Monday, January 10, 2005

Ezra, the Exile, and the Invention of Modern Biblical Criticism

Where did we get the idea that Ezra wrote the Torah, and thus in some way "invented" Israel during the exile? Michael Green, a Chicago philosopher who I have praised for the ways he uses the web to teach, steered me here, where Noel Malcolm describes this idea passing through the head of an 18th-century freethinker:

Also composing a radical critique of Christianity in the 1720s...was the prominent scholar Nicolas Fréret, Secretary of the Académie des Inscriptions et Belles-Lettres in Paris. His 'Lettre de Thrasybule à Leucippe' (a survey of paganism, Judaism and Christianity, written as if by a learned Greek in the first century ad) raises some standard objections to the theory of the Mosaic authorship of the Pentateuch: those books of the Bible contain things that 'can only have been written a long time after the Law-giver', a fact which 'greatly diminishes their authority'. The prophetic books, too, may have been put together only after the events referred to in their so-called prophecies. But Fréret goes further. Cleverly, he turns the tables on the traditional claim that divine revelation was authenticated by prophecies and miracles: he remarks that the Jews were more obedient to God after the return from the Babylonian captivity, despite the lack of miracles, whereas their worst disobedience to God had come in earlier times, when miracles were (allegedly) in plentiful supply. His conclusion is that the miracles had never happened, and that the significant new factor here was that after the captivity the Jewish people had, for the first time, come under the spell of a Scripture which claimed that they had. 'Those miracles . . . were inserted after the event into a history which, as they admit, was compiled by the person—Ezra—who led them back from Babylon, who established their new government, rebuilt their city with the temple of their God, and determined the form of their religion, which had been entirely abolished.'

But who first proposed the idea that "ancient Israel" was the exilic invention of a scribal elite? In a wonderful article, Malcolm explains how the usual idea among radicals, through the 18th century, was that the great manipulator was Moses, who had invented the Israelite religion for political purposes (for the concept of the manipulative elite invention of religion, the great source is of course Machiavelli). But "it took some time, apparently, for writers in the radical tradition to recognize that with the Ezran theory they could have the best of both worlds: they could discredit the authority of Revelation all the more thoroughly, while still retaining the basic idea of politically motivated imposture, merely reassigning it from Moses to Ezra himself"!

Malcolm, a really interesting Hobbes scholar, writes that "while the title of 'founder of modern biblical criticism' is nowadays given sometimes to La Peyrère, sometimes to Spinoza, and sometimes to Simon, it is hardly ever awarded to Hobbes," despite the fact that he seems to have been the first to mention the idea of exilic authorship in print. He argues that the idea was in the air at the middle of the 17th century--

--but the first person to write it down was a Muslim anti-Jewish polemicist named Ibn Hazm in the 11th century! It is in response to this polemica tradition that much early Jewish Bible criticism, such as that of Ibn Ezra, may initially have arisen. The whole article is a revelation, as it were, and anyone interested in what Bible criticism is, and how it got the way it is, will want to read it.

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The scores use a multiple scorecard design. Each version uses 10 or more individual scorecards, and an individual is typically compared with similar others. (For example, a borrower with two 30-day late payments will be scored against a population with some minor delinquencies.) An individual is then graded according to what variables seem to indicate a repayment risk in that group. This feature may cause a borrower with delinquencies to score in the same range as a borrower without delinquencies.

Nearly all large banks also build and use their own proprietary statistical models for credit scoring purposes, often in conjunction with the FICO score or other outside scores.

The statistical models that generate credit scores are subject to federal regulations. The Federal Reserve Board's Regulation B, which implements the Equal Credit Opportunity Act, expressly prohibits a credit scoring model from considering any prohibited basis such as race, color, religion, national origin, sex, or marital status. Regulation B also stipulates that credit scoring models must be empirically derived and statistically sound. Furthermore, if an adverse action is taken as a result of the credit score ( e.g. an individual's application for credit is denied) then specific reasons for the denial must be provided to the individual. A statement that the individual "failed to score high enough" is insufficient; the reasons must be specific.

