Sunday, May 26, 2019

The Loan Shark Prevention Act

Bernie and AOC have joined together to pass the Loan Shark Prevention Act. Could this may become a big issue in 2020?

Image Credit: J Pat Carter for the Washington Post/via Getty Images

“Loan Shark Prevention Act is only two pages long. It includes language that would prevent lenders from adding fees to “evade” the interest rate cap and sets penalties for violators, including a forfeiture of all interest on the illegal loans.”  It’s Alexandria Ocasio-Cortez’s first bill jointly with Bernie Sanders. “It’s something Sanders has proposed for many years: a 15 percent interest rate cap on all consumer loans, which would reduce what many Americans pay on their credit cards and effectively eliminate the payday loan industry.”

Bernie has proposed similar laws over the years, so this one should not come as a surprise.  But the introduction of this legislation is undoubtedly in response to the Trump administration’s pushback of payday loan protection in February 2019. “The Trump administration . . .  rolled back protections set to make payday loans less risky for borrowers, which could affect millions of young people: Almost 10 million millennials have taken out one of these high-interest, short-term loans in the past two years.

“The Consumer Financial Protection Bureau, the government agency tasked with regulating financial companies, said it plans to abandon Obama-era payday loan stipulations that would require lenders to ensure borrowers could repay their loans before issuing cash advances.”

You might ask, “What happened to usury laws?”  Usury has a long and tangled history. The Code of Hammurabi (1750 B.C.) regulated the amount of interest that could charge.  Both Plato and Aristotle thought usury immoral and unjust The Greeks first regulated interest, then deregulated it. There was so much unregulated debt that Athenians were sold into slavery and threatened to revolt.  The Romans finally regulated interest at 12% a year.

Charlemagne outlawed interest throughout his empire, and in 11th Century England, the taking of any interest at all was punished by taking the usurer’s land and chattels.  Under Medieval Canon Law, usury was punishable by ex-communication. Under Medieval Roman law, usurers were fined at four times the amount taken, while robbers were punished at twice the amount taken.

In later times, in the United States, states generally capped interest rates   at 6% a year. But starting in the early 1900s, there was a move towards deregulation in some states.  Still, usury laws are common enough in state laws, but due to a 1978 decision by the Supreme Court, these laws provide no protection.   The answer lies in a 1978 Supreme Court ruling, Marquette National Bank of Minneapolis vs. First of Omaha Service Corp. “The case not only changed the law, but also became a light-bulb moment for the industry, setting it on a 30-year path that deeply affected state economies and Americans’ debt levels.

“There have been a few seminal events in the industry; this was one of them,” says Scott Crawford, a former analyst in the Congressional Budget Office and for credit card issuer HSBC. He is now CEO of DebtGoal.com. “There was a premium for being in states with lax usury laws. It gave you a strong advantage over operators in other states.”

The Supreme Court decision allowed lenders to apply the law of their state against borrowers in other states.  That’s why so many credit card companies have their main offices in South Dakota and Delaware: because those states have lax protections against high interest rates.

Of course, if the Loan Shark Prevention Act were to become national law, it would override states laws and the Marquette decision.  It would likewise defeat the Trump administration’s plans to bolster the payday loan industry.  Given that millions of millennials are taking high-interest, short-term loan, this is an important legislative attempt.

How much interest is being paid on credit cards and payday loans?  Payday loans average 400% per year, with the rates in some states approaching 700%. Consumers are paying $104 billion annually for credit card interest and fees.  

Here’s a chart of card typs and average low and high interest rates.

Card TypeLowHighOverall
Travel Rewards Cards15.62%19.24%15.99%
Airline14.62%21.99%16.24%
Hotel15.24%21.99%16.12%
Business Credit Cards13.12%19.87%15.37%
Cash Back Credit Cards13.24%22.99%20.90%
Student Credit Cards13.99%22.62%19.80%
https://www.valuepenguin.com/average-credit-card-interest-rates

You may want to compare the rates charged on payday loans and credit cards with the amount that banks pay in interest to their customers:   0.09% on savings accounts. Given these differences, limiting lenders to 15% per annum would seem fair overall.

You might also consider what major banks pay their CEOs   Last year, Jamie Dimon of JPMorgan, James Gorman of Morgan Stanley, Brian Moynihan of Bank of America, Michael Corbat of Citigroup, David Soloman of Goldman Sachs, and Tim Sloan of Wells Fargo collectively made $151.9 million in salary and bonuses. Altogether, that is an 8% increase on 2017 And why not?  They are ripping off the consumers.

Summing up: there is nothing wrong with charging some interest for the use of money, but if banks will only give you 0.09% for your money, they shouldn’t be allowed to charge 24% for the same money.  Yes, there is some risk in making a loan, and the banks have to charge enough to cover that risk. But historically, the worst period for bad loans between 1999 and 2014 was a bit over 3%. Usually, it’s a lot lower.  15% should pretty much cover it.

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