ECONOMIC GROWTH CENTER YALE UNIVERSITY P.O. Box 208629 New Haven, CT 06520-8269 http://www.econ.yale.edu/~egcenter/ CENTER DISCUSSION PAPER NO. 971 Bringing “Honest Capital” to Poor Borrowers: The Passage of the Uniform Small Loan Law, 1907-1930 Bruce G. Carruthers Northwestern University Timothy W. Guinnane Yale University Yoonseok Lee University of Michigan May 2009 Notes: Center Discussion Papers are preliminary materials circulated to stimulate discussions and critical comments. Preliminary; please do not cite or quote. Carruthers is the Gerald F. and Marjorie G. Fitzgerald Professor of Economic History in the Department of Sociology, Northwestern University; Guinnane is the Philip Golden Bartlett Professor of Economic History in the Department of Economics, Yale University; Lee is assistant professor of economics, University of Michigan. Correspondence to Guinnane ([email protected]). We thank the Russell Sage Foundation, the National Science Foundation, and the Economic Growth Center (Yale) for supporting this research. This paper was revised while Guinnane was a Fellow at the Center for Advanced Study in the Behavioral Sciences. For comments and suggestions we thank Benjamin Chabot, Michael Easterly, Herbert Emery, William English, Price Fishback, Carolyn Moehling, Martha Olney, Mark Spörer, Scott Redenius, Donald Smythe, and seminar participants at LSE, Oxford, Cambridge, San Diego, and the University of Paris, as well as attendees at the 2005 meetings of the Canadian Network for Economic History and the 2007 meetings of the American Sociological Association. Scott Redenius helped us organize the state banking statistics. We extend a special thanks to Fishback and his co- author Shawn Kantor, who made their extremely useful dataset available for other scholars to use. Elisabeth Anderson and Elise Couper provided excellent research assistance. This paper can be downloaded without charge from the Social Science Research Network electronic library at: http://ssrn.com/abstract=1413905 An index to papers in the Economic Growth Center Discussion Paper Series is located at: http://www.econ.yale.edu/~egcenter/publications.html Bringing “Honest Capital” to Poor Borrowers: The Passage of the Uniform Small Loan Law, 1907-1930 Bruce G. Carruthers Timothy W. Guinnane Yoonseok Lee Abstract The Uniform Small Loan Law (USLL) was the Russell Sage Foundation’s primary device for fighting what it viewed as the scourge of high-rate lending to poor people in the first half of the twentieth century. The USLL created a new class of lenders who could make small loans at interest rates exceeding those allowed for banks under the normal usury laws. About two-thirds of the states had passed the USLL by 1930. This paper describes the USLL and then uses econometric models to investigate the state characteristics that influenced the law’s passage. We find that urbanization and state-level economic characteristics played significant roles. So did measures of the state’s banking system. We find no evidence that party-political affiliations had any effect, which is consistent with the USLL’s “progressive” character. Finally, we find little evidence that the passage of the USLL in one state made passage more likely in neighboring or similar states. If anything, the cross-state influences were negative. Our findings suggest that the Russell Sage Foundation only imperfectly understood the political economy of the USLL, and that a different overall approach might have produced a result closer to their aims. JEL Codes: N21, N22, I38, G21, G28, K23 Keywords: Uniform law, small loans, consumer credit, usury laws. For the first forty years of its existence the Russell Sage Foundation (RSF) focused heavily on efforts to reform the conditions under which poor people obtained credit in the United States. Through lobbying, research, publications, and other efforts, the Foundation identified itself as the clearinghouse for information, the leader of several reform proposals, and the primary interlocutor for lenders and industry groups that sought to improve their industry’s image. This paper focuses on the Foundation’s main initiative, the Uniform Small Loan Law (USLL). A uniform law is a model bill that is introduced separately in many state legislatures; in theory, this approach can lead to every state having the same law for the matter in question. The USLL reflected two central ideas. The law’s supporters thought that making small loans was inherently expensive, and that the only way to have it done by legitimate business was to allow small-loan lenders who could charge up to 3.5 percent interest per month, far in excess of the interest rates allowed under existing state usury laws. The law reflected the perception that borrowers were hurt less by high interest rates than by other features of the “loan-sharking” business, such as a lack of transparent terms. Two-thirds of the states passed the USLL, and it formed the basis for the federal consumer credit