Troubles in Paradise for Bitcoin

A few weeks ago I wrote an article on Bitcoin here. The major advantage of Bitcoin was that it is ‘unregulated’. However, that has caused people to enter the Bitcoin exchange business who aren’t particularly tech-saavy, but rather money hungry. A huge security breach at one of the major Bitcoin exchanges has been reported and now withdrawals have been suspended. Yikes… it is becoming clearer that Bitcoin is more of a speculative investment rather than a true form of money.

See the update on the security breach: here.

“Shche ne vmeria Ukraina”: Ukraine has not yet perished.

In its strategic position between Europe and Asia with a population of about 45 million people, Ukraine is a very important country to both the European Union and Russia.  This importance is at the forefront of all of the bloodshed in Ukraine. Primarily, both trade regions would benefit from Ukraine economically, but Russia also stands to gain some power and influence with ties to Ukraine. In order to understand the escalating situation in Ukraine and Russia’s influence, it is essential to take a look at Ukraine’s political system and its modern ties with Russia (post-independence from the USSR in 1991).


Parliament, Prime Ministers and Presidents

The President of Ukraine is elected by the population for a 5-year term, but they are also eligible for a second term. Prime ministers are appointed by the president with approval from Parliament. The Parliament must have constitutional majority. Parliament in Ukraine is called the Verkhovna Rada or just Rada. It’s meaning can be said to be “Supreme Council”. Parliament meets in the Verkhovna Rada building in Ukraine’s capital Kiev and has a unicameral (one-chamber) parliament of 450 deputies.  The Parliament determines domestic and foreign policy, approves budgets, designates elections for the President, impeaches the president, appoints the Prime Minister, appoints parts of the Constitutional Court of Ukraine and declares wars and peace.

Background on Ukraine: How They Broke Free from Russia

During the 18th century, most of Ukrainian’s territory was absorbed by the Russian Empire. Following the collapse of Russia in 1917, Ukraine had a brief period of independence from 1917-1920. However, they were forced back into Russian rule which also engineered two famines in the area from 1921-22 and 1932-1933 where over 8 million people died. Final independence was achieved in 1991 when the USSR dissolved.

How Viktor Yanukovych rose to power:

There was a mass protest, albeit peaceful, called the “Orange Revolution” in November 2004 where authorities overturned a rigged presidential election.  Official count said that Prime Minister Viktor Yanukovych won the poll, but many believed it was rigged. Viktor Yushchenko, opposition candidate, (Note: This is a different Viktor Y than the Prime Minister) challenged the results and led to the streets in mass protest. The Supreme Court annuls the result of the poll. In December 2004 there is a new poll and Victor Yushchenko wins. Viktor Yanukovych challenged the results while resigning as Prime Minister. The Supreme Court rejects the challenge and Viktor Yuschenko is sworn in January 2005. The president nominates Yulia Tymoshenko as Prime Minister and the Parliament approves. In September, Yulia Tymoshenko is ousted and Yuri Yekhanurov is her successor.

In January 2006, Russia briefly cuts Ukraine’s supply of gas. In March 2006, Viktor Yanukovych’s party tops polls in Parliamentary elections with Yulia Tymoshenko taking second and incumbent Viktor Yuschenko taking third. Viktor Yanukovych allies his party, Party of Regions, with the Socialist party rather than the Socialist Party team up with the Orange Revolution supporters (Yuschenko and Tymoshenko ), who are in the the Our Ukraine party. This helps to empower Yanukovych.  President Yuschenko accepts Viktor Yanukovych’s nomination for Prime Minister rather than have Parliament call for new elections in August 2006. In December 2007, Yulia Tymoshenko is appointed prime minister, again.

In March 2008, Russia’s state-owned natural gas company, Gazprom, agrees to supply Ukraine’s industrial consumers directly. In January 2009, Russia stops all gas supplies to Ukraine after unpaid bills due to the financial crisis. In December, Ukraine and Russia sign a deal on oil transit for 2010.