There exist several generally accepted algorithms for extracting the primary contributing factors to a low credit score. One or more of these algorithms is typically used to supply a list of reasons when a loan applicant has been denied credit, in order to satisfy the Regulation B requirement that specific reasons are disclosed. Some consumers feel these adverse action reasons are somewhat disingenuous, as the only determining factor for credit denials is a numeric score — the "reasons" are summed up only for the consumer.

Each of the credit reporting agencies has developed its own version of the credit score intended to compete with Fair Isaac's score. Although not as widely used, these scores (for example Trans Union's "TransRisk" score or Experian's "ScoreX" and "PLUS" scores) are less expensive than the FICO score. These scores are often derisively referred to by consumers and lenders as "FAKO" scores, for they do not use official Fair Isaac methodologies. The cost savings of a non-FICO score are tempting to some banks and credit card companies, who need an accurate risk assessment on millions of accounts every year. For ease of use, these scores tend to be mathematically scaled so that they fall in the same general range as the FICO score. Fair Isaac offers scoring models for the U.S ., Canada, and South Africa. It also offers a "Global FICO" for many other countries.

Credit scores are designed to measure the risk of default by taking into account various factors in a person's financial history. Although the exact formulae for calculating credit scores are closely guarded secrets, Fair Isaac has disclosed the following components and the approximate weighted contribution of each:

35% punctuality of payment in the past (only includes payments later than 30 days past due)
30% capacity used: the ratio of current revolving debt (credit card balances, etc.) to total available revolving credit (credit limits)
15% length of credit history
10% types of credit used (installment revolving consumer finance
10% recent search for credit and/or amount of credit obtained recently
The above percentages provide very limited guidance in understanding a credit score. For example, the 10% of the score allocated to "types of credit used" is undefined, leaving consumers unaware what type of credit mix to pursue. "Length of credit history" is also a murky concept; it consists of multiple factors - two being the oldest account open and the average length of time an account has been open. Although only 35% is attributed to punctuality, if a consumer is substantially late on numerous accounts, his score will fall far more than 35%. Bankruptcies, foreclosures, and judgments affect scores substantially, but are not included in the simplistic pie chart provided by Fair Isaac.

Further, Fair Isaac does not use the same "scorecard" for everyone. The scorecards are segmented so that there are over 100 different actual scoring models that are applied to different individuals based on different ranges of input values (some scorecard segmentations include: age, depth of credit history, etc.) The implications of this segmentation are that while the approximate weighted contribution above may be an average across all scorecards, individuals will receive different scores or weightings based on the scorecard segmentation that they fall into. Some consumers have noticed their scores decreasing by small amounts for no apparent reason.

Current income and employment history do not influence the FICO score, but they are weighed when applying for credit. For instance, an unemployed individual with no other sources of income will not usually be approved for a home mortgage, regardless of his or her FICO score.

There are other special factors which can weigh on the FICO score.

Any monies owed because of a court judgment, tax lien, or similar carry an additional negative penalty, especially when recent.
Having above a certain number of consumer finance company credit accounts also carries a negative weight (critics say that this causes a vicious cycle, locking people into continuing to use consumer finance companies).
The number of recent credit checks also can weigh down the score, although the credit agencies claim to allow for credit checks made within a certain window of time to not aggregate, so as to allow the consumer to shop around for rates.

A FICO score generally ranges from 300 to 850. It exhibits a left-skewed distribution with a US median around 725. 660 is generally regarded as potentially subprime and represents an important break point for credit worthiness. The performance of the scores is monitored and the scores are periodically aligned so that a credit grantor normally does not need to be concerned about which score card was employed.

Each individual actually has three credit scores for any given scoring model because the three credit agencies hold their own, independent databases. These databases are independent of each other and may contain entirely different data. Many lenders will check an applicant's score from each bureau and use the median score to determine the applicant's credit worthiness.

