Shane, Mathew

English

Research Papers in Economics

Staff Paper Series
      Staff Paper P70-23                                                                         December  1970
THE IMPACT OF THE MINNESOTA USURY LAW
By
Mathew Shane
Department of Agricultural Economics
University of Minnesota
Institute of Agriculture
St. Paul, Minnesota 55108Staff Paper P70-23 December 1970
THE IMPACT OF THE MINNESOTA USURY LAW
M.athewShane
Staff Papers are published without formal review within the Department
of Agricultural and Applied EconomicsTliE IMPACT OF THE MINNESOTA USURY LAW
Mathew Shane
The University of Minnesota
Every legal statute must be judged by how well its
intention is realized in actual events. In the case of the
1/ Minnesota usury law,- its intention is to protect con8umers
from paying “unreasonably high” intere~t rates. Thus, the
usury limit must be interpreted as b~irig the absolute maximum
reasonable loan charge. By considering the role which in-
terest rates play in the economy, this yaper will investigate
whether the Minnesota usury law has had the protective effect
that was intended.
Prices are a means of rati.onin~ goods in a market economy.
When the price mechanism i$j operating correctly, prices are
sat so that the supyli~s of’ goods are equal to the demands
for them. Interest rates are also prices--the price for
borrowing funds. however, although we are in general against
?
~’The earliest enactment of a usury law in Minnesota
At that time, the general statement of the law was in 1877. “
aJ.lowed a maximum charge of twelve dollars per hundred per
year. In 1923, that limit WMS reduced to eight dollars per
hundred per year. however, as the law now stands that eight
dollar limit is binding only on congumer mortgage loans. All.
other classes of loans have been either exempted or have a
higher limit. For instance~ bank installment and creclit
union loans have a maximum limit of approximately twelve
percent.2
restricting yr ice movorwont~$ an intorforence with the price
rntioning mechanism, we mu~t interpret the usury law as a
statement of belief by the legislature that the restriction
of interest rate movements corrects some distortion in the
money markets that is not prasent in most other markets. Im-
plicit in this is an argument that banker~ are somehow differ-
ent from other groups of businessmen that theyj unlike
other businessmen, would charge exorbitantly high prices
unrelated to their costs if their behavior is not restricted.
There is the further assumption that the restriction of in-
terest rate movements will not restrict the flow of credit.
Since the law dictates a maximum allowable rate, it is
only when that rate is exceeded that the law is binding and
thus would affect the credit market. Using the national FHA
mortgage rate as a proxy for the mortgage rate in Minnesota!
we find from Table I that previous to 1969 the lJHA rate never
2’ If bankers reached or surpassed the eight percent limit.-
are unreasonabl.e$ then why did they not charge the maximum
allowable rate throughout the entire period? Banks can only
partially control the rates they charge on loans and deposits.
~’It i~ assumed here th~t the natic)rial F}iA rate is a
rcasonuble approximation of the mortgago rate in Minnesota.
This can be f9U~J~JOrted by the fact that the mortga~e l-ate
quoted in Sylvia l’orterts column in the Minneapolis Tribune,
&lay 18, 197o, of 9.29% was only four-hundredths of n Perc@nt
higher than the rate quoted to me by a leading Twin Citl.es
mortgage lender on May 15, 1970.TABLE I
THE INTfi;REST RATES ON NEW FHA MORTGAGE LOANS AND Baa
CORIJORATE BONDS , YEARLY AVERAGES , 1961-1969*
FNA Baa Corporate
Yield Bond Yield (1) - (2)
(1) (2) (3)
1961 _5.80 5.08 .72
1962 5.61 5.02 l 59
1963 5.47 4.86 .61
1964 5.45 11.83 .62
1965 5.46 4.87 .59
1966 6.29 5.67 .62
1967 6.55 6.23 .32
1968 7.13 6.94 .19
1969 8.19 7.81 .38
*Source: The Lconomic Report of the President, February, ———.
~0, ~)p. 242-21*3.
Since banks are only one of many financial in~titutions,
they must charge a rate which is competitive with what is
available in other markets. Otherwise they risk losing their
customers to other competitive institutions.
The yield on Baa corporate bonds, a competitive long
,.,
term rate, is presented alongside the FHA rate in Table I.
Over the period of the 19601S, yicl.ds on EJaa bonds and F~~A4
loans have moved largely in the samo direction, Over the
period 1961.-1969, the average annual rate differential be-
tween the FIIA yield and tho Baa corporata bond yield is .51.
