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12-1-2017

Review Of "Loan Sharks: The Birth Of Predatory Lending" By C. R. Geisst

John P. Caskey Swarthmore College, [email protected]

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Recommended Citation John P. Caskey. (2017). "Review Of "Loan Sharks: The Birth Of Predatory Lending" By C. R. Geisst". Journal Of Economic Literature. Volume 55, Issue 4. 1623-1624. https://works.swarthmore.edu/fac-economics/448

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G Financial Economics sharking.” His economic rationale is muddled: “. . . it would be expected that the presence of so Loan Sharks: The Birth of Predatory Lending. By many competing lenders would have forced loan Charles R. Geisst. Washington, DC: Brookings sharks out of business. But in reality, all lenders, Institution Press, 2017. Pp. ix, 261. $26.00, legitimate and otherwise, wanted to be in the cloth. ISBN 978–0–8157–2900–6, cloth; 978– high-interest lending business” (p. 29). As Geisst 0–8157–2901–3, e-book. JEL 2017–1012 explains, in 1916, Congress passed the Federal The title of this book, Loan Sharks: The Birth Farm Loan Act, which created federal land banks of Predatory Lending, is misleading. Most peo- to support agricultural credit markets. Other top- ple would expect a history of the early years of ics covered in these chapters include: the green- consumer fi nance, in which unlicensed high-cost back exceptions clause; restrictions on foreign lenders dominated. That is indeed part of the ownership of land; speculation on commodities at book. But the book is more accurately described the Chicago Board of Trade; the absence of a fed- as a somewhat haphazard, popular account of eral income tax; the Panic of 1893; the rise of lay- major developments in US fi nancial history from away credit for consumer purchases; the Panic of 1890 through 1935. The theme that the author, 1907 and birth of the Federal Reserve System; the Charles R. Geisst, hopes will unite the topics is Pujo Committee hearings on “money trusts”; and “loan sharking,” which he defi nes broadly to mean stock market speculation and state Blue Sky laws. high-cost lending, whether for consumer fi nance, Chapter 3 covers the period from about 1920 mortgage loans, or stock market speculation. through 1927. In this era, the Russell Sage The fi rst two chapters discuss consumer fi nance Foundation pushed states to adopt a Uniform and farm mortgages, as well as sundry other top- Small Loan Law (USLL) allowing annualized ics, from about 1890 through 1920. In that era, interest rates of 36 percent. It argued this was several states maintained a 6 percent ceiling necessary for the development of a legal small- on annual interest rates. As Geisst recognizes, loan market. Geisst (p. 232) views this rate as “Even at double the legal rate, legitimate lend- excessive, writing, “. . . the rates allowed under ers would fi nd it diffi cult to make small loans due the USLL hardly were fair or just. It is diffi cult to the administrative costs and work involved” to imagine a borrower realistically being able to (p. 81). In fact, banks of that era did not provide repay debts when the legal borrowing rate ranged consumer loans; this gap was fi lled by unlicensed from 30–40 percent per year.” Nevertheless, lenders, such as the salary buyers and pawnbro- many states enacted versions of the USLL and kers common in urban areas. Salary buyers were licensed, for-profi t consumer fi nance companies the illegal “payday lenders” of the time, provid- opened. The chapter also reviews the Florida ing workers with advances on their salaries at land boom, the high failure rate of small state- interest rates of 10–20 percent per month. Geisst chartered banks, the spread of mortgage-based does not explain the economic rationale for such securities and commercial real estate fi nancing in high rates in competitive markets. As the era pro- New York City, concerns about German repara- gressed, some states passed laws allowing annual tion payments, the McFadden Act of 1927, and interest rates over 6 percent on consumer loans. the rise of the call loan market for stock market This permitted philanthropists, religious groups, speculation. and others to form mutual loan societies, credit Chapters 4 and 5 cover the lead up to, and unions, industrial banks, and remedial loan orga- aftermath of, the Great Depression. In the late nizations to provide consumer credit on terms 1920s, many households carried heavy debt more favorable than those of the illegal lenders. burdens. In some states, there were efforts to In the case of Midwestern farm mortgages, local set more restrictive usury ceilings than permit- lenders often originated them and sold them to ted under the USLL since, “…most had come Northeastern