A new Vantage score has been offered by all three credit bureaus to creditors since spring 2006. It will soon be available to debtors. Its range is from 501 to 990. It is graded A (901-990), B (801-900), C (701-800), D (601-700), and F (501-600). It remains to be seen whether the Vantage Score will replace the FICO score or even be accepted by many creditors.

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If your credit card uses different rates for purchases, transfers, and cash advances, realize that the card issuer may pay the lower interest rate balance first. Consequently, if you carry a balance, your high-rate cash advance may not be "paid" until all lower-rate balances are paid in full.
Fixed-Rate credit cards are not fixed forever. Rates can be changed at any time, as long as the card issuer provides 15 days advance notice of the change in terms. Fees may also increase. These "Change in Terms" notices are usually included with your monthly statement.
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Anonymous said...

A payday loan is a short-term loan that you promise to pay back from your next pay cheque. A payday loan is sometimes also called a payday advance.

Normally, you have to pay back a payday loan on or before your next payday (usually in two weeks or less). The amount you can borrow is usually limited to 30 percent of the net amount of your pay cheque. The net amount of your pay cheque is your total pay, after any deductions such as income taxes. For example, if your pay cheque is $1,000 net every two weeks, your payday loan could be for a maximum of $300 ($1,000 x 30%).

Before giving you a payday loan, lenders will ask for proof that you have a regular income, a permanent address and an active bank account. Some payday lenders also require that you be over the age of 18.

To make sure you pay back the loan, all payday lenders will ask you to provide a postdated cheque or to authorize a direct withdrawal from your bank account for the amount of the loan, plus all the different fees and interest charges that will be added to the original amount of the loan. The combination of multiple fees and interest charges are what make payday loans so expensive (Click here for an explanation of the various fees associated with these types of loans.

The lender should also ask you to sign a loan agreement. If the lender does not offer to give you a copy of the loan agreement, ask for one. Read this document carefully before signing it, and keep a copy for your records

How and when do I pay back the loan?
A payday loan agreement usually says that you must pay the total amount you owe for the loan on or before the date stated in your loan agreement. This includes the amount you borrowed, plus interest and any additional fees and charges.

Some lenders will cash your postdated cheque or process your direct withdrawal on the day the loan is due. However, some lenders may require that you pay the loan in cash, on or before the due date.

If you have not paid the loan in cash by the due date, some lenders may cash your cheque or process the direct withdrawal you signed on the day after your loan's due date, and charge you another fee. Ask the lender what the most inexpensive way is for you to repay your loan.

How does a payday loan affect my credit report?
Credit-reporting agencies collect information on whether or not you make your payments on time. This information, also called your "credit history", is part of your credit report and is used to calculate your credit score.

Making payments on time can help improve your credit score by demonstrating that you are able to manage your debt. Even if you have poor credit, you can rebuild it by using a credit card or other type of credit and paying back the money you owe on time.

This is not the case with payday loans. Since payday lenders are not currently members of the main credit-reporting agencies, getting a payday loan and paying it off on time will not improve your credit score. However, if you do not pay your loan back on time and it is sent to a collection agency, this will likely be reported to a credit-reporting agency and could have a negative impact on your credit report.

How much will a payday loan cost?
A payday loan is much more expensive than most other types of loans offered by financial institutions such as banks or credit unions. Before you apply for a payday loan, find out about all the fees and charges you will have to pay — including the fees you will be charged if you cannot repay the loan on time. The fees may not be easy to see right away, so read the agreement carefully before signing it. If you do not receive an explanation of all of the fees, charges and interest that will apply to the loan, or if you are not satisfied with the explanation you receive, do not sign the loan agreement.

How does the cost of a payday loan compare with other credit products?
Payday loans are much more expensive than other types of loans, including credit cards. But how much are you really paying? How does the cost of a payday loan compare with taking a cash advance on a credit card, using overdraft protection on your bank account or borrowing on a line of credit?

