USURY LAWS – Alternative Banking Group report
Antonia Loconte, 3/18/2012 (firstname.lastname@example.org)
Summary: State usury laws carry less weight than they did in the past. It could be beneficial to restore their importance, if there were ways to ensure that consumers could get the credit they need to acquire basic necessities (or some other means of access to those necessities). Right now, the banking system allows major lenders to seek out the most permissive usury laws available, open branches in those states, and sell credit everywhere in the U.S. using those laws – i.e., effective deregulation.
Usury laws have been around for millennia, due to the moral concerns people have about one person profiting from the need of another, which creates opportunities for exploitation and impoverishment. Some societies and religious doctrines, such as Judaism, Catholicism, and Islam, have attempted to completely ban the practice of lending money (or goods) at interest. Opponents of usury laws argue that they are socially disruptive, because when the usury rate is lower than the market rate for a particular loan, it discourages lenders from making that loan, which negatively affects potential borrowers, especially less creditworthy borrowers. More commercialized societies have usually tolerated moneylending to some degree, but they have often restricted the interest rates that one can legally charge.
In Britain, Parliament legalized lending money for interest in the 16th century. For the next 300 years or so, interest ceilings were set at various rates below 10%, until those ceilings were removed entirely in 1854. Prior to declaring independence from Britain, the American colonies had also adopted versions of the English usury statutes. Court interpretations surrounding those usury laws, both in the United States and pre-revolutionary Britain, have become part of the common law of the various U.S. states.
Variations on these statutes are still in effect in the vast majority of U.S. states. These statutes are usually thought of as “general” usury laws because they attempt to set a ceiling for all loans of money, or “forbearances of debt.” Their particular limits vary. For example, a local sampling of state laws shows that New York has a “general obligations” law prohibiting annual interest rates above 16%, Connecticut and Vermont prohibit loans at more than 12% per year, Massachusetts’ limit goes up to 20%, Pennsylvania is 25%, New Jersey allows interest rates on personal loans to be as high as 30%, and New Hampshire is one of a few states that has no general limit at all. Loans that exceed these rates would not be legally enforceable, at least not to the degree that they exceed the usury limit (though some courts would declare the entire loan invalidated). Some states also have criminal law triggers for usury that are higher than the general limit; for example, the New York law makes it a crime to charge more than 25% interest on a loan. There is also a federal racketeering law (RICO) that kicks in whenever an interest charge exceeds twice the usury limit of whichever state law applies.
Why these laws don’t protect people the way they used to
Here’s the catch: most of these state laws don’t apply to the vast majority of loans that are made by natural persons, business organizations, and other legal entities, especially when it comes to consumer credit. This diminished relevance of the general usury laws is due to more specialized laws, both state and federal, that have been enacted over the last century or so, along with legal decisions that have created historical exceptions for certain kinds of borrowing (such as buying goods on credit). What exists now is a very complicated patchwork, amplified by the general move toward deregulating financial institutions that picked up steam in the high-interest-rate, high-inflation environment of the late 1970’s.
If we seek to address this situation, one of the things we need to appreciate is that the various types of banking institutions have begun to overlap significantly in recent decades, primarily because of the belief that they need to diversify investments and expand banking functions in order to compete and survive. The move to eliminate usury laws has been a part of this evolution.
One of the biggest exceptions, and the biggest factors in the loosening of usury laws, has been loans from national banks. Right now, the U.S. has about 5400 commercial banks. Around 30% of these commercial banks are nationally chartered by the Office of the Comptroller of the Currency, and about 70% of banking assets are held by these national banks (a total of more than $8 trillion, out of about $13 trillion in overall commercial bank assets). Commercial banks are the most important type of bank, in terms of size, wealth, and the variety of banking functions in which they engage. All of the national banks, and about 850 state banks, are members of the Federal Reserve System, which means a lot of their oversight is through the Fed. Most of the other commercial banks are overseen by the FDIC.