In February 2010, Viktor Yanukovych is declared winner of the presidential election (5 years after Yuschenko served his full term). His main rival in the elections, Prime Minister Yulia Tymoshenko, claims the election is rigged. She steps down from Prime Minister as many of her Parliament supporters switched sides and gave her a no-confidence vote. President Yanukovych appoints Mykola Azarov to succeed her. In December 2010, former Prime Minister Yulia Tymoshenko is charged with abuse of state funds. She denies the charge and says it is due to political motivations. The Supreme Court jails her after saying she abused power in a gas deal with Russia in 2009.

Why Ukraine is important to Russia & Russia important to Ukraine:

It has very fertile black soil and generates substantial amounts of meat, milk, grain and vegetables. It also has a heavy industry which provides machinery to Russia for mining and drilling. However, Ukraine depends on Russia for energy supplies. To be clear, 75% of its oil and natural gas comes from imports.  Ukraine agreed to a 10-year gas supply and transit contracts with Russia in January 2009, but due to strict terms of the contract Ukraine’s state led gas company was not able to develop.

The Weak Economy in Ukraine Leads to a Need for Aid

Steel prices dropped during the financial crisis and exposure to financial borrowing lowered growth in 2008. In November that year, Ukraine made a deal with the IMF for $16.4 billion dollars. However, the Ukrainian government stalled and did not implement reforms. As a result of the lost deal, Ukraine’s economy contracted 15% in 2009. A new agreement with the IMF was reached in 2010 and Ukraine negotiated a gas discount with Russia to continue to allow them to use a naval base in Crimea. The IMF agreement was stalled again in 2011 due to the governments lack of implementation of gas tariff increases. This was a result of opposition activists protesting in the street against tax reform on businesses.  2012 ended in a recession.

The Trade Deal the EU Proposed and Russia’s Push Back

The European Union wanted an Association Agreement with Ukraine in early 2013 which contained a free trade component with the EU as well as allowing for the existing free trade agreement between Ukraine and Russia to continue. A country may have more than one free trade agreement, but Russia does not want to work with Ukraine if Ukraine works with the European Union. The EU trade agreement would lead to lower customs, non-tariff barrifs, higher export quotas and EU standards on products. In an effort to encourage Ukraine not to work with the EU, Russia blocked all imports to Ukraine in August 2013. Import flows resumed a week later, but Russia also sent another signal to Ukarine by making Ukrainian exports to Russia go through a longer check process. This was not a blockade or embargo, but rather what Sergei Glaziev, an advisor to President Putin, said is:

The tough application of customs procedures was a pilot test for future customs practices, should Ukraine decide to make the ‘suicidal step’ of signing the Association Agreement with the EU.

Russia’s fear with an EU and Ukraine trade agreement is that Ukrainian goods will face increased competition from EU goods and cannot compete with the standards of goods of those exported to the EU. As a consequence, they will be ‘dumped’ on the Russian market, which will undercut producers. “Dumping” in trade terminology is when a country or business prices their goods lower than the price abroad in order to sell them quickly and hurt foreign producers by driving them out of business. Further, President Putin fears that EU goods would be re-branded as Ukrainian goods and then shipped to Russia.  Ukraine stands a lot to lose if Russia cuts free trade ties, specifically because they import a large portion of natural gas from Russia.

Why People Revolted in Ukraine

Russia badly hurt Ukraine by stopping natural gas supplies in 2006 and in 2009 and the people of Ukraine did not forget this or their long history with Soviet rule. As President Yanukovych continued to work with President Putin of Russia, Ukrainians felt that continuing ties with Russia distanced them from the economically strong European Union. In November 2013, President Yanukovych favored strong ties with Russia in rejection of the European Union trade agreements. Remembering the success of protests during the “Orange Revolution” which helped force a revote for President, Ukrainians took to the streets in Maidan Square in Kiev.


How It Got Bloody & Where it Stands Right Now

With Russian support, President Yanukovych called for police attacks on protestors, enacted severe anti-protests laws and supposedly abducted opposition activists. This intensified demonstrations against the government. Russia and the European Union have made statements calling for negotiations between protestors and the government. However, Russia has also made strong statements saying that President Yanukovych was elected fairly and should remain in office.  After massive gunfire from February 17-21, where about 100 protestors were killed, a cease fire was enacted. This came after support from European, Russian, and Polish leaders. The deal was accepted and the Parliament called for new elections.