insurance companies. Interest to realize that lending small amounts at 36 per- rates on these loans were about 2 percentage cent interest was no bargain for the borrower” points higher than those for farm mortgages in (p. 155). Chapter 4 reviews the late-1920s debate the Northeast, a gap Geisst attributes to “loan over proper Federal Reserve policy in response 1624 Journal of Economic Literature, Vol. LV (December 2017) to rising debt levels and stock market fervor. As counterexample is Kenneth A. Snowden’s (2013) Geisst notes, nonfi nancial fi rms actively lent in history of the mortgage market at the turn of the the booming call loan market. Chapter 5 pro- twentieth century. He attributes higher farm vides a familiar recounting of the government’s mortgage rates in the Midwest to high informa- response to the fi nancial disruptions of the Great tion and monitoring costs faced by people in the Depression. These include the creation of Federal capital-abundant Northeast who saw loan oppor- Home Loan Banks to buy performing mortgages tunities in other regions of the country. This from savings banks, the Home Owners’ Loan makes more sense than vague charges of “loan Corporation to purchase delinquent mortgages sharking”. Similarly, Geisst includes no serious from banks, the Federal Housing Administration, analysis of the advantages and disadvantages of and the Reconstruction Finance Corporation. his proposal to revise usury laws to set limits on Chapter 5 also discusses the Pecora hearings, the spreads over interest rate benchmarks. Glass–Steagall Act, reforming the Fed to create References the open market committee and a unifi ed dis- count rate, and Regulation Q. Calder, Lendol. 1999. Financing the American Dream: A Cultural History of Consumer Credit. Princeton In a postscript, Geisst (p. 235) argues in favor and Oxford: Princeton University Press. of usury laws but, “No single fi xed rate is (or was) Snowden, Kenneth A. 2013. “Mortgage Banking in the agreeable as a usury ceiling, and that casts a long United States, 1870–1940.” Research Institute for shadow over the intellectual basis of usury ceil- Housing America Special Report. ings because critics maintain that any rate is arbi- John P. Caskey trary and political.” Geisst (p. 236) proposes that, Swarthmore College rather than a fi xed interest-rate ceiling, usury laws should set a limit on the spread over some bench- H Public Economics mark interest rate to “. . . allow lending rates to adjust to market conditions while still protecting The Economics of Tax Policy. Edited By Alan J. borrowers from the vagaries of the market.” Auerbach and Kent Smetters. Oxford and New The book has several weaknesses. It tries to York: Oxford University Press, 2017. Pp. x, 390. cover too many topics in just 236 pages and, ISBN 978–0–19–061972–5, cloth. necessarily, many are treated very superfi cially. JEL 2017–0951 There is no coherent framework that links the various topics. There are no tables or graphs to As the editors of this volume observe in their show trends or put data points in perspective. opening chapter, major changes have occurred, Despite this, readers certainly won’t miss one or in both the US economy and in what research- two key themes, e.g., consumers often pay very ers know about the effects of taxes, since the last high interest rates for closed-ended small loans, major federal tax reform, the Tax Reform Act of but readers will wonder why the greenback exclu- 1986. This book provides background informa- sion clause is relevant. For those who would like a tion on a wide array of tax topics and proposes more engaging and focused account of consumer relevant, research-based reforms. Each chapter credit over much of the same period covered by covers a separate aspect of the federal tax code Geisst, I recommend Financing the American and is authored by an expert from that fi eld of Dream by Lendol Calder (1999). research. Together, the chapters are stunning in Economists will be frustrated that the book their breadth, exploring everything from envi- lacks any serious discussion of the factors that ronmental taxation, to capital gains and estate create variation in interest rates at a point in taxation, to tax compliance. A thoughtful dis- time. High-cost loans can be explained by large cussion by another leading scholar in each fi eld risk-screening and monitoring costs relative to follows each chapter. These discussions provide the size of the loan, risks of loan losses, lend- additional perspective on each of the topics. ers’ market power, borrowers’ ignorance, etc. The chapters generally begin with a back- Geisst mentions some of these factors, but it is ground section covering both the history and the always in passing with no serious analysis. A good intended purpose of the current design of the