USURY LAWS – Alternative Banking Group report
Version 2 – Antonia Loconte, 3/28/2012 (firstname.lastname@example.org)
Summary: State usury laws offer less protection to consumers than they did in the past, due to legal developments over the last 30 years. It could be beneficial to strengthen them again, if there were ways to ensure that consumers could get the credit they need to acquire basic necessities (or if they had 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 permissive laws – i.e., effective deregulation.
I: Historical overview – the meaning of “usury” and the reinvention of “interest”
ROUGH TIMELINE FOR THIS SECTION:
10,000-8,800 BCE – Neolithic (farming, animal husbandry) cultures appear in Asia Minor/Middle East
5,000 BCE – cattle are used as first “capital” – grain, seeds, olives, nuts, etc. also lent at “interest”
4,100-3,600 BCE – copper mining cultures develop around towns, metals become available for trade
3,100 BCE – Sumerian cuneiform script develops – first standardized writing
3,000 BCE – onset of Bronze Age (metallurgy develops) – metals are being lent at “interest”
2,800 BCE – deeds of sale show private land ownership in Sumer; credit law begins evolving
2,600 BCE – common usury rates of 33.33% for grain, 20% for silver evolve – last for 2000 years
1,800 BCE – Code of Hammurabi codifies usury rates, limits debt slavery, requires formalized loans
650 BCE – specialized banking business emerges (taking deposits, changing money for profit)
600 BCE – maximum Babylon interest rate for grain (33.33%) is lowered to equal rate for silver (20%)
600 BCE – laws of Solon in Greece – debt relief, debt slavery outlawed, Athens’ usury laws eliminated
539 BCE – Persians conquer Babylonia; interest rate up to 40%, economic progress shifts to Greece
520 BCE – usury (any lending at interest) is condemned in Buddhist Jatakas and Hindu Sutra texts
508 BCE – democracy established in Athens; Attican economy ascends, Athenian silver coin spreads
500 BCE – lowest Greek interest rates are for real estate loans, loans to cities
400 BCE – investment in productive capital becomes common, as does private banking, asset leverage
400-200 BCE – lowest interest rates are now for “normal” small business loans to good credit risks
400-200 BCE – cities normally have poor credit; borrowing done via wealthy citizens’ credit
300-150 BCE – low-risk interest rates drop below 10% (influx of gold, silver increases money supply)
197 BCE – Rome begins dominating Mediterranean; trade shifts away from Attican region
197 BCE – 100 CE – Roman usury law prohibits interest over 8.33% per year (dating to 450 BCE)
100 BCE – Rome has become financial center of world; foreign traders run much of its banking
100 BCE-100 CE – Roman interest rates vary; during peacetime, low interest (4-6%) on safest loans
88 BCE – Sulla sets maximum Roman interest rate at 12%; lasts for over 400 years
0-300 CE – prosperity of Alexandria includes 12% usury rate, ban on loan interest exceeding principal
100 CE – India’s Laws of Manu tolerate interest within legal limits; “usury” refers to excessive interest
550-850 CE – Justinian Code reduces usury limit to a 4-8% range (bankers could charge highest rate)
700-1200 – Islamic banking develops; collection of “riba” (interest beyond time value of $) is banned
800 CE – Charlemagne forbids any increments on loans – usury defined as “asking more than is given”
11th century – trade/learning begin to revive in Europe; usury declared a form of robbery by Popes
900-1500 – usurers are periodically excommunicated by Catholic Church
1200-1400 – doctrines to avoid “usury” begin to evolve, e.g., theory of interest as loss expense
1200-1300 – fractional reserve banking develops – banks retain 25-30% of reserves when lending
1200-1300 – exchange banking begins – lasts 500 years as common means of lending
1400-1500 – public pawnshops established in Italy (which also accepted deposits), Belgium
1300-1400 – insurance evolves; owners of property transfer risk to insurer for a fee
1200-1500 – attitudes toward finance evolve, as banking becomes more business-oriented
1517 – Protestant Reformation begins; moneylending at interest is tolerated, if it isn’t excessive
1600-1800 – American colonies follow England, setting maximum rates of interest
1822-1836 – Catholic Church declares that legal interest may be accepted by everyone
1854 – England abandons its fixed legal limits on interest rates
1760-1960 – 6% interest is the traditional rate in the U.S., especially in the East
1900’s – U.S. legislation, court rulings reduce effect of state usury laws, especially in recent years
2006, 2010 – stronger usury laws (15-20% cap) are reintroduced in Japan after moneylending scandals
2000’s – much of Islamic world prohibits usury, with some places allowing for commercial lending
When we speak of “usury” in modern language, we usually mean the practice of lending money at an interest rate that most people consider excessive. Historically, however, there have been long periods of time – especially during the last 1500 years – when the common definition of “usury” included any amount of interest charged on a loan, not just an excessive amount. It is worth talking about this changing definition as it affected both consumer and business lending, because that interplay has strongly affected the financial concepts and legal norms that now affect modern consumers.