However, protestors did not believe that the government was done turning their weapons on its own citizens. Confrontations continued until February 22 where the heavily armed guard in Kiev around the president was weakening. The President fled to southeast Ukraine and gave a TV interview saying he was still in power.  February 22, Parliament voted to impeach the president. Opposition leader, Yulia Tymoshenko is released from prison.

Where does Ukraine go From Here?

Political turmoil is not over, but hopefully the violence is. New elections should be pursued earlier than 2015 by Parliament and perhaps a deal with the European Union will reemerge. The problem is although a majority of the population does want a closer relationship with Europe, the south and east of Ukraine still want a close relationship with Russia. However, Russian does not want to cede power to anyone and does not want a Ukraine-European Union deal to occur. One thing is clear–President Putin likes to push western democracy to a breaking point by encouraging Ukraine’s former government to push back against its “unruly” people.  The problem is Ukraine is the ultimate loser in this bloodshed as it will take time and trust to rebuild its government and economy. However, the European Union and the United States also look weak for allowing conflict to persist so long, while Russian President Putin may be grinning for not only winning the most gold medals in the Winter Olympics in Sochi but also because he still has power of influence, even if it is by controlling badly needed natural gas to Ukraine.

Like Ukraine’s national anthem says, ““Shche ne vmeria Ukraina”. Ukraine has not yet perished.


Below is a timeline of events in 2013 that includes the start of the protests, deaths of civilians and police and an impeached president.

November 2013-Current: Timeline of Events

On November 21, Viktor Yanukovych announced that Ukraine would seek a trade economic agreement with Russia rather than the European Union.

This event started the protests, yet the Ukrainian people were already upset with the government due to slow economic growth during and after the financial crisis as well as corrupt politics.

December 17, Russia already starts to take care of the Ukrainian gov’t by cutting the price of Russian natural gas to Ukrainians and buying $15 billion worth of the troubled Ukrainian bonds.

January 22, the first tragic incidents between protestors and the police occurs. Two die by ammunition. Anti-protest laws are put into place.

January 28, the prime minister resigns and parliament repeals the anti-protest laws that sparked violence in the first place.

February 16, protestors end their occupation of Kiev City Hall after 234 jailed protestors are released.

February 18, 26 people are dead, including 10 police officers after protestors attacked police lines and set fires outside of parliament. This is in response to parliaments hesitation on constintutional reform to limit presidential powers.

February 22, Parliament impeaches President Yanukovych. He takes flight to Crimea, an island in Ukraine, with heavy Russian influence. Acting Interior Minister, third in command after the President and Prime Minister, have an arrest warrant out for the former President for “mass killings of civilians”.


The Problem With Little White Girls (and Boys)

A worthy read encompassing race, culture, humanitarianism, the efficient allocation of resources, and how not to take ourselves too seriously. I commend it to you.

Pippa Biddle

White people aren’t told that the color of their skin is a problem very often. We sail through police check points, don’t garner sideways glances in affluent neighborhoods, and are generally understood to be predispositioned for success based on a physical characteristic (the color of our skin) we have little control over beyond sunscreen and tanning oil.

After six years of working in and traveling through a number of different countries where white people are in the numerical minority, I’ve come to realize that there is one place being white is not only a hindrance, but negative –  most of the developing world.

Removing rocks from buckets of beans in Tanzania. Removing rocks from buckets of beans in Tanzania.

In high school, I travelled to Tanzania as part of a school trip. There were 14 white girls, 1 black girl who, to her frustration, was called white by almost everyone we met in Tanzania, and a few teachers/chaperones…

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Walmart’s “Made in the USA” Ad

I had several posts last year on nationalism (see them here). Grover Cleveland over at Pileus offers yet another example of it.


