A Stitch in Haste

(Cross-posted previously at Overlawyered.)

In Part One, I proposed the following heuristic regarding paternalism:

To summarize, although it is not a proper function of government to proscribe "bad" decision making, perhaps a few isolated, objectively defensible carve-outs can be allowed in which the government makes it just a little bit harder to make a bad decision. Perhaps. Stated differently, a paternalist exception that actually proves the libertarian rule should probably be embraced and not shunned.

But does this qualify as such an exception?

In a payday loan transaction, the lender makes a small advance (typically $100-$500) to its customer, agreeing to hold a personal check for the loan amount plus a fee until the customer's next payday. ... The borrower receives cash immediately. Fees charged can range from $15 to $30 on each $100 advanced, although the typical fee is at the lower end of that range.

The fee may seem modest when presented as a dollar amount, but when calculated as an annual percentage rate (APR), the cost is relatively high. A charge of $15 to borrow $100 for 14 days amounts to an APR of 391%. A survey by consumer advocates found APRs on 14-day payday loans ranging from 390% to 871%.

No fewer than five separate bills were introduced in this session of Congress to limit or even ban payday loans. No fewer than four federal financial regulatory agencies, including the Federal Reserve, have launched investigations of the practice. Not to mention the states.

There are many other examples of financial market proscriptions in the name of paternalism — usury, loan sharking, "refund anticipation loans," and that perennial favorite of libertarians, "price gouging" — that all attempt to block voluntary transactions by competent adults.

It is a basic principle of economics* that more choices lead to higher potential utility for consumers. Stated differently, restricting freedom of choice and freedom of contract always makes people worse off.

So what right, exactly, does a politician, regulator or bureaucrat have to say that a payday loan, even one with a stratospheric interest rate, is "wrong" for a given borrower in a given circumstance, and therefore ban it?

Note that the common, if indelicate, response that "people are stupid" is not relevant. That observation serves as a justification (perhaps) for labeling requirements and "Truth in ..." laws such as the Truth in Lending Act. More information, like more choices, can be a good thing, if the cost of presenting that information does not exceed the benefit it provides.

But that's not the same as a ban. Even a fully informed consumer who is perfectly willing to pay an "outrageous" (i.e., a usurious) interest rate is barred from doing so. Why?

It also can't be merely a manifestation of the general defense of "unconscionability" in contract law. "Unconscionabilty" is an "as applied" concept: unconscionable in what context? Umbrella proscriptions declare a contract invalid not "as applied," but facially. So the argument becomes circular: Such loans are unconscionable because they're, um, unconscionable? That's a no-go as well.

Perhaps it's an externality argument — A 390% APR on a payday loan might not offend the borrower, but it offends us, and we therefore are entitled to block it, not to help the borrower, but to help ourselves. "Will of the majority" and such.

That way madness lies. It is the ultimate slippery slope. If we can ban, for our selfish goals, an offensive interest rate imposed on others, then what other "offensive" strictly private activities might we start banning?**

So I ask again: What precisely is the justification for a government to ban voluntary, fully informed, fully private loans — or other private contracts, or other private activities generally?

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(*Which is why, apparently, some economists try to argue the exact opposite. Go figure.)

(**Some of you might be able to guess where I could go with this line of reasoning — see Lawrence v. Texas. Fans of Overlawyered might also think "foie gras.")

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POST SCRIPT: Not long after I finished this post, an interesting item popped into my news aggregator. I'll excerpt it here without comment --

Need cash to pay your next bill? Send us a text message, we'll send you the money in just a few minutes.

Such slogans are spreading in Finland and other Nordic countries, with barely a mention of the annual lending rates of up to 1,000 percent involved.

Lending cash to young people through SMS messages at rates banks can only dream of is becoming increasingly popular in Nordic countries, according to a survey conducted by Finland's financial watchdog. ... In Finland and 12 other EU countries these lenders are out of reach of financial regulators because they do not collect funds from the public, the watchdog said.

Those who accept a loan offer get the money transferred to their bank account just a few minutes after sending an SMS with their national identification number. For a two-week loan of 100 euros the payback is 120 euros, equivalent to an annual lending rate of about 1,000 percent, which would be illegal in some European countries.

Discuss.