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1.2.3 The Development of “Special” Usury Laws

Consumer credit as we know it today did not exist, for practical purposes, prior to the twentieth century.31 Pawn broking, of course, had been around for millennia, and personal loans secured by real estate were not unknown. Yet the vast majority of credit transactions were commercial. The total amount of credit available in the nineteenth century United States was limited, and most of it was directed towards industrial development where the profits available were higher and the risks lower than for individual loans. Furthermore, demand for individual credit was lower than it is today. Not only was individual borrowing socially frowned upon, but the economy was not oriented toward the production of consumer durable goods. In the days before automobiles, televisions, refrigerators, and other modern appliances, there was less for an individual to buy on credit.

This is not to say that individual Americans had no need to borrow for personal expenses prior to the twentieth century, or that there was no demand for goods, but rather that the official credit system simply did not extend to the average wage-earner. Given interest ceilings under general usury statutes in the neighborhood of six percent, and the proportionately higher administrative expense in small personal loans than in large commercial loans, banks could make more money lending to businesses. Thus, individuals in need of personal loans had to resort to loan sharks or “salary lenders.” The typical arrangement seems to have been a loan for $5 on a Monday, repayable on Friday (payday) for $6—an annual interest rate of 1040%.32

The problem of loan sharking was pervasive in the nineteenth century,33 leading to increased recognition of both the financial plight of wage earners and their need for a legitimate source of credit. Early attempts to reform were small-scale, informal and uncoordinated, but seemed to follow one of three basic strategies. First, cooperative societies were formed, generally following models pioneered in Europe, in which individuals pooled their money for their mutual benefit. The earliest of these societies took the form of mutual savings banks, organized under existing banking laws, but catering to and owned by small depositors. As the name implies, however, mutual savings banks were primarily concerned with encouraging thrift rather than providing credit. Building and loan associations, on the other hand, were cooperative organizations established primarily to provide mortgage money to members. Both of these institutions, precursors of modern savings banks and savings and loan associations respectively, had become widespread by the turn of the century.34 A later model of the cooperative society, which did not emerge in the United States until the first decade of the twentieth century, was the credit union. Like its predecessors, credit unions emphasized the pooling of resources, but further required the existence of some common bond among the members, typically a common employer.35 Credit unions took off during the 1920s, due largely to the lobbying efforts of a Massachusetts businessman, who pushed for the introduction of enabling statutes at the state and federal level.36

A second response to the loan shark problem was more strictly philanthropic.37 Organizations supported by donated funds made small loans at no charge except administrative expenses. Some employers apparently followed the same route. The money available through such organizations does not appear to have been sufficient enough to make much of a dent in the demand for small loans.

The third and latest strategy aimed at combating loan sharking was to attract credit, previously extended only to businesses, to the consumer credit market by making consumer lending a profitable prospect. Primarily, this was done by creating exceptions to the general usury law for small, unsecured loans with the aim of making these loans attractive to legitimate, mainstream creditors. The small loan and industrial bank laws, as well as early credit union laws, all first adopted in the early twentieth century, aimed to increase the amount of consumer credit available by increasing the legal yield on consumer credit.

The small loan laws, pioneered by the Russell Sage Foundation38 and the research that it supported, took a direct approach to attracting capital to the consumer market. The Uniform Small Loan Law, the first draft of which was issued in 1916, created a licensed class of small loan lenders authorized to charge rates significantly in excess of the general usury ceilings. In return, these lenders accepted regulation, the risk involved in personal lending, and the higher administrative expense of small loans. For example, the fourth draft of the uniform law39 allowed the charging of 3.5% monthly on loans of $300 or less. This rate was much higher than the general usury ceiling, but was nevertheless vastly lower than the rates charged by loan sharks.40

Industrial banks, first organized under regular state banking laws early in the twentieth century, took a less direct approach to increasing the yields on consumer credit.41 These institutions accepted individual deposits and made loans secured by those deposits. Arthur Morris devised a plan which treated loans as repayable in a single lump sum at the end of the agreed term and computed interest accordingly. However the Morris Plan required the borrower to make regular “deposits” in the bank which were calculated to equal the total amount of principal and interest due at the end of the term. Essentially, the Morris Plan allowed industrial banks to increase yields by charging interest on sums the borrower had already repaid (i.e., by ignoring the declining principal balance on the loan).42 Although this device was an evasion of existing general usury laws, many states adopted statutory exceptions to general usury laws to validate the practice, and industrial banks came to serve a market of consumers seeking loans in excess of the $300 limits set for small loan licensees.

