You can tell that a lending institution is trying to take advantage of borrowers when it refuses to tell them exactly what interest rate it is charging them. That is not any principle of economics but rather a practical observation on abusive lending.
It is prompted by news reports of industry opposition to a proposal in the Minnesota Legislature that would require tax preparation services that offer “refund loans” to disclose the true borrowing costs to customers.
This proposal, part of the tax bill House and Senate conferees were working on Wednesday night, has less importance than other issues facing the state. But it’s an excellent example of fairness-in-lending issues.
Is renting out money any different from selling rhubarb or tennis shoes? Is there any economic or social reason to regulate money-lending more than other services such as lawn-mowing or preparing wills?
Historically, most economists have argued that lending or borrowing money is no different from any other voluntary economic transaction between two rational, uncoerced individuals. No one forces you to borrow money. No one forces you to eat rutabagas. If you want to borrow money, you decide whether or not the price you pay for it is a good deal or not.
Some people may choose to borrow money at terms that others may view as harmful, but such “bad” borrowing decisions by adults are fundamentally no different from “bad” eating decisions. Just because some individuals make self-harming decisions is not justification for government action.
That view still commands considerable sympathy among economists, libertarians and Republicans. But it runs counter to the teachings of Judaism, Christianity and Islam, all of which prominently emphasized justice in money-lending. Indeed, at one time or another all three religions effectively banned charging any interest at all. Judaism and Christianity have finessed such outright bans, but overt interest charges still are taboo to most Muslims.
Given theological objections to excessive interest and to abusive asymmetry of power between lenders and borrowers, governments historically regulated lending to a much greater degree than they did selling cinnamon rolls. Usury laws that placed statutory limits on interest rates were common in many states, including Minnesota, until recent decades.
One result of such laws was exactly as predicted by economic theory. Placing a price ceiling on any good below the market-clearing price causes a shortage. In lending, usury laws meant that high-risk borrowers — or borrowers for whom accurately assessing risk was costly — simply did not have access to legal credit. Whatever illegal or “informal” credit was available usually carried effective interest rates well above any statutory ceilings.
Over the past four decades, most usury laws have been repealed or limited. At the same time, the federal Truth in Lending Act and various state legislation has required more open disclosure to borrowers of the true cost of the loans they seek. Most economists approve of such credit cost disclosure requirements. History shows that it is easier for lenders to deceive borrowers about the true price of a loan than for gas stations or grocery stores to fool their customers about the true price of gasoline or pork and beans.
Economic theory and history demonstrate that markets produce better outcomes for society when all decision-makers have good information. Requirements to fairly disclose the price of a product are both efficient and fair.
That brings us back to tax refund loans. Tax services, such as H&R Block and Jackson Hewitt, have prepared consumers’ returns on a fee-for-service basis for years. Recently, they’ve offered customers loans equal to most of the amount of the calculated refund. These loans are for quite short terms — usually only a few weeks elapse between the electronic submission of a tax return and the automatic deposit into the preparing firm’s bank account of the refund loan owed.
Receipt of the refund accomplishes payment of the loan. The amounts usually are quite small, usually just a few hundred dollars.
Making these loans cheap depends on electronic filing and automatic deposit. High-volume tax services already need plenty of information processing capacity. Adding the necessary software to administer refund loans has relatively low marginal cost.
But there is some administrative cost and there is some risk. Moreover, any time loans of small sums are made for short terms, any administrative costs will represent larger percentages of the amounts loaned than if similar costs are incurred loaning larger sums for longer periods.
In other words, the high interest rates may be well justified. But there is no reason why tax businesses should not be required to fully disclose, both in absolute dollar and Annual Percentage Rate (APR) terms, the exact cost of the loans.
Cendant, a large corporation that owns Jackson Hewitt tax service, reportedly is lobbying heavily against a loan cost disclosure requirement in the Legislature.
Citizens and legislators who are interested in efficient markets should support full disclosure.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.