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Wednesday, October 15, 2014

Layaway: Live after Death

Government intervention resurrects long-dead retail practices

Everything that is old is new. Denim jeans, gratuitous use of neon, retro glasses, and nü-metal have all returned from the dead to plague the living. In the spirit of making the old new and relevant, Walmart has kicked off its seasonal layaway program, a practice that was discontinued in the mid-2000s but resurrected in 2011.

For those who can't remember this antiquated ritual, which was a common practice during the Great Depression, here’s how it works: after the customer makes a small down payment, the store will “lay” the item “away” until the customer completes payment. You might ask: Why didn't people just use their credit cards? The answer is that credit cards didn't really exist back then. Some stores engaged in financing and extended credit to select customers, but the interest rates were high, and, keep in mind, these were stores, not debt collectors or banks.

With the bad economy of the Great Depression, consumer credit dried up as risk of default increased. Layaway was beneficial because it allowed the consumer to guarantee a good’s availability while the store minimized its risk exposure. The availability of goods was a concern because supply chains were not as developed, and when a store ran out, it might be out indefinitely.

Layaway largely disappeared during the 1980s with the massive expansion of consumer credit and credit card companies. Credit card companies were able to offer lower rates because they specialized in analyzing and pricing risk. They also took on the burden of debt collection. This shift was a win-win for everyone involved. Customers benefited by being able to immediately enjoy their purchases. Stores benefited from getting the full value of the purchase upfront while simultaneously freeing up storage space that was previously occupied by layaway.

So why has layaway returned? A simple answer would be a tighter market for consumer credit due to the recent recession. Yet, there have been recessions in the past. A more encompassing answer would have to incorporate the machinations of the public sector, too. The passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the activities of the newly minted Consumer Financial Protection Bureau (CFPB) have played a considerable role in altering the practices of consumer credit, perhaps permanently.

The CFPB’s ostensible purpose is to protect consumers by regulating the financial industry. In practice, this means that the CFPB is against the high interest rates and fees charged to certain market segments and that it frowns upon “exotic” credit products (read: any service that is non-plain vanilla, whatever that means). The outcome has been a tightening up of credit as lenders move away from financial products that the CFPB doesn’t like — and in the case of Walmart’s layaway program, a return to those that they do.

Walmart may have only brought layaway back in 2011, but Senator Elizabeth Warren (D-MA), the mastermind behind the CFPB, was cheering Kmart’s layaway plans back in 2008. Her argument was that layaway could be a good thing as money that was previously spent on interest and interchange fees could now be spent on “socks, haircuts, prescription drugs and a million other goods and services.” In other words, consumers are now putting money toward principal, not interest.

The problem with this statement and general viewpoint is that it makes a false comparison between different types of credit. Credit card companies provide a valuable service by acting as a middle man between customers and stores. Customers get their wares by compensating stores today while credit card companies are assured they will be compensated sometime in the future. This enables transactions to take place that would otherwise not occur, which creates economic value.

The solution, then, is not to force consumers into one type of credit service, but to offer multiple avenues by which consumers can afford to buy goods and services. They can decide the appropriate route to take. Then again, government has never been comfortable with free choice — or, in the case of the CFPB, with the idea that people are even capable of making their own choices.

Consider the Walmart plan. Customers must make a $10 or 10 percent down payment on their purchase, whichever is greater. This year, holiday layaway starts on September 12 and final payment and pickup must be made before December 15. If, for whatever reason, things go awry, Walmart will refund all payments less a $10 cancellation fee.

So is layaway an improvement in extending credit to customers? For most, probably not. The easy mistake would be to compare layaway (free) to carrying a credit card balance (which incurs interest). In that comparison, layaway is obviously attractive. Nevertheless, to make a direct comparison of rates would be a mistake, as the credit services are different. With credit cards, consumers receive the product immediately. With layaway, they receive the product upon final payment. In a sense, customers do not actually need Walmart to offer a layaway program; they can simply start saving the money themselves. Layaway essentially offers Walmart an interest-free loan. Put another way, while credit cards allow consumers to enjoy their goods today and pay later, layaway reverses this transaction by allowing Walmart to enjoy the customer’s money today and pay back the customer in the form of goods later. Layaway thus represents a shift in credit away from consumers and toward corporations. So much for consumer protection!

In a competitive market economy, stores and credit card companies have to compete to attract customers. Government intervention will not protect consumers. It will merely kill credit for certain customers and cause stores to resurrect long-dead retail practices.

As economist Alex Tabarrok asks, “Are we living in the Soviet Union? Who worries about Walmart and Kmart running out of goods?”

Clearly layaway, like neon, is a fad past its time. Only hipsters and government bureaucracies relish these fads’ return.

  • Adam C. Smith is an assistant professor of economics and director of the Center for Free Market Studies at Johnson & Wales University. He is also a visiting scholar with the Regulatory Studies Center at George Washington University and coauthor of the forthcoming Bootleggers and Baptists: How Economic Forces and Moral Persuasion Interact to Shape Regulatory Politics.
  • Stewart Dompe received his PhD in Economics from George Mason University. He has published articles in Econ Journal Watch and is a contributor to Homer Economicus: Using The Simpsons to Teach Economics. Follow him on Twitter @stewartdompe