regulations enacted in the 1960s. Many of the issues raised in connection with the USLL in the early part of the twentieth century remain with us today. States are faced with the problem of pawnshops and so-called “payday” lenders, whose interest rates seem exorbitant to people used to borrowing from a bank. Like the lenders the USLL sought to displace, contemporary providers of small loans argue that the cost of lending in this market require high interest rates to generate a competitive return on invested capital. The USLL also reflects a major divergence between the US and many European countries. In many European countries, credit cooperatives became a major part of the consumer- and small-business lending market in the late nineteenth century, and remain so today. The U.S. credit union sector is tiny in comparison to that of Germany, the Netherlands, and other European countries. The reasons for this divergence are complex and cannot be addressed fully here. But we see in the USLL’s history two major 3 foundations, Russell Sage Foundation and the Twentieth Century Fund, making very different determinations of how to address this issue. This paper focuses on the USLL’s passage: which states passed the law, and when. After describing the USLL and the Foundation’s role in drafting and pushing the measure, we develop and estimate econometric models of the law’s progress through the states. The econometric analysis reflects our reading of the Foundation’s rich archives, its own publications, and other contemporary writings. The larger project addresses several related issues that cannot be discussed at length here. Anderson, Carruthers, and Guinnane (2009a) studies the way the Russell Sage Foundation positioned itself as a source of expertise in the general area of credit for poor people. This paper contains more extensive narrative and archival material not reproduced here. Anderson, Carruthers, and Guinnane (2009b) addresses the broader question of why the Foundation decided to push the USLL: why, after brief involvement in other remedies described below, it focused on the uniform-law approach. The evidence on this point supports two types of motivations. One was the Foundation’s understanding of the way this credit market worked; it had a purely intellectual reason to support the approach embodied in the USLL. The other set of reasons turn on the Foundation’s goals as an institutional actor. The uniform-law approach was more likely to allow the RSF to make an impact in this field without a permanent commitment of resources, and without entangling it in disputes with other entities such as Edward Filene’s Twentieth Century Fund.1 A final paper (Carruthers and Guinnane 2009) studies the industry the USLL created, using lender-level data from several states to describe the size and structure of the new small-loan lenders, and using policy experiments in the late 1920s to investigate the lenders’ sensitivity to the maximum interest rate. Figure 1 displays the time-path of the USLL’s passage. Although a few states passed the measure after 1930, we end our econometric investigation at that point for reasons discussed below. Figure 2 displays the states that passed the measure and when they did so. This map 1 Anderson (2008) develops political learning theory by demonstrating how institutional conditions and political pressures contributed to the emergence and development of RSF experts' policy ideas, and discusses the implications of the USLL episode for current understandings of institutional change. A final paper in the project will use the records of state regulatory authorities to study the small-loan industry created by the USLL. 4 suggests strong geographic spillovers which are the subject of much econometric investigation. The present examination focuses on the process of pushing the law through the several states. A number of studies have examined the determinants of states’ decision to pass a specific law or set of laws. The most comprehensive analysis of this sort is Fishback and Kantor’s study of the political-economy of workmen’s compensation laws (Fishback and Kantor 1998a, 2000). Our econometric approach differs from theirs, and we focus on a single legislative measure. But the spirit of the analysis is similar. 1. Credit for the Poor and the Foundation’s activities Starting in the 1890s, reformers in the U.S. came to view credit as a serious problem in causing or exacerbating poverty (see, for example, Calder (1999, pp.112-123)). In their eyes, borrowers usually sought small loans only because of financial necessity: unexpected medical expenses or interrupted income due to unemployment. The circumstances surrounding emergency borrowing threatened to drive small debtors into the hands of loansharks, and other unscrupulous lenders.2 The Foundation was established in April of 1907 in New York City. Credit for poor people was an initial concern and remained a major focus of the Foundation’s efforts until World War II.