Interview: Brooking’s Aaron Klein on Faster Payments, Consumer Credit & the Fed

Speaker A: Hey, all. Jason here. In this episode, I had the chance to chat with Brooking Institutions Aaron Klein. Aaron has deep expertise in financial services policy, drawing on his extensive experience that includes working on, drafting and supporting the passage of Dodd Frank in the wake of the 2008 crisis, a stint as Assistant Secretary for Economic Policy at the Department of Treasury, and prior to joining Brookings, directing the Bipartisan Policy Center's Financial Regulatory Reform initiative. Our discussion today primarily focused on consumer payments and consumer credit regulation and policy, but as you'll no doubt notice, touched on a wide variety of related topics, including the role of the Federal Reserve in policymaking. A reminder, if you're enjoying this show, please follow rate and review on your preferred podcast platform, as it does really help others to find the show. And if you want to help support Fintech Business Weekly and independent journalism, or upgrade to a paid subscription or reach more than 93,000 listeners by sponsoring an episode with that, here's the show. Welcome back to Fintech Business Weekly. Today I'm joined by Aaron Klein, the Miriam K. Carliner Chair of Economic Studies and Senior Fellow at the center on Regulation and Markets at the Brookings Institution, a nonprofit public policy organization. Aaron, thank you so much for joining me today. For folks who might not be familiar with Brookings or with your work specifically, can you give a bit of an overview on some of the policy areas that you focus on?

Speaker B: Sure, Jay. It's a pleasure to be on. Longtime listener, first time guest, really excited, uh, to be here. Uh, Brookings is, uh, think tank in America dedicated to coming up with impactful, uh, policy ideas. Uh, I worked for 12 and a half years in the federal government. Uh, basically I did the Bush administration as the chief economist on the US Senate Banking, Housing and Urban Affairs Committee, where I played a hand in major legislation from Sarbanes Oxley to Dodd Frank to, uh, tarp. In the process, I, uh, was lucky enough to get an appointment to work for President Obama as a Deputy Assistant Secretary of the treasury for Economic Policy for the first Chairman Obama, uh, responding to the financial crisis and bailout. After that career in government, I joined the think tank world and have dedicated my time since then to trying to come up with ideas that can make the financial system work better for working people and coming up with honest, uh, assessments and data and analysis of the impact of policies that are being tried. Some of the policies I worked on didn't work out that well. It's been painful to write that, but you got to be honest with yourself. Uh, on the other hand, I think a lot of policies could be made a lot better. And I have some ideas out there. So it's everything from financial regulation to macroeconomic policy. I've been doing some trade stuff. I've been doing some travel and tourism. It's a wide variety. At one point I joked I was a deputy Assistant Secretary for random things at the Treasury Department. And I tend to follow when I find an issue. I, uh, am a little bit like a cat picking at the. At the string. Uh, forgive me if I butchered this analogy. I'm a dog person at heart, but you just kind of keep picking and picking and picking until what's really there. Uh, I went down a deep rabbit hole on payments in this. And sometimes when you find the kernel of. Of truth and the kernel of what's going on, it's quite surprising and can lead you to a different, uh, take than a lot of the existing entrenched opinions.

Speaker A: Yeah. As I was preparing for this, I was looking at your biography on Brookings, uh, and was, uh, pleased, impressed, uh, to see that you had a hand in crafting and securing the passage of Dodd Frank, which I cannot tell you the number of times I've had to Talk to people 15 or 20 or more years younger than I am and explain the importance of the Durbin amendment and how that has played a role in where sort of fintech and neobanks and all this stuff has gotten to. But I reached out to you because, um, I know you from, from Twitter, and we were joking before we got on here that every once in a while, social media can still be a positive force for connecting people who have, um, you know, overlapping interests. Um, and so I wanted to start with an area that I've seen you post and seen you write about that might feel like it's somewhat in the weeds for fol, but really does shape a lot of the business models. And more importantly, it sounds like from both of our perspectives, uh, impacts consumers, uh, and that is specifically payments and the speed at which funds become available. So something I hear a lot, and I spend more time than I care to admit on the conference circuit with sort of biz, dev corp, dev, uh, VC types, uh, and often bemoaning the state of, uh, payments technology in the US and pointing to things like the United Kingdom, which has had faster payments for almost two decades now, since 2007, 2008, um, or more commonly these days, using examples like Brazil with pics, India with upi, which I'm sure you're familiar with, despite the United States having two or arguably more in some ways. But two instant payment. Rails Clearinghouse's RTP, uh, and FedNow. Consumers still struggle to actually access real time payments. And often, at least in my experience looking at consumer products, are charged a significant premium in some cases to get access to their funds. Why can't we have nice things? Why can't we have instant payments in the US

Speaker B: So because of the Federal Reserve. The Federal Reserve doesn't want Americans to have real time access to their money. They have ignored and violated the law for decades to stop it because it is a massive source of profit for the banks they regulate. And the Fed is captive to the banks they regulate and enjoys at this point being lawless, substituting their own judgment. Uh, the lack of real time payments in the United States has extracted over $100 billion. We're approaching $200 billion by my estimate of wealth from people living paycheck to paycheck and put in the profits of uh, bank CEOs, payday lenders and check cashers based on when the UK got real time payments, which by the way, the UK got real time payments about four years after Mexico got real time payments, uh, and uh, by some measures 30 years after Japan did. So the answer to your question is very simple. The Federal Reserve is 100% at fault because the law requires it. The Expedited Funds Availability act passed in the 1980s when there were lots of concerns about float when people interest was a thing and interest rates were 10, 12% required the federal Reserve to make people's funds available as fast as technology allows since 1987. Jason, do you know how many times the Federal Reserve has made uh, funds available faster?