I was just taking in a few minutes of the Olympics when I saw a new Walmart ad touting its pledge to purchase $250 billion of American-made products (or perhaps more accurately, its  “pledging [of] $250 billion to products purchased from American factories”).  Roll the tape and see for yourself:

It is a bit odd to see Walmart pitching this “Made in the USA” message while blaring a song (“Working Man”) by the non-Americanband Rush!*  It really made me chuckle to see Walmart undercut its mercantilist-esque theme by choosing the best product for what it is trying to accomplish – just like most of us – and that product is made by non-Americans!

Of course, I generally don’t care where my products (or music) come from as long as they meet my needs (price, quality, etc).  Just like Walmart with its music selection, the wise consumer choooses products no matter where they come from and just says yes to free markets without any mercantilist-induced…

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SolarCoin: The “GREEN” Bitcoin?

As a followup to my Bitcoin post, there is a new “solar energy” coin in the solar marketplace that operates much like Bitcoin. It is a coin in which people with solar panels can trade in their energy-saving certificates, which they receive monthly for feeding energy into the solar grid, for coins.  However, these coins are currently WORTHLESS in the market (unlike Bitcoin), but if it catches fire with solar panel owners founders say it can be worth $20-$30/coin. The problem is what incentive is there for someone to want SolarCoins? When comparing cash vs. SolarCoins, SolarCoins are not accepted everywhere, they do not store value nor are they a unit of account (i.e. prices of goods are not quoted in terms of how many SolarCoins it requires to buy).  Alternatively, cash does. The only thing that SolarCoin seemingly offers, like Bitcoin, is the money is unregulated and thus “untraceable”.

Okay, perhaps maybe there is another “benefit” of  SolarCoins… it is “green”.

Check out SolarCoins here: SolarCoin article in New Scientist

Obamacare: The Debate Continues…

The controversy over Obamacare continues. The Congressional Budget Office just released a very mixed report on the future prospects of the law as it pertains to expected labor market trends. You can read the 15-page report here.

More interesting, however, is this Intelligence Squared debate last month in which the motion under debate was “Obamacare Is Now Beyond Rescue.” Enjoy:


Payday Lending and the Regulation of Consumer Finance IV

Thus far, I have introduced the market for payday loans (Part I), surveyed the most common criticisms of this fringe credit market (Part II), and evaluated those criticisms in light of the empirical literature (Part III). In this fourth and final segment, I group the public policy rationales for restrictive regulation into three broad categories—market failure, externalities, and the nudge approach—and address their applicability to the market for payday loans.

Market Failure and Public Policy

The most heavily cited justification offered for regulatory action in the field of public policy is market failure.[1] This has been no less the case among advocates for restrictive regulation of the fringe credit market. Bar-Gill and Warren, for example, urged the creation of a national-level consumer credit regulatory agency as a “more effective regulatory response to the identified failures in consumer credit markets.”[2] Market failure as a paradigm reflects an implicit assumption that a free enterprise system is the default method of organizing economic activity, leaving to government the limited role of intervening to correct failures of the market to achieve desirable outcomes. This perspective frames policy debates but can be misleading in at least two important ways.

First, in economics, market failure typically refers to an instance in which a market does not achieve the level of efficiency or produce the overall level of social welfare depicted by an abstract economic model, an admittedly stylized account of a market’s operation. As economist Peter Klein explains, “Orthodox welfare analysis typically compares real world outcomes with the hypothetical benchmark of perfectly competitive general equilibrium. It is unsurprising, then, that actual market outcomes will come up short.”[3] Thus, while such models are useful in limited applications, such as communicating the intuitions behind certain economic concepts, they are of limited value in evaluating the operations of actual markets.

Second, and relatedly, the frictionless markets of orthodox models have no institutions. Indeed, because such models assume perfect information and zero transactions costs, they require no institutions. Institutions, both formal and informal, arise for the very purpose of coping with imperfect information and transactions costs. Being long habituated to contemplating a frictionless and thus institutionless world in economic analysis, it is very easy to imagine a false dichotomy between the operation of a market and the institutions—both formal and informal—that give it shape. Real markets, on the other hand, consist of a rule environment and individual agency within that rule environment. The rules of the rule environment consist of formal laws and informal norms or customs which constrain the choice sets and inform the expectations of contracting parties. When such arrangements center on the exchange of a particular good or service, a market for that good or service obtains.