However, the differential narrows significantly from .71
in 1961 to .38 in 1969. The 1968 and 1969 differentials
were influenced by the fact that the maximum allowable yield
on FHi4 loans was 7.5% up to March 1969. Only then was it
raised to 8.5%. Consequently, the monthly differentials
in 1969, presented in Table II, reflect the fact that the
FHA rate was restrained by law while the Baa Corporate Bond
Rate was not. This would imply that the rate differentials
in the early and late months of 1969 were below the competitive
rate.
An estimate of’ the competitive mortgage rates in 1969
can be determined by adding the .51 avoragc differential to
the monthly Baa rates presented in Table Il. Considering this
competitive rate, it can be seen that starting in June of
1969, and continuing up to tl~e latest available data, the
mortgage yield hms been abovo the usury limit of eight IJ65r-
cent. Since this limit is only binding on consumer mortgage
credit, its impact should be observed in the housing market.
Thus we will now turn our attention to trends in housing
starts over the 1960’s.
The number of yearly housing starts more than doubled
between 1961 and 1969, from 13,077 to 26,273 (See Table 111).TABLE 11
THE NEW FHA MORTGAGE YIELD, T1lE C(MWJ?BTITIVE FHA MORTGAGE
YIELD, AND THE Baa CORPORATE BOND YINLD, MONTHLY
AVERAGES, 3.969*
FHA Baa Corporate Competitive
Yield Bond Yield (1) - (2) FHA Yield
~onth (1) (2) (3) (4)
Jan 7.50 7.32 l la 7.83
Feb 7.50 7.30 .20 7.81
March 7*79 7.51 .28 8.01
April 8.05 7.54 .51 8.05
May 8.06 7.52 .!54 8.02
June 8.06 7.70 .36 8.21
July 8.35 7081h .51 8.35
Aug 8.36 7.86 .50 8.37
Sept 8.36 8.05 .31 8.56
Ott 8.40 8.22 .18 8.73
Nov /3. 48 8.25 .23 8.76
D(3C 8.48 8.65 -.17 9.16
‘Source by column:
(1) and (2): Ibid, , p. 243.
(3): The Difference between column (1) and (2).
(4): Column (1) plug .51.6
THE TUTAL) N(.JMDE1{ OF HOUSING STANTS , AND THE NUMBER
OF ONk;- AND TWO- FAMI1,Y E1OUSING STARTS IN
MINNESOTA , 1961, 1965, 1968 AND 1969*
.-
Number of Number of one- and Percentage
Housing Starts Two-Family Housing Starts (2) of (1)
~ears (l)-
—
(2) (3)
1961 13,077 7,32’3 55.98
1965 18,485 9,001 48.69
1968 27,503 11,480 41.74
1969 26,273 8,790 33.45
—
*Source by column:
(1) and (2): The Federal Reserve Bank of Minneapolis ,
lluilding Permits , Annual Summar .
(3): Column (2) “+ as a percent. of column
Although the number of starts of private one-and two-family
homes increased from 7,323 in 1961, to 11,480 in 1968, an
increase of 57%, by 1969 they had decreased to only 8,790
new starts. Private one- arkcltwo-family housekeeping units
have thus fallen as a percent of all new housing starts over
the period, from 56% to 33%. Between 1969, when the usury
law became binding on mort~age credit, and 1968 the number of
new housing units declined by 4.48%. This is entirely ex-
plained by the 27.40% decline in ono- and two-family homes.
The number of new apartment building starts, whose financing7
would not be subject to the usury law, increased 9.11%.
Throughout 1969, when the return from commercial loans was
consistently above the usury limit, the available long term
funds went mainly to commercial enterprises. Only a small
residual was left to finance new private residential homes.
This indicates that far from protecting the consumer, the
impact of the Minnesota usury law has been to severely re-
duce the amount of funds available for private home buyers,
while expanding that available for other users of credit.
Since the usury limit has had a binding effect only on home
mortgage borrowers, and since home buyora unlike corporate
and business borrowers cannot move to other form~ of finance,
the im~)act of the usury limits has been to &revent home
mortgage borrowers from competing effectively for funds. It
is this factor that has lead to the drastic reduction in
one- and two-family housing starts. In T~ble IV, the monthly
percentage change for one- and two-family housing starts
is presented for 1969. The decline in new home starts in
the second six months of the year was 33.26% when the usury
law was binding compared to the! 7.05’M claclina in the first
half of the year. However, other factc)rs must be considered
in the reduction of private housing *tarts, in addition to
the usury limit.
