A payday loan loophole

Payday lenders are the bottom-feeders of the financial industry, offering short-term loans with high fees to borrowers who typically live from paycheck to paycheck. Even those that play by state rules can still ensnare over- extended borrowers in debt traps. Yet some payday lenders can’t seem to live with any regulation at all. With the support of a handful of compliant Indian tribes, they’ve opened online operations that they claim are beyond the reach of regulators in Sacramento and other state capitals. But their bid for sovereign immunity is a sham, and if the courts don’t put a stop to it, Congress should.

In a payday loan operation, the borrower usually writes a postdated check for the amount he wants to borrow plus a flat fee (typically 15% to 16.5% of the amount sought by the borrower). The lender cashes the check at the end of the loan period, erasing the debt. Online lenders require borrowers to grant them access to their bank accounts, which are automatically debited at the end of the loan period. In either case, the trouble starts if the borrower doesn’t have enough in his account to cover the payment. Lenders may roll over unpaid debts into new loans with new fees, and online shops can run up multiple overdraft charges by repeatedly seeking payment from tapped-out accounts. Within weeks, a customer can easily owe more in fees than he originally borrowed.

Although some consumer groups want lawmakers to all but ban payday lenders, California and 34 other states have chosen instead to cap the amount they can lend, the fees they can charge and the number of times they can renew loans. But a number of online payday lenders are ignoring those relatively permissive requirements, claiming they’re “economic subdivisions” of Midwest Indian nations. This tactic has helped them fend off cease-and-desist notices and tie up regulators in the courts.

Payday lenders tried to avoid state rules once before by affiliating themselves with banks, only to have federal regulators bar such marriages of convenience. If the courts fall for the current ruse, they’ll be establishing a loophole that’s not just illogical, it’s dangerous. If companies can evade state regulations simply by agreeing to funnel a share of their profits to a tribe, reservations could become virtual havens for all manner of online scammers and financial predators. Consumers would have little recourse, and law-abiding companies in the state would have trouble competing. Congress should make clear that each state’s payday lending rules, and its consumer-protection laws in general, apply to any business offering products there, no matter what deal it may cut with an Indian tribe.