Because state laws can’t trump federal laws, such as the 1863 National Banking Act that established the national banks, the usury laws of individual states can only be applied to national banks if the federal government is willing to let that happen. Congress did enact a federal usury law, but it is relatively weak – it allows the national banks choose the higher of two limits: the applicable usury rate set by the state law wherever the bank is located, or a rate derived from the Federal Reserve discount rate (the interest rate that the Federal Reserve charges depository institutions when they borrow money from their regional Federal Reserve bank’s “discount window” – which is usually higher than the short-term market interest rates, in order to encourage private lending). The system has been set up to give some competitive advantages to national banks. If a state has multiple usury rates that apply to the consumers who make up a national bank’s market base for a certain type of lending, the national bank is allowed to apply the higher rate. For example, a national bank would not be bound by a usury rate that applies to state-chartered banks (e.g., institutions that take deposits and make commercial loans), if a higher rate existed for other state-chartered lending institutions that also wrote the same type of loan. This preferential treatment for national banks stems from federal court cases holding that it was the intent of Congress to place national banks at a competitive advantage over state banking institutions when it enacted the National Banking Acts of 1863 and 1864. This is often referred to as the “most favored bank” policy, and due to the continuing competition between state-chartered banks and federally-chartered banks, it has ultimately led to state bank deregulation as well.
Based on the U.S. Supreme Court’s 1978 decision in Marquette National Bank of Minneapolis v. First of Omaha, national banks may “export” their “home state’s” usury limit to other states. This means that if a national bank is based in South Dakota, but does business in New York with New York residents, it is not bound by the anti-usury laws that regulate interest rates for New York, as long as the bank’s home office has a “reasonable relationship” to the credit transaction itself.  The Marquette case has opened up the door for the creation of the national credit card market; after that case was decided, banks like Citibank and Chase Manhattan quickly opened up branches in states with permissive usury laws (South Dakota and Maryland), and began selling their credit card services all over the country. The Bank Holding Company Act did not prevent them from doing this. Interest rates were very high at that time (due in part to the “monetarist” policies of the Federal Reserve), and credit card interest rates quickly rose to over 20% nationally. Those rates did not go back down even when market interest rates dropped again – a practice that is justified by some free-market advocates based on the notion that banks use their profits from the credit card industry to cover the losses they sustain in other areas, like home loans and commercial lending. (One must ask whether it makes economic sense, or whether it is economically just, to indirectly transfer home and commercial lending losses to “high-risk” people who buy consumer goods using high-interest credit cards.)
Following Marquette, Congress tried to balance the competitive playing field somewhat by enacting a statute (as part of the 1980 Deregulation and Monetary Control Act) that would allow state commercial banks, thrifts, and credit unions to also have the option to refer to the federal funds discount rate as an interest ceiling when they offer credit. Based on the language of that statute, state banks are now able to use the most favorable usury rate available under their own state law, even if a lower usury rate specifically applies to banks than to other types of lenders. Since 1980, state banks have begun to make interstate loans, exporting the interest rates from their home states, the same way that national banks do – a practice that was not stopped by the courts that later considered the issue. (See the First Circuit’s 1992 decision in Greenwood Trust Co. v. Commonwealth of Massachusetts.) Another Supreme Court decision, Smiley v. Citibank (South Dakota) (1996), held that state banks could also export late fees and other lender-imposed fees related to the extension of credit, because those can be considered “interest” under the federal statute and its accompanying regulations (even if those fees wouldn’t be considered “interest” under a particular state’s law). The Gramm-Leach-Bliley Act of 1999 specifically provides that state banks can charge interest at any rate being used by a national bank that has a branch in its home state.
Given the ability of national banks to export extremely high interest rates all over the country, this series of lawmaking events has essentially resulted in the most permissive usury laws being applicable everywhere – unless they are pre-empted by some other law applicable to a specific type of lending.
KEY TIMELINE FOR THIS SUBSECTION:
1816 – introduction of thrift institutions (savings and loans) in U.S. (Philadelphia)
1831 – introduction of first “building society” in U.S.
