When usury laws are counterproductive

by on April 15, 2017 at 12:30 am in Data Source, Economics, Law | Permalink

We study the effects of interest rate ceilings on the market for automobile loans. We find that loan contracting and the organization of the loan market adjust to facilitate loans to risky borrowers. When usury restrictions bind, automobile dealers finance a greater share of their customers’ purchases, which allows them to price credit risk through the mark-up on the product sale rather than the loan interest rate. Despite having little effect on who receives credit, usury limits therefore have a substantial effect on who provides credit and on the terms of credit granted. Usury limits may harm defaulting borrowers, who face greater liabilities in default than they would if loan contracts were unconstrained.

That is from a new paper by Brian Melzer and Aaron Schroeder, via Kevin Lewis.

1 Saint-Frusquin April 15, 2017 at 2:11 am

The whole point of fiat money : having anyone else bear the risk but pocketing the premium. Also called moral hazard in my sub101 economic courses from the last century

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2 prior_test2 April 15, 2017 at 3:31 am

Changing out just two words for one describes pretty much the entire history of money – ‘The whole point of seigniorage : having anyone else bear the risk but pocketing the premium.’

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3 Axa April 15, 2017 at 2:40 am

Defaulting borrowers pay more while punctual ones pay less interest. Is this situation counterproductive?

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4 Slocum April 15, 2017 at 6:34 am

Those who don’t default are not helped either. They pay less in interest but more in principal (because the purchase price of the car is higher). So their overall costs are not reduced. And their only lender option is the dealer, who is the only one in a position to charge low-rated buyers a higher purchase price in exchange for a loan with an nterest rate they wouldnt qualify for based on their credit rating.

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5 Anonymous April 15, 2017 at 7:45 am

The way I read it, the high credit rating customers had a better bargaining position, and could demand a lower sales price. Making the laws somewhat moot. Risky customers still pay more, by a different.

Can you get the “Costco price” with bad credit? I’d think not.

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6 TMC April 15, 2017 at 11:50 am

At least with mortgages you can get out from it after you have 20% equity.

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7 Careless April 16, 2017 at 11:16 pm

presumably people with positive equity in their cars could, too. Just harder to have.

8 prior_test2 April 15, 2017 at 6:43 am

really this is a boring story. the main thing is how good Germany is compared to the United States. Great cars, great labour laws. Much better than GMU!

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9 Thiago Ribeiro April 15, 2017 at 6:44 am

rubbish. the Only Great Country is Brazil. the women, the beaches, the waxes. Germany is nothing, united states is less.

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10 Boris_Badenoff April 15, 2017 at 7:50 pm

Which is why everyone in the world wants to emigrate to Brazil! Oh, wait . . .

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11 required April 21, 2017 at 3:21 pm

Emigrate From

Immigrate To

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12 prior_test2 April 15, 2017 at 7:43 am

So, wenn Deutschland so viel besser ist, warum nicht deutsch nutzen?

Und Deutschland ist ein Land, GMU ist eine Universität – sie sind nicht zu vergleichen, mindestens wenn man eine bisschen Ahnung hat.

(To the German speakers – why yes, I’m an Ami, and I speak German as if my mouth is filled with hot potatoes, too – at least according to several people.)

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13 TMC April 15, 2017 at 11:53 am

This is where I applaud the Germans. They think you are a dipshit, but are are too polite to tell you to go home.

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14 Anonymous April 15, 2017 at 7:51 am

Dealers seem very disinterested in cash offers these days. I assume this is because rather than this being about credit costs, it is about sales and inducement to upgrade. Get everyone thinking “costless purchase,” then shift them to a higher option package, or even a more premium car.

Use a different model, one about maximizing customer commitment.

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15 Ted Craig April 15, 2017 at 8:02 am

New car sales today are like going to the movies. Just as the theater makes its money off the refreshments, the stores make their money off F&I and parts and service.

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16 Alan April 15, 2017 at 8:34 am

+1. And used cars.

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17 mulp April 15, 2017 at 7:16 pm

So, why do dealers oppose the Tesla Internet sales model?

