Payday Loans and Consumers Hurt When Usury Laws Squeezed

Payday loans, like most other forms of lending in America, are subject to state usury laws that are intended to provide borrowers with a modicum of protection. Yet is it possible that usury laws are so restrictive that they are squashing competition, which leads to a weaker market (and hence lessened individual financial well-being)?

Lithograph by Edward W. Clay. Praises Andrew J...

Regulation is Harmful

Numerous studies citing recent examples like those by Jonathan Zinman of Dartmouth University and noted financial analysts Donald Morgan and Michael Strain for the Federal Reserve give us clear statistical examples of how overly tight regulation of payday loans is harmful rather than helpful. However, this recent study by Efraim Benmelech (Harvard University Economics professor) and Tobias Moskowitz (University of Chicago Business professor) looks into America’s past to give readers a more complete understanding of the historical impact and cycles of usury legislation.

Benmelech and Moskowitz indicate that such financial regulation is close correlated with restrictive political and economic policies that have been traditionally designed to exclude lesser groups and protect the interest of powerful incumbents. As banking history in America goes back much farther than the faxless payday loan industry, it is the well-established incumbent to the upstart short-term consumer lender. Usury laws help the incumbents; the incumbents are also typically involved in key lobbying against payday loans.

“The Political Economy of Financial Regulation: Evidence from U.S. State Usury Laws in the 19th Century”

This is the title of Benmelech and Moskowitz’s paper, and while it may seem that by focusing almost entirely on the financial landscape of 19th century, the authors pigeonhole their report into a category less than practical for modern times. Such is not the case, however. This is the primary question they pose in the report:

Do usury laws serve as a social insurance mechanism that transfers wealth across states of the world and households in the interests of social welfare? Or, do private interests with political power impose usury laws to benefit themselves and impede competition? In short, do usury laws protect the poor or financially distressed, or do they reward financially strong incumbents by limiting access to others?

After studying both private and public interest scenarios, Benmelech and Moskowitz find that powerful banks (incumbent groups) have historically used regulation to “capture rents at the expense of other groups by imposing maximum legal rates.” Thus, said incumbents produce a effect in which they benefit from these usury laws, in that other groups seeking foothold in the market payday loan companies in our more modern example, and by extension consumers) cannot access finance as easily.

State governments have supported the incumbents

From the authors’ conclusion:

When the cost of regulation is low, private interests impose tight restrictions to extract rents and impede competition. When the cost of regulation is high for those private interests, states relax the constraints. We find that financial regulation is also correlated with other restrictive political and economic policies adopted by the state that are designed to exclude other groups and protect incumbent interests.

As it was true for 19th century America, much the same is true now. In Zinman’s “Restricting Consumer Credit Access:
Household Survey Evidence on Effects Around the Oregon Rate Cap,” we see that there was a definite negative connection between capping the rates of payday loans in Oregon. As the Dartmouth professor predicts more such regulation to come – following the path of history as Benmelech and Moskowitz show – consumers interested in the tenets of freedom should take in the reports named here and be sure that their Congressmen and Representatives are familiar with the work. That is one of the most effective ways to combat the unchecked dominance of incumbent banks that would limit consumer’s ability to access affordable credit. Competition must survive.