During the first few thousand years of recorded history, it was considered normal to charge some level of interest on loans – at first, on “productive” goods like seeds or cattle, which could physically produce offspring and crops, and later, on “nonproductive” goods like precious metals. There was always a need for some people to borrow from other people, which could lead to enslavement of a debtor or their family if debts weren’t paid back. Once central governments began to evolve, they attempted to regulate the formalities of the loan process, including the amount of interest that could be charged on personal debts. This was intended to protect people from loan sharks – though it took a long time before the physical enslavement of debtors was outlawed, and some would argue that the forms of debt slavery that exist today, such as sharecropping and low-wage employment, are only different in degree, given the amount of human labor that is directed at paying off interest owed to bankers and rentiers.
Once concepts of business investment and banking began to develop, the focus moved more toward commercial lending, and interest rates started to vary. For example, normal loans to Greek cities or wealthy individuals for business purposes would be 10-12% from 600-300 B.C., and a few points lower for the next two centuries (to borrowers with the best credit). Meanwhile, risky, unsecured personal loans to poorer debtors varied wildly, often commanding high interest rates, which was where the usury protections were really needed. For example, fourth century B.C.E. Greek usury rates were often 36% per year, but at times climbed to 48% per month for loan sharks (over 500% per year), or even common “payday lenders” who were known to demand up to 25% interest per day – which would equate to 9000% per year. Pawn shops also lent at 36%. Business loans were often secured by property, and those debtors often had better credit in general, so the standard interest rates for commercial loans were usually a lot lower. Overall, the prevailing interest rates tended to decline as the world center of commerce moved from Babylon (in modern-day Iraq) to Greece (which was much more of a free-market society), and then from Greece to Rome (a more agricultural society), and to Byzantium/Constantinople (where the influence of Christianity became prominent). (Rates were always lowest when commercial society was flourishing; in times of turmoil and uncertainty, they would go up. This begs the question: does the charging of high interest rates to non-wealthy consumers interfere with their economic development, since economic development of business is promoted by low interest rates?) Meanwhile, religions such as Judaism, Christianity, Islam, Hinduism and Buddhism all had prohibitions against usury at some point – some for longer stretches than others, and in the case of some schools of Islam, continuously.
Importantly, the interest rates in Western Europe during medieval times (which were contemporaneous with the Constantinople-based empire) were a lot higher than those Byzantine rates, and were also above the higher-end Roman or Greek rates, a fact that likely affected Christian attitudes toward interest in general. Christianity had been critical of usury, first by clergy, then by the laity as well; by 800, the legal code of Charlemagne forbade usury completely, which was defined as any debt “where more is asked than is given.” The Church began excommunicating usurers several decades later, and usury was considered a criminal offense. The ban was originally focused on pawnbrokers and loan sharks who charged extremely high interest rates on personal consumption loans to the poor. However, eventually it expanded – by the 12th century, charging interest on a mortgage was considered usury by the Church, as were credit sales above the cash price. Usurers were expected to pay restitution, like thieves. This Church policy didn’t result in the elimination of usury in Europe (though there were occasional “reform” waves banning usury), but it did affect how people thought about usury, including social and political leaders. Forms of credit that wouldn’t involve usury began to evolve, and different theories of interest developed – for example, it was acceptable to charge extra for a loan if the money was for reimbursement for a loss the lender experienced because of the loan, but it was unacceptable if the extra charge was intended to be an outright gain for the lender. Fractional-reserve banking – the practice of lending out more in credit than one had in cash reserves to pay depositors – also began to spread around this time, beginning with goldsmiths who realized they could “create money” by lending out more in gold certificates than they actually had in their stash of gold bars, since depositors didn’t demand all of their gold at the same time. “Interest” began to refer to the compensation for delaying repayment of a loan, which opened the door for charging penalties (e.g., late fees) that would not be considered profit from the loan itself. Fees for the time and effort of making the loan were also imposed; however, the fact that a loan was risky would not justify making a profit from the loan (in contrast to the modern rationale justifying high interest rates on high-risk loans). Eventually, though, Europe became more commercialized, and merchant banking became prominent, which resulted in usury prohibitions again narrowing their foci to “obvious” usurers like loan sharks, rather than commercial banks.