Let's compare the cost of using different types of loans. We'll assume that you borrow $300, for 14 days. Note the considerable difference in the cost of each type of loan.

Things to consider before you apply for a payday loan
Even if you think you may be turned down, ask your bank or credit union for overdraft protection on your bank account, or a line of credit. These are relatively inexpensive ways of obtaining access to extra funds, for short-term use.


If you are turned down for any of these credit options, ask why. If the reason is that you have a poor credit history, contact the three credit-reporting agencies to get a copy of your credit report. Read the reports carefully to make sure that all of the information in it is correct. If you find any errors, contact the credit-reporting agency to find out how you can have the information corrected. The three major credit-reporting agencies in Canada are Equifax Canada, TransUnion Canada and Northern Credit Bureaus. All three of these agencies will give you a copy of your credit report for free if you request that it be sent to you by regular mail.


Ask yourself if you really need to take out a loan, or whether you can get by until your next pay cheque. If you need the money immediately, try to make other arrangements. For example, you may be able to cash in vacation days. Or you might consider getting a short-term loan from a family member or a friend.


If you find that you need to apply for a payday loan because you have no alternative, only borrow an amount that you are 100 percent sure you can repay on the due date of the loan.


Don't borrow more than you need.

Things to consider if you take out a payday loan
Don't be afraid to ask a lot of questions. Read carefully — and take home with you — a copy of the loan agreement that you are being asked to sign. Don't feel pressured to sign the loan agreement right away if you have questions and want more time to read through the agreement on your own. If the lender does not want to give you a copy of the agreement, look for another lender.


Be sure to ask about all the fees, charges and interest that apply when you first get the loan, and what other charges you will owe if you can't pay the loan back on time.


If you are taking out a payday loan at another location to pay back the first payday loan, or you are extending or "rolling over" the loan that you had with the same lender, you could find yourself in serious financial difficulty. The fees, charges and interest will add up quickly on these types of loans, which can put you into serious debt.
How can I figure out the cost of each type of loan?
To estimate the total cost of a loan, including the annual cost of the loan expressed as a percentage of the amount borrowed, follow the steps below.

Step 1:

Determine how much interest you will pay. First, find out the annual interest rate that applies to the loan (if there is one). Figure out the daily interest rate by dividing the annual interest rate of the loan by 365 days. Then, multiply that rate by the length of time you are taking the loan. Finally, multiply the result by the amount you will borrow, in dollars:


Amount of interest

= Annual interest rate

--------------------------------------------------------------------------------
365 days × Length of the loan
(number of days) × Amount of the loan

Step 2:

Determine the total cost of the loan by adding any fees that may apply to the interest you will have to pay. Find out what fees apply to the loan and add them to the cost of the interest, found in Step 1:


Total cost of the loan = Amount of interest + Total fees


Step 3:

Estimate the annual cost of the loan, expressed as a percentage of the amount borrowed. First, divide the total cost of the loan, found in Step 2, by the amount of the loan. Then, divide this rate by the length of time you are taking the loan (in days) and multiply it by 365 (the number of days in the year):


Annual cost of the loan (%)

= Cost of the loan

--------------------------------------------------------------------------------
Amount of the loan ÷ Length of the loan
(number of days) × 365 days

Let's find out the cost of a $300 payday loan, taken for 14 days.

We'll assume that the lender charges you a one-time set-up fee of $10 and a service fee of $40, which includes interest on the loan.


Step 1:

Determine how much interest you will pay. In this case, there is no interest fee. The interest is therefore $0.


Step 2:

Figure out the cost of the loan by adding together any fees that apply and the interest you will have to pay. In this case, you would add the $10 set-up fee and the $40 service fee together:

$10 + $40 = $50


Step 3:

Estimate the total annual cost of the loan, expressed as a percentage of the amount borrowed:


Annual cost of the loan (%)

= Cost of the loan

--------------------------------------------------------------------------------
Amount of the loan ÷ Length of the loan
(number of days) × 365 days
= $50
———— ÷ 14 days × 365 days
$300
= 4.35 or approximately 435%

The total cost of the payday loan would be $50 with an annual cost of 435 percent of the amount borrowed.






