Monday, July 11, 2005

The end of anonymity

Thinking about the London subway bombings last week, it seems like one thing is certain. In just a few years, after one or two more incidents like this, we are very likely to see the end of anonymity in human society.

What happened on Thursday is that several people walked with complete anonymity into several subway stations. They planted their bombs invisibly and then either left the scene or remained to be detonated. We have no idea who they were, where they came from, who they associated with or where they went if they left the scene.

We consider anonymity like this to be completely normal today. And we see the effects of this anonymity constantly, simply by reading the paper or watching the news. Anonymity gives criminals a huge advantage. The O.J. Simpson case and its "trial of the century" brought this point home with a big splash 10 years ago. On June 12, 1994, two people died in a brutal murder and no one can conclusively prove who did it. We have no idea who was on the street near Nicole Brown Simpson and Ronald Goldman at the time of the murder, or where O.J. Simpson was that night.

The O.J. case is one end of the spectrum – a gigantic murder mystery. At the other end are tiny crimes that happen anonymously everyday. For example, one of my neighbors found the envelope of a credit card bill torn open and lying on the grass near his mailbox last week. He has no idea who did it, and therefore had to cancel all of his credit cards that afternoon.

It would be relatively easy to eliminate anonymity today, and that is why its end is near. All that we need is a way to read biometric information (thumbprint, iris, whatever) whenever a person enters and leaves an area like a subway station. This might be done very simply with thumbprint-reading turnstiles. This type of identity gathering will occur at the entrance to every subway station, building, airport, mall, campus, park, stadium, etc. In addition, the identity of every car will be tracked as it moves around.

That will be the first level of the net. With these simple measures, we would know the identity of everyone who entered the subway stations on Thursday. That data would make it easy to discover the identity of the London terrorists in just a few days.

Then the net will tighten. Once it is known who is entering each facility, it will be possible to use cameras to track each person's motion and identify their exact location on a moment by moment basis. If Person X stops to talk to Person Y, that will be known. So will all of Person X's and Person Y's phone calls, email messages, package deliveries, purchases, etc. No longer will email messages and spam arrive with anonymity – we will know exactly who sent them, and so will "the authorities". That means that once the criminals are caught, all of their associates will be caught as well. Entire terrorist cells will be rooted out quite easily once anonymity disappears.

Is this good or bad? It doesn't really matter – it is inevitable. Anonymity is simply an artifact of our non-technological past. The only reason we have anonymity today is because, in the past, it would have been too expensive and too onerous to eliminate it. Today we can use technology to eliminate anonymity at low cost and with only small inconvenience. We will gladly deploy the technology to eliminate everything from petty theft to global terrorism. Given a choice between "anonymity" and "the potential to have a city blown up by terrorists", we will choose to lose our anonymity.

Once anonymity is gone, it is very likely that we will eliminate crime as we know it today. That will be a very good thing. According to this page, in the year 2000 in the United States there were:In 20 years, people will look back at the level of crime and terrorism that we endure today with a certain horror, in the same way that we look back in horror at all of the deaths caused by things like smallpox.

I can not agree with your assessment. It would not be cheap and easy to track people at that level, and I think that an occasional crime is a small price to pay for the loss of freedom that you would have in such a society. Using your own example of Gattica, the point wasn't that they had a good example of how to do things, but that the entire system was corrupted and topheavy and not everybody was given a chance to succeed or fail.
This is just silly.
Except that smallpox was a far worse horror than all crime and war combined, I basically agree. It might take more like 30 years than 20. 15 for early adopter cities.
By the way, if you don't know, there is a very popular book on this topic by David Brin. It's called "the transparent society".
I think you are correct. And it *will* be cheap and easy, because it's not as though every person needs to be tracked and assessed. All that needs to happen is a crime needs to be noticed, and then the perpetrators need to be identified and their whereabouts tracked. Once this is all automated it will lead to a marked reduction in crime. Yes there will certainly be governmental (or other) abuses, just as there are now with the current level of technology. But the benefits will be largely seen as worth the trade-off.