Still, it wasn’t until London became the world financial center toward the end of the 18th century that usury laws became weakened in Catholic countries. Since around 1530, Protestants had been tolerant of modest interest rates, saying that Scripture only forbade “biting usury,” as opposed to usury that is not injurious to another person. This allowed commercial interests and economists to begin exploring and testing the economic effects of different interest rates. England began allowing lending at interest during the 16th century, and for several hundred years after that, interest ceilings were set at rates below 10%, until England completely eliminated the legal limit on interest rates in 1854 (right around the time the U.S. economy began to supersede the British Empire as the world’s largest). Meanwhile, the Catholic Church declared around 1830 that all interest allowed by law could be taken by everyone. (However, some countries have reintroduced usury limits, such as Japan – which allowed interest rates over 100% in the 1950’s, but due to widespread consumer debt and scandals involving extreme tactics used by moneylenders to obtain loan repayment, has reduced its rates to 29.2% and then 20% in recent years, with lending limits based on borrower income (1/3) – prompting some moneylenders to leave the market. South Korea, meanwhile, allowed registered moneylenders to charge up to 66% to borrowers, which has led Japanese lending firms to enter its lending market since the Asian debt crisis of 1997-98; the legal limit there is currently 39%, but illegal loansharking is common, according to the Korea Times.)
Prior to declaring independence from Britain, the American colonies had adopted versions of the English usury statutes. In fact, every state or territory had a general usury law by 1886, according to the FDIC report cited in FN 10. 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 the usury 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. See 18 U.S.C. § 1961.
II: Common arguments for and against usury laws
There have been numerous arguments made over the years against the practice of lending money for a profit (that is, charging interest in excess of the principal of a loan), along with the specific instances in which the interest rate exceeds the level that is considered socially acceptable or reasonable. Some of the arguments are based on morality, particularly the arguments with religious roots, while others are based on economic, sociological, environmental and anthropological concepts. Opponents of usury laws generally argue that they are socially disruptive despite “good intentions,” because when the usury rate is lower than the market rate for a particular loan, it discourages legitimate lenders from making that loan, which negatively affects potential borrowers, especially less creditworthy borrowers.
Some of these arguments (many of which interrelate) are:
-Income via interest extracted from another is unjustified when it’s not the product of one’s labor; profits from one’s own labor are distinguished from profits acquired simply by owning something, like land, that requires the borrower to add labor before it is fruitful (traditional objection in many faiths, societies, and also in Marxist doctrine);
-Money becomes an end in itself, rather than a socially-contracted abstract mechanism to facilitate the relationship of supply and demand, which diminishes the importance, and full reward, of ordinary labor;
-Strict usury laws prevent middlemen who control credit from exploiting small borrowers, particularly the needy and destitute who require personal consumption loans. A counterargument is that such borrowing for necessities is inevitable, and usury laws make things worse because “loan shark” demand rises when other lenders can’t make loans at market interest rates – plus, the usury laws increase the loan shark interest rates further by adding the risk of legal prosecution to their cost of doing business. In this view, it is better and more economically efficient to allow people the freedom to contract, and address usury issues by educating borrowers about money, especially since usury laws can also be creatively evaded by all sorts of mechanisms, like sale-and-leaseback agreements.
-Usurious rates cause poor people to pay more for their money than wealthy people – this redistributes resources from the poor (seeking to buy basic necessities with money that has a huge marginal utility to them) to the rich (seeking to buy luxury goods with money that has relatively diminished value), and becomes part of the apparatus by which a wealthy class develops a plutonomy. (Several studies cited in the Visser/McIntosh paper, including the National Consumer Council’s 1995 study, discuss this mechanism; it also happens on the level of debtor nations who are impoverished by interest payments.) Through the mechanism of compounding interest, money becomes self-perpetuating power in itself, a “quasi-monopoly,” instead of a mediating agent. Arguably, this is unconstitutional, given that money is a government service to which everyone should have equal access.