Speaker A: How many?

Speaker B: Zero. They have never once changed the timehold despite the law says Shall. I wrote laws in Congress as a staffer. You fight tooth and nail over Maeve or Shall. Does the agency have discretion? Does the agency have to. By the way, this is very reminiscent to me of another law Congress passed, uh, that the Fed ignored in 1994 called the Homeownership Equity Protection act, which said the Federal Reserve shall promulgate regulations about subprime mortgages. Alan Greenspan and his other Ayn Rand acolytes at the Fed thought that was unnecessary. And do you know when the Fed promulgated regulations they were required to in 1994. You know when they did it on sub private mortgages?

Speaker A: When? I have no idea.

Speaker B: 2007. Did anything happen in subprime mortgage land between 1994 and 2007 that was consequential?

Speaker A: I think one could argue that there was some consequential actions.

Speaker B: Yeah, uh, the Financial Crisis Inquiry Commission laid. The independent bipartisan commission pointed exactly to this. Thumbing their nose at the law because poor people with mortgages can be have wealth extracted for them which can, you know, uh, uh, make the Federal Reserve and the banks they regulate very rich and also promotes a ideology by which the suffering of low income people is due to their own fault for being exploited. You talk to some of these folks and say, oh, you know, why should you get money access to your money faster? You should be able to manage it more. Well, how do you manage your money when you don't know how much money you have? We're recording this on Wednesday, September 9th. Uh, I hope I didn't let the cat out of the bag there. Uh, if you deposited a check in the United States Friday, September 4th, you might have access to it now you might not. Monday, uh, was a holiday here. Federal Reserve closes their payment system. No promise until business day after the next business day. Maybe you'll get it sometime. So how'd you live over the weekend? How did you pay your bills? How did you buy diapers? You know, the Fed has a financial literacy pamphlet for you. Uh, uh, why don't you eat that? Don't worry, they're eating very nicely. Uh, uh, steaks at their country clubs. I see them around Washington D.C. let me tell you Jason, part of my anger on this is I helped write the check 21 law that created the technology that allows Americans to deposit their paycheck on their phone. Uh, we did that because back in 2001 after 9 11, the Fed realized that the banks had problems when you couldn't fly planes for a week because we used to fly all our checks around. And the Fed was being uh, responsible and said we want to pass a new law to stop flying all these checks around and save everybody money out of the system. And I as a uh, naive young, uh, Hill staffer said great, that's like Pareto. Efficient is a dead weight cost to society. You're spending a billion dollars a year flying the checks around. As an environmentalist, I love taking planes off the ground and emails. Uh, and I said well wait a second. Shouldn't people get access faster to their money when the check deposit. Oh no, no, no, no, no. The Fed said oh, we're not sure about that. We need to study it. The law already requires us to if the technology works, don't worry Aaron, etc and so forth. And they fought it off. Uh, and sadly the consumer groups didn't focus on that. They focused on some fringe, uh, uh, hypothesis of like you needed a paper check to prove a payment which was proven to be dispositively unnecessary and was a mistake in part. I think in the US we don't realize the true cost of our slow payment system. If, uh, we spent more time abroad, I think Americans would appreciate the cost. Uh, uh, but the, the reality is that the reason we don't have real time payment systems is 100% the Federal Reserve and perhaps some Federal Reserve, uh, folks, uh, who are listening to this podcast will say, well Aaron, you know you, it's easy for you to blame us. What have you done? And I'll say, actually I sent you a petition which is required under the law. Any citizen can petition a regulator to do a regulation that they have the authority to. In fact, I sent it to the Fed and the cfpb, the Consumer Financial Protection Bureau, which got some joint authority in this space. Uh, Jason, next month will mark two years since I submitted my petition. You want to know what happened?

Speaker A: They, uh, ignored it, correct?

Speaker B: Uh, well, the Fed ignored it. The CFPB followed the law because that's an agency that follows the law. They did a notice in public comment on my petition. They received six comments and they responded in writing as required by the law, agreeing with me. In fact, they said we stand ready when the Fed is ready to act. But again, this is just the American Procedures act, one of the many laws the Fed chooses when they follow or when they don't. Uh, by the way, it's not just my petition. The Feds ignored Jeremy Kress's petition on a different issue. Professor from Michigan. He petitioned the Fed and the occasional the FCC responded. Another lawful agency. Uh, but you know, we can go on and on about the laws the Fed doesn't follow. In the world of payments, the reason America doesn't have real time payments is the Fed refuses to follow the law.

Speaker A: Uh, as somebody who actually had to file a lawsuit against the Federal Reserve to enforce a foia, uh, a Freedom of Information act request, which they then responded to by denying. I am very, uh, very sympathetic and definitely think we could have an ent a series of podcasts on Fed reform. But I did want to circle back to the impacts of the payment speed issues and the funds availability that we're discussing, uh, because they are closely linked with another topic, uh, that you've hinted at. Um, and I mean longtime listeners will most likely know that I spent close to five years working in the payday lending industry which uh, has really given me a lot of experience and let's say mixed feelings, mostly bad about sort of this category. But can you talk a little bit about the history of overdrafts as a product and how they sort of transformed from a courtesy from your local small town community bank to in many cases a huge profit center.