To see why market failure can mislead us in evaluating the performance of markets, an analogy is in order. Like a market, a traffic system consists of a rule environment and individual agency within that environment. The rules of the road consist of formal traffic regulations as well as informal customs which arise among drivers over time—indeed, many of the latter precede and give rise to the former. But what does it mean to say that such a system fails? What amount of error, what degree of congestion, what number of accidents, injuries, fatalities, etc. constitute failure? As soon as we permit the threshold to be raised above zero, defining the limit becomes arbitrary, and the vacuous nature of “failure” in this context becomes evident. Whatever our intuitions about an ideal traffic system, the relevant question from a systems design point of view is whether some viable alternative rule configuration is likely, given the likely reactions of agents to the new rule environment, to outperform the current system along the relevant margins. This is not only an empirical question, it is a comparative one.

Much of the empirical literature discussed in Part III relies heavily on state-by-state comparisons of how different rule configurations have performed along relevant margins of welfare. This is by far a more fruitful mode of analysis than the market failure approach because each state, shortcomings notwithstanding, demonstrates a more or less attainable alternative market for consumer credit. As Nobel laureate Ronald Coase put it, “Until we realize we are choosing between social arrangements which are all more or less failures, we are not likely to make much headway.”[4] Genuine abuses have occurred in the market for payday loans both among unscrupulous lenders and heedless borrowers, but the choice over which set of rules to apply should be informed by comparative institutional analysis. As an analysis of the empirical literature in Part III suggests, this is not a set of rules that categorically excludes payday lending.

Externalities and Public Policy

Advocates for restrictive regulation of payday lending also employ the externalities justification for regulatory action. Externalities refer to the benefits or costs of an exchange which are not fully captured or borne by the parties to the exchange. Negative externalities are spillover effects which harm individuals not a party to the exchange. The concept of externalities is often subsumed within the market failure rationale but merits separate treatment, which I provide below.

Radical critics of the payday loan industry argue that financial distress caused by payday loans generate negative spillover effects for third parties. Recall Bar-Gill and Warren:

Consumer credit products also pose safety risks for customers. Credit cards, subprime mortgages, and payday loans can lead to financial distress, bankruptcy, and foreclosure. Economic losses can be imposed on third parties, including neighbors of foreclosed property, and widespread economic instability may affect economic growth and job prospects for millions of families that never took on a risky financial instrument.[5]

The rationale here is simple. If the parties to an exchange are informed about the nature of the bargain and its attendant risks yet still elect to engage in the exchange, there is a strong presumption in favor of noninterference, permitting the parties to bear the consequences of the transaction between themselves. However, when parties beyond the scope of the agreement stand to bear considerable costs associated with the exchange, the presumption of noninterference is eroded and a case can be made to legally alter or preclude the exchange to protect the interests of third parties or society more generally.

The externalities rationale is compelling, but simply not available in the case of payday loans. As Part III has demonstrated, the link between payday loans and financial distress is highly dubious, rendering theorized externalities chimerical.

Nudge Approach to Public Policy

The nudge approach to public policy has also been invoked as a justification for regulatory intervention. It stems from the body of research in the cognitive sciences which has caused social scientists to deviate from the rational choice assumption of contemporary economic theory. Essentially, human beings, given their limited cognitive resources, use mental shortcuts (heuristics) “which reduce the complex tasks of assessing probabilities and predicting values to simpler judgmental operations.”[6] These heuristics are often reliable but laboratory research has demonstrated that individuals err systematically and predictably, evincing cognitive biases which lead to suboptimal decision making. Over the past several decades, research aimed at realistically assessing the limits of individual decision making in market contexts has coalesced into the field of Behavioral Economics. Where this research paradigm bears directly on the analysis of legal rules, it has taken on the moniker of Behavioral Law and Economics. This body of research asks questions such as “How are legal rules likely to perform given what we know about actual human decision making and market behavior?”