It eliminates the zero profit new car sales and leaves the used Tesla car sales to the dealers cutting high profit deals to bad credit risks on used Teslas.

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18 Anonymous April 15, 2017 at 9:35 am

I remember now that the big battle at Honda was about us accepting a tracking device as a $200 cost, with six months free service. I kept saying “take it off” (thinking that it was really a $20 device and they wouldn’t bother). I had to be pretty stubborn, and it came off (or not).

That would fit the “maximizing commitment” and “parts and service” model. Who knows how many end up paying for years of pointless car tracking.

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19 Bill April 15, 2017 at 8:25 am

I prefer payday lenders.

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20 dearieme April 15, 2017 at 8:58 am

Usury laws interfere with markets discovering prices. Of course they are a silly bloody idea.

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21 Troll Me April 15, 2017 at 11:04 am

When the market price is a 30% interest loan worth half your annual income, the market is unlikely to be serving the social interest well. Is the “freedom to pay usurious rates” itself of such inherent value that we should ignore the destruction that results from one additionally weighted brick on individuals who are already sinking?

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22 TMC April 15, 2017 at 11:57 am

Read the literature on this. Sometimes this is the best option. Would you borrow $1000 for bail or lose more than that by sitting in jail for a trial?

Either way, none of your business if someone decides to do this.

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23 Troll Me April 15, 2017 at 12:09 pm

I understand. There are some rare situations where this applies. But you really need to get creative, right?

But when that person, after years of payments to an originally small loan, ends up on your doorstep, not a drop to drink and no where else to go …

How creative do you need to be to understand a) orders drink at bar with last money, b) goes to get Payday loan, c) drinks the rest of the money away, and d) enter into impossible cycle.

You only need to make that mistake once, and if you’re on a tight budget they can have you by the balls for a decade, talking many thousands of dollars in “returns” from an initially small loan.

If you don’t know, you might wonder. But if you know, you know. It’s dumb. If you have had a blessed enough life to never have understood such a situation personally or second hand, then you’ve have a blessed life. Appreciate it.

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24 TMC April 15, 2017 at 6:27 pm

I think there was a paper here from some ivy league professor who expected exactly what you do when she went to work for a payday lender. Talking to it’s customers she found there are many valid reasons for people to use it’s service. Ended up changing her mind. Turns out life is creative enough.

25 Troll Me April 17, 2017 at 2:41 pm

I understand that there are legitimate uses.

I think they are uncommon enough to warrant certain controls. For example, a maximum interest rate of only 30% or 50% might be OK.

26 Moo cow April 15, 2017 at 10:26 am

Now I get it.

We traded in our 2009 in Jan. I insisted on getting the KBB/Edmunds value at the top of the range. $3000. The “sale to a private party” value was around $5000. I don’t like selling used cars and mine are never very valuable so this shrinkage is ok with me.

I was curious about what would happen with the car so I watched the dealers website. About 2 weeks after we traded the car in it was “on sale,” marked down (?) From $8499 to $7999. I thought who would buy it? Anybody with an Internet connection can look up the value. Now I know.

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27 Anonymous April 15, 2017 at 10:34 am

+1, this is probably much bigger in the low end, used car market

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28 Troll Me April 15, 2017 at 10:52 am

1 is 100.

There is some special situation where some defaulting person might lose out (1) and therefore this is the general logic of relevance (100).

Therefore all the other people who buy cars they cannot afford or prove ability to pay for, and as a result do not spend money they cannot afford to spend (they defaulted!!), will be unable to fully enjoy their freedoms to default.

Seriously? For the 100 people that usurers would screw up, to latch on to the rare possibilities that it could work out better?

You’ve got people who economic situation is empirically proven to affect their psychology in a way that predisposes them to making bad decisions on precisely this sort of calculation. And SOME ONE repeatedly pumps studies which emphasize the theoretical plausible maybe-once-in-a-blue-moon benefit with zero regard for how many people see years or decades of their lives eaten up after some dumb mistake with a usurious loan.

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29 Careless April 16, 2017 at 11:26 pm

Seriously? For the 100 people that usurers would screw up, to latch on to the rare possibilities that it could work out better?