-Usurious rates interfere with goods being put to the best social use – instead, apportionment is based on purchasing power; a counterargument would be that high interest rates actually ensure money will be put to its best use, because they discourage the wasting of money; usury laws arbitrarily exclude high-risk borrowers from the equation, even if their use of the money would be socially beneficial
-Usury is one of the attacks on the poor that punishes people for economic downturns or their individual failure to earn a lot of money (regardless of the social utility their activities have), making society unstable by leaving some people without resources, and amplifying the social exclusion of the relative poor;
-Social cohesion is damaged when people prey on each other rather than aid each other’s progress; in general, the pursuit of commercial interests and personal wealth is a distraction from serving the community/state;
-In an economy that relies on consumption, it’s destructive and immoral to promote high-interest, credit-based spending as the way to give lower-income people purchasing power; also encourages bank profit expectations that foster speculative behavior, risk of bailouts. Usurious interest rates are a part of credit expansion that has replaced wage increases for the labor force, in order to perpetuate consumption.
-Purchasing power decreases due to high interest rates – prices go up, no one benefits – compare to interest rates in flourishing business environment;
-Our money is issued as debt, so interest payments are constant – usury is part of that system; it’s wrong for commercial banks to hold monopoly on money/credit creation process, at zero cost to them
-Usury discounts future value in favor of present value, which is disastrous – and the higher the discount rate (based partly on interest rate), the more pronounced the effect. The depletion and exhaustion of resources is encouraged by the idea that it’s better to have x amount of currency now, rather than later; “economic rationality” can actually lead to the extinction of a species, and the prioritizing of short-term investments over long term investments, in which benefits come much later than costs. Financial economy does not reflect ecological economy (which does not function based on compound interest). Rather than observing principles of intergenerational equity (e.g., future generations have a right to the land and the environment as well as present ones), it exploits the future for the interests of the present.
-Usury acts as an agent of economic instability by making interest-based economies subject to “boom and bust” cycles;
-J.M. Keynes – argued that a ceiling on interest rates would increase investment, because most economic problems come from people preferring to save rather than to invest money – low interest rates would let borrowers borrow more in order to invest, while lenders would invest more in capital because of lower lending rates. He argued that this would give borrowers more cash, which would be used for consumption. A counterargument is that arbitrarily low interest rates discourage savings, placing upward pressure on those same rates; this requires either the creation of money or credit at an accelerating pace, which contributes to inflation, or non-price rationing, which reduces efficiency. Bowsher (see FN 6) reports that when interest rate ceilings were imposed in certain states, banks shifted their money to states with more permissive usury laws, allowing businesses in those states to be more competitive; passing statutes that make the usury laws inapplicable to corporations (as some states have done) winds up giving them a competitive advantage over other types of firms, or individuals.
-Silvio Gesell – condemned interest because it caused sales prices to be more related to the “price” of money on the market than to the actual needs of people, or the quality of the products. He argued that money should be treated as a public service that was subject to a use fee; this was tested via the “stamp scrip movement,” which some say was destroyed when its success began to threaten banking monopolies. Successors to Gesell (e.g., Margrit Kennedy) argue that interest functions as a cancer in our social structure, and that inflation-free money should be adopted, with a circulation fee acting like a negative-interest-rate mechanism. The key obstacle to an “anti-hoarding” scrip approach seems to be the difficulty of getting alternative schemes started, and getting people to use them when it is a lot easier to use other kinds of money (as discussed in the Federal Reserve article cited in FN 8).
-Adam Smith – he argued that usury laws were justified, because high interest rates would leave borrowing to “prodigals and projectors” who wouldn’t be as likely to be able to pay back the loan, as opposed to more responsible people, who would not be willing to borrow at such high interest. A counterargument to this position is Jeremy Bentham’s position that innovative investing is responsible for economic progress, which carries high risk, so it requires high rates of interest to fund it. Established businesses and wealthy individuals can borrow at lower interest rates, a disparity with an anticompetitive effect that spreads from credit markets to goods and services markets.