In a series of articles beginning in the late 1990’s and culminating in a popular book titled Nudge (2008), Cass Sunstein and Richard Thaler began arguing that public policy should be oriented toward correcting the mistakes of market participants, mistakes based on cognitive biases, and to nudge individuals toward more closely realizing their own goals.[7] Although the aims of such a program are admittedly paternalistic, Sunstein and Thaler advocate for a softer form of paternalism—dubbed “libertarian paternalism”—aimed strictly at helping individuals achieve their own goals with the help of rules that nudge them away from error.

Though not uncontroversial,[8] this approach has its virtues. First, it avoids the false dichotomy of the market failure approach between market activity and the institutional or rule environment. It acknowledges that market participants necessarily economize on scarce information and that formal and informal institutions constrain choice and inform the expectations of market participants. Second, in order to reconcile the paternalist goals of such an approach with individual liberty and free markets, Sunstein and Thaler offer a libertarian constraint: interventions are to be aimed solely at guiding individuals to the outcome at which they aim but miss due to cognitive biases. Because policy makers can never know precisely what decisions makers aim at (subjective value), what this constraint means in practice is that a policy must impose only minimal costs on individuals who deviate from the path outlined by the policy. In other words, libertarian paternalism means that policy makers must not strictly forbid behavior they deem suboptimal for the individual concerned.[9]

This libertarian constraint of the nudge paradigm, if it is to mean anything in practice, cannot permit outright bans or effective bans on payday lending. As discussed in my last post, individual consumers may subjectively value this instrument in ways not apprehended by a third party policymaker. Libertarian paternalism is consistent, however, with more moderate approaches, including the disclosure requirements of TILA and even maximum rollover limits with generous thresholds. Each of these policies nudges consumers towards more virtuous decision making with respect to payday borrowing without strictly overriding their preferences. Each policy also has the virtue of interfering little with the substantial subset of payday borrowers who do use payday loans as intended.

Some critics argue that consumers who use fringe credit products evince more than slight error in choosing fringe products where more conventional means are available.[10] Where nudges fail, some scholars argue that ‘pushes’ may be in order.[11] In response, more might be said about some of the virtues of fringe credit relative to mainstream counterparts. I will limit my remarks to a brief comparison of payday loans and credit cards.

When it comes to the use of credit by cognitively limited consumers (all of us!), what concerns us is really the propensity of the consumer to incur unmanageable debt from use of the product. In this connection, two questions naturally arise. Given the structure of the product and propensity of a customer to err in his decision making: (1) What is the likelihood of misuse of the product, e.g., likelihood that the product will be used in excess of need or frivolously? (2) What is the likely magnitude of the harm in the event of misuse, e.g., susceptibility of overleveraging and the consequences thereof? The following table illustrates:

Comparison of Payday Loans and Credit Cards

Credit Cards

Payday Loans

Debt Potential


Low to Moderate

Basis of Eligibility

Credit Score


Susceptibility of Overuse



Susceptibility of Frivolous Use



Likely Result of Overleveraging

Reduction of credit score/Collections

Ineligibility to Borrow/Collections

The debt potential of credit cards is quite high in relation to payday loans. Credit card companies aim to issue credit lines at about 20% of the borrower’s annual income.[12] In fact, 36.8% of American Express cardholders have a credit limit of $20,000.[13] Of course, consumers are free to apply for and hold multiple cards at a given time, and many do. The relatively high interest rate on payday loans notwithstanding, a consumer’s capacity to borrow is strictly anchored to the amount of his next pay check. Skiba and Dobbie (2011) found that the lenders in their sample offered loans of no more than half the borrowers’ net monthly pay.[14] Hawkins (2011) reports that “Even if the borrower goes to multiple lenders, it is unlikely they could get a loan for more than their biweekly salary. Lenders report payday loans to Teletrack, a credit bureau for fringe credit transactions, and lenders check Teletrack before extending loans to ensure potential borrowers have not taken out other payday loans.”[15]

