«OHIO STATE LAW JOURNAL VOLUME 66, NUMBER 4, 2005 Predatory Lending and the Military: The Law and Geography of “Payday” Loans in Military Towns ...»
670 OHIO STATE LAW JOURNAL [Vol. 66:653 often recent immigrants or former agricultural laborers, formed the foundation of the emerging lower middle class of urban American society.110 These people usually borrowed to meet unexpected needs, such as family illness or moving expenses.111 Nevertheless, they held steady jobs and had family obligations which prevented them from simply skipping town.112 Salary lenders targeted these workers because their steady supply of disposable income made them likely to repay, and their frequent minor income shocks made them likely to borrow.113 It was these salary lenders whom working class people in the eastern United States first came to describe as “loan sharks.”114 Although the term was new, the contractual terms and collection tactics of the lenders were reminiscent of the high-cost wage-based lending common in previous centuries. In a typical transaction, a debtor would borrow five dollars and repay six within the next week or so.115 Very similar to today’s payday loans, the charge of 20% of the loan principal amounted to around 520% per annum, assuming a two-week maturation period.116 The charge of one or two dollars itself seemed fairly innocuous for any one given week. But, when a debtor lost a job, was not paid for his work, became ill, had a family member become ill, or was prevented from paying for any other reason, the simple transaction rapidly swelled into a sizeable drain on an already strained budget.
111 Id. at 128.
112 Id. at 128–29.
113 Ackerman, supra note 70, at 89–90; Robert W. Kelso, Social and Economic Background of the Small Loan Problem, 8 LAW & CONTEMP. PROBS. 14, 15–20 (1941).
114 Haller & Alviti, supra note 109, at 125–26. Thus, today=s payday lenders are loansharks in the most historically correct sense of the term. Contrary to Hollywood imagery, the term Aloanshark” did not come to describe the mafia until at least the 1930s. PETERSON, supra note 28, at 10.
115 HOMER & SYLLA, supra note 65, at 428.
116 Id. There were, of course, variations in loan terms. Many lenders used one-week balloon payments. Id. Also, often lenders charged African Americans rates twice as high in the same type of transaction, where a loan of five dollars was repaid with seven at the end of the week. Id.
117 Haller & Alviti, supra note 109, at 133.
2005] PREDATORY LENDING AND THE MILITARY 671 owed the original $15.”119 More compelling were the records of one salary lender in New York City, which showed that out of approximately 400 debtors, 163 had been making payments on the loans for over two years.120 Late nineteenth and early twentieth century salary lenders charged interest rates far in excess of state usury laws. A far cry from contemporary American attitudes about credit, early American culture strongly condemned borrowing money for personal purposes. Early colonial leaders, including the founding fathers of the U.S. Constitution, believed borrowing was a moral vice.121 Accordingly, these leaders adopted interest rate caps, called general usury laws, which limited annual interest rates to around six percent.122 With a few exceptions, these interest rate caps remained intact into the twentieth century.123 Nevertheless, salary lenders in eastern U.S. cities managed to conduct business through a variety of thinly veiled disguises and sham transactions.124 For instance, many lenders justified ignoring the interest rate cap by phrasing the contract as a purchase or assignment of future wages, rather than as a loan.125 Other lenders would manipulate the legal “time-price doctrine” to avoid interest rate caps.126 Under English law, when a buyer purchased a physical good over time through installments, it was not considered a loan for purposes of a statutory interest rate cap.127 This led some lenders to avoid interest rate caps by, for example, requiring the debtor to “purchase” a worthless oil painting at the time the loan contract was signed.128 The debtor would owe the same amount of money, and could immediately throw the painting away, but the transaction would be at least superficially legal.129 119 Id.at 134.
120 Id.at 133.
121 HOMER & SYLLA, supra note 65, at 274.
122 KATHLEEN E. KEEST & ELIZABETH RENUART, NATIONAL CONSUMER LAW CENTER,THE COST OF CREDIT: REGULATION AND LEGAL CHALLENGES 37 (2d ed. 2000); Ackerman, supra note 70, at 85; Tracy A. Westen, Usury in the Conflict of Laws: The Doctrine of the Lex Debitoris, 55 CAL. L. REV. 123, 131 n.45 (1967). Most of these statutes were roughly modeled on the English Statute of Anne. See Laurence M. Katz, Comment, Usury Laws and the Corporate Exception, 23 MD. L. REV. 51, 52 n.11 (1962).
123 KEEST & RENUART, supra note 122, at 37.
124 Peterson, supra note 69, at 852–54 (providing a more thorough discussion of salary lender evasion of state usury law).
125 LENDOL CALDER, FINANCING THE AMERICAN DREAM: A CULTURAL HISTORY OFCONSUMER CREDIT 50 (1999); DAVID J. GALLERT ET AL., SMALL LOAN LEGISLATION: A HISTORY OF THE REGULATION OF THE BUSINESS OF LENDING SMALL SUMS 180 (1932).
