One of the puzzles of Congressional efforts to “reform” our financial system to avoid future crises is the amount of attention to lenders who had nothing to do with the crisis (almost as puzzling as the inattention to many who did).

Today’s Washington Post, for instance, details the efforts of payday lenders to fight back against both Senator Dodd’s new consumer agency and Senator Hagan’s amendment, that would essentially eliminate the consumer option of payday loans.

In general, any efforts to restrict consumer choice is rarely likely to improve consumer welfare. This has been repeatedly demonstrated in research on payday lending. Senator Hagan played a key role in banning such products in North Carolina. What was the result of that ban? Don Morgan, at the Federal Reserve Bank of New York, decided to test whether such a ban helped or hurt consumers. He compares how households in North Carolina fared after payday loan bans. The results: since the loans were banned in 2005 in North Carolina, compared to states where payday lending is permitted, households in NC have bounced more checks and complained more to FTC about lenders and debt collectors. “The increased credit problems contradicts the debt trap critique of payday lending, but is consistent with the hypothesis that payday credit is preferable to substitutes such as the bounced check protection sold by credit unions and banks or loans from pawnshops” states Morgan.

Where Hagan proposes to ban payday, Dodd proposes to have banks and non-profits directly compete with payday lenders, but with one big, important difference: taxpayers would cover a substantial portion of the credit losses. Buried at the end of Dodd’s massive bill in Title XII is a grant program that would cover credit losses on “payday” loans made by non-profit community lenders as an “alternative to more costly payday loans.” Of course the private sector loans will be more costly, as the lender will have to charge a rate that covers its losses. The difference between Dodd’s proposal and the private sector is that while private sector payday loans may be expense, they are entered into voluntarily, whereas Dodd make the taxpayer an unwilling participant in subsidizing high risk borrowing. Perhaps Dodd should examine previous efforts to subsidize high cost mortgage lending, before we repeat the same mistakes in payday.