Carving out statutory exceptions to the general usury laws proved an effective means of increasing consumer credit. Not surprisingly, it also proved to be difficult to limit. Although credit laws developed differently in each state, statutory usury exceptions were soon made, not only for small loan lenders, but also for industrial banks, as discussed above, credit unions, mortgage lenders such as savings banks and building and loan associations, and eventually, banks making “installment loans” to finance consumer purchases.43


  • 31 {30} See generally Curran, Legislative Controls As a Response to Consumer Credit Problems, 8 B.C. Ind. & Com. L. Rev. 409 (1966–1967); Note, Interest Rates and the Law: A History of Usury, 1981 Ariz. St. L.J. 61.

  • 32 {31} See Commonwealth v. Donoghue, 63 S.W.2d 3 (Ky. Ct. App. 1933) (discussing the 1930s versions of salary lenders); Lynn Drysdale & Kathleen Keest, The Two-Tiered Consumer Financial Services Marketplace: The Fringe Banking System and Its Challenge to Current Thinking About the Socio-Economic Role of Usury Laws in Today’s Society, 51 S.C. L. Rev. 589 (2000) (fuller discussion of the historical antecedents of today’s fringe lenders); § 2.5, infra (discussing modern incarnations of salary lenders).

  • 33 {32} See Robert Mayer, Loan Sharks, Interest-Rate Caps, and Deregulation, 69 Wash. & Lee L. Rev. 807, 808–809 (2012) (discussing the evolution of salary lending and loan sharking during the Civil War era). See generally Combating the Loan Shark, 8 Law & Contemp. Prob. 1-205 (Winter 1941) (issue devoted to articles on usury, small loan laws, and loan sharking).

  • 34 {33} See generally Bodfish, History of Building and Loan Associations in the U.S. (1931); Cobb, Federal Regulation of Depository Institutions: Enforcement Powers and Procedures (1984); Sherman, Modern Story of Mutual Savings Banks (1934); Welfling, Mutual Savings Banks (1968); Redfield, Savings Banks and Savings and Loan Associations: The Past and the Future, 16 Bus. Law 170 (1960).

  • 35 {34} See 1 Credit Union Law Service Ch. 1 (Matthew Bender 1987) (discussing the evolution of credit unions); §, infra (discussing credit unions).

  • 36 {35} Reed White, If It Quacks Like a Duck: In Light of Today’s Financial Environment, Should Credit Unions Continue to Enjoy Tax Exemptions?, 28 Ga. State U. Law Rev. 1367, 1373 (Summer 2012).

  • 37 {36} See Kawaja, Regulation of the Consumer Finance Industry: A Case Study of Rate Ceilings and Loan Size Limits in New York State 23 (1971).

  • 38 {37} See generally Curran, Trends in Consumer Credit Legislation (1966); Hubachek, The Development of Regulatory Small Loan Laws, 8 Law & Contemp. Prob. 108 (1941).

  • 39 {38} Reprinted in Hubachek, Annotations on Small Loan Laws (1938).

  • 40 {39} See Robert Mayer, Loan Sharks, Interest-Rate Caps, and Deregulation, 69 Wash. & Lee L. Rev. 807, 821–835 (2012) (describing how the advent of the Uniform Small Loan Law led to a reduction in loan sharking). Cf. Christopher L. Peterson, Usury Law, Payday Loans, and Statutory Sleight of Hand: Salience Distortion of American Credit Pricing Limits, 92 Minn. L. Rev. 1110 (Apr. 2008) (arguing that the enactment of the small loan laws eroded the consensus for a uniform and relatively low usury cap).

  • 41 {40} See generally Curran, Trends in Consumer Credit Legislation 52 (1966); Saulnier, Industrial Banking Companies and Their Banking Practices (1940).

  • 42 {41} See § 5.3.3, infra (further explanation and calculation methods).

  • 43 {42} See Curran, Trends in Consumer Credit Legislation 65 (1966) (discussing the varying scope of installment loan laws). See also Garcia v. Chrysler Capital L.L.C., 2016 WL 5719792, at *1–2, 7 (S.D.N.Y. Sept. 30, 2016) (discussing the 1956 enactment of retail installment act that overrode the time-price doctrine).