Financial History Issue 130 (Summer 2019) | Page 29
of states to police activities outside their
own borders, has made governing the
small-sum lending industry within a fed-
eral framework especially challenging. The
stickiness of the problem became apparent
in the early 20th century, when states such
as New York attempted to prevent lend-
ers from charging their residents more
than the state’s maximum interest rate
of 6% per year. Lenders soon discovered
a loophole, however, setting up shop in
neighboring states with lax usury laws and
sending money and legal documents to
borrowers through the mail. The differ-
ences in how each state treated the same
transaction created incentives for lenders
to shift the legal location of their transac-
tions in order to escape unfavorable regu-
lations, a process known as “regulatory
arbitrage.”
So began a game of whack-a-mole, as
restrictive states beat down one form of
illegal lending only to find another pop-
ping up in a different corner. State-by-
state campaigns for the adoption of uni-
form lending laws represented one means
to combat arbitrage and rein in high-rate
lenders. Even in the absence of a uniform
or model law, states also learned from one
another as they drafted and updated their
lending rules, with states such as New
York leading the charge.
And, over the course of the century, the
states made much progress, with many
adopting uniform rules for small cash
loans and imitating one another’s laws on
credit sales. But they found themselves
almost back at square one by the early
1980s, when a United States Supreme
Court decision and subsequent legislative
changes further limited state authority
over national banks and the small-sum
lenders that partnered with them.
Second, governing small loans has
been difficult because policymakers have
struggled to draw appropriate regula-
tory categories, with the goal of treating
similar activities similarly and different
activities differently. This line-drawing or
categorization problem has taken several
different forms over the course of the past
century. For example, policymakers have
been unable to decide whether small loans
should be regulated just like other forms
of credit or merit their own specially
tailored rules. Before the rise of the small-
sum cash lending business in the 1890s,
the law did not draw a distinction between
big loans and small ones. The same usury
laws applied across the board; only pawn-
shops were subject to a special set of regu-
lations. But in the 1910s, the drafters of the
Uniform Small Loan Law proposed that
small cash loans—defined as loans under
$300—should be governed by their own
rules, which would allow charges greater
than those permitted under most state
usury laws. Proponents of the law persua-
sively argued that a higher rate of charge
was necessary for small-sum lenders to
recoup their fixed administrative costs,
manage the risks of small-sum lending
and earn a profit.
Although the uniform law was widely
adopted in the 1920s and 30s, it also pro-
voked strong opposition from populist
politicians like Mayor Fiorello LaGuardia
of New York City, who claimed that the
law permitted “legalized usury” and was a
boon to the small loan “racket.”
LaGuardia saw no need to allow small-
sum lenders to charge higher rates than
those permitted for commercial banks.
Since then, lawmakers have vacillated
between two poles, sometimes treating
small loans as a special category of debt
and sometimes regulating them just like
any other form of consumer credit.
Policymakers confronted a similar cat-
egorization puzzle when deciding how to
regulate cash loans and the sale of goods
on credit. They wrestled with whether or
not the law should distinguish between
these two types of transactions, and the
related questions of what constitutes a
“loan” or “interest” on a loan. At the
beginning of the 20th century, the law
drew a sharp distinction between interest
on a cash loan, which was strictly limited
in most states, and the charge for a sale
of goods on the installment plan, which
was not. The different legal treatment
of these two forms of lending then cre-
ated incentives for lenders to evade unfa-
vorable regulations by disguising a cash
loan as a credit sale. Lenders regularly
engaged in this form of regulatory arbi-
trage, which put pressure on policymakers
to discard longstanding legal distinctions
between the two transactions. As a result,
the laws governing cash loans and credit
sales slowly converged over the course
of the past century. Yet the distinction
between sales credit and cash loans did
not disappear entirely, as reflected in the
different legal treatment of payday loans
versus rent-to-own transactions.
Finally, small-sum loans have been
especially tricky to govern because their
regulation has been bound up with the
problems of poverty and poor relief,
which have compounded the complexity
of the puzzle. To policymakers, small-sum
lending has exemplified both the promise
and the perils of modern American capi-
talism for low-income households. On
the one hand, small loans have promised
low-wage workers a measure of indepen-
dence from state support and entry into
the growing consumer economy. Credit
has served as a private safety net, allow-
ing workers to manage financial shortfalls
and make big-ticket purchases without the
aid of public welfare or private charity.
On the other hand, workers’ need to bor-
row has also symbolized the failure of the
economic system to lift up all households.
The high demand for small loans has
repeatedly made clear that the rising tide
of American prosperity has left some boats
grounded on the shore. Furthermore,
onerous debts may increase demands on
the state for poor relief, turning self-
supporting families into public charges.
Critics have labeled the business a “racket
in human misery” and the purveyors of
these products “loan sharks.” Thus, the
link between small loans and poverty has
justified both tightening and loosening the
reins on the lending industry, pulling poli-
cymakers in opposing directions. At some
moments, policymakers have supported
the small loan industry; at other times,
they have treated small loans like a species
of vice, unsavory and barely tolerated.
Which impulse predominates at any
given moment has depended, in part, on
which lenders serve as the public face
of the industry and how they encounter
reformers and policymakers—as partners
in formulating regulation or as adversaries
in litigation. Attitudes have also changed
over time depending on public awareness
of the peculiar economics of small-sum
lending, the availability of other sources
of credit and their regulation, levels of
public concern about poverty and prevail-
ing ideas about the proper relationship
between the state and the market. These
changing ideas and attitudes, combined
with the work of consumer advocates,
www.MoAF.org | Summer 2019 | FINANCIAL HISTORY 27