Information asymmetries are common in credit market models, but the usual assumption,

at least in commercial lending, is that borrowers are the better informed party and that

lenders have to screen and monitor to assess whether firms are creditworthy. The opposite

asymmetry, as we assume here, does not seem implausible in the context of consumer lending.

“Fringe” borrowers are less educated than mainstream borrowers (Caskey 2003), and many

are first-time borrowers (or are rebounding from a failed first foray into credit). Lenders

know from experience with large numbers of borrowers, whereas the borrower may only have

their own experience to guide them. Credit can also be confusing; after marriage, mortgages

are probably the most complicated contract most people ever enter. Given the subtleties

involved with credit, and the supposed lack of sophistication of sub-prime borrowers, our

assumption that lenders know better seems plausible.

While lenders might deceive households about several variables that influence household

loan demand, we focus on income. We suppose that lenders exaggerate household’s future

income in order boost loan demand. Our borrowers are gullible, in the sense that they can

be fooled about their future income, but they borrow rationally given their beliefs. Fooling

borrowers is costly to lenders, where the costs could represent conscience, technological costs

(of learning the pitch), or risk of prosecution. The upside to exaggerating borrowers’ income

prospects is obvious—they borrow more. As long as the extra borrowing does not increase

default risk too much, and as long as deceiving borrowers is easy enough, income deception

and predatory—welfare reducing—lending may occur.

After defining predatory lending, we test whether payday lending fits our definition. Payday

lenders make small, short-term loans to mostly lower-middle income households. The

business is booming, but critics condemn payday lending, especially the high fees and frequent

loan rollovers, as predatory. Many states prohibit payday loans outright, or indirectly,

via usury limits.

To test whether payday lending qualifies as predatory, we compared debt and delinquency

rates for households in states that allow payday lending to those in states that do not. We

focus especially on differences across states households that, according to our model, seem

more vulnerable to predation: households with more income uncertainly or less education.

We use smoking as a third, more ambiguous, proxy for households with high, or perhaps

hyperbolic, discount rates. In general, high discounters will pay higher future costs for a

given, immediate, gain in welfare. Smokers’ seem to fit that description. What makes the

smoking proxy ambiguous is that smokers may have hyperbolic, not just high, discount rates.

Hyperbolic discount rates decline over time in a way that leads to procrastination and selfcontrol

problems (Laibson 1997). The hyperbolic discounter postpones quitting smoking,

or repaying credit. Without knowing whether smokers discount rates are merely high, or

hyperbolic, we will not be able to say whether any extra debt for smokers in payday states

is welfare reducing.2

Given those proxies, we use a difference-in-difference approach to test whether payday

lending fits our definition of predatory. First we look for differences in household debt

and delinquency across payday states and non-payday states, then we test whether those

difference are higher for potential prey. To ensure that any such differences are not merely

state effects, we difference a third time across time by comparing whether those differences

changed after the advent of payday lending circa 1995. That triple difference identifies any

difference in debt and delinquency for potential prey in payday states after payday lending

was introduced.

Our findings seem mostly inconsistent with the hypothesis that payday lenders prey on,

i.e., lower the welfare of, households with uncertain income or households with less education.

Those types of households who happen to live in states that allow unlimited payday loans

are less likely to report being turned down for credit, but are not more likely, by and large,

to report higher debt levels, contrary to the overborrowing prediction of our model. Nor are

such households more likely to have missed a debt payment in the previous year. On the

contrary, households with uncertain income who live in states with unlimited payday loans

are less likely to have missed a debt payment over the previous year. The latter result is

consistent with claims by defenders of payday lending that some households borrow from

2Consistent with a high discount rate, Munasinghe and Sicherman (2000) discover that smokers have

flatter wage profiles and they are willing to trade more future earnings for a given increase in current earnings.

