The controversy around Mark Warner's payday lending bill, explained

Payday lending is not something you'd think a major Democratic politician would want to boost. But Sen. Mark Warner (D-Va.) has gotten himself into some hot water over a bill that critics say would do exactly that.

Payday lenders and their ilk have come under increased scrutiny recently for offering poor Americans small short-term loans with catastrophically high interest rates. According to Pew Charitable Trusts, 12 million Americans use payday loans each year, averaging $520 in fees just to borrow $375.

Speaking with The Week, Warner's office was adamant that the senator is not motivated by any great concern for payday lenders. Instead, a spokesperson claimed that Warner's benevolently titled Protecting Consumers’ Access to Credit Act tries to "restore long-standing legal precedent and encourage access to credit for low- and middle-income Americans" by fixing a problem of patchwork regulation.

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But like most things to do with finance, the details are complicated.

At issue is the different ways that states try to handle payday lenders. Some states try to crack down on them with caps on interest rates. But other states are more lenient. And the situation is further complicated by big national banks, which operate under federal law and only have to comply with interest rate caps in the state they're chartered in.

That loophole enables national banks to engage in "rent-a-charter" schemes. Since these banks aren't subject to an interest rate cap (or are subject to a more lenient one), they can issue a predatory loan, then immediately sell that loan to a smaller payday lender barred by state law from issuing it on its own.

A 2015 case in the Second Circuit, Madden v. Midland, put the kibosh on this practice within its jurisdiction. But by ruling that the state law governing whoever owns the loan gets final say, it upended a long-standing legal concept called "valid when made" — which says, basically, that if the terms of a loan are acceptable in whatever jurisdiction it's created, they remain acceptable even if ownership of the loan is transferred to another party.

This is where Warner comes in. The senator's bill would basically enshrine "valid when made" as national law, "notwithstanding any state law to the contrary."

Why do that?

His office pointed out that banks can have lots of mundane business reasons to sell a loan to another party. But giving state law final say over the terms of loans throws that secondary market into uncertainty, and makes it harder for banks to tailor loans made to all types of Americans, rich and poor. When banks' freedom to diversify is limited, the fear is that banks have to offer low-income Americans less credit or higher interest rates, because they can't make up the money by putting higher interest rates on loans to richer Americans. Warner's office pointed to a study that found the Madden decision did result in a drop in the supply of credit available to low-income Americans in the states of the Second Circuit.

Critics object that, whatever its intent, the bill will give "rent-a-charter" schemes more room to flourish.

"This bill could open the floodgates to a wide range of predatory actors to make loans at 300 percent annual interest or higher," wrote the Center for Responsible Lending in a letter protesting the bill — and co-signed by 151 other national and state organizations. "In about 34 states, a $2,000 loan, 2-year installment loan at an APR exceeding 36 percent would be illegal. This bill risks making high-cost loans permissible across the country."

Interest rate caps in state law are "the simplest and most effective method to protect consumers from the predatory lending debt trap," the letter continued. If Warner's bill is passed, that tool basically becomes useless. And the only avenue left for fighting predatory interest rates will be a national cap. The letter also points out that while Madden did result in a decrease in credit to struggling Americans, the amount of loans being made to that population was small to begin with.

When speaking with The Week, Warner's office agreed that "rent-a-charter" schemes are a serious problem. But they believe the problem is better addressed by regulatory agencies like the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and Consumer Financial Protection Bureau, who are tasked with policing loans sales and the relationships between loan originators and buyers directly. And they view their bill as a narrowly tailored effort to rationalize the loan market, in the hopes of giving more low-income Americans access to credit.

That argument certainly isn't crazy. But there's always the practical question of just how much such agencies can realistically do. That civil rights groups like the NAACP are arguing that state law interest rate caps are too valuable a tool to lose should give everyone serious pause.

It's also worth noting Warner has a bit of a reputation for being cozy with payday lenders. As Virginia governor, he signed a 2002 bill that critics say opened up the state to the payday industry, and only called for more regulations years later. Overall, he's far from the biggest Senate recipient of donations from payday lenders, but in 2014, when he was re-elected to the Senate, he did receive more money from the industry than any other Democratic senator that year.

As for the argument that Warner's bill could actually help low-income Americans, that's ... plausible. But a better alternative, one without all these perverse side effects, would be to address low-income Americans' precarious finances directly with a nonprofit public option for small loans and banking services. The idea of having the U.S. Postal Service do just that has gotten some traction recently.

I don't believe Warner is out to get the poor. But his bill is a good example of how Democrats' preference for market-friendly incrementalism has hit the point of diminishing returns.