Governmental person-level tracking began with birth-certificates, the footprinting/fingerprinting of individuals, & social-security-number issuing decades ago; the only reason we don't have more accurate and detailed tracking is simply because the technologies (i.e., computers, databases, ubiquitous cameras, ATMs, point-of-sale machines, wireless Internet, cellphones, GPS, and biometrics) weren't cheap and readily available. Now they are. It is simply a matter of tying it all together, which is already taking place. Most people will readily trade anonymity for convenience - every time you swipe a credit card, use an ATM, make a cellphone call, or use your little "super-saver" tag at a grocery store, someone can track your time and location (although presently only after-the-fact mostly). Who amongst us feels threatened by that? Only the "privacy advocates" who get quoted in the media; the rest of us just live our lives.
Anonymity is a fairly recently development. In the past people lived in small communities where eveyone knew and relied on each other. You could choose anonymity be going somewhere no one knew you, but you would most likely be shunned and possibly harmed.
I like the idea of no more anonymity in public places. It will be like when humans lived in a cave or a small settlement. If you want to cheat on your wife, everyone will know. It's not necessarily a bad thing.

The issue that many would have is that the ability to monitor people on this scale is real power. I believe if the power is only held by the government, then there will inevitably be abuse.

To counteract this, I'd like to see every public camera or monitoring device made available through the internet for anyone to make use of. In this way the power this system would bring would be balanced throughout society. Abuse will be far more difficult.
If the lack of anonymity makes people feel more secure, it could actually lead to an increase in crime if it gives the criminals easier targets.

Crime is just an economic issue. Raise the costs high enough and criminals will quit. The question is will the massive govt dB actually work well enough to raise the cost.

My bet is no. Evil has existed since the beginning of time. 4 billion cameras and fingerprint scanners tied to a cluster of Oracle dB's won't change that.
I too believe in universal identification, but there will be people that will fight it to the death and even become terrorists because the bible tells them the Beast wants to number them.
I'm not sure that fingerprint/iris scans would even be required. Facial recognition with a giant databank of all video collected would be enough to track anyone wherever they go and wherever they've been. People could use a disguise, but I think in the end it would be very difficult to evade a million cameras.
Guess the Anonymous radio button I just checked will disappear :P.

Who am I?
Universal identification may help catch terrorists after the fact, but it won't prevent terrorism from happening. Just because you can *identify* somebody does not mean you know what there *intent* is. Tim McVeigh had no criminal record when he bombed the Oklahoma Fed building. None of the 9/11 hijackers made any attempt to conceal or falsify their identity.

Getting caught after the fact was probably not a deterrent for McVeight. It certainly wasn't for the 9/11 hijackers. Eliminating anonymity won't eliminate serious crime.
I agree. The only people who want to remain anonymous are those with something to hide. If you don't want other people to know you're doing something, you probably shouldn't be doing it. I'd gladly live in a society without anonymity.
Now I understand how the utopian culture depicted in Star Trek came to be.
The problem with a system which can backtrack any criminal to find the associates is that it can do the same with anyone else, for any reason.

Backtrack all the political activists you don't like to find their associates, and harass them.

Or the adherents of some particular religion.

Or the people who visit "clothing optional" resorts.

Any system like this is tailor-made for totalitarianism.  Anonymity and privacy are required for freedom.
Or the people who visit "clothing optional" resorts.

I can't see how any of the examples you cite would limit freedom.

Perhaps one day google will add this type of search to its service. Upload a picture of a person to google and facial recognition would generate a number. Then search for occurrences of that number over a given timeframe. Anyone would be free to access the database.

Instead of a few investigators trying to solve a crime, millions could potentially contribute.

Politicians, lobbyists, etc could all be tracked and odd patterns could be exposed.

In the end this type of system could minimize a great deal of abuse criminal or otherwise in society. In the end it could promote freedom.
"I can't see how any of the examples you cite would limit freedom."

If every second of one's life can be scrutinized by anyone who cares to, the people who are most likely to do so are the ones with the most narrow concept of what is decent and proper.  Even if the government doesn't care (and if John Ashcroft can be approved for the office of Attorney General, you can be sure that there are busybodies at the highest level), people like that can make your life very difficult.  This is one of the reasons people leave small towns.

I can see the combination of no anonymity or privacy combined with busybodies resulting in greatly increased murder and suicide rates; if people cannot shut others out of their lives, there are only two other things that can give.
So, what happened to the Gattaca reference? I know it was wrong (blood sample, not fingerprints), but wouldn't strikeout with corrections, or a post script UPDATE: be preferable to disappearing it?
Here's the response from my blog:

For a vivid dystopian imagining of this technology, "Minority Report" is hard to beat. Identified by long-range retina scans, people are followed -- everywhere -- by the equivalent of personalized multimedia junkmail. Not an improvement. More classically, telescreens from 1984 made things very "secure".

