Legislating against ‘loan sharks’ isn’t as simple as it sounds

From California to Congress and from Sen. Elizabeth Warren (D-Mass.) to Sen. Bernie Sanders (I-Vt.), there is quite a push across the nation to enact caps on consumer loan interest rates. Advocates of these policies claim that caps will protect consumers from “predatory” lenders. In reality, the policy will merely hurt those borrowers it intends to help by eliminating access to credit.

The beauty of the free market is that if a product can be offered for a cheaper price — someone will provide it as long as they can still make a profit. Government price controls usually lead to a drop in supply, because the profit motive to provide the product is gone. Rate caps on interest are essentially price controls for loans. For an extreme example, simply look at what is occurring in Venezuela: Price controls on goods have driven up demand for an increasingly restricted supply, resulting in long lines for basic necessities and the rise of a dangerous black market.

Rate caps will simply mean that the cost of lending money goes up — and as a result, lenders will try to reduce their costs. They will do this by only lending to people who are least likely to default. This forces those who are denied credit to turn to much riskier alternatives on the black market. Considering that nearly 40 percent of Americans cannot cover a surprise $400 expense, having access to legitimate short-term loan options is increasingly important.

Yet, policymakers across the nation are pushing these policies under the guise of helping consumers. California might soon enact Assembly Bill 539, which would cap interest rates at 36 percent on loans between $2,500 and $10,000 — half of the state’s loans. And recently, presidential hopeful Sen. Sanders and Rep. Alexandria Ocasio-Cortez (AOC) teamed up to introduce legislation in both chambers that would cap interest rates at 15 percent. Both policies have the intention to stop “loan sharks” (Sen. Sanders and AOC’s bill is even titled the “Loan Shark Prevention Act”). But, if passed, it would likely push potential borrowers directly into the hands of black market lenders.

What is particularly noteworthy of California’s proposed cap is who its most vocal proponents are: Lendmark Financial Services, Opportun, and OneMain Financial. All three big-name financial service lenders have publicly supported the bill. One Main Financial even recently wrote in an opinion piece that it has chosen to “self-impose a cap of 36 percent APR” because they claim that it is the “’sweet spot’ where loans can be offered in a sustainable model.”

When a company vocally supports regulations that would limit its own industry, it should serve as a warning sign to policymakers and the public alike. There’s usually a catch.

In this case, the California bill would allow many lending companies — including the aforementioned One Main Financial — to sell “add-ons” to their loans which can drive up consumer costs. Thus, the proposed rate cap regulations wouldn’t affect these lenders’ bottom lines. Rather, they’re allowed to game the system by making additional profits off imposed fees.

As any Economics 101 class will show, rate caps only limit access to credit for those who need it most. The result is forcing denied borrowers into the hands of black-market loan sharks, the exact opposite of what these regulations were intended to do. Policymakers in the Golden State and in Washington, DC should realize these warning signs before it is too late.

Jeff Joseph served as head of domestic policy for the U.S. Chamber of Commerce from 1982 to 1997. He also helped launch and later led a DARPA-funded non-profit focused on bringing broadband internet to K-12 schools. He was a member of the Spectrum Group from 2006-2009 and most recently organized the non-profit Charitable Fundraising Council. He is an adjunct professor of business strategy and public policy at George Washington University and George Mason University. Follow him on Twitter @jeffjoseph77