Federal authorities are currently prosecuting Nicodemo Scarfo Jr.—the 36-year-old son of jailed-for-life Philadelphia godfather Nicodemo "Little Nicky" Scarfo—for running a loan-sharking and gambling operation in New Jersey. According to a New York Times article, an FBI sweep of Junior's computer hard drive revealed that he was breaking federal usury laws by charging annual interest of 152 percent a year for his very illegal loans.
Now, 152 percent is steep by Citibank standards, but it's a sweet deal compared to the terms offered by the "payday loan" companies, which charge average APRs of nearly 500 percent for their very legal loans. Payday loan companies, which include such chains as ACE Cash Express and the cheerfully named Check Into Cash, operate like this: If a borrower needs, say, $200, he writes a personal check to the payday loan company for, say, $250, but postdates it to his next payday. The company gives him $200 and keeps the $50 as its fee when it cashes the postdated check on its day of reckoning. If the borrower's account is empty that day, the borrower must "rollover" the loan, that is, pay the operator another hefty fee to prevent the check from bouncing. Payday lenders routinely threaten habitual defaulters with check-forging charges.
Given such astronomically high APRs, payday lending is extremely lucrative. The industry issued $9 billion worth of loans last year, primarily to working-class folks with lousy credit and scant savings, and it is expected to lend $18 billion by 2004. Many military personnel who live paycheck-to-paycheck depend on the payday loan outlets, which cluster around Army bases like ants on picnic potato salad.
So, why do we book the bookmaker but leave the payday loan shops alone? It's not like Scarfo was breaking his customers' legs or anything. The answer seems to reside in our culture's continuingly conflicted notions about usury. Plato condemned money-lending for creating wealth inequality and political disharmony, as did the ancient Romans, who set the planet's first interest-rate ceilings. The Bible offers the most familiar rants against usury, describing the creditor-debtor relationship as inherently exploitative. "The rich ruleth over the poor, and the borrower is servant to the lender," admonishes Proverbs22:7, which countless popes quoted to demonize even 1 percent interest. Proverbs formed the basis of Stuart England's interest-rate laws, and the American colonialists brought those sentiments stateside.
Utilitarian sourpuss Jeremy Bentham attacked the laws in his painfully unreadable Defence of Usury, but for the most part few questioned interest-rate controls. The colonies set APR ceilings in the 4 percent-7 percent range, and those caps changed little for over two centuries. Neither low inflation nor economic malaise could nudge lawmakers to modify the limits, which were regarded as important checks against man's inherent evil (thank you, Puritanism). State caps loosened a tad during the credit-card boom of the 1970s, but with a few exceptions even the loosest topped out at around 18 percent. The feds, meanwhile, entered the enforcement game: The anti-mob RICO Act of 1970 made loan sharking (defined as charging twice a state's maximum rate) a federal crime. This is the rule that has ensnared Scarfo and so many other mafiosi.
But check cashers have carved out a few loopholes, claiming that strict rate caps prevent them from providing a vital public service. Since 1990, the industry has convinced legislators in 24 states to exempt their storefronts from the strict APR ceilings that govern banks and credit cards. Small, short-term loans, they've argued, help working families meet emergency costs, and thus deserve special consideration. Moved by this appeal—and, quite possibly, by the check cashers' sizable campaign contributions—lawmakers have made exceptions for the so-called "merchants of misery": States created separate rate caps for payday loans that average 400 percent. Consumer advocates grumble, but the check cashers have serious political clout; in California, where the legal APR on a 14-day loan is 391 percent, lenders spent $528,000 on killing a bill that would have lowered the cap to "only" 312 percent. (The legal rate for all other consumer loans in California is just 10 percent.)
A few states have tried to stick to the Puritan game plan, but check cashers have grown crafty. A 1978 Supreme Court decision affirmed the concept of rate exportation, by which federally chartered banks can offer financial "products"—read: small (generally under $1,000) loans, via credit cards or check-cashing partners—nationwide, but in accordance with the usury ceilings in their home states. Quick to recognize an opportunity, Delaware, South Dakota, and six other states scrapped their small-loan laws (which is why your MasterCard bill always seems to originate in Sioux Falls). So, a check casher in a tough state can team up with a bank in a loose state to offer a gargantuan APR—500 percent, 1,000 percent, even 5,000 percent—regardless of local usury statutes. Virginia, for example, caps small-loan APRs at 36 percent. But a savvy Virginian lender can partner with a bank based in Delaware and then "import" that state's unregulated banking laws. The store may be in Richmond, but the rates are pure Wilmington.
Traditional street-corner loan sharks, alas, have not benefited from the deregulatory zeal. Legislators are hesitant to extend the payday loopholes to underworld figures, whose political influence is, er, a bit shaky. The sharks' dealings remain major felonies under RICO, even when they offer rates several hundred percentage points lower than the nearest ACE Cash Express, and they often provide better customer service. Unlike their legal counterparts, sharks negotiate rates, grant grace periods, and give "frequent borrower" discounts to loyal customers—especially business owners with deep community roots. An April New York Times survey of the practice in immigrant enclaves—the sharks' current core constituency—included the tale of one bodega owner who receives a 20 percent APR from his shark, a reward for years of dependability. For a cash-only businessman whose murky immigration status or poor credit rating might get him laughed out of Chase Manhattan, that's a solid deal.
True, sharks also have a reputation for braining debtors with baseball bats. But violence is far rarer than one might surmise from watching The Sopranos. The New York Times report found few complaints of shark-related mayhem. Sharks prefer to seize personal property from defaulters, or hold immigration documents hostage, since brutality is likely to attract police attention. "I've always understood that it worked pretty well," Daniel J. Castleman, chief of the Manhattan district attorney's investigations division, told the Times. "We don't get a lot of reports about intimidation."
They would get even fewer, of course, if loan sharking was pushed aboveground. Lenders could seize defaulters' property with the government's blessing, thereby eliminating any need for vises or blowtorches. More important, the sharks would provide a dose of marketplace competition. At present, the payday lenders have a government-protected monopoly on small loans to the millions of financially marginalized Americans—the bankrupt, the poor, the credit risks, the newly arrived. If these people need a few hundred greenbacks in a pinch, their only legal option is the storefronts and their astronomical APRs. Legalized private lending would depress storefront rates: How could Payday Plus outlets charge 500 percent when Joe Loan Sharks asks just 150 percent?