1863 – National Currency Act establishes official currency, national banking system
1864 – National Banking Act allows federal charters for national banks
1873 – Tiffany v. National Bank of Missouri establishes “most favored bank” doctrine
1908 – introduction of credit unions in U.S. (Manchester, NH)
1913 – Federal Reserve Act establishes Fed, current system of creating money
1933 – Glass-Steagall Act establishes FDIC
1933 – Home Ownership Loan Act allows federal S&Ls
1978 – Federal charters allowed for thrifts
1978 – Marquette National Bank decision (allows national banks to export higher interest rates)
1979 – Paul Volcker becomes Fed chair; begins raising interest rates to record highs, lowering inflation
1980 – “great divergence” of income inequality begins (income increases stop being realized relatively evenly, as average incomes stagnate, while large income gains start accruing to top income bracket only)
1980 – Deregulation and Monetary Control Act loosens/eliminates restrictions on interest rates
1980 – top income tax rate is cut from 70% to 50%, then again to about 30% in 1986
1982 – interest rate cut spurs borrowing/stock investing; inflation is kept low, so wages don’t increase
1987 – Alan Greenspan replaces Paul Volcker as Fed Chair, begins process of deregulating banks
1992 – Greenwood Trust decision (confirms state banks can export interest rates)
1994 – Riegle-Neal Interstate Banking Act (allows bank branching into other states; Comptroller decides governing interest rate can be based on whichever bank office has reasonable relationship to loan)
1999 – Gramm-Leach-Bliley Act (effectively ends separation of commercial and investment banking)
2010 – Dodd-Frank Act
Other important exceptions
Loans from credit unions – federal credit unions have a general usury ceiling of 15% per year, unless the Federal Credit Union Administration grants higher rates based on economic circumstances. State credit unions must look to the laws of their states, though obviously federal deregulation has changed the situation significantly.
Loans for home mortgages – the 1980 Federal Deregulation and Monetary Control Act not only deregulated the amount of interest that banks could pay on deposits, and the amount of interest they could charge on general loans; it also declared that state usury laws no longer affected consumer real estate loans at all, unless the states passed new laws reclaiming control over those interest rates within three years. Congress passed this law in response to the economic climate of the time, which saw very high inflation, and very high interest rates on the open market. This is a structurally significant development, since many of the lending institutions that developed through the cooperative actions of common citizens – mutually held savings and loan institutions, credit unions, and building and loans – were primarily motivated by the need of the average person to build or buy a house, and many of those institutions had limited their lending to home loans. Under the new law, they were no longer limited by state usury laws – and, furthermore, the banks would be permitted to use flexible interest rates in their loan agreements. 
Small personal loans – during the 19th century, it was difficult to find legitimate institutions that would make personal loans. This was partly due to the social stigma against borrowing for personal needs, partly due to the relative lack of durable consumer goods available for purchase, and significantly due to the higher administrative costs per loan for lenders as compared to commercial lending, which discouraged them from offering such loans. As a result, when people needed personal loans, they often wound up going to loan sharks, or borrowing from “payday lenders” who charged astronomically high interest rates – for example, lending $5 on Monday and demanding repayment of $6 on Friday (pay day). Late 19th and 20th-century solutions like cooperatively-owned thrifts, credit unions and small, donor-funded lending organizations helped alleviate this problem, but the biggest impact came from the business world when it devised its own solution – it managed to get laws passed across the country that would allow small loans to carry higher interest rates than were permitted under general usury laws, as long as their lenders would accept government regulation and higher risk. For example, a version of the Uniform Small Loan Law allowed 3½% interest per month on loans of $300 or less, despite usury laws – a high rate, but a lot better than the three- or even four-digit annual percentage rates of the loan sharks. These laws still exist. For example, Connecticut allows licensed small loan lenders (excluding banks, credit unions, or licensed pawnbrokers) to charge up to 17% per year on the first $600 of a loan, and 11% on the next $1200; if the loan is over $1800, only 11% per year may be charged on the entire cash advance. (§ 36a-563.) Open-end loan agreements for up to $15,000 (which can be paid off at any time) can involve an annual percentage rate of up to 19.8%, calculated on the unpaid principal balance. (§ 36a-565.)
Loans that were technically something else – early in the 20th century, industrial banks started accepting individual deposits, and making loans secured by those deposits, based on a model dubbed the “Morris Plan.” This model treated the loan as being repayable in a single lump sum at the end of the loan term, with interest computed accordingly. However, the borrower had to make regular “deposits” in the bank that added up to the total amount due – in essence, allowing the bank to charge interest on loan principal that had already been repaid. Many states adopted laws that would validate this practice, even though it was an obvious attempt to evade the general usury laws. There have been other mechanisms used to avoid usury laws – for example, lending according to Islamic law often involves a bank buying a house and leasing it back to the occupant, rather than having the occupant be the owner and pay interest on the loan, which is forbidden.
Buying goods on credit – this type of purchase is not traditionally considered a loan, and is regulated using separate laws – so usury statutes don’t apply. Most states began regulating credit sales of goods after World War II. Those laws were intended to tighten regulation of retail installment sales and motor vehicle retail installment sales, often creating limits on finance charges, and requiring disclosure of credit terms and limitations on creditor remedies. However, these laws still allowed regulated lenders to charge relatively high rates. Apparently, it is common for credit card issuers to fall under the exceptions for retail installment debt – both store credit cards like Macy’s or Nordstrom, and general credit cards like Visa or MasterCard.