(In fact, the Old Testament proposed a “Jubilee” process every fifty years, where all debts would be forgiven, recognizing the need for a corrective mechanism to the effect of compounding interest!)
III: Why the current U.S. laws don’t protect people the way they used to
There’s a catch to those usury laws on the books here in the United States (which were mentioned in part I of this report): 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, including loans made for 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. The state usury laws are described as “a complex and disorganized array of rules” in a 1998 FDIC report on the deregulation of the credit card industry (discussed below).
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 (the rest being through the Office of the Comptroller of the Currency). 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 (whose legal citation is 439 U.S. 299), 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.  It would be up to the federal government to change this if it wanted to. 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, Chemical and Chase Manhattan quickly opened up branches in states with permissive usury laws (South Dakota and Delaware), and began selling their credit card services all over the country. (See discussion below.) 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. Another Supreme Court decision, Smiley v. Citibank (South Dakota), 517 U.S. 735 (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.
As mentioned above, the negation of usury laws is particularly dramatic with respect to credit card availability. In 1950, the first general-purpose charge cards were introduced by Diner’s Club and American Express in response to increased consumer demand for durable goods like appliances and electronics, but the card balances had to be paid off every month. In the late 1950’s, banks started issuing general-purpose credit cards that allowed the cardholder to carry a monthly balance at interest, but their use was limited to the banks’ local areas. A big change occurred in 1966, when Bank of America licensed its BankAmericard logo to other banks, and created a national system to process credit card transactions. Those banks later became the Visa network. Not to be outdone, another group of banks formed the Master Charge (now MasterCard) association that same year. They succeeded in convincing merchants across the country to accept their cards, and to use their nationwide payment system. After a period of turmoil and controversy about these new credit cards, they became accepted in the 1970’s, and credit card debt began to grow. However, each state’s usury laws applied to the credit card transactions of its residents, which required a lot of careful monitoring by the credit card lenders. This also kept profits down in the states where usury ceilings were low, giving the banks less incentive to lend money to consumers in those lower-interest states, since they weren’t making a lot of money on the compounding interest. Thus, it was more difficult for consumers to qualify for a credit card, especially for higher-risk borrowers.
The floodgates really opened after the Marquette decision. By that point, interest rates had risen in the U.S., so credit cards were not being marketed in states whose usury rates were relatively low (for example, Sears stopped marketing its credit card in five states (including South Dakota) whose interest rate limits were 12% or less, and it permanently closed the accounts of customers who became delinquent on payments). By 1980, the average pre-tax earnings of banks issuing Visa and Master Charge cards were actually lower than the outstanding balances on the cards, in contrast to a 4% pre-tax profit in 1977. That year, 37 states had some type of interest rate ceiling on credit cards, with the lowest ceiling being Minnesota, at 8%. Credit was generally harder to come by due to the high nominal interest rates (as noted below, the prime rate was actually over 20% in 1980).
Noticing that the economy in South Dakota was very poor, Citibank (which had lost over $1 billion on credit cards) contacted the governor’s office in South Dakota to talk about a proposal: if the state would pass legislation that would allow Citibank to move its credit card operations from New York to South Dakota, they would create hundreds of high-paying jobs in that state (they had about 3,000 people working in the Long Island credit card unit at the time). They had been hoping to entice New York to change its usury law, but New York didn’t bite; however, South Dakota’s legislature and banking industry jumped at the proposal to open up a “limited, credit-card-only bank,” and Citibank drafted the legislation quickly. The legislature passed it, and 3,000 jobs moved to South Dakota; today, the state has no general interest rate limit. Other banks began making overtures to South Dakota as well, but other states – especially Delaware – quickly caught on, and also passed legislation making it tempting for banks to relocate. As of 1998, six of the top ten banks with high-volume credit card lending were located in Delaware, amounting to 43% of all credit card volume. Nevada, South Dakota, Ohio and Virginia also had above-normal percentages of those loans (each between 4% and 9% of the U.S. total).
Even when the general interest rates subsided around 1982, returning to about 8%, the credit card companies didn’t lower their own interest rates – people kept paying 18%, especially people who hadn’t been able to get credit cards before. Between 1980 and 1990, the average household credit card balance went from $500 to about $2700. In 1991, national legislation was proposed to cap credit card interest rates at 14%, which passed the Senate, but died out when banking-industry economists speculated about bank failures, causing a stock market drop.
