Financial History Issue 112 (Winter 2015) | Page 21

poverty, as it was difficult to exact high rates of interest from somebody who had no money. As the Depression gave way to World War II, a few states had largely exterminated their sharks. In most states, however, sharks continued to thrive so alternatives, especially credit unions, again touted themselves as the way to “keep away from loan sharks!” In a 1940 pamphlet, proto-Keynesian economist William Trufant Foster (1879–1950) exposed the “modern loan shark,” men who could turn $20 into over $1,000 in just nine years by becoming a “bootlegger of small loans” in states — like Florida, Georgia, Missouri, Oklahoma, Tennessee, Texas and Washington — that prevented legitimate lenders, like banks and credit unions, from flourishing. “Never has a campaign to enforce a 10% usury law,” he explained, “prevented wage earners from borrowing money at 240%” because the demand for small consumer loans was so pervasive. Foster claimed that loan sharks lobbied in favor of maintaining or even lowering usury rates because “low legal interest keeps out legitimate lenders” like “legal, stringently regulated personal finance companies” that could lend profitably at rates between 24–42% per year. Foster was particularly peeved at well-meaning but uninformed persons who unintentionally aided loan sharks by pushing for lower usury ceilings or repeal of the Uniform Small Loan Law. “Persons who are uninformed, but of good intent,” he lamented, “cooperate with persons who are wellinformed, but of evil intent.” Payday lending began in a tentative way during the Civil War, was common by the 1910s and was pervasive by the early 1940s. In order to avoid anti-sharking legislation, early payday lenders bought the right to collect a part of the borrower’s wage on his or her next pay day, kept no books, blacklisted people who asked for receipts and did business across state lines through the use of agents. As Foster explained, “this often means that only the agents can be reached, not the culprits higher up and farther away.” The agents claimed to own no assets, “not even their office desks.” After World War II, banks, credit unions, finance companies and specialized small loan companies began to offer substantial quantities of short-term signature loans to America’s increasingly affluent working class, and their competition forced the old school loan shark far offshore. Nevertheless, the civil penalty for exacting usurious interest remained very low, ranging from loss of excess interest to loss of all interest and principal; it was a criminal offense in only a few states, and even in those places it was just a misdemeanor. Unsurprisingly, then, loan sharking came to be dominated by gangsters. This new breed of shark, which evolved in the New York City underworld during the Great Depression but did not increase its range nationally until the early 1950s, treated the body of the borrower and the lives of his family members as the ultimate security for loans and interest payments on the order of 5% per week. Organized crime sharks also lent to small businesses and, when necessary, sucked business inventories dry in order to recoup their capital and “vigs,” much as depicted in the HBO series The Sopranos. By 1966, loan sharks tied to organized crime lent an estimated $1 billion at rates between 250 and 2,000% per year. Although their reputation for violence often rendered the actual breaking of thumbs and limbs unnecessary, violent loan sharks were considered such a pressing social problem that in 1968 Republican presidential candidate Richard Nixon made attacking them a “significant part” of his campaign. Congress responded by passing the Consumer Credit Protection Act of 1968, which outlawed “extortionate credit transactions” in an effort to undercut the “economic foundations of organized crime.” The act imposed stiff penalties (up to a $10,000 fine and 20 years imprisonment) for the use of violence, or the threat thereof, in credit collections. By degrees, the government largely killed off the organized crime shark, partly by vigorously suppressing organized crime syndicates and partly by fostering lawful alternatives. The result of the latter policy was the modern payday loan industry, a rapidly growing beast that made $14 billion in loans out of about 10,000 offices in 2000 and $27 billion out of 22,000 locations in 2012. Many experts argue that the modern industry is highly competitive and hence the rates charged, high as they are, are fair because they represent the risks and other costs associated with making numerous small loans. High rates on small sums for short periods do not amount to much money, they note, so many borrowers are actually better off getting a payday loan than having their electricity, heat or water turned off or paying bounced check fees. Other experts, however, retort that many borrowers (more than half in many states) roll over their loans from paycheck to paycheck because they cannot repay the principal or because the lender makes it difficult for them to do so. As a consequence, borrowers end up paying far more in interest and fees than they anticipated. State payday loan regulations vary greatly, providing researchers with clues about the extent to which specific regulations, like rollover prohibitions, help to prevent borrowers from falling into the maw of this most recently evolved species of shark. The debate, in other words, is no longer over the price of borrowing but the exact terms of the loan and its repayment. “Debt trapping ought to be prohibited,” as Robert Mayer put it.  Robert E. Wright is the Nef Family Chair of Political Economy at Augustana College in South Dakota and a member of this magazine’s editorial board. He is the author of more than 15 books including One Nation Under Debt (2008) and is the co-author, with Museum Chairman Richard Sylla, of Genealogy of American Finance (Columbi H