am wrong, as did the editor, to his credit.
    re: http://www.whychurch.org.uk/welloff.php
    Try reading the chart correctly: it says 28% v 33% for D and E, 27% vs 49% for C1 and C2. If you strip out the ‘A’, then D&E combined are over-represented. Even if you don’t they are more than one-quarter of church members.
    Even including the ‘A’ social class, the proportion of Church members who are in social classes who might need non-bank lending is c.85% of the national average. So the over-weighting of ‘A’ and ‘B’ classes does NOT mean that only an insignificant number of church members might seek “informal lending”
    BTW I did NOT say over-represented.

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