I agree that anonymity as we know it is changing, and trying to preserve the status quo indefinitely is futile. However, that does not mean we should be apathetic about it. Vitally important questions remain around how this information will be managed, what it can be used for, who will have access, how abuse will be punished, and what people's rights are when it comes to their own information.
Dont worry, Big Brother will take care of you. History has proven that the governments that have more control over their people and large amounts of information about everyones affairs usually take better care of their populations.

Another flaw in your analysis, in relation to the london bombings or the 911 bombings: the information would enable us to know who just murder all those people, it would do nothing to stop the murder. The complete and total loss of liberty may reduce petty crimes, but suicide bombers, rapists, and murderers very often arent too worried about getting caught when they perpatrate their acts.

If given the choice between turning my life over to big brother or having to cancel my credit cards, I'll just cancel my credit cards. The government can protect my property and enforce my contracts with complete disregaurd to my identity. Given the choice between living in a free society and having thousands of people die or living in a controlled society, I'd rather watch citizens die.

Furthermore, nothing should be made illegal simply because it has the potential to be abused. You'll bitch when you lose your freedom of speach in this blog, but you will lose it because it has the potential to be abused. The same goes for MP3 players, DVD burners, fast cars, weapons, and a hundred other things. I refuse to support laws that are addressed to the lowest eliments of society and I refuse to give up my freedoms because other peoplpe have abused them.

"People willing to trade their freedom for temporary security deserve neither and will lose both."

- B. Franklin

ps. Proud to post anonymously from behind multiple firewalls, with encryption, and under a spoofed IP.
Marshall, My name is Mario G. Nitrini 111.

I was personally involved in The OJ Simpson Case and am One of Three of the MOST covered up people in this Case. The Other 2 are Bill Wasz and Rocky Bateman.

I had an Article written about Me by Bill Boyarsky in the Los Angeles Times on June 23rd, 1995 and I was also on David Bresnahan's National Radio Show in March of 2001.

I went to the Link You had Posted about The OJ Simpson Case. It's NOT the Writers Fault, but it's "MISSING" LOT'S of Behind the scene's Situations, LOT'S.

There IS going to be Legal Happenings with Certain People that had some kind of a Connection to The OJ Simpson Case.

Marshall, I found Your article Very Interesting, but I Did Not Grasp the entire Meaning of it. I don't Believe Much in Statistics for Reasons, because Statistics Don't tell the whole story.

I will tell You this Marshall. The OJ Simpson Case IS going to Heat-Up Again.


Mario G. Nitrini 111
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it has become very easy to borrow loans these days. Advancements in technology particularly with the Internet have made it convenient for loan seekers to track the loan of their choice. With just a few clicks on a lender's website you can access the desired loan online. The ease with which loans are available online nowadays is the main reason behind the growing number of debt-related problems.

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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
= 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
We will work with you to develop a plan that best serve your particular needs. We will then negotiate with your lender to incorporate any changes that are needed to make the plan acceptable both to you and to your lender. Keeping you in your home is advantageous to the lender. Our job is to help them appreciate that advantage.

You may have been told that a short sale is your only course of action. What you may not have been told is that you may be dealing with the consequences of that action for many years.


We understand that you may be facing immediate deadlines and that any delay can mean a loss of meaningful options for relief.


Though we are happy to assist you with bankruptcy, should that be necessary, we believe it is an option that is avoidable more often than people realize.


Restructuring plans may include:

Adding delinquent payments and any foreclosure fees to the back end of the loan. This may include a permanent reduction in your interest rate.

Forbearance plans may be used to temporarily halt the foreclosure process for up to four years while you make payments to become current with the lender.


In our negotiations with your lender we are seeking to lower your payments, lower the interest rate, mitigate any negative impact on your credit rating, and keep your home from going into foreclosure. The lender benefits by continuing to receive payments on the mortgage, and saving on the costs that would be incurred in a foreclosure.


We will need to document your income and expenses for the last two years. Documentation will include pay stubbs, tax returns, bank statements and property tax bills, and all of the paperwork associated with your mortgage. We will need copies of your bills to document your financial situation and the factors that led to your falling behind. Please provide any other letters or notices that demonstrate that you faced a reduction in your income or higher than expected expenses.


We will ask you to prepare a draft letter that explains in your own words what factors have led to your need for a modification from the lender. It is important that you author this letter, and that it is not generic. Please include the details that bring to life the financial difficulties that you have faced. If you feel that you were not properly and fully informed regarding the terms of your loan, please describe the process by which you came to sign the loan papers and what your understanding of the terms of your loan was at that time.

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