Loans taken out by corporations – many states forbid corporations from using the usury statute as a defense in a lawsuit on a debt. Since usury laws are most commonly applied when a debtor raises them as a defense to a lawsuit by a creditor seeking to collect a debt, this effectively means that usury laws don’t apply to corporate borrowers in those states.
Late fees and other charges – some state laws include late fees and other additional charges as part of the “interest” limitation in their usury laws, while other states do not consider them to be types of interest. These interpretations have been influenced by the long-standing court interpretations of British and early American usury laws. However, as discussed above, the federal definition of “interest” in the statutes governing national banks is read very broadly by the courts, so banks have been able to “export” favorable interpretations of the law to other states, allowing them to charge fees that might otherwise be prohibited in that state.
QUESTIONS FOR THOUGHT:
Is there a pattern in historical interest rates that will show that the current system of consumer credit is less advantageous for consumers than prior systems that existed?
If consumer credit profits are really subsidizing losses in the areas of real estate lending and commercial lending, does this mean that people who cannot afford homes – or who are renters – are effectively subsidizing the acquisition of residential real estate or commercial property by others? What is the effect of this on real-world income redistribution? Note too that the average homeowner owns about 50% of their home now, down from about 70% of the value of their house in 1980.
What is the connection between the relaxation of usury laws and the ability of banks to take money from consumers and use it to fund their own investments in proprietary securities businesses, or those of their affiliates? Is this a redistribution of wealth?
Does the Community Reinvestment Act have any potential applicability here (requirement that banks return to their communities some of the benefits they get from their bank charter, and that they serve the convenience and needs of the local community)? Is this being meaningfully enforced?
Would other models better accomplish the desired result of giving consumers access to basic necessities? For example:
A basic income that is paid by the government to everyone (or otherwise recognized as a universal entitlement to resources), applicable to a set of “basic necessities” like food, education costs, housing, clothing, health care (or a more limited set of consumer “staples”);
Guaranteed low-interest loans to consumers of the type available to banks (for example, government borrows money at .5% interest rate, lends it to consumer at 2.5% to pay off debt, cutting payments significantly – on a $300,000 mortgage with a 6% interest rate, for example, it would cut $1500 monthly interest payment to $500 monthly interest payment, saving the homeowner $12,000 per year, and the government would make a profit on the deal);
Guaranteed low-interest consumer credit (possibly nondischargeable in bankruptcy like student debt);
Reform to make more debt dischargeable in bankruptcy;
Programs that reduce the principal owed on consumer debt, perhaps through tax reform (for example, reforming the home mortgage itemized deduction into a more progressive tax credit); and/or
Programs that reduce the principal owed on other “underwater” debt (or transfer equity from the investor to the bank/bondholder), allowing consolidation and writing-down of losses, instead of passing them on to consumer borrowers in ever-escalating amounts.
 http://www.usurylaw.com/ contains a list of each state’s general usury rate, and a very basic discussion of each state’s usury laws. I have not verified this list, or these descriptions, for accuracy, given the purpose of this overview.
 There were over 14,000 commercial banks in the U.S. as of 1980, but many have merged, reducing the overall number. In comparison, as of 2009, Japan only had 150 national banks, and the whole E.U. had about 2500.
 The other main types of banks – that is, institutions that take deposits and make loans – are savings banks, savings and loans, and credit unions. In recent years, savings banks and “savings and loans” have become a lot more alike, but historically they were different. Savings banks were philanthropic, depositor-owned “thrifts” that were formed to help people save money generally, with federal charters allowed only since 1978. Meanwhile, the savings and loan institutions began as “building societies” that were specifically designed to pool funds so people could afford housing. Their lot was strengthened by the Home Owners Loan Act of 1933 that allowed federal S&Ls to be formed. These banks, as well as credit unions, have different regulatory frameworks than do the commercial banks, which are split among federal and state oversight. However, all of these banking forms have become more similar in recent years, as their limitations on permissible investments/activities have become deregulated in the name of diversification. This includes credit unions, which began as small, member-owned mutual associations designed to service closely-tied communities of people who weren’t being served by larger banks, but have been transformed in recent years into somewhat larger, less restricted banking institutions with about $1 trillion worth of assets, though they still enjoy an exemption from federal income taxation. The impact of commercial bank and savings bank holding companies (in which a bank is owned or controlled by another company, creating relationships of affiliates) on banking activities is also something to consider, since the 1999 Gramm-Leach-Bliley act allows affiliates to engage in SEC-supervised underwriting of proprietary investment securities. Under Dodd-Frank, which eliminates the federal Office of Thrift Supervision, both types of holding companies will now be regulated by the Federal Reserve. (In 2008, both Goldman Sachs and Morgan Stanley became holding companies.)