Speaker B: So among smaller mid sized banks today, overdraft generally and credit unions, I want to be very clear, credit unions are in some ways way deeper into overdraft, some of them than banks. And that's often forgotten because, oh, if you're a non profit, how could you possibly fund your stadium naming rights off of charging usurious fees to low income people trying to live paycheck to paycheck. But you know, come uh, come by the old Chula Vista concert, uh, venue outside of San Diego known as uh, uh, Northern Ireland, uh, uh, Island Credit Union, nicu. Uh, uh, you can catch a good show there sponsored uh, by somebody else's overdrafts. The point here is that people realized, banks realized that a fair amount of people run close to the edge of a population that's growing as income volatility grows structurally in America and that there were a series of tricks they could do to force overdraft. So for example, um, suppose you wake up with $200 in your bank account and you buy a cup of coffee for five bucks, lunch for 15, fill up your gas tank for 60 and then uh, your student loan payment comes in overnight for 180. If you did it the way that you were a responsible person looking at your balance every minute of the day before you made a purchase, you would have made one overdraft. When the $180 student loan come in, if you reorder the debt, your transactions, uh, from largest to smallest, which banks and credit unions are legally able to do. Now you have six, five overdrafts because the 180 puts you up there and then every single one, including your $5 cup of coffee. This enables some banks and credit unions to make obscene amounts of money on overdraft. Uh, before this podcast, Jason, I was looking at two of my uh, uh, banks I like to think about. Uh, the first is bank of America. That's just generic, you know, one of the biggest banks in America. Right? Uh, um, they average a little bit under $2 of overdraft per customer. Generated about a little under $200 million in overdraft last year. The second is a small bank called Wood Forest bank that branches in Walmart. They average $95 of overdraft per customer. Uh, in fact, I think they make about two thirds of the gross dollar amount of bank of America in total overdraft revenue. How can they do that? Well, they reserve the right to reorder your debits and credits. That puts there. If you look through the fine print, they target customers. 8% of Americans are responsible for 80% of the overdrafts. Uh, and they go out and find and aggressively market those people, particularly people who are unable to open checking accounts, bank accounts at other places because they're on something called the Do not bank list, run by Check X. But Wood Forest offers them a second chance checking account. In other words, Wood Forest is not using the Check X. Check the box for anti money laundering. Know your customer that many other banks are and instead their regulator, the occ, who's given them a perfect, uh, reg, uh, to my knowledge, regulation. Even though Wood Forest and any given year loses money on everything that isn't overdraft, they make all of their profit on overdraft. They, they are not a bank. The fact that the comptroller of the currency calls them a bank makes me throw up in my mouth. Because they're a check casher with a banking charter, maybe a payday lender, the banking charter, uh, and the regulators seem to do nothing about it. Successive ones. Democrats, Republicans, et cetera. Now, Jason, you asked how overdraft, what overdraft has to do with payments. And this is a seminal moment in my career that starts with me taking my kids ice skating. I live in Silver Spring, Maryland, which is the town I grew up in. My kids today go to the same middle school and high school I went to. Right. So I haven't gone very far in life. I'm still living the, uh, life I lived as a kid and my kids were much younger. I was taking them ice skating at our little local rink. And afterwards on a Saturday morning, we'd go and I do my bank banking at what you'd call a large regional bank. One day I'm sitting in the teller line and there's, uh, a woman in front of me and a woman at the teller. And I know the teller well, and the woman there and her are having a bit of a thing. The woman's getting very angry. What do you mean my check won't be available until Wednesday? Well, I need the money. I have deposit. I have debits coming. What's going to happen? You're. Well, we'll do an overdraft. How much? $35. How much? Oh, My God, I, you know, that's outrageous. You know, I have two or three of these. Well, it's 35 each one. Oh my God, I can't afford a hundred dollars of this to go for fees. Why won't the money be there until Wednesday? Monday happened to be a holiday. Uh, and so I'm like, huh, this is interesting. I helped write the Czech law. I'm a bit of an expert on consumer banking, financial literacy, at least I thought I was. This is an interesting problem this woman has. What blew my mind was the woman in between us in line, who walks up to her, puts her hand on her and goes, sweetie, I gotcha. Leave here, go around the corner to the check casher. Check cash. Or I'll charge you 20 bucks, come back to the bank, give them cash. Well, when does the cash. Cash will be in your account instantly. 20 bucks at the check casher, $105 for three overdrafts. So I thought to myself, here's a story, Jason, three people walk into a bank. A person with this problem, a person who knows the answer, and a person who thinks they're an expert on bank regulation, consumer finance, and consumer protection. Eventually, I did enough research and analysis to prove that 70% of check cashing customers in the United States have bank accounts, disproving the myth that had been told to me from the minute I started in this field that check cashing was about the unbanked. And I always wondered, how does America have more check cashers and payday lenders than McDonald's and Starbucks combined? As the share of unbanked have fallen by more than half in America is because check cashing. The majority of customers at a check casher have bank accounts. Well, why would you be at a check casher if you have a bank account? The check casher is providing you a service, instant funds availability that the bank can't. Banks that have changed funds availability schedules have seen a decline in overdraft, sometimes of, uh, 50%. And that's the core element. Speed of payment and overdraft are inextricably linked. And if you move to a real time payment system, overdraft would fall substantially. And some of these things that call themselves banks but are overdraft factories would go out of business. Uh, and in addition, the 20 to 30% net profit margin for many of America's banks would get cut in half. That source of revenue and overdraft. And the Federal Reserve and other bank regulators prioritize bank industry profits. And if those profits come off of that woman in front of me in line who's just trying to pay her bills on time, got paid late. If it comes out of a woman whose child support was delayed because they're ex husband was a little late, screw them because it's not going to come out of the bank regulator staffs. Their paychecks come in every day and they don't care. And I find it immoral, I find it horrific and I find it one of the reasons why the financial system is failing Americans and why people are so angry about it.

Speaker A: So you have actually managed to do something that is quite rare in this specific sector which is teach me something new specifically the check cashing piece. So I mean I, I mentioned, you know, I came from uh, the world of payday lending where there are also myths about who's using those products and why they're using those products

Speaker B: every payday.

Speaker A: Definitionally, yeah, definition.

Speaker B: I can't tell you how many senior people in both political parties, members of Congress, oh, payday lending, we're going to solve that by getting people bank accounts. I said what share of payday borrowers do you think don't have a bank account? They're like, well most of them. I'm like actually it's 0.0.0. Right.

Speaker A: I mean correct. Definitionally uh, in the state laws that authorize those products. Although this stuff is change is continually changing in a sort of game of whack a mole. But historically they've been referred to as deferred deposit transactions because the consumer would walk into a physical location, write a paper check that the lender would hold and then either return when the person came to repay the loan or if they did not come to repay it in person, deposit that check. I'm curious and that actually is a good segue to my next question. Um, the second payday lender uh, I worked for, although I don't think it uh, chose to describe itself as that was backed by some well known venture capital companies, uh, actually including Google and sort of positioned itself and this was the mid 2010s as you know, sort of a Silicon Valley. We're using big data and machine learning to help consumers that big banks and other companies don't want to help. That company ultimately failed. But there's a whole crop of apps. The actual legal mechanics vary and are a little bit different but companies like Earn in, Bridget Dave, Moneyline, whatever and a lot of them position themselves as an alternative to overdrafting or better than an overdraft or, and I tend to find this piece the most Very pernicious calling, uh, them, you know, 0% APR. How do you think about this sort of category of products compared to what I'll call like traditional bank overdraft?

Speaker B: Right. So because overdraft is so incredibly expensive, right. $35 generally is, is the fee has nothing to do with the cost to the bank to provide the credit over sometimes a couple hours, sometimes a couple days, right. If once you start running the depends on the size of the overdraft. But you can get, uh, aprs on overdrafts from a couple hundred percent to a couple billion percent, right? The proverbial $2 cup of coffee overdraft that gets repaid in six hours. Uh, overdrafts almost never lose money for banks, right. Some payday lenders do default. They give bad paper checks. There's no money in the account when they come, uh, nobody overdraft default is extremely rare because that's your bank. They get the very next money that comes back in. Uh, the point you made about these other alternative lenders is I've thought a lot about this and I think about price. Economists think about price as a competitive process, right? People compete to lower price for the same quality of good. Uh, but there are some types of goods for which price is a signal. And in fact making that good cheaper is problematic. If I showed you a Louis Vuitton handbag and offered it to you for 80 bucks, right. Would you buy it?

Speaker A: Uh, I, I probably would not buy it either way, but I think I get the point you're trying to make. Right?

Speaker B: Price is a signal on handbags, right? Price is a signal on a lot of things, right? You would think it was a knockoff because there is no such thing as a $80 Louis Vuitton bag. Uh, price becomes a signal. So put yourself in the shoes of people who have been heavy overdrafters, right? 8%. The 8% who do 80% of the overdrafts. Uh, another, uh, statistic as it comes to payday lending is that a, ah, uh, quarter of payday loan transactions end up being revolved many, many times. So you get this weird thing where if you say you can only do three payday loans per six months, that will only impact about a quarter to a third of the customers, but will cut 70% plus of the volume of the business. So you begin to see who the real profitable customers are, uh, to the, to the lender. These people see short term credit is incredibly expensive and so price to them becomes a signal. And so when somebody comes offering $10 to borrow money overnight, $20. They go, hey this is a pretty good deal. And then you get down to this point where they say, you tell me how much this costs, right? Uh, this is the tip model so to speak. I'm going to give it to you for free. You pick to me what you think is a fair price. Well, the economists, uh, the 50% of people who've never gone into this world because they always have a thousand bucks in their bank account think well you know, you tip them a couple bucks. But the people who've lived this experience say well you just saved me a hundred dollars, you just saved me $35 overdraft, $50 payday loan, whatever it is. A lot of behavioral economics shows that people think what's fair when, when somebody saves them is to split it 50, 50 or 40, 60 and they'll offer about half the savings back. And that to me is indicative of the structural problems we've created in this space. Now there's a secondary. Uh, before I leave that point, one last thing. I'm conducting new research. Uh, in a couple months I hope to have a new seminal paper out on this where I've done a survey of about 1200 kind of lower income people on their banking product. And one of the questions I asked was to borrow 200500 bucks over two weeks. What do you think is a fair price to pay back? I use the word fair specifically. And a lot of people said 550 bucks to pay back $50.

Speaker A: So 10% on a 2 week loan. So 260% APR plus they m deem that as fair.

Speaker B: Now if you said to those same survey respondents is 260% APR A uh, fair rate? They would say no. Right? People think APR is anchored in things like credit cards, mortgages, long duration assets or other types of loans. Generally speaking, 36% is a line where fair becomes unfair or usurious. Uh, you part of your question, which was a very thoughtful question, was like how do I think of apr? And I think of APR a bit as a useful metric, something that can be compared across. But APR breaks down in two different dimensions. One, it breaks down under very short time periods, right? To borrow a nickel for ten minutes, uh, doesn't really work out very well. The second thing is APR requires a fixed time period. APR is a, ah, basis by which we assumed there was a duration of credit. And even when you look at unsecured credit cards, they annualize the borrowing amount. A lot of financial technology has created environments in which the speed of repayment can be varied. I think about some of this in business lending where it says we'll take a percent of your swipe.