Gruber and Mulainathan (2002) find that high cigarette taxes make smokers ”happier,” consistent with

hypberbolic discount rates (because taxes help smokers commit to quitting). DellaVigna and Malmendier

(2004) show how credit card lenders can manipulate hyperbolic discounters by front-loading benefits and

back-loading costs.

payday lenders to avoid missing payments on other debt. On the whole, our results seem

consistent with the hypothesis that payday lending represents a legitimate increase in the

supply of credit, not a contrived increase in credit demand.

We find some interesting differences for smokers, but those differences are harder to

interpret in relation to the predatory hypothesis without knowing apriori whether smokers

are hyperbolic, or merely high, discounters.

We also find, using a small set of data from different sources, that payday loan rates

and fees decline significantly as the number of payday lenders and pawnshops increase.

Reformers often advocate usury limits to lower payday loan fees but our evidence suggests

that competition among payday lenders (and pawnshops) works to lower payday loan prices.

Our paper has several cousins in the academic literature. Ausubel (1991) argues that

credit card lenders exploit their superior information about household credit demand in their

marketing and pricing of credit cards. The predators in our model profit from their information

advantage as well. Our concept of income delusion or deception also has a behavioral

flavor, as well, hence our use of smoking as a proxy for self-control problems. Brunnermeier

and Parker (2004), for example, imagine that households choose what to expect about future

income (or other outcomes). High hopes give households’ current “felicity,” even if it

distorts borrowing and other income-dependent decisions. Our households have high hopes

for income, and they make bad borrowing decisions, but we do not count the current felicity

from high hopes as an offset to the welfare loss from overborrowing.

Our costly falsification (of household income prospects) and costly verification (by counselors)

resemble Townsend’s (1979) costly state verification and Lacker andWeinbergs’ (1989)

costly state falsification. The main difference here is that the falsifying and verifying comes

before income is realized, not after.

More importantly, we hope our findings inform the current, very real-world debate,

around predatory lending. The stakes in that debate are high: millions of lower income

households borrow regularly from thousands of payday loan offices around the country. If

payday lenders raise household welfare by relaxing credit constraints, anti-predatory legislation

may lower it.

Payday lenders make small, short-term loans to households. The typical loan is about $300

for two weeks. The typical fee is $15 per $100 borrowed. Lenders require two recent pay

stubs (as proof of employment), and a recent bank account statement. Borrowers secure

the loan with a post-dated personal check for the loan amount plus fees. When the loan

matures, lenders deposit the check.

Payday lending evolved from check cashing much like bank lending evolved from deposit

taking. For a fee, check cashiers turn personal paychecks into cash. After cashing several

paychecks for the same customer, lending against f uture paychecks was a natural next step.

High finance charges is the main criticism against payday lenders. The typical fee of $15

per $100 per two weeks implies an annual interest rate of 15x365/14, or 390 percent. Payday

lenders are also criticize for overlending, in the sense that borrowers often refinance their

loans repeatedly, and for ”targeting” women making the transition from welfare-to-work

(Fox and Mierzewski 2001) and soldiers (Graves and Peterson 2004).

Despite their critics, payday lending has boomed. The number of payday advance offices

grew from 0 in 1990 to 14, 000 in 2003 (Stegman and Harris 2003). The industry originated

$8 to $14 billion in loans in 2000, implying 26-47 million individual loans. Rapid entry

suggests the industry is profitable.