The basis of eligibility between these two credit products also has important features, some of which favor payday loans. A credit card consumer is eligible for a revolving line of credit on the basis of his credit score. The credit score is based on several elements such as repayment history, amounts owed on revolving accounts, and length of credit history.[16] The basis of eligibility for a payday loan is much simpler: the applicant must be employed at the time he applies for a loan. The virtue of the small-scale, employment-based extension of credit from payday loans can be seen in an observation by Hawkins that:

Credit card limits are not constrained by the amount the consumer is paid during any specific pay period. Instead, companies, theoretically at least, estimate a person’s general future income. If a consumer losses her job, she still has access to her entire credit limit. The access to credit is independent of the consumer’s actual income after the credit limit is approved, and credit card companies frequently increase consumers’ limits.[17]

The fact that payday lenders do not consult credit scores means that borrowers which are already financially distressed through mainstream products such as credit cards and mortgages can still take out a payday loan. This feature, through adverse selection, can expose payday lenders to a riskier demographic of credit consumer and leave them susceptible to a charge of causing the financial distress they simply inherited. But a credit card consumer being able to continuously draw upon tens of thousands of dollars in credit (even if there is a lapse in income) is highly problematic.

One such problem arises from the susceptibility of misuse. Credit consumers show a tendency to use their credit limits as a heuristic for the amount of debt they can effectively manage.[18] For a credit card consumer who holds several cards, this mental anchor can prove disastrously high relative to the consumer’s income. Moreover, the ease of use by swiping at the point of sale can induce a cognitively limited consumer to underestimate the cost of his purchase and overestimate his ability to repay over an extended time horizon. A payday borrower, on the other hand, is highly constrained by the loan instrument in the amount that he can borrow at one time and relative to his income. Unlike the painless swipe of the credit card consumer, a typical payday borrower must go through the process of taking out an additional loan for any purchase of more than a few hundred dollars. The explicit assessment of a separate fee on each $100 borrowed renders the marginal cost of an addition sum of credit highly salient to the payday borrower. All of these factors leaves a credit card consumer much more likely to amass unmanageable debt on frivolous items than a payday loan borrower.

Finally, comparing the likely consequence of overleveraging via each of the two instruments is instructive. Although, it is difficult to establish the link between payday loans and bankruptcy, that link is firmly established in the case of credit cards.[19] Moreover, unlike payday lenders, credit card companies report defaults to credit rating agencies which results in a diminished credit score. Credit scores are not only important for the ability of consumers to gain access to future credit at low rates, but landlords and employers increasingly rely on credit ratings in assessing applicants. A low credit score can greatly constrain opportunities beyond future access to credit.

One might conclude from this comparative analysis of payday loans and credit cards that payday loans are actually more robust against the types of financial distress which arise on the basis of cognitive bias than credit cards. Though selection effects can result in a higher risk clientele for payday lenders relative to more mainstream credit products, payday lenders compare favorably in rates of default. In the Colorado study, Chessin found the charge-off rate of Colorado payday lenders from 1996 to 2004 to be only 65% of the charge-off rate for credit card companies over the same period.[20] Why does such a high risk demographic perform so much better with payday loans? As the comparative analysis with credit cards suggests, the reason may lay in the structure of the product itself. In fact, the results of the structural analysis and favorable default rates discussed here taken together with studies that link payday loans with increased survivability should force policymakers to consider whether some conventional credit products cause distress that fringe products help to contain. Policymakers should consider this evidence before succumbing to the notion that fringe credit should be conformed to the model of its mainstream counterpart.


The rapidly growing payday loan industry has been the object of growing concern nationwide. Many consumer advocates are harshly critical of the industry and several states have imposed restrictive regulation on payday lenders from price caps to all-out bans. At the federal level, the Consumer Financial Protection Bureau was established in part to consider uniform national regulations of payday lending. Here, over the course of four posts, I have explored the main criticisms and reform proposals surrounding the payday loan industry and evaluated them through a review of the empirical literature. I find little evidence for the harshest criticisms of the industry or that the most restrictive reform proposals would be welfare-enhancing. Thus, I conclude that the most restrictive reform proposals are unwarranted. Policy experimentation at the state level shows promise and should ultimately reveal a set of policies which are consistent with consumer freedom and privacy while addressing the problem of misuse by a subset of consumers. It should be noted that the optimal policy outcome is not one in which no misuse takes place. Such a standard would lead to bans on most products available in the marketplace to the great detriment of consumers. Regulation of consumer finance, like all regulation, must balance consumer choice and consumer protection. Policymakers should carefully guard that balance with respect to payday loans.

