Sen. Bernie Sanders (I-VT) and Rep. Alexandria Ocasio-Cortez (D-NY) recently introduced the Loan Shark Prevention Act, which they claim will end the plague of unfettered, unscrupulous usury in the United States. “Under the legislation we are introducing today, we would establish a national usury rate to make sure that no bank or store in America could charge an interest rate higher than 15 percent,” Sanders said.
Ocasio-Cortez, the other half of the democratic socialist dynamic duo, chipped in via Twitter: “There is no reason a person should pay more than 15% interest in the United States. … It’s a debt trap for working people + it has to end.”
Once again, as is their prerogative, Sanders and Ocasio-Cortez are lobbying unwarranted attacks against the free-enterprise system. Moreover, they are resorting to ad hominem attacks because their policy positions lack rigor and cannot withstand basic economic scrutiny.
In a press statement accompanying his release of the legislation, Sanders noted, “The reality is that today’s modern-day loan sharks are no longer lurking on street corners breaking kneecaps to collect their payments. They wear three-piece suits and work on Wall Street, where they make hundreds of millions in total compensation and head financial institutions like JPMorgan Chase, Citigroup, Bank of America and American Express.”
Never one to mince words, Sanders and AOC have declared all-out war on “rapacious” Wall Street (and Main Street) moneylenders. However, as usual, they have erred in two significant ways: (1) misidentifying the problem and (2) proposing a so-called “solution” that would actually make things worse.
First, the notion that Wall Street is rife with usury is completely untrue. According to Credit Karma, “the average annual percentage rate on a two-year personal loan from a commercial bank was 10.22%, according to Federal Reserve data for the first quarter of 2018.” Further, the average interest rate on a new auto loan was just 4.74 percent in the same period.
It is true that some creditors, such as payday lenders, charge high interest rates. However, these moneylenders are simply filling a niche (and desired) role in the market. For those who have a history of not repaying loans (high-risk borrowers), payday lenders are willing to provide credit. In turn, because it is very likely a large number of these high-risk borrowers will not repay their loans, payday lenders charge more interest to mitigate the increased risk they assume. In other words, there’s a good reason why payday lenders charge higher rates, and it’s not because they are greedy.
Further, the very people who take out payday loans support their existence. According to a 2016 Community Financial Services Association of America report, “Over nine in ten borrowers agree that payday loans can be a sensible decision when consumers are faced with unexpected expenses. … Nearly all borrowers (96%) say the payday loans they have taken out have been useful to them personally, with two-thirds (66%) saying they have been very useful. … Moreover, borrowers are likely to recommend payday loans to friends and family (75%) and support allowing other regulated lenders to offer payday loans (78%).”
One more fact Bernie and AOC are conveniently overlooking as they slander the lending industry: payday lenders, on average, enjoy a lower rate of profit than many other industries. According to the Fordham Journal of Corporate & Financial Law, payday lenders have an average profit margin of 3.57 percent. To put this in perspective, the average profit margin is 7.9 percent for all U.S. companies.
Second, aside from the fact they are woefully wrong on the merits of moneylending, Sanders and Ocasio-Cortez’s bill would do irreparable damage to the borrowing prospects of those with poor credit scores, the very constituency they are supposedly trying to help. Ample research shows payday lenders (and other so-called “usury institutions,” as defined by Sanders and AOC) have increased household welfare.
According to a report by the New York Federal Reserve, “in states with higher payday loan limits, less educated households and households with uncertain income are less likely to be denied credit, but are not more likely to miss a debt payment.”
Additionally, in Restrictions on Credit: A Public Policy Analysis of Payday Lending, Petru Stoianovici of Charles River Associates and Michael Maloney, economics professor at Clemson University, found “no empirical evidence that payday lending leads to more bankruptcy filings, which casts doubt on the debt trap argument against payday lending.”
Despite the political rhetoric, AOC and Bernie’s beloved Loan Shark Act aims to address a problem that largely doesn’t exist, and it would cause significant harm to those Ocasio-Cortez and Sanders say they care about the most.
Hopefully, the Loan Shark Act’s fate will reside at the bottom of the deep blue sea, where the sharks truly swim.
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