Speaker A: MCA is merchant cash advances. Yeah.

Speaker B: And from the merchant's point of view that's a really great product because now you've aligned my obligation with my cash flow which is a, uh, a structural problems. Merchants have. I, I worked in retail. I never waited tables as a kid. I feel like you either in the growing up you either kind of worked at a restaurant or a store where like the traditional, you know, teenage jobs, I was on the retail side. And anybody who works in retail tell you it's a very seasonal business. August is, can be very slow. Uh, Christmas season can be where your money's made ebbs and flows and fixed rate installment loans can be much more challenging to manage as a cash flow. But when the lender and the borrower haven't agreed on a time horizon, how do you even calculate apr? And so I think APR is useful, but I also think it's not something that you want to uh, uh, clasp your handcuff yourself to as the only valid metric. And I think it's becoming increasingly difficult to use APR as financial technology creates products for whom APR is not the best yardstick. So if you can say we lived in a Newtonian world for the 20th century where APR was great, we're now in an Einsteinian world where the physics are breaking down and relativity is such that APR is becoming less and less useful. And then the question is, well, what ought to replace that? And that's kind of the cutting edge where I'm trying to do some research.

Speaker A: What you're describing about borrowers who broadly use what I tend to refer to as high cost short term credit, that's kind of a term that I think the UK uses to talk about the category broadly which I think at this point it's like a payday loan is a very specific type of product. But there are all these different kinds of permutations I found in uh, I don't think I've done quite the depth or breadth of research that you have. But in the course of, in, in the course of working in these companies, you know, I did actually personally interview uh, hundreds of customers. My um, my academic, academic background is in social science research and ethnography. Um, and I've also read just a disturbing amount of like the academic literature because I'm a nerd and sort of the conclusion I came to, and it sounds very consistent with sort of how you're talking about it is That a lot of these customers, these borrowers are price insensitive and in the, in the payday category. And I would generally extend this to the other kinds of apps that we're talking about, um, what customers cared about. And like I was a marketer so it was my job to make a TV commercial or make the annoying pieces of mail you get in the mailbox. And what people cared about, number one was will I be approved when I apply? Can I get the money? When will I get it? So I was doing payday loans on the Internet. So we had ach, which is that funds availability fund speed question that we started with when do I have to repay it? Uh, they didn't really care about the price and as a result you could look at 10 payday lenders and the price was always, I think literally always whatever was the highest maximum rate permissible in the given state. One more thing you mentioned that I want to reinforce on or double click on is you uh, were talking about how a small proportion of people are the ones who make up the great amount of volume. And I think for me if I had to draw any kind of nuance it would be that there are a very small number of people who these kinds of products arguably could be emphasis on, could be welfare enhancing for uh, this is a little bit coarse, so I apologize. But in the payday world we tended to call them the one and dones and they were the people who borrowed for back to school and they borrowed for Christmas. But the problem, and uh, I think you hinted at this, was those people didn't actually tend to be profitable borrowers because even though they were repaying their loan on time, as the lender you have the cost of underwriting everybody, including the people who were declined. It costs money to underwrite applicants in the online space. You're going to pull data not from the traditional credit bureaus but uh, but from actually at this point all the traditional credit bureaus have alternative bureaus like Clarity, uh, and Data X. So you're paying to pull data even though you're declining people, uh, marketing cost is very, very high. And so the only way in aggregate that at least when I worked in the industry, and I don't think it has changed very much, the only way that as a business it could be profitable was if you had those people who are coming every payday, borrowing, repaying, but then they would run out of money again and they would have to reborrow. And the only thing that would really prevent that was if there was state law or State regulation that sort of regulated some of, you know, how frequently, how quickly could they reborrow? Is there a cooling off period? Uh, there is a state run, state mandated database called Veritech in some states that sort of can be used to, to govern some of that. But there really seems to be just absolutely no interest in the current environment in, in doing anything like that.

Speaker B: So, so let me, let me unpack some of that. Right. First, the idea that the only way it could be profitable. Well, maybe there's just too many payday lenders. Maybe if there were fewer stores and you were competing less each other for the small volume, for this customer acquisition cost. I think Colorado went through a reform where the number of payday lenders in

Speaker A: the uk, The UK did a reform and the number of lenders, high cost, short term lenders dropped by like 80%.

Speaker B: But the same number of people were still finding service. So there's this argument like, oh, you're going to cut off credit availability. Well, wait a second. No, like, you know, maybe we should have more McDonald's than in Starbucks than payday lenders and check cashers. Uh, um, so that's the first kind of point. The second point about price sensitivity is I think you have to think about the alternative cost of things. So you mentioned Christmas, uh, which is something I don't know that much about, but I do.

Speaker A: Holiday, Holiday season. No, no, no, no, no.