[1] As one popular volume on regulation puts it: “Many of the rationales for regulating can be described as instances of ‘market failure’. Regulation in such cases is argued to be justified because the uncontrolled market place will, for some reason, fail to produce behaviour or results in accordance with the public interest.” Baldwin, R., Cave, M. Understanding Regulation: Theory, Strategy, and Practice (1999), p.9.

[2] Bar-Gill, O., Warren, E. “Making Credit Safer” (2008) University of Pennsylvania Law Review, Vol. 157, Number 1, p.98.

[3] Klein, P. New Institutional Economics, p. 2, available at

[4] Ronald Coase as quoted in Klein, id.

[5] Bar-Gill, O., Warren, E. “Making Credit Safer” (2008) University of Pennsylvania Law Review, Vol. 157, Number 1.

[6] Tversky, A. & Kahneman, D. (1974) Science, New Series, Vol. 185, No. 4157. (Sep. 27, 1974), p. 1124.

[7]Thaler, R.H. & Sunstein, C.R. (2008). Nudge: Improving Decisions about Health, Wealth, and Happiness. New Haven: Yale University Press.

[8] Some scholars caution that this perspective merely trades one epistemological problem for another: “Behavioral law and economics can tell us that people sometimes make mistakes, and that they sometimes do at time T what they will report at some time T+1 that they wish they had not done. But it cannot tell us what they really want…As convenient and tempting as it may be to extrapolate from our own introspection that others want what we do, or should, want, we simply have no access to others’ beliefs and desires.” Hill, Claire A. 2007. Anti-Anti-Anti-Paternalism. NYU Journal of Law & Liberty 2(3) p.448.

[9] Proponents of nudging place great weight on the easy opt-out feature of libertarian paternalism but do not specify criteria for evaluating ease. Baldwin and Cave warn that:

Critics, however, are liable to say that this is too easy a response. ‘Ease of opt-out’, they would stress, is a contentious issue that lies at the heart of nudging and the proponents’ answer evidences the dangerousness of nudge: it treats the centrally important issue of opt-out feasibility as a small and relatively uncontentious matter. This approach, the objectors would say, sows the seeds of an illiberal system of control. Baldwin, R., Cave, M., Lodge, M. Understanding Regulation: Theory, Strategy, and Practice (2011), p.124.

[10] Recall Bar-Gill and Warren’s statement that taking out these loans is “difficult to rationalize.”

[11] Over the course of a series of papers, Lauren E. Willis argues that nudges are often an inadequate substitute for substantive regulation. In the area of consumer finance, “Attempts to train people so as to ‘debias’ decision-making have largely failed,” she claims. Am. Econ. Rev.: Papers & Proceedings 429 (2011), p.430. Elsewhere, Willis argues that policy makers resort to financial education often to avoid “the more formidable task of developing procedural regulation that would effectively match products in the fast-moving financial market with the consumers for which they are appropriate.” 94 Iowa L. Rev. 264 (2008-2009), p.264.

[12] Hawkins, J. (2011), at 1375.


[14]Dobbie, W. &Skiba, P.M. (2011), Information Asymmetries in Consumer Credit Markets: Evidence from Payday Lending. Vanderbilt Law and Economics Research Paper No. 11-05, available at

[15]Hawkins, J. (2011), at 1394.

[17]Hawkins, J. (2011), at 1374-75.

[18] Id. at 1376.

[19] See Hawkins, J. (2011) wherein he quotes Ronald Mann: “[e]ven if credit card spending and consumer debt are held constant, an increase in credit card debt—a shift of consumer borrowing from noncard borrowing to card borrowing—is associated with an increase in bankruptcy filings.”

[20]Chessin, P. (2005) at 408.