Around this time, the industry also began recognizing that the most profitable customers were the ones who kept a running balance, but were unlikely to default on their debts, so they began targeting those customers. Interest rates and credit lines became variable, depending on the customer’s risk of default; likewise, minimum payments were made lower, in order to generate more interest income from each dollar of principal. (This explains why your credit score increases if you keep a running balance, instead of paying your complete balance every month.) Today, the standard minimum payment is only 2%, which encourages consumers to be heavily leveraged. This data-driven strategy led to Citibank becoming a $30 billion annual credit card business by the 2000’s; meanwhile, average household credit card debt was around $7500 in 2004. Also, standard penalty fees jumped from around $5-$10 to $29-$39, because of the 1996 Smiley Supreme Court decision; as a result, banks began finding ways to generate late fees, like making the due dates for payments Sundays or holidays, hoping to trip up customers. Late payments are also used as an excuse to raise interest rates – after all, they are a “violation” of the credit card agreement. Modest reforms passed by Congress in 2009 (the Credit Card Accountability, Responsibility and Disclosure Act) prohibit certain abuses, like card issuers being able to change the rate or terms of a credit card agreement at any time, without notice, and penalty fees that aren’t reasonably related to the cost incurred by the insurer or reasonably necessary to deter the type of violation involved, but the CARD act does not cap interest rates.
When people take on debt through credit card loans, which are unsecured, general-purpose loans, it creates additional trouble. The interest rates are higher than other types of consumer loans, which compounds people’s credit problems, and people who use credit cards because they have no other options are already at risk to begin with. According to the FDIC study, the number of bankruptcies filed between 1986 and 1996 increased from about 400,000 to 1,000,000, while the percentage of credit card debt “charged off” through bankruptcies rose from less than 1% to about 2.3%. Meanwhile, Canada experienced similar problems almost immediately after Visa entered the country in 1968. Because Canada has had no usury limit since 1886, lenders could charge any interest rate they wanted, which led to a huge increase in both credit card debt and personal bankruptcies between 1966 and 1976 – a figure of about 340%. The U.S. personal bankruptcy rate grew by only 8% during that time, when usury laws were still limiting credit availability. Since the deregulation of the credit card industry in the U.S., both countries have had dramatic increases in bankruptcy filings, though Canada’s has been higher. (Unlike the U.S., Canada did not reform its bankruptcy law during that time period, suggesting that bankruptcy law reforms in the U.S. are not to blame for the increase.)
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
1966 – BankAmericard (Visa) and Master Charge (MasterCard) establish national credit card networks
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, which reach all-time record highs (by far) for modern capital markets, 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)
1996 – Smiley decision allows banks to export late fees, etc., calling them “interest”
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 lenders 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.
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. (See FN 2 and 3.)
Buying goods on installment 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 legal defense. Since usury laws are most commonly applied by raising them as a defense to a debt lawsuit by a creditor, this effectively means that usury laws don’t apply to corporate borrowers in those states (consistent with the traditional non-application of usury law to commercial lending).
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.
 This section draws heavily from “A History of Interest Rates” by Homer Silla, available here: http://www.scribd.com/doc/60202091/A-History-of-Interest-Rates-Homer-Silla
 Islamic lending tends to involve the lender becoming an owner of the “collateral,” and leasing/renting it to the borrower, with ownership percentages being shared based on how much of the money has been paid back; in business contexts, the lender becomes a partner, entitled to some of the profit, and also sharing the loss.
 Examples of “alternative” European arrangements that gained general acceptance include the following: forced loans (in order to fund some city governments, wealthy citizens would be forced to make loans to their cities, but would be allowed to accept interest as a return on their payments); “insurance” setups, also called “five-percent contracts,” in which an active business partner would insure a passive business partner against loss on an investment, and would also promise the special partner a fixed rate of return; the “census,” which allowed a farmer, a noble, or even a state to receive a sum of money – usually cash – secured by their profit-producing lands, monopolies, etc., and afterward to pay a yearly annuity to the buyer of the “census;” bills of exchange, in which a merchant made a payment in local currency to another merchant, and received in return a bill that would be payable at a future date in another place and in another currency, with disguised “Interest” being built into the exchange rate; and “public pawnshops,” which were financed by charitable donations, and which charged a small fee for the care of the pawned objects, and the administration of the business – usually 6% (though some of them eventually began accepting deposits and paying interest for the loss of use of the money, which made them more like savings banks).