Speaker B: We're going to talk about everybody's holiday, at least my holiday. And, and uh, and, and your holiday. Christmas is a dominant holiday. Christmas is Friday, December 25th this year. Payday Friday for some people, maybe some people, their payday will come in on December 24th. Uh, who knows what time, uh, for some people will probably get pushed to Monday the 28th. Depends on how this ACH process works. Depends, uh, on what the Fed decides to do on Christmas Eve. All of which nobody will know. But what you do know, uh, is that you're going to have a gift for your kid under the tree that morning regardless of when your paycheck comes in. That will drive some people to overdraft. That will drive some people to payday lenders. That will drive a lot of decisions all around. Uh, anybody who's direct deposit is supposed to come in on that Friday the 25th. The money was probably pulled from their employer on Tuesday the 22nd. The biggest misnomer I get when I publish research is people go, oh, this is really interesting. But it doesn't apply to me because I have direct deposit. Direct deposit is not instant ach is a multi day process depending on the time, day and physical location of where you are in America. Uh, for those of you who've not done this deep dive, ACH is like a laundry machine. It piles up laundry like you pile up payments, you put it in the machine, you run it and then everything comes out clean at once. Real time payments is like doing your clothes one by one by one. Each payment moves through individually and goes through. So you know, the Fed runs this laundry machine at specific hours on the East Coast. So they'll say, oh, it's good until 5pm well that's 5pm in New York, it's 2pm in California, it's 9am in Hawaii. Uh, but they don't really tell you that. The point there that I'm, I'm raising is the reality of life changes these different points. The price insensitivity is the consequence of not having access to that money. Now the consequence of not having a gift under your tree at Christmas is, is far more dire than $35 or $50. The consequence of, of, of uh, various payments. The second part is about income volatility. 60% of workers are hourly worker. You lose a day, your kid was sick, how are you going to make ends meet over the weekend? So it's a price insensitivity because of the consequence. And that's why you can go to the statutory maximum, switching holidays for a moment to the ones I know better. Uh, in a couple of weeks I'm going to be at synagogue for Yom Kippur, repenting for my sins for the year. It's a holiest Jewish day. One of the sins all Jews repent for is the charging of usury interest, which is mentioned at least three different times in three different books of the Old Testament by which they talk about at various points charging money to people in need. There's a distinction between people of your same family, of your same coalition tribe, and then there's charging usury interest of people in need. And this is a biblical sin in the Old Testament, uh, and it's one that I point out that society has struggled with as long as we've had a, uh, Western biblical society, which is when people are in need and they're willing to pay anything, there is an immoral rate to charge them. And states have codified this at different levels at ah, different points in the states. Federally we don't really have, uh, we have some types of usury law, not others. Banks generally don't provide products at greater than 36% interest. Rate, although there are some new different products. Now, Overdraft, as an economist, is that it is way over 36%. But it's called a fee, not a credit. Again, this is how the regulators, per your earlier question, decided to let this blossom by charging it as a fee, not as credit, which is really what it is. That was a mistake on their part. That has had some pretty pernicious consequences. Uh, but what the right answer is morally, I don't know. Uh, when you talk to people, people are often happy with the service they're providing. Check, cash and credit. You talked about your academic work. Lisa Sirvan wrote an excellent book called the Unbanking of America, which was a similar process. Uh, and so this to me, I think a little bit about what Steve Jobs said when he developed the first iPhone. People don't know what they want until you show them. I think if you showed Americans the real time payment world that the rest of the world has enjoyed, and you pointed out that that would eliminate hundreds to thousands of dollars that are being sucked out of the bottom half of America's uh, wealth every year to go to bank profits. There's a famous bank CEO who named his yacht Overdraft. Uh, uh, it was a TCF bank out of Minnesota. Maybe took some of the Minneapolis Fed people out on the boat periodically full, uh, shout out. I think Neel Kashkari, the president of Minneapolis Fed is my favorite regional bank president and I think Neil, uh, uh, would see some of the injustice here. So no need to pick on the Minneapolis Fed. They've been at the forefront of dealing with some of these too big to fail issues. Uh, but I think society has gone awry in how we've exploited people in need of this. Uh, and I think we'd all do a little bit better if we apologize for the charging of usury interest and thought about that a little more deeply.

Speaker A: You make an excellent point. And uh, I'm not an economist, but occasionally I can sound like one because I spend so much time in this space, uh, in illustrating why people are price insensitive. I mean something, you know, again, going back to some of the in person interviews, um, and my own sort of like ethnographic research background. You know, it's very easy to sit in an office in a high rise in San Francisco, which is where one of the payday lenders I worked for was located, or in downtown Chicago, a couple blocks actually, uh, from the Federal Reserve on Jackson street, uh, or across from the World Trade center at Goldman Sachs, where I also worked and Sort of uh, have meetings and write SQL queries and talk about how you're helping people. But the reality is that 99.9% of the people in those buildings and in those meetings have never experienced what you're describing, which when your time horizon is I've got $50 in my checking account or maybe I have negative $50 in my checking account and I need to put gas in the car, I need to buy medication for my kid, I need to pay the electric bill. You don't have the luxury of a time horizon that is months or years. This is frankly one of the things I get frustrated about in the fintech comms and messaging space because frankly I find it a little bit condescending to talk about buy one less coffee, budget better, save more. The reality is that being poor as you've illustrated is very expensive as far as the kinds of fees uh, you incur uh, as a result of not having a lot of money. And uh, then I would sort of add to that that the time horizon that you are able to think and plan within, you don't have the luxury of planning on a month or year's time horizon. You're planning on a week's or days time horizon.

