Call it a no-brainer, but prices organize the market economy. As they rise and fall, the movements exist as information for the producers and providers of what we want most and least. But what if prices are corrupted or distorted?
A recent distortion came to light in 2021 when Illinois lawmakers passed the Predatory Loan Prevention Act. Simply put, the legislation imposed a 36% interest rate cap on all loans made by non-bank, non-credit union financial institutions to individual borrowers. Ostensibly enacted to protect needy people from excessive interest rates and harsh repayment terms, the legislation at least theoretically ignored the basic truth that artificial price caps lead to shortages. Call it basic economics.
Eager to test what reads as basic, economists J. Brandon Bolen (Mississippi College), Gregory Elliehausen (Board of Governors, Fed), and Thomas Miller (Mississippi State) decided to research the impact of the Predatory Loan Prevention Act . Their findings confirmed the theory “that a binding interest rate ceiling decreases the availability of credit for high-risk borrowers.”
Following the legislation, lending to subprime borrowers fell by 30%. Minority borrowers in particular have been hit hard, with “over 60% of black borrowers and over 70% of Hispanic borrowers” finding they were “unable to borrow money when they needed it” after the imposition of the rate cap.
Reduced access to capital has proven to be rather crippling for those excluded from credit markets. Bolen et al report in their study that individuals “with incomes below $50,000 per year were more likely to respond that their overall financial well-being had declined” as a result of the legislation. The source of the decline included late payment of bills, visits from debt collectors, “pledge [of] personal possessions, borrowing money from disreputable sources, skipping urgent appointments or expenses, losing utilities and impacting children. Compassion can be very costly to those to whom it is directed. And that’s just the short-term impact of price controls.
The long-term implications of price caps intended to protect the poorest would be less discussed but no less problematic. In other words, it is always useful to consider the second and third stage implications of legislation that sets an artificial price on a marketable good.
While we know the short-term challenges that have unfolded for subprime borrowers, the future is perhaps less discussed. A failure to obtain credit essentially relies on itself. Seen from another angle, it is difficult to borrow without a borrowing history. This is why access to loans in the early days is so crucial. A foot in the door now paves the way for better access to credit across the board.
Bolen, Elliehausen and Miller seemed to confirm this. From their study, they found that while loans made to subprime borrowers by small lenders decreased by 30%, their average loan size increased by 37%. The increase in average loan size indicated that more money was lent to those with relatively established credit histories, as those without a borrowing history went completely credit free. surface. Stop and think about what that means.
Rate caps don’t just depreciate the riskiest borrowers here and now. Arguably more crippling for them, as price controls reduce them to “borrowing money from unsavory sources”, is their inability to build a credit history. Figure that “disreputable sources” means establishing credit well outside the surface market. Translated for those who need them, rate caps have more than jeopardized the finances of the kind of borrowers they were meant to help, because price controls have not only pushed borrowing back to the black market.
It’s something to think about. Borrowing begets borrowing. When we are able to borrow, we are able to build a credit history that makes us more creditworthy in the future. Except that borrowers must be able to take the first step up the lending ladder. It’s hard to do with price controls that limit the first stage.