Wait, is nathan actually dumb enough to think that these people with horrible credit would be buying these cars if the dealerships couldn’t make up the money they were going to lose on the defaults? Because that’s what it sounds like

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30 Troll Me April 17, 2017 at 2:44 pm

No.

I’m not saying they would buy the cars. I’m saying that maybe it would be better if they could not drive off the lot in a $2000 car that would cost them $5000 in future payments to own under conditions that will very likely lead to further degradation of their credit rating (etc.).

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31 Troll Me April 15, 2017 at 11:08 am

If the rules are “too strict” or maximum interest rates “too low”, then let’s get empirical and talk about decimal places.

Laws against usury are in principal and a prior GOOD.

Now let’s get practical. The 1 in 100 dedicated individuals who picks themselves out of the swamp thanks to a 30% interest auto loan would most often have found another way. My sympathy lies with the 99 drunks and financially illiterate who got screwed because the nanny state, or the church, or anyways, did not step in to prevent it.

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32 Troll Me April 15, 2017 at 11:46 am

If it’s 10 in 100, then that really starts to change the calculus. It is not 10 in 100. It’s people making dumb decisions, and providing them with additionally dumb options will not help them.

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33 Careless April 16, 2017 at 11:36 pm

then let’s get empirical and talk about decimal places.

IOW, find a value below the market clearing price that clears the market.

dear god, man

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34 Troll Me April 17, 2017 at 2:45 pm

For someone who so easily believes that people can do dumb things when it suits your purposes, somehow your faith in decimal places provided by the market is stunning.

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35 Allen April 15, 2017 at 11:26 am

Seems like we should try to structure society so that people don’t need 30% interest loans to survive. Decent paying jobs, affordable housing, mass transit, affordable education, and universal healthcare. Usury is a symptom of a sick society, not the cure.

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36 Enquiring Mind April 15, 2017 at 11:56 am

Predatory lending discussions are under-represented in the usury theory land dilations on human behavior. Look at what happens with the various asymmetries and then factor in those externalities, assumptions and such, then come back when there is a more substantive discussion than “restricting usury means inefficiency (Oh, the horror), people are priced out of stuff” that passes for economic commentary.

How many in ivory tower land drive used cars, get payday loans or otherwise have any semblance of understanding of life among the great unwashed?

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37 TMC April 15, 2017 at 12:27 pm

I’d bet many of the commenters here have used cars or drive them until the wheels fall off. My blazer has 174k miles on it, far more than the cars of any of my renters. I get TV envy when I go to them too.

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38 liberalarts April 15, 2017 at 11:57 am

Not yet mentioned, but there are firms that creatively find a third way to lend to low credit score people without having to charge them market interest rates. For example, Autotrakk installs a security code-based starter that only allows people to start the car if they type in the code that they get when they make their payment. If you are late with your payment, then you can’t start your car until you pay. In this way, some of the moral hazzard of borrowing is reduced and Autotrakk can lend to very low credit score customers at interest rates that are lower than the risk of a straight up loan to such individuals: http://www.fi-magazine.com/news/story/2006/04/autotrakk-offers-leases-to-credit-challenged-customers.aspx
Pretty slick.

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39 TMC April 15, 2017 at 12:24 pm

That’s pretty cool. I’d like to put that on the doors to my rentals. maybe even let them swipe a debit/credit card.

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40 Troll Me April 15, 2017 at 12:32 pm

The community resists.

It’s expensive to house homeless people. Keep them housed. Go upscale if that end of the market is not for you.

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41 TMC April 15, 2017 at 6:31 pm

I have houses in medium/nicer areas. People just have odd priorities. The lock above would just help them out with what’s important.

There’s reasons people are renters.

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42 Troll Me April 17, 2017 at 2:46 pm

Interesting thought you propose. I’m just not sure it would take off as an idea. Technologically it probably wouldn’t be difficult, but a lot of related issues are involved.

43 liberalarts April 15, 2017 at 9:24 pm

TMC–I have often wondered if advertising a lower rent for people who commit to automatic monthly debits for rent payment would help attract better tenants. That is: rent is $1,000 per month, or $900 per month for those who sign up for automatic payments.

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