Speaker B: So a couple points on that. Uh, uh, there's a great book by Rachel uh, Schneider, the Financial Diaries that really drives that home. And that book was uh, uh, supported by the Financial Health Network which runs a fantastic workshop called FinX, which is part of their Emerge conference which I strongly recommend anybody listening to this podcast who's never had these experiences sign up for. They give you like this is what you need to do today. Here's some different forms of money. Go do it. And you have to go to the Western Union, you have to go to the check casher, you have to figure out how to borrow money, how to send money, how to access money that you have. And it's eye openening. I uh, wish every single senior leader at the bank regulators did this. I think it would change how they would see the world. Number two, I, I uh, love to ask people how often they budget. So I, I do a budget once a year. I don't know how often you budget. My research has shown that the more money you have the less frequently you budget. And per your comp, that's other research has shown that uh, and so this idea that the frequency of budgeting, it is really uh, um, part of this broader point of the elite extracting wealth from common people. It reminds me of the billionaire uh, right wing Twitter troll Bill Ackman, who is constantly talking about how, you know, the government subsidizes low income people way too much on his precious taxes. But when his investments were at risk at Silicon Valley bank, like a four year old who stubbed his toe, went crying to his mom, please bail me out, daddy. Please, please, please. If I lose money on my fintech investments, the world will end. And sadly, the federal reserve and the Biden administration bailed Bill out, which really was a massive mistake. And I think gives a lot of credence to the populist message that there's no distinction between the parties because they all bail the billionaires out. Uh, Silicon Valley bank was no tarp, Was, uh, no great financial crisis. Uh, it might have been for Bill Ackman's portfolio. But I'm sorry, Bill. Uh, and what I'm really sorry is to the Americans who are paying higher overdraft fees. Because as Adam Leviton's research from Georgetown has shown, when big banks like SVB bail out big billionaires like Bill, the money is recouped through higher assessments on all banks. And those banks tend not to charge higher fees to their wealthy customers. Uh, it reminds me, you know, of somewhere they go, well, geez, you know, if you want to take a free vacation, uh, every year, just sign up for a deluxe platinum black card and get all the points. And you say, well, wait a second, you know, that's a. That requires a FICO score of 780. And my score isn't that high because, um, when I was a kid, my parents had their, uh, uh, had problems. So they put the electric bill in my name, and my dad took out a credit card in my name when I was 14 and didn't know about it and ran it up. Now that didn't happen to me. I don't want anybody to take this clip out. But I've talked to people to whom that did happen. Uh, you know, credit is an intergenerational experience. Uh, the sociologist Frederick, uh, uh, Wheatley from Princeton has some great research on this. In addition, the denial of credit, which was a point you raised, has a profound experience. Talk to people who are denied credit credit. And it is a very scarring experience to many people. They will pay a premium to ensure that doesn't happen again. And that premium is exactly extracted in the types of marketing you described. I used to say, I can tell you how predatory your product is if you show me your marketing materials. The more you say you will not be denied, the more, uh, extractive your product is. And that is because you're targeting a group of people to whom the real cost of denial, they're willing to pay a premium. And if you think, oh, well, you know, silly them, uh, people are willing to pay premiums for lots of things. How many people here have paid to upgrade a flight? How many people listening to this podcast have paid, um, for fancier seats at a concert or at a show? Uh, people pay for lots of different premia. It's for their, uh, uh, that they extract problems. Uh, uh, benefits from not being denied is a reason that some people are willing to pay and experience and try being denied and see if that changes your worldview.

Speaker A: Absolutely it is. Again, if you've never been, uh, if you've never received that notice of adverse action, uh, if you've never been declined, uh, it's embarrassing, it can be shameful.

Speaker B: Uh, by the way, does that notice of adverse action really help you?

Speaker A: Uh, no, not really.

Speaker B: Uh, I mean, that's part of it. We have such a, we have such a flawed credit allocation system. I often joke that I think Brad Pitt was right in Fight Club. Spoiler. If you haven't seen Fight Club, I don't know why you're listening to this podcast. No offense. You should watch a great movie, uh, and then come back to the podcast. Because Fight Club said what they're trying to blow up in Fight Club are the credit bureaus. And had we, if we eliminated credit reporting and eliminated FICO today and had to come up with a whole new system, it would be better, cheaper, fairer and more equitable.

Speaker A: So I know we're actually slightly over time, but I have one last question for you and I will let you go. Um, something that I have found frustrating as an operator, observer, ah, analyst in this space is that at least from what I've seen, it seems that policymakers, regulators tend to address, um, this market by looking at products. So we've been talking and frankly we're almost guilty of it in the same podcast. You know, we talk about overdrafts, we talk about payday loans, we talk about these fintech apps. We actually haven't mentioned buy now, pay later, but it serves a fairly similar or overlapping need. You know, high interest rate credit cards, um, but I'm sure you've seen this in your research. The reality is that people, particularly at the lower end of the income, lower end of the credit spectrum, and those are two distinct things, but they tend to correlate or have overlap, are often using more than one of these products at the same time or even Having one. So having a repayment to one of these cash advance apps cause the other cause an overdraft. So it's not as simple as saying uh, we just need a regulation of overdrafts or if we caps at 36%, that'll fix everything. I guess my question is what is, what is stopping regulators, policymakers from looking at this more holistically, more like on a consumer or on a household level versus this product by product lens?

