Thanks for having me back at Credit Slips! This week I’ll be blogging about two forms of credit that are increasingly popular: auto title lending and pawnshops.

Pawnbroking is back, and in a big way. Recent television shows like Pawn Stars and Hardcore Pawn are a testament to the resurging interest in this ancient form of lending. In a new paper with Susan Payne Carter and Marieke Bos, "The Pawn Industry and Its Customers: The United States and Europe,"we document important facts about the pawn business. Pawnbrokers take collateral or a “pledge,” (anything from jewelry to tools to dental implants!) in exchange for about 50 percent of the item’s resale value, plus interest.

What’s not surprising is that the vast majority of pawn borrowers use gold, in part because pawnbrokers give much better deals (offering around 85 percent of the gold’s resale value) due to limited resale risks (compared to the risks involved with electronics or dental implants, neither of which age well). Pawn loans, often lumped in with "fringe banking" and sometimes considered usurious, have lower costs to the borrower than one might think.  The average interest rate in the U.S. is 15% for 30 days, and in Tennessee where I live, the interest rate is just 2% per month. While these rates are still high compared to mainstream credit, they are often much cheaper than some natural alternatives like payday lenders who charge 10-20% fee over just a few days, not a month. More importantly, the downward spiral of financial distress often associated with fringe banking is largely absent in pawn credit. Defaulting on a pawn loan has no impact outside of losing the collateral; it does not affect the individual’s prime or subprime credit opportunities in the future. Interestingly, given these relative high borrowing- and low default- costs, we find that the majority (around 80 percent) of borrowers manage to pay back their pawn loans.

In a follow-up paper published in The Review of Financial and Banking Law, Professor Carter and I show how pawnshops can function quite well in light of the behavioral economics factors driving behavior. Borrowers who pawn items like wedding rings are especially inclined to retrieve their collateral; the sentimentality of their pledge apparently functioning as an efficient commitment device, thwarting off the potential feeling of loss associated with forfeiture of your personal property. (Try to explain to your wife where your wedding ring went!) This type of behavior is fertile ground for examining the nuances of alternative borrowing behavior.  

In general, so little is known about how pawnshops are used that our main goal is to learn whether pawn credit helps or harms consumers who often have no other options. Marieke Bos’ shows people turn to pawnshops quite rationally. For example, borrowers are more likely than the general population to have low credit scores and to have already exhausted their other credit options. For more on the rationality of pawn borrowers. (See "Rationality in the Consumer Credit Market: Choosing between Alternative and Mainstream Credit").

Once the scourge of the lending world, pawnshops serve seven million Americans a year. Pawnbroking helps borrowers manage their personal finances in a way that wouldn’t be possible with traditional credit options alone.