Payday lenders present stiff competition for pawnshops, even though the internet, namely

E-bay, significantly foreclosure costs for pawnshops (Caskey 2003). The number of pawn

shops in the U.S. grew about six percent per year between 1986 and 1996, but growth

essentially stalled from 1997 to 2003. Prices of shares in EZCorp, the largest, publicly

traded pawn shop holder, were essentially flat or declining between 1994 and 2004, while

Ace Cash Express share prices, a retail financial firm selling check cashing and payday loans,

rose substantially over that period (Figure 4). EZCorp CEO, Joseph Rotunday, blamed

payday lenders for pawnshops’ dismal performance:

The company had been progressing very nicely until the late 1990s.... (when)

a new product called payroll advance/payday loans came along and provided our

customer base an alternative choice. Many of them elected the payday loan over

the traditional pawn loan. (Quoted by Caskey (2003) p.14).

Payday lending is heavily regulated (Table 1). As of 2001, eighteen states effectively

prohibited payday loans via usury limits, and most other states prices, loan size, and loan

frequency per customer (Fox and Mierzwinski 2001). Note that the payday loan limit ranges

from 0 (where payday loans are illegal) to 1250. Nine states allow unlimited payday loans.

Payday lenders have circumvented usury limits by affiliating with national or state

chartered banks, but the Comptroller of the Currency—the overseer of nationally chartered

banks–recently banned such affiliations. The Federal Deposit Insurance Corporation still

permits payday lenders to affiliate with state banks, but recently restricted those partnerships

(Graves and Peterson 2005).

Regulatory risk—the threat of costly or disabling legislation in the future—looms large for

Payday lenders. The Utah legislature is reconsidering its permissive laws governing payday

lending. North Carolina recently drove payday lenders from the state by expressly outlawing

the practice.

Heavy regulation increases the cost of payday lending. High regulatory risk increases limits

entry into the industry and increases the expected return required by industry investors.

Driving up costs and driving away investors may be exactly what regulators intended if they

view payday lending as predatory.
We define predatory lending as a welfare reducing provision of credit. Households can be

made worse off by borrowing if lenders can deceive households into borrowing more than is

optimal. Excess borrowing reduces household welfare, and may increase default risk.

We illustrate our concept of predatory lending in a standard model of household borrowing.

Before we get to predatory lending, we review basic principles about welfare improving

lending, the type that lets households maintain their consumption despite fluctuations in

their income.

The model has two periods: today (period zero) and payday (period one. Household income

goes up and down periodically, but not randomly (for now): income equals zero today

and y on payday. If households consume Ct in period t, their utility is U (Ct).Household welfare

is the sum of utility over both periods: U (C0)+δU (C1), where δ equals the household’s

time rate of discount. Households with high δ value current consumption highly relative to

future consumption. In other words, high discounters are impatient.

A digression here on discount rates serves later discussion. In classical economics δ is

constant. If δ changes over time, so does household behavior, even if nothing else changes.

If δ(t) is hyperbolic, households will postpone unpleasant tasks until current consumption

does not seem so precious relative to future consumption (Laibson 1997). With hyperbolic

discounting, that day never arrives, so hyperbolic discounters have behavioral problems: they

procrastinate. They may never repay debt, much less begin saving. Hyperbolic discounters

who start smoking may never quit.

Returning to the model, if the marginal utility of consumption (U 0) is diminishing, households

will demand credit to reduce fluctuations in their standard of living. Households

without credit, however, must fend for themselves (autarky). Welfare under autarky equals



U(0)+δU (y). The fluctuations in consumption for households without credit make autarky

a possible worst case, and hence, a good benchmark for comparing cases with credit.

If households borrow B at interest rate r, welfare equals U (B) + δU (y − (1 + r)B).

Borrowing increases utility in period zero, when the proceeds are consumed, but lowers utility

in period one, when households pay for their borrowing. Rational, informed households trade

off the good and bad side of borrowing; they borrow until the marginal utility of consuming

another unit today just equals the marginal, discounted disutility of repaying the extra debt

on payday:



U 0(B) = δ(1 + r)U 0(y − (1 + r)B). (1)

Equation (1) determines household loan demand as a function of their income, their

discount rate, and the market interest rate: B(y, δ, r). For standard utility functions,

household loan demand is increasing in income and decreasing in the discount factor and

interest rate: By > 0; Bδ < 0; Br < 0. Household welfare with optimal borrowing equals



U (B(y, r, d))+δU (y − (1+r)B(y, r, δ)). As long as households follow (1), their welfare with

positive borrowing must be higher than without (autarky).

