The Fat Tom Consumer Credit Plan

In hard times the activities of the payday loan companies are news. And my eyes have certainly been opened by the debt collectors' mail that arrives at my current flat (for the previous occupant) and the lenders' solicitations that come, unaddressed, through the door every week.

I'm not one to want this closed down. I think that if a lender and a borrower agree on an interest rate of 50% pA or 99% (Vanquis Bank credit card cash advances) then they should be allowed to make that deal. Credit is a useful way to advance and improve life, or minimise crises, and people with no money should not be kept down by denying them access to it. If a lender can be found, and the repayments are agreeable, then they should get credit if they want.

But experience shows that lots of people get into trouble. Rolling over loans intended for a few weeks into insane annual interest rates. Terrorised by doorstep agents, from the legitimate to the loan shark. Dragged into court and too paralysed to open their post. Some people should not be borrowing, but there's no way to tell in advance who they are.

This is not necessarily a moral fault on the part of these people. We must never forget that money, and especially credit, is a technology, and failure to master one technology or another does not make you a bad person. Just as there are some people too blind to drive, there are some people who cannot see the nature of a debt with interest. For those people, a credit card with a £300 cash advance facility and a 99% interest rate is just a free gift of £300 with some vague future obligation. There are people whom I would trust with anything I possess and any sum of money in cash, but for whom I would never write a credit reference for a debt of £50, or £10, or a penny, not because I would resent the loss, but because I would not want to be responsible for causing them pain when, once again, they confront the reality of debt.

What's more, much of the lending that's offered is completely wrong. If you are paid annually or quarterly, then perhaps a credit card makes sense, but for a weekly or monthly payslip it's madness. What you need is a bank account with a payment card. A loan for an asset -- a car or a house -- can make sense, if you need the asset and you can afford the payments, but store credit for a new sofa, valueless the moment it's delivered, when you already have a manky one, is an inexplicable choice.

There is room here for the educational system to step in. The lessons are not complicated:

• Lenders are not your friend. Their purpose is to make money out of you.
• They can make a small amount of money if you can afford to repay. They can make much more if you can't.
• Compound interest, yo!

But these lessons can't alter the fact that one of the loans that can make sense for some people, on some occasions is "until the end of the month." It's dangerous, but payday borrowing can be the right way to deal with the garage bill on top of the maxed-out overdraft, or forgetting to set up payments for the water bill. Some people will recognise the danger, decline the loan, and let their creditors -- and credit rating -- take the hit. Some people will take the loan and repay it. But some people will take it and fail to repay it, and it is very often not their fault in any reasonable sense, because, as I say, loans are a technical matter and need a certain cast of mind to understand them.

But the law takes no account of that, and nor should it. Adults can borrow in the same way they can do anything else. If they don't repay, the contract allows the lender to use the courts to force them to repay, and if the court would be too expensive the debt can be sold on to people whose speciality is making life so hideous for a delinquent debtor that they will do anything to try and make it stop. With interest and collection fees, this can go on forever, turning a small loan into an endless money stream -- a much more profitable business than lending. The standard proposal in response to this observation is anti-usury laws:- Controls on interest rates. But this is economically stupid and somewhat unfair. People should be able to borrow and able to lend at whatever rate they can agree, if they want. Price controls cause shortages, and access to credit is more important in the final analysis than price.

So, we need a change. We need to allow those who can handle it, to freely agree prices to borrow, without destroying the lives of those who can't. Thirty years ago that would have been an impossible dilemma, but it's not any more. The Fat Tom consumer credit plan is simple:

• Interest rates are uncontrolled. Anyone can lend (if they have a consumer credit licence) or borrow at any price.
• Unsecured loans (or loans on impaired security, like a second mortgage, or hire purchase where the security won't cover the whole amount) from companies whose business is lending (so not your landlord or e.g. the water company, or the person installing your heating or anyone who has to give credit to do business) cannot be enforced in the courts provided the borrower entered into the loan in good faith
• Such loans cannot be pursued in any way more than one year from the first missed payment.

This sounds like a recipe to close down consumer credit as lenders struggle to get their money back. Thirty years ago, it would have been. Who, after all, would ever bother to repay? But today, the courts are only a secondary defence of the right of lenders, and almost completely irrelevant to small lenders. The first defences are the credit reference agencies and their own risk management, and the plan lets all of that carry on as they and in fact makes it central. It hardly matters if you can be forced to repay a loan, provided anyone who might lend to you knows, reliably, how it turned out last time. That reliable knowledge is what the credit agencies do, and what they have got so good at lately. Those tools are all lenders need to lend responsibly, so giving them access to the courts as well is unnecessary and oppressive. I am claiming that people who can handle credit can be adequately controlled by the knowledge of the consequences that default will have on their future ability to borrow, because lenders will be financially unable to lend to people who can't afford to repay.

Some people will regard forgiveness after a year as morally weak. I don't think it is, but it's certainly no worse than bankruptcy. Some debt can only be dealt with by writing it off, and the excellence of the modern credit reference system means that we can achieve the desired effect quite simply, without the legal process and the irrelevant disqualifications.

People who can't manage credit will fail to repay, and they will be more or less permanently excluded from borrowing, while still able to get a bank account. Default on shop credit, followed perhaps by default on a high-rate loan, will be the end of it, as the red flags go up on the credit reference. It's horrible not being able to borrow, but better, overall, than being pursued by collector after collector, to the grave or bankruptcy, for a debt that can never be repaid. The cost of the most defaults will be quite small, and it will be covered by a general increase in unsecured credit rates, which I think is fair place for it. Capable borrowers may pay a little more and that may seem unfair, but they benefit from their greater financial skill. The greatest single benefit is that lenders, losing the protection of the courts and the indefinite collection value in a bad loan, will have to take all the more care care to ensure that their borrowers can afford to repay. Fewer unsustainable loans will be made although some marginal borrowers will be refused loans that they might have repaid. There is another sneaky little benefit as funds withdrawn from consumer credit seek commercial lending as an alternative.

Now there are some questions here. What would stop someone borrowing with no intention to repay? Simply that like the mythical nuisance dog, they only get one bite. Lenders will demand that credit reference agencies keep on top of borrowers' identities, so that £250, which might be the maximum starter loan anyone with certain demographic profile can get, would be the last loan as well, unless it was repaid. The crafty development of a trustworthy profile by borrowing and repaying gradually increasing sums is something that data systems can spot, and mark down (or up, it's a statistical business so if that's the way the outcomes go...) And, while it might be even harder for people with skimpy personal histories or foreign connexions to which they might return, to get unsecured credit, then I think it should be. A bad risk is a bad risk, regardless of whether you can go, futilely, to court to get an unenforceable judgement.

Bank overdrafts are a little tricky. The unapproved overdraft -- actually drawing beyond whatever sum is agreed, isn't really a loan so much as a cockup and I think banks should be able to recover it. But the agreed overdraft is a consumer loan and should come under the plan.

The other question is the fate of someone who failed, years ago, to repay. Are they locked out of credit forever? Will they ever be able to get a mortgage? But this is exactly the same situation as it is now. Some lender will discover that it is worth taking the risk. Some borrowers will have to get guarantors next time. We don't want default to be consequence-free, but nor do we want people bankrupted for £500.

This is not a complete plan. We would need to ensure that secured loans were sensibly relating the asset to the loan to prevent lenders switching to a general charge as a replacement for unsecured lending. The look-through provision of the consumer-credit acts would need attention to stop personal lending being disguised as small-business. Lenders would need to control their products to deter fraudulent borrowing. The credit agencies would need to further improve their hygiene and disclosure processes to ensure that only the right people were denied. Schools have a huge role to play -- I don't have much time for teaching children to be good consumers, but we teach them road safety , and credit safety is hardly less important. We would need to ensure that unlicensed credit was efficiently suppressed to prevent sharks using their brutal extralegal enforcement. And we must continue to ensure that bad credits still have access to the payment system -- basic bank accounts -- without exposing the banks who we will require to provide it.

But as a defence of decency, and the possibility of a reasonable life for simple people, the credit reference agencies are a better tool than anti-usury laws could ever be.

Added 25 August 2013

Feedback has been on a couple of themes: Firstly that consumer credit agencies are irrelevant to lenders like Wonga who don't use them, and second that the CoE's plan for church credit unions makes a plan like this irrelevant.

Credit unions are an interesting plan, and all competition is good. But unions can't avoid the risk management question -- is it wise to lend? They sidestep it by rules about membership, regular deposits before loans, maximum loan sizes and others, but these are really just stereotyped risk management. The rules select people who are very likely to repay -- settled people who can make regular payments and will join the scheme before they need funds. More people should join credit unions but they don't remove the need for payday loans, and the obvious ways to abuse credit unions means that they'll never get very large.

Wonga's willingness to avoid credit references makes me admire them, but does not affect the plan. Any lender can decide to lend on any criterion they want. If some lenders decline to update the bad-debtor lists, that's not fatal: It will slightly increase the price of credit, but as it's happening now, that increase will already have taken place. The limitation of bad debt age to a year still works -- it might prompt maverick lenders to use credit agencies, or it might not, but it will still stop lives being wrecked for £200.