When Does a Lender Become a Loan Shark?
At what point does a lender (good) become a loan shark (bad)? The question has exercised philosophers—and unhappy borrowers—from antiquity to the present. In Loan Sharks: The Birth of Predatory Lending, finance professor Charles Geisst recounts the debate in the U.S. from the late 19th century through the Great Depression. The history illuminates today’s debates over, say, what the Consumer Financial Protection Bureau should do to control payday lenders, though Geisst is shy about drawing conclusions that might be useful to policymakers.
Loan sharks thrive where traditional banking is absent. They fill an unmet need, albeit often in a heartless, exploitative way. But one thing you’ll learn from the book is that there’s never been consensus on what’s a fair limit for interest rates. “In Rome it was 12 percent, in Elizabethan England 6 percent, and in the United States, it has ranged from 6 percent to 40 percent,” Geisst writes. That said, a few principles seem to have been widely accepted over the decades. One: It’s fair to charge higher rates for riskier loans. Two: It’s less fair in cases where the borrower is judgmentally impaired or uninformed—say, a recent immigrant who may not understand what the words “floating interest rate” mean.
In the U.S., the largely rural populist movement put up the first organized opposition to predatory lending. The populists favored high inflation, which would make high-interest loans easier to pay back over time. The members of the progressive movement, who succeeded the populists in the early 20th century, tended to be better educated, better organized, and more urban. They worried that high inflation would raise their cost of living. Recognizing that nature abhors a vacuum, the progressives organized kinder, gentler lending channels such as charities and various mutual-aid organizations, including credit unions, benevolent societies, and Morris Plan Banks, named after the lawyer Arthur Morris, who began making small installment loans to upstanding citizens of modest means.
About this time, in 1907, the Russell Sage Foundation was formed “for the improvement of social and living conditions in the United States.” Recognizing that state usury laws capping interest rates at 6 percent or 7 percent were too restrictive for legitimate lenders to make a profit on small, risky loans, and therefore left illegal loan sharks to fill the gap, Russell Sage’s researchers devised the Uniform Small Loan Law. The model legislation allowed licensed lenders to charge as much as 40 percent interest a year as long as they provided ample disclosure of their terms to borrowers. By the 1940s, 31 states and the territory of Hawaii had enacted the law, helping put loan sharks out of business.
Geisst blames poor lending practices—not loan-sharking precisely—for the stock market crash of 1929. Investors borrowed heavily from their brokers to buy shares, which happened outside the regulated banking system. “Broker loans had become a form of shadow banking, a term that became widely used eighty years later during another financial crisis,” he writes. When lending abruptly dried up, interest rates on loans shot to as high as 20 percent in a single trading day.
The conclusion of many of the people Geisst features in his book is that the best way to fight loan sharks is not to outlaw them but rather to give borrowers cheaper and safer options. But Geisst himself, a former investment banker who now teaches at Manhattan College, never fully embraces this prescription. He sometimes describes high-interest lending as the disease itself, not just a symptom: “Loan sharking in its many forms has caused stock market panics, structural banking problems, and often has impeded economic recovery after severe economic downturns.”
Loan Sharks has its flaws, but it’s valuable for the history alone. Unfortunately, Geisst ends his narrative at the Great Depression, without explaining why, and relegates the 80 years since to a five-page postscript, leaving himself in debt to readers with an interest in the present. If only there were some way for us to collect.