Wall Street's jitters continued Tuesday, as investors continued to worry that the "easy money" era is over. While there is some hope that the turbulence in the credit markets is a temporary phenomenon that might straighten itself out in a couple of months, there appears to be widespread fear that the days when one could cheaply purchase insurance against a bank default or other financial disaster are over. Suddenly, investors looking to borrow a few billion dollars or so for a leveraged buyout are facing sticker shock.
Maybe some of these newly chastened investment bankers should have spent some time over the last couple of years standing in line at their local payday loan center. They might have a better sense for what it's like to have to pay through the nose to get some spending money. Then again, it's unlikely that there are any payday loan centers near the neighborhoods in which investment bankers live, because usury is generally only at home among the poor.
That's right, usury. The word has an archaic, Old Testament edge to it. But it's very much alive in the United States today, provided you need a couple of hundred bucks instead of a couple of billion.
Usury laws just aren't what they used to be. Let's cut straight to the chase:
From "Usury Law, Payday Loans, and Statutory Slight of Hand: An Empirical Analysis of American Credit Pricing Limits," by Christopher L. Peterson, a law professor at the University of Florida:
In virtually every measurable way usury law has become much more lax since 1965. In 1965 every state in the union had a usury limit on consumer loans. Today nine states have completely deregulated interest rates within their borders. In 1965 banks were bound to comply with all state usury laws. Today banks are free to charge whatever interest rate they choose within the loose and changing tolerances chosen by banking regulators for their safety and soundness guidelines. In 1965 no state had law either explicitly or implicitly authorizing prices with an annual percentage rate of over 300 percent. Today, at least 36 states have law allowing lenders to charge over 300 percent. In 1965 usury laws were drafted with sufficient rigidity that 45 states held actual allowed annual percentage rates to 60 percent or under. In 2007 the number of states accomplishing this has fallen to only seven.
Other fun facts:
- "The best available nationwide estimate suggests that the average payday loan borrower repays $793.00 for a $325.00 loan."
- "Between 2000 and 2004 alone, the number of payday lender locations more than doubled from 10,000 to 22,000."
"Lax" seems a mild choice of words to describe government sanction of usury. But there is an unmistakable undercurrent of anger running through Peterson's study, and it's not hard to understand why. For thousands of years, the practice of usury has generated moral opprobrium. Charging those who are least able to pay the highest rates of interest is patently uncivilized.
Perhaps that's why almost none of the states that have loosened their usury limits are willing to admit it. Peterson's unique contribution to the academic literature on usury in the United States is the creation of a data point he calls "salience distortion." Salience distortion measures the difference between the actual price a lender can charge for a loan, in terms of an annualized percentage rate, and the most salient numerical figure in the statute describing that fee. Typically the statute will limit a lender to charging, say 15 percent of the value of the loan, glossing over the fact that a payday loan is typically meant to be paid back in only two weeks.
"Every state that has legalized triple digit APR consumer loans to the working poor uses a small, misleading number in their legal text to do so. This suggests that political leaders understand what many traditional neo-liberal economists apparently do not. In the real world how a value is described can be much more important than the value itself. Many state legislatures use small, innocuous numbers in usury law because they are attempting to minimize the public and media outcry over their decision to legalize triple digit interest rate loans."
Just for fun, imagine the outcry if a big New York bank tried to charge triple digit interest rates on a loan to a private equity player like Blackstone or KKR. After the smoke cleared from the wreckage on Wall Street, someone might do something crazy, like pass a law making the unconscionable illegal.
(Thanks to Credit Slips, a group blog written by six academics who focus on credit and bankruptcy issues, for the link to Peterson's paper.)