Speaker B: First I'm going to start by being nice to the regulators for a change. Their job is to, is more circumscribed. Their job is by charter. Right? One is to look at banks, one is uh, they're not tasked. One of the reasons we created the CFPB in Dodd Frank was to give a one regulator that broad lens to bring in non banks and banks to regulate more by product type. Which even then in the most Democratic Congress we've had in a generation, with a Democratic president, the auto dealers still got to carve out because of their political power. So you couldn't look at auto loans, they were different if they went through the dealer, which is by the way, subprime auto, hella shady. Even then the CFPB had its boundaries for the massive entrenched political party. So in the United States, I give the regulators a bit of a pass on this because they're circumscribed by their laws and authorities. And my goal is for the regulators to follow the law. Novel uh, concept Federal Reserve. But to the other ones, they have to kind of think that way. And that's why the CFPB was such a powerful regulator. It's also why the attempts to destroy the cfpb, particularly in the second Trump administration, are so focused because they have that capability and that capability scares the people to whom that extractive wealth is. So that's, I think first, the second point on policymakers in is, and this is, is that we've been trapped in a set of false narratives provided by both sides. So some, many of my friends on the left have come to the conclusion that there's so many problems in this problematic basic banking system that we ought to have the post office run basic banking. Which to me is like, clearly you haven't been to the post office that often. One time I went and their scale was broken. And I'm like, you have one job which is to weigh things like, oh, you have to go to another post office, right. A million reasons postal banking doesn't work based out of Europe. You may have had More experience than when I was in France. I went into the post office to try to do banking services and realized firsthand, uh, the problems with asking the person that delivers your mail to handle a financial transaction. Uh, so we get caught into this. Well, we need the government, a public bank of this or that, and we should have banks operate like utilities. Well, if you live in the D.C. area, do you want your bank to go out, uh, to have an outage as frequently as your power company? Uh, because a Pepco company is a disaster in the D.C. area, you shouldn't have banks as utilities. America is a fantastic banking system. The fact that we have over 4,000 banks and more credit unions than banks is a comparative advantage. So we've been trapped in this old world thinking where the right says caveat emptor, the market will fix it. You know, if there's a market failure, teach people more financial literacy, uh, not realizing that the true market failures are embedded in the structure of the product. I can't get instant access for my funds, right. I can't go into a bed bank and require the bank to use FedNow to instantly access their money. That was the very first question you asked about that. The Fed designed FedNow to be a Fed flop. They designed it specifically not to allow consumers to request it. They refuse to monitor how much banks are charging their customers. Senator John Fetterman asked the Fed, how much are banks charging people to use Fed now? And the Fed said, we don't know. And he said, well, why don't you find out? And they said, we don't want to know. Imagine that they, they, they are an ostrich asking for ignorance because it's shameful for them to look in the mirror, uh, which I hope more of them do when they're atoning for their sins like I will be. And the point there of, of the matter is policymakers. And I'm going to come out with a proposal in a couple months for something I'm tentatively calling a working bank account, which is a whole rewrite of the American basic banking system. Because the basic banking product we've designed is for a foregone era with foregone technology. Uh, and other countries, by the way, have seen the payment system leave the banking system. I wrote a big paper on China. When I came back from China and saw WeChat and AliPay, and WePay had taken over the payment system and just left the banking system. And I came back, uh, from having been in Shanghai and did some research, and there was almost nothing written on it. But the Gates foundation had funded 17,000 studies on Kenya's M pesa. And I said, well, I know two things. I know the size of Kenya and I know the size of China, and I know the amount of knowledge produced on one and the other. So I wrote a paper, one uh, of my most cited works, uh, on the Chinese payment system. Consumers will leave the banking system if they're offered a better, cheaper, faster product. That would be a problem in the U.S. china eventually viewed it as a problem. And they took Jack Ma and he went away. Jack Ma was the owner of Alipay, which was one of the two largest two companies, essentially took the payment system out of the banking system. And the other company said, whoa, okay, I get what's going to happen here. Uh, and Americans, you know, you may want to laugh about that, but, uh, I believe Donald Trump took 10% of multiple different companies because he decided to take 10% of that. So what happens in China maybe could happen in the US the banking system and policymakers ought to be much more bold because the American public wants more bold and they don't want state run banking and they don't like the system they have today because it's so extractive. But nobody is bothered, like Steve Jobs did, to say, here's a system that's run by private entities with all the benefits of that technological advance that isn't predicated on extraction. And if that means that a handful of banks like First Texas, which over 10 years made $1 billion in overdraft revenue on $300 million of net profit of being a bank. So, Jason, they lost $700 million taking deposits and making loans. But the Comptroller of the currency, uh, gave them an outstanding CRA and has let them go 10 years. These are comptrollers of Democrats and Republicans. They ought to be ashamed of themselves for passing this thing off as a national bank. Uh, indicative of how captive some of these regulators are, then, you know, we'll have a little bit of a different system. We may not quite have as many payday lenders as we did before. Uh, but you know what? I think those storefronts may be purposed to something more useful for society.

Speaker A: Aaron, I could talk about this for probably several more hours actually, but this is all the time we have for today. For folks who want to keep up with your work at Brookings, where can they find you and what you're publishing?

Speaker B: Right, so you can find me on my expert page on Brookings. You can follow me at Twitter at Aaron D. Klein uh, you can Google it. It'll come up in different things, but generally my Brookings page. If you look at Brookings, Aaron Klein Brookings, you'll show, uh, maybe if enough of you search that, I will once again beat the Aaron Klein right wing Breitbart guy, uh, who advises the Netanyahu government is the number one Aaron Klein, uh, on Google search engine. That's one of my egotistical, uh, goals.

Speaker A: All right, Google Aaron. So he can get to the top of Google. Uh, Aaron, uh, I hope to talk to you again soon, and thank you so much for taking the time.

Speaker B: Thanks, Jason.