The welfare gain from borrowing depends on the cost of credit production. Suppose the

cost of lending $B to a particular household equals (1 + ρ)B + f, where ρ represents the

opportunity cost per unit loaned and f is the fixed cost per loan. Think of f as the cost

of record-keeping and credit check required for each loan, however large or small the loan

may be. If the going price for loans is (1+r) per unit borrowed, the lenders’ profits equal

(r − ρ)B − f.



With perfect competition among lenders, the loan interest rate is competed down until

it just covers the costs of the loan: r = ρ + f /B. Equilibrium r and B are determined

where that credit supply curve equals demand (1).

Equilibrium in the payday credit market is illustrated in Figure (3). If fixed costs per loan

are prohibitively high, the market may not exist. Perhaps the payday lending technology

lowered the fixed cost per loan enough to make the business viable.3 Before the advent of

payday lending, households who applied to banks for a very small, short-term loan may have

been denied.

Fixed costs per loan imply that smaller loans will cost more per dollar borrowed than

larger loans. That means households with low credit demand will pay higher rates than

households with high loan demand. Loan demand is increasing in income, so high income

households who demand larger quantities of credit will enjoy a ”quantity” discount, while

lower income households will pay a ”small lot” premium, or penalty. That price ”discrimination”

is not invidious, however; the higher cost of smaller loans reflects the fixed costs of

lending. The high price of payday loans may partly reflect the combination of fixed costs

and small loan amounts (Flannery and Samolyk 2005).

A usury limit lowers household welfare. Suppose the maximum legal interest rate is r.



At that maximum rate, the minimum loan that lenders’ cost is f /(r− ρ) = B. Low income

households with loan demand less than B face a beggar’s choice: borrow B at r or do not

borrow at all. Such households would be willing to pay more to to avoid going without

credit, so raising the usury limit would raise welfare for those households.

Competition is another key determinant of how much households gains from borrowing.



3Alternatively, or additionaly, the demand for small, short term loans may have increased in the mid

1990s. The welfare reform then almost certainly increased demand for such credit as households who once

”worked” at home for the government were forced to go to work in the market.

Even with no competition — monopoly—households cannot be worse off than under autarky.

The monopolist raises interest rates until the marginal revenue from higher rates equals the

marginal cost from lower loan demand:



B(y, r) = −(r − ρ)Br(y, r). (2)

At that monopoly interest rate, rm, household loan demand equals B(y, rm).Household welfare

under monopoly equals U (Br(y, rm))+δU (y −(1+rm)Br(y, rm)). Welfare is lower under

monopoly because credit costs more and their standard of living fluctuates more (because

costly credit reduces their demand for credit) If households borrow from the monopolist,

however, they must better off than without credit.

In sum, welfare for rational households is highest if credit is available at competitive

prices. If households choose to borrow, they must be at least as well off as they were

without credit. Limiting loan rates cannot raise household welfare and may reduce it.

Monopoly lenders lower household welfare, but even with a monopolist, households cannot

be worse off than without credit.

The high cost of payday lending may partly reflect fixed costs per loan. Before payday

lending, those fixed costs may have been prohibitive; very small, short-term loans may not

have been worthwhile for banks. The payday lending technology may have lowered those



fixed costs, thus increasing the supply of credit to low income households demanding small

loans. That version of the genesis of payday lending suggests the innovation was welfare

improving, not predatory.





In the textbook model household welfare cannot be lower than under autarky because households

are fully informed and rational. Here we show households how can be made worse off



than without credit if predatory lenders can delude households about their (households’)

future income.

Suppose that by spending C(τ ), lenders can convince a prospective borrower that her

income on payday will be y +τ. The cost C can be interpreted variously as the cost of a guilty