Freedom Line Blog

We at CFIF have consistently highlighted the peril of federal, state and local government efforts targeting the short-term consumer lending sector.

Less than two years ago, we specifically sounded the alarm on a New Mexico law artificially restricting interest rates on short-term consumer loans.

Well, a new study entitled “A New Mexico Consumer Survey:  Understanding the Impact of the 2023 Rate Cap on Consumers” that surveyed actual borrowers confirms our earlier warnings:

Key findings include:

•Short-term,small-dollar loans help borrowers manage their financial situations, irrespective of the borrower’s income.

•The rate cap has failed to improve the financial wellbeing of New Mexicans, specifically those who had previously relied on short-term, small-dollar loans.

•Most former short-term, small-dollar loan users struggled with paying their bills since the rate cap took effect on January 1, 2023. At the same time, a majority of borrowers indicated they were unable to access credit at some point following the rate cap.

•When unable to obtain credit, consumers said they were left with poor alternatives, including late bill payments, skipping urgent appointments or vital expenses, or pawning valuables.

•The vast majority of borrowers want the option to return to their previous lender, demonstrating support for the loan options available before the rate cap.”

The lesson is once again obvious:  Although bureaucrats claim to help struggling consumers through such overregulatory efforts as capping repayment rates, the real-world impact only eliminates a source of reliable, legal short-term loans to navigate temporary emergencies.

To illustrate, a 2018 Federal Reserve System Board of Governors study on the economic wellbeing of U.S. households found that almost 40% of U.S. families don’t couldn’t cover even $400 in emergency expenses.  Outrageously, 51% of military service members live paycheck-to-paycheck.  Unfortunately, credit cards aren’t always a viable option, and traditional bank loans are unavailable due to the small amounts needed.  Although higher-income Americans with stronger credit histories can borrow from banks, use assets they possess as leverage or use their savings amounts, people with lower credit scores and little in savings cannot.  According to the Fair Isaac Corporation, some 46% of consumers possess credit scores below 700, meaning that traditional bank loans aren’t possible for them.

Fortunately, short-term consumer finance loans can allow struggling Americans to access money needed to meet emergencies.

Under counterproductive laws like New Mexico’s, however, consumer finance lending becomes less available.  The unintended consequence of that is sadly foreseeable:  More people seek out illegal loansharks, suffer overdrafts, or simply fail to cover temporary costs.  As the World Bank found, such regulatory and legislative efforts as New Mexico’s lead to “increases in non-interest fees and commissions; reduced price transparency; lower number of institutions and reduced branch density; and adverse impacts on bank profitability, in addition to the lack of access for smaller and riskier borrowers.”

As expected, New Mexico’s H.B. 132 restrictions are already punishing the very people that it ostensibly claims to protect, making consumer finance lending more difficult, more expensive and less available.  It offers an ominous warning to other jurisdictions considering similar laws, and a quick lesson to New Mexico political leaders who can correct their mistake.

As the global economy slows, inflation remains elevated and wages fail to keep pace, we continue to emphasize how government regulators targeting short-term lenders only end up hurting the people they claim to be helping.

Now, a stark new study just released by Gregory Elliehausen of the Federal Reserve among other authors hammers home that point.  Namely, new laws artificially capping interest rates resulted in surveyed borrowers themselves saying that borrowing money when they needed it only became more difficult.  “Disapprobation of high interest rates,” the study begins, “reflects a longstanding and widely held belief that lenders take advantage of needy individuals by charging high interest and imposing harsh terms.”  Their work clearly found, however, that government mandates manifesting that disapprobation inflicted even greater pain:

[W]e find that the interest-rate cap decreased the number of loans to subprime borrowers by 44 percent and increased the average loan size to subprime borrowers by 40 percent.  We examine the welfare effects of the loss of credit access using an online survey of short-term, small-dollar-credit borrowers in Illinois.  Most borrowers answer that they have been unable to borrow money when they needed it following the imposition of the interest rate cap.  Further, only 11 percent of the respondents answered that their financial well-being increased following the interest-rate cap, and 79 percent answered that they wanted the option to return to their previous lender.  Thus, the Illinois interest-rate cap of 36 percent significantly decreased the ability of small-dollar credit, particularly to subprime borrowers, and worsened the financial well-being of many consumers.”  (Emphasis added.)

Rather than harming the very working Americans they claim to be helping, government officials at the federal, state and local levels need to increase access to small-dollar credit by first doing no harm.