 12 U.S.C. § 85. Rate of interest on loans, discounts and purchases. “Any association may take, receive, reserve, and charge on any loan or discount made, or upon any notes, bills of exchange, or other evidences of debt, interest at the rate allowed by the laws of the State, Territory, or District where the bank is located, or at a rate of 1 per centum in excess of the discount rate on ninety-day commercial paper in effect at the Federal reserve bank in the Federal reserve district where the bank is located, whichever may be the greater, and no more, except that where by the laws of any State a different rate is limited for banks organized under State laws, the rate so limited shall be allowed for associations organized or existing in any such State under title 62 of the Revised Statutes.
When no rate is fixed by the laws of the State, or Territory, or District, the bank may take, receive, reserve, or charge a rate not exceeding 7 per centum, or 1 per centum in excess of the discount rate on ninety day commercial paper in effect at the Federal reserve bank in the Federal reserve district where the bank is located, whichever may be the greater, and such interest may be taken in advance, reckoning the days for which the note, bill, or other evidence of debt has to run. The maximum amount of interest or discount to be charged at a branch of an association located outside of the States of the United States and the District of Columbia shall be at the rate allowed by the laws of the country, territory, dependency, province, dominion, insular possession, or other political subdivision where the branch is located.
And the purchase, discount, or sale of a bona fide bill of exchange, payable at another place than the place of such purchase, discount, or sale, at not more than the current rate of exchange for sight drafts in addition to the interest, shall not be considered as taking or receiving a greater rate of interest.”
 This “reasonable relationship” approach was later applied to state banks who engage in interstate lending.
 Because the Bank Holding Company Act (which prohibited a bank in one state from owning a bank in another state unless the second state’s laws specifically allowed it) didn’t apply to institutions unless they both accepted demand deposits and made commercial loans, and credit cards were consumer loans only, banks that took deposits and issued credit cards – but didn’t make commercial loans – weren’t considered banks under this law. As a result, Citicorp and Chase Manhattan – both New York state banks – were able to establish separate credit card banks in South Dakota and Maryland, respectively, because those states had more favorable usury laws.
 A few states actually cite the federal funds discount rate as part of their general usury calculation, e.g. Delaware, whose general usury limit is the Federal Reserve Rate, plus 5%.
 See 12 U.S.C. § 1735f-7 (located in Subchapter V of the National Housing Act). A few states did pass laws to retake legal control of this field, but none of them imposed new usury ceilings.
 Even the federal funds rate for overnight interbank lending had reached 12% by 1980, a baseline that was already higher than a lot of states’ usury rates. As for the prime lending rate, it jumped to over 20%.
 By 1980, this was already a huge problem for the S&Ls, who in theory were losing money on every loan, because with the high prevailing interest rates, their borrowing cost was now higher than their lending profit could be under the usury interest cap. Meanwhile, most of the payments they were taking in from their existing loans had been negotiated at much lower interest rates. As an example, New York’s usury law prevented lenders from charging more than 8% interest on consumer loans, but it cost the banks over 12% interest just to borrow money from each other – meaning that they were losing as much as 4% on every loan, which dried up the general availability of consumer loans. In 1980, the New York State legislature temporarily repealed the usury ceiling for four years to deal with this situation, then continued to renew the repeal until it was made permanent in 1994. Now, New York has a criminal usury ceiling of 25% that constitutes the only relevant limitation in this lending area.
 The scope of S&L lending was broadened during this time period, with increased percentages of loan portfolios allowed in areas such as commercial real estate (20% of overall portfolio), personal, family or household loans (20%, then up to 30% in 1982), and educational lending (5%). Savings and loans could also issue credit cards, and create trusts.
 For a sample list of exclusions to a state usury statute that includes retail installment contracts and credit cards, see http://www.dfi.wa.gov/consumers/interest_rates_exception.htm