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The Justice Dept. May Have Met Its Match in the Payday Lending Industry

Payday lenders haven't been able to shake the unrelenting glut of regulations and laws aimed at curtailing many of their business practices. However, a Justice Department-backed initiative called Operation Choke Point goes too far, and it has elicited a first of its kind lawsuit from the industry's players.

Among the key players in the space that I will point out in this article are First Cash Financial Services (NASDAQ: FCFS  ) and EZCORP (NASDAQ: EZPW  ) . I chose these because of the assortment of payday lenders, they've been the most put upon, and even singled out, for their practices.

Concerns about the industry have mainly stemmed from the exorbitant amount of interest and fees payday lenders charge borrowers for loans. The Operation Choke Point initiative, however, should not be a reason to avoid the space, as the measure is riddled with provisions that I believe will be found to run afoul of the law. If the payday lenders prevail, it could be just the catalyst needed for many of these companies' stock prices to rise.

The lawsuit
Upon learning of Operation Choke Point, however, players in the space screamed bloody murder and they are refusing to just sit back and take it.

At the beginning of the month, Community Financial Services Association of America sued several federal banking regulators. They charge that the initiative is "a clear attempt by certain federal agencies to circumvent the law."

Choke Point sticks it to banks too
The way the initiative is to be enforced is also troublesome. It is calling for banks to step up their investigation into payday lenders to determine if they are fraudulent. The last time I checked, banks handled money, not criminals. Regardless, this Justice Department-supported task force is passing the buck to banks.

Michael Bresnick, the executive director of the task force, defended Operation Choke Point. He said banks should consider whether originating debit transactions on behalf of Internet payday lenders violates federal law that guards against money laundering.

The fallout of such a task has already resulted in at least 80 banks severing ties with payday lenders. These banks include JPMorgan and Bank of America. The banks are either refusing to open new accounts, closing existing accounts or both.

The rational behind holding banks more accountable for the businesses they allow accounts for is to force them to choke off the way these businesses receive their funds.

Shifting business models
Many payday lenders had already begun shifting to other areas to make money. This includes offering more pawn shop and retail services.

Take First Cash Financial, for example. Last year it paid about $70 million to buy pawn stores in Texas. This was a smart move considering the growth of the pawn market in the Lone Star State, especially in the Houston area.

When it reported its first quarter earnings this year, it said that its core revenues from retail sales and pawn fees increased 20%. This was great news considering its payday loan business suffered a 17% decline.

The company blamed the decline on increased competition and regulatory pressures. Referring to its payday lending business as "non-core," the company noted that it accounted for just 6% of its total revenues during the first quarter. Furthermore, it was expected to account for less than 5% of its revenues by the end of the year.

EZCORP also saw its retail sales increase. They were up by 4% with jewelry sales accounting for much of that growth during its most recent quarter. It's struggling with its pawn business however, expecting it to be roughly flat by the end of the year.

Operation Choke Point simply unfair
Operation Choke Point is the brainchild of President Obama's Financial Fraud Enforcement Task Force. I understand that its goal is to stomp out fraud. However, this is the wrong way to do it. The opponents of the initiative are correct in arguing that the federal government cannot take regulatory action at the expense of legitimate businesses' liberties and rights to due process.

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A previous version incorrectly stated Cash America as a plaintiff. The Fool regrets the error.

Read/Post Comments (2) | Recommend This Article (2)

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  • Report this Comment On June 18, 2014, at 6:04 PM, ywalker1 wrote:

    After reading your article, it is important to note an incorrect statement. Cash America International, Inc. was NOT the company that "sued several federal banking regulators," as stated in the fifth paragraph of this article. Please correct. Our company has taken no such action. Thank you. Yolanda Walker, vice president of Public Relations and Corporate Communications, Cash America International, Inc. (NYSE:CSH).

  • Report this Comment On June 20, 2014, at 3:49 PM, laserlin wrote:

    It's outrageous enough that the government went around the constitutional and due process to go after these businesses which haven't broken the law. But what makes it exceedingly reprehensible is that they collaborated with banks that have committed serious crimes against the American people. Selling fraudulent mortgages, robo-signing, the list goes on.

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Tedra DeSue

Tedra is an investment writer with two decades of experience covering the equity and capital markets. Her start was in covering the muni bond market, and while that's still a passion, she now focuses on covering tech, financial and biotech stocks. Momentum and Growth stocks are her favorite investment picks.

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