126 KEEST & RENUART, supra note 122, at 38.
127 Id. at 37–38.
128 CALDER, supra note 125, at 50.
129 See, e.g., id.
672 OHIO STATE LAW JOURNAL [Vol. 66:653 Beginning in the 1910s and 1920s, a widespread movement aimed at cracking down on the salary lending industry, now often called the “loan shark problem,” developed. Nonprofit organizations, often backed by the fortunes of deceased captains of industry, attacked salary lenders through legal advocacy and by providing low-cost charitable alternatives to salary loans.130 The media began exposing and editorializing against salary lenders, creating pressure for reform. Appellate courts began handing down stinging rebukes of salary lenders and developing common law language exhorting trial judges to ignore salary lender subterfuges that concealed illegal interest rates.131 State legislatures began amending their general usury laws to raise interest rate caps in order to attract legal private capital to the markets for consumer loans.132 These “special usury laws,” commonly called small loan laws, allowed lenders—who would agree to licensing, bookkeeping, security interest, and collection practice rules—to lend small amounts at between 36% and 42% per year.133 The hope was that, with these new interest rate caps, honest, respectable private lenders would flow into the market for costly consumer loans, creating healthy competition and driving the salary lenders out of business.134 And finally, large industry accepted these reforms because they themselves wanted to begin lending to consumers at moderate prices which nevertheless exceeded the low colonial-era general usury laws. Collectively, these forces significantly curtailed salary lending throughout the United States for most of the twentieth century.
Economic forces and legal changes in the 1970s and 1980s began to lay a foundation for a resurgence in salary lending, however. Unprecedented inflation forced the Federal Reserve Board to adopt monetary policy resulting in high long-term commercial interest rates. The high cost of funds made it difficult for banks, credit unions, and other mainstream lenders to loan money within state interest rate caps. It became fashionable for neoclassical economists and legal and economics scholars to goad leaders into abandoning usury laws. State legislatures were increasingly making a habit of granting special permission to lenders to charge higher and higher interest rates. Retail installment stores, pawnshops, and rent-to-own furnishing stores all successfully lobbied for special treatment. Many state legislatures also raised, or even eliminated, their interest rate caps.135 Moreover, the Supreme Court’s decision in Marquette 130 KEEST & RENUART, supra note 122, at 38.
131 See, e.g., In re Home Disc. Co., 147 F. 538, 546 (N.D. Ala. 1906) (characterizing salary lenders as having “brought on conditions which were yearly reducing hundreds of laborers and other small wage earners to a condition of serfdom in all but name”).
132 KEEST & RENUART, supra note 122, at 39.
133 GALLERT, supra note 125, at 89; KEEST & RENUART, supra note 122, at 48.
134 See KEEST & RENUART, supra note 122, at 48.
135 Id. at 55.
2005] PREDATORY LENDING AND THE MILITARY 673 National Bank v. First of Omaha Service Corp.,136 which is discussed in greater detail in the next Part, encouraged these trends.
At the beginning of the 1990s, the best available estimate suggests that fewer than 200 business locations nationwide offered payday loans—loans that were clearly a throw-back to the old salary lending business mostly stamped out 50 or so years before.137 Businesses offering payday loans at this point were usually focused primarily on cashing paychecks for consumers who lacked traditional banking services. These businesses found that they could attract larger clientele and make staggering profits by agreeing to “cash” consumers’ post-dated personal checks. If a consumer needed a loan, she could write a check for funds she did not actually have in her checking account.138 If the “check casher” agreed to wait two weeks before attempting to tender the check, then the consumer would have time to make some more money, deposit additional funds in her checking account, and thus cover the check by the agreed-upon date.139 The term “payday loan” derived from this practice because often the date consumers wrote on their checks corresponded to their next payday. When sued by consumers alleging usury violations, these check cashers maintained that they were not lending money, but were simply cashing a check.140 Current payday lenders make similar arguments. Some payday lenders claim to be “leasing” money to the consumer, rather than making a loan.141 In these sale-leaseback transactions, the consumer “sells” a household appliance to the business, which then “leases” it back for a fee until the consumer can repurchase it. “The appliance, however, is never actually delivered to the lender.
Instead, the lender gives the consumer cash and takes only a post-dated check from the consumer as security.”142 Other payday lenders disguise their loans as “catalog sales.”143 Similar to the worthless oil painting dodge of a century ago, these lenders require that the consumer buy certificates, which they can redeem for merchandise from a catalog. The consumer writes a check and in return obtains cash and some certificates redeemable for merchandise from a catalog on display.144 While the borrower may never redeem the catalog certificates, the 136 Marquette Nat’l Bank v. First of Omaha Serv. Corp., 439 U.S. 299 (1978).
137 JOHN P. CASKEY, THE ECONOMICS OF PAYDAY LENDING 3 (2002).
138 Johnson, supra note 36, at 12–13.
140 See Schmedemann, supra note 26, at 978.
141 Jeff Gelles, Payday Loans Will Just Make It Worse, PHILADELPHIA INQUIRER, Nov.
21, 2001, at C01.
142 Johnson, supra note 36, at 18–19.
143 People v. JAG NY, LLC, 794 N.Y.S.2d 488, 489 (N.Y. app. Div. 2005) (describing the loans as “sales of gift certificates for catalog merchandise”).
674 OHIO STATE LAW JOURNAL [Vol. 66:653 real point of the transaction is that the lender waits about two weeks before tendering the borrower’s check. Oblivious to the recurring patterns from disguised salary loans of a century earlier, some courts have gone along with these charades.145 The Federal Reserve Board, however, has been relatively
quick to recognize the fees associated with these transactions for what they are: