What can we learn from the history of regulation of small sum high-cost lending? Anne Fleming, in a thoughtful, carefully researched, and stimulating book, City of Debtors examines the history of regulation of ‘fringe finance’ in the US since the early twentieth century. Fleming argues that Americans are torn between concerns to protect working class and poor debtors from exploitation by high-cost credit, while still permitting access to credit, and allowing individuals to control their own financial lives. She highlights a number of continuing themes in the history of credit regulation, including regulatory arbitrage and reforms as often representing a coalition of reformer and lender groups.
Her narrative begins with progressives’ concerns at the beginning of the 20th century with salary lenders (modern payday lenders) who provided short term loans to urban workers usually in contravention of the usury laws. In response to public concern, reformers collaborated with ‘high-road’ lenders to develop the model Uniform Small Loan Law with generous price caps, as a legitimate method for providing small loans to the working class. The price caps reflected the views of reformers (The Russell Sage Foundation) that it was inherently costly to offer small loans to poor consumers and that this would attract capital to the industry. Licensing of a limited number of lenders gave stability to the industry, reducing incentives for excessive competition.
This reform represented a confluence of lender and reform interests, with lenders interested in stability and legitimacy and indeed viewing the law as constituting the industry. In order to deter unlicensed loan sharks from undercutting the law, severe sanctions were introduced for failure to comply with the requirements of the Act, including the unenforceability of any credit contracts. The need for such strong sanctions was based on the theory that low income individuals would be unlikely to challenge loan sharks through the courts.
Regulatory arbitrage and regulatory circumvention existed throughout the twentieth century. The time-price doctrine in US law (the price depending on whether the purchaser paid cash up front or over time) historically exempted sales finance from the usury law resulting in irrational distinctions between different forms of financing purchases, and offering incentives for the creation of fake instalment sales to get around usury laws. Although small loan interest rates were regulated from the 1920s , sales finance was relatively unregulated, and often did not disclose the costs of lending. Certain parts of the sales finance business became associated with practices similar to those which stimulated the English Hire Purchase Act 1938. Known as ‘chain repossession’ in the US and the ‘snatch back’ in the UK, sellers repossessed goods when individuals fell behind on a repayment notwithstanding that borrowers had repaid most of the debt, with the seller subsequently reselling the goods at a profit. The seller in the US might also take a wage assignment against the borrower which if enforced could result in loss of employment. Regulation of these practices was often justified as protecting individuals from becoming a public charge on the state.
In later eras, rent-to-own and leasing companies would attempt to circumvent the protections in retail instalment sales law. The Federal structure of the US offered further opportunities for arbitrage. Thus some early salary lenders in New York structured their loans to be governed by the law of the state of Maine which did not have usury ceilings. And in the 1970s, a bank successfully convinced the Supreme Court in Marquette National Bank of Minneapolis v. First of Omaha Service Corp. that banks, by chartering in a state without usury ceilings, could export that rate throughout the country.
The book provides a rich analysis of the subsequent decline of the Small Loan law and the development of credit law as part of the ‘law of the poor’ in the 1960s, when credit exploitation of black and minority consumers, often through door-to-door selling, was attacked under the unconscionability doctrine (see here )and the Supreme Court used the due process clause to establish minimum standards in credit enforcement. But the book also demonstrates the limits of litigation and the need for legislation, as well as the difficulties of policing the ‘fly-by-night’ operator. The book concludes by discussing the rise of the check cashers and modern payday lenders which have, according to one payday lender cited in the book, become “an adjunct of the welfare system”.
Credit has historically functioned as an informal safety net in the US (see here) with a reluctance in the US to provide state subsidised lending for the poor (although the US tax system was used to provide generous tax subsidies for middle class borrowers). Fleming highlights a belief among some groups that state provision might undermine an individual’s dignity, and result in the ‘stigma’ of welfare. Fleming concludes that the contemporary challenge for policy makers is how to regulate small sum lending in ‘a world in which welfare and small sum credit are the two sturdiest life rafts available to those drowning in the choppy waters at the edge of the economy’.
The book is a valuable contribution to debates on high cost lending even if it does not provide any solutions. It might have benefited from further engagement with theories of the role of consumer credit in contemporary capitalism. For example how would this history of high-cost credit fit with Soederberg’s description of the US as a “debtfare state” with credit as a form of secondary exploitation of the surplus population?
What relevance does this US history have for the UK?
Many of the themes identified also can be identified in UK credit history such as regulatory arbitrage and legislation representing a confluence of industry and consumer groups. In the 1950s some finance companies attempted to avoid the bite of regulation by constructing their hire-purchase agreements as hires. The recent rise of auto log-book loans exploits a loophole in protections for consumers against seizure of their goods. Reforms which represented a congruence of industry and consumer interests include the 1938 Hire Purchase Act, the outcome of a Bill promoted by Toynbee Hall (see here) an organisation working with poor debtors and the Hire Purchase Trade Association. The Consumer Credit Act 1974 was supported by both finance groups and consumer groups. In both cases these Act gave legitimacy to the credit industry as well as providing consumer reforms.
The UK never developed a Small Loans Law, although social reformers such as Dorothy Keeling urged Parliament in the 1920s to follow the US model as a solution to problems of illegal moneylending in large industrial towns such as Liverpool.
The UK also faces the contemporary challenge of regulating high-cost credit in a shrinking safety net where the poor continue to pay more (see the recent Office of National Statistics study here). The Financial Conduct Authority has capped the cost of payday loans, promises to cap the cost of logbook loans, but is not certain whether to regulate the price of home credit and overdrafts. Even with price caps, credit remains costly for individuals in these markets. The recent Treasury committee report did not identify any ‘silver bullets’ for addressing this question, although more secure employment and reasonable housing costs might be a start. It is not obvious what is the solution. The suggestion that Housing Associations might provide lower cost appliances to compete with the rent-to-own companies merits further study. The welfare state in the UK did historically attempt to protect low income individuals through social grants, and subsidies, but increasingly individuals are being left to the credit market to make ends meet.
Consumer credit law is complex partly because of regulatory arbitrage and historical attempts at circumvention. Given the incentives to circumvent regulation and the assumption that individuals would be unlikely to bring actions for contraventions of rules, legislators often inserted strong sanctions in laws such as the Moneylenders Acts, similar to the Uniform Small Loans Law. Undoubtedly this had value but it also provided opportunities for individuals to reject agreements on technicalities. Given the seeming individual injustice in these cases, judges were reluctant to apply the letter of the law resulting in tortuous interpretations. Successive generations have attempted simplification. This was the objective of the Crowther Committee which deplored the technical morass of interpretation under the earlier Moneylenders Acts. But the Consumer Credit Act 1974 carried forward significant complexity which resulted in litigation often focused on technicalities rather than substantive fairness. The FCA developed its high level principles such as treating customers fairly as a response to the technicalities of detailed rules, inviting firms to embed these in their products and treatment of consumers. The Payment Protection Insurance scandal indicated the limitations of this strategy with the finding that managers in many cases received substantial commissions for selling insurance policies to consumers.
Finally there is the role of competition. Contemporary reformers generally assume that vigorous competition in credit markets is good for consumers. Measures such as the Uniform Small Loan Law restricted competition and were criticised subsequently for doing so. In the UK the finance houses in the 1950s ran a cartel which limited competition. The Crowther Committee believed that vigorous competition would benefit consumers and reduce the price of credit. This had some truth. However, historical evidence does suggest that increased aggressive competition in credit markets often leads to a lowering of credit standards and a search for methods of increasing profits through exploitation of consumer biases. The PPI scandal in the UK occurred in a highly competitive market where competition on price, among other factors, created incentives for firms to find other methods of maximising profits for shareholders through the highly profitable sale of credit insurance.