 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 haven’t verified this list for accuracy, given the broad informational purpose of this overview.
 (Interestingly, despite these varied levels of usury, the standard interest rate throughout most of the eastern U.S. was 6% for about 200 years, until the 1970’s.)
 For sources discussing these arguments, see initially, “A short review of the historical critique of usury” by Wayne A.M. Visser and Alistair McIntosh, and the 2005 paper “Usury Laws: Are They Justified,” by Shiva Thiagajaran, available here: http://www.swarthmore.edu/x11298.xml. This paper heavily cites Norman Bowsher’s 1974 report to the St. Louis branch of the Federal Reserve (in discussing Keynes’ justification for usury), separately available here: http://c.research.stlouisfed.org/publications/review/74/08/Usury_Aug1974.pdf.
 Relative poverty often causes individuals to become socially isolated, leaving people without the disposable income to participate in a normal manner in the community (even if they have access to food and shelter via social programs). For example, not having access to transportation, membership fees for social organizations, or admission fees for institutions can reduce a person’s ability to behave as a full member of society. The marginalization of the poor into ghettoes or isolated households reduces their political and social participation, leading to the breakdown of communities. See, e.g., James Russell, “Double Standard: Social Policy in Europe and the U.S.”
 See “A Short Review of the Historical Critique of Usury”, n.6. For a different perspective on the scrip movement of the 1930’s, see “Stamp Scrip: Money People Paid to Use,” by Bruce Champ, 2008 (available HERE: http://www.clevelandfed.org/research/commentary/2008/0408.cfm ).
 This section draws heavily from “Banking Regulation in the United States” by Carl Felsenfeld and David L. Glass, as well as from the chapter on usury in “The Practice of Consumer Law: Seeking Economic Justice,” a publication of the National Consumer Law Center.
 “The Effect of Consumer Interest Rate Deregulation on Credit Card Volumes, Charge-Offs, and the Personal Bankruptcy Rate,” Diane Ellis, Mar. 1998, available here: http://www.fdic.gov/bank/analytical/bank/bt_9805.html
 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.
 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 FN 22.)
 The leading case in this area is Greenwood Trust Co. v. Massachusetts, 971 F.2d 818 (1992).
 This section draws heavily from “The Effect of Consumer Interest Rate Deregulation on Credit Card Volumes, Charge-Offs, and the Personal Bankruptcy Rate,” Diane Ellis, Mar. 1998, available here: http://www.fdic.gov/bank/analytical/bank/bt_9805.html. It also draws from “The Ascendancy of the Credit Card Industry” by Robin Stein, a 2004 article for New York Times Television. It is available here: http://www.pbs.org/wgbh/pages/frontline/shows/credit/more/rise.html.
 The Credit Card Industry: a History, L. Mandell, 1990 (cited by the FDIC paper).
 In 1980, federal banking rules required a formal invitation by a state legislature in order for a bank to set up operations outside its home state. See also, FN 16.
 Delaware still has a usury law, as noted above; however, the legislature decreed that any judgment based on a written contract entered into after May 13, 1980 shall bear interest at the rate specified in the contract. Credit card agreements are written contracts, of course. See Title 6, § 2301 of the Delaware Code.
 Credit card companies figured out that classifying borrowers into “portfolios” and charging the lower-quality borrowers higher rates works out well for them, because the higher-quality borrowers won’t borrow at high interest rates – they have other options. Riskier borrowers, however, are willing to pay the higher rates. In fact, higher-quality borrowers often use credit cards because they are convenient, paying off their balances every month, or running a balance for a short time only. Credit card debt has accelerated during the last few years, though, as previously high-quality borrowers have had to use their available credit, young people not yet in their prime earning years have seen their debt increase, and many people across the board have had “off-years,” taking on debt to maintain their standards of living. When people take on higher financial leverage, they become more likely to file bankruptcy if they experience sudden financial shocks (job loss, illness, divorce).
 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 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.
 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