The mortgage lenders, un~hble to use the interest rate
to equilize the supply and demand for mortgage? funds, have
developed other legal systems of achieving a competitive8
THb: NUMBER OF ONE - AND TWO-FAMILY HOUS lNG STARTS MONTH,
1968 AND 1969 IN MINNESOTA*
The Number of One- and
Two-Family Ilousing Percentage
Starts Change
1968 1969 (1) - (2)
Jan
F eb
Narch
April
May
June
July
AUg
SCpt
oct
Nov
r)ec
Total
480.89
587.96
829.73
1262,06
1259.40
694.71
978.05
815.10
1079. W
1274.69
1018.62
905.22
11,185.91
458.65
424.13
734.09
1046.66
723.43
1132.73
819.39
611.87
817.05
102/1.56
~lk6,72
448.31
8,779.59
6.29
-27.87
-11.53
-17.07
-42,56
+63.05
-16.23
-24.94
-24.32
-19.63
-56.52
-~oe[f~
-27.40 (average)
*Source by column:
(1) and (2): The monthly totala were derived from
monthly total hou~ing starts for
Minnesota by assuming that the yearly
percentag~ held for each month.
(3): Percentage difference of (1) minus (2).re turn. Since they are inhibited by law from charging more
than the 8% limit, the mortgage lenders have resorted to
charging points to the seller of the home and raising the
downpayment requirements to the buyer. This has two effects:
the seller knowing that he must pay points raises the price
of his home to offset the cost of the points, and secondly,
the higher downpayment requirement prevents many people from
buying a home who would otherwise do so. Recent requirements
in Minnesota have been for a 2S-30% downpayment. Thus, for
instance, on a $30,000 home not financed under FHA or VA,
between 7.5 and 10-thousand dollars is needed for a down-
payment. Very few of even the most affluent families have
that amount of liquid ca~:ital available.
Therefore, &iven the situation which has existed since
tht? middle of 19699 the average family cannot buy a home.
Since the price of homes rise between five and ten percent
a year, a delay in the purchase of a 330,000 home for even
one year causes an additional cost of between $1,500 and
$3,000. If you multiply this by the 260&unit reduction in
the building oi’ new private homos between 1968 and 1969,
this gives a total cost to Mi.nnegota residents of $3,900,000
to $7,800~ooo in 1969 alono.
Further, there are other- interest regulations restrict-
ing the rate that can be paid on time and savings deposits.
Since interest rates on com~etitive financial assets in the
national bond market have continued to go up while thesavings and time rates have been at their maximum rate, this
has caused an outflow of savings and time deposits into these
markets.~1 One reason of this, the ratio of time to total
deposits in commercial banks (pre@ented in Table V) rose from
an average of 35.8% in 1960 to 51.l%~in 19689 but dropped tO
47.6% in 1969. The fact that the loan to deposit ratio rose
indicates that banks partially offset the loss in deposits
by utilizing a higher percentage of total deposits for loans.
]Iowevor, in addition to the outflow of funds from
Minnesota into the national capital markets? there has even
been a reverse movement of funds through the correspondent
banking system. Although net correspondent balances held by
Minnesota banks almost doubled from 1964 to 19689 they de-
creased between 1968 and ~969. This has been an additional
force to restrict the incrnase in credit in the state.
The very large increase in intorost rates is one other
factor which has played a role in the severe reduction of
new home starts in 1969. With a fixed interest rate over
the mortgage term, the cost of taking out a mortgage at cur-
rent rates if you anticipate that interest rates will fall,
is high. A one percent decrease in interest rates on a
$30,000 mortgage constitutes a savings of ayproxirnately
$39000 over twenty years. Thus there is a great inducement,
~/The savin?,s rato was limited to 4.50% until early this
year when it was raised to 5.50% and more on various categorie~
of savers. At the same time, rates of over 8% were available
in the national bond markets. That is enough of an incentive
to make even the smallest saver movo into the bond market.11
TABLE V
THL LOAN TO DEPOSIT RATIO, TIME DEPOSIT IIATIO, AND NET
CORRESPONDENT BALANCES OF MINNESOTA BANKS, 1960
1964, 1968 and 1969*
Total Loans Time Deposits Net
to to Correspondent
Total Deposits Total Deposits Balances
Year (1) (2) (3)
1960 50.7 35.8 92.00
1964 51.7 45.2 77*95
1968 55*9 51.1 138.15
1969 63.1 47.6 136.20
*Source by column:
(1) and (2): CCX1l Report@ for all commercial banks
as of December of the year indicated.
(3): Average call report data for June ancl December
of the year indicated. The net figure was ob-
tained by taking total demand balances with
other banks and subtracting demand deposits of
commercial banks in the United States.
as interest rates rise, to reduce the demand for funds.
~onclusions
What can we then conclude about the implication of the
Minnesota usury law compared to the intention of protecting
the consumer from paying “unreasonable” interest rates?
For most of the period under consideration ~ince the usury
limit was not binding$ it had no effect at all. During the12
period when the competitive mortgage rate was greater than
the 8% limit, there was a r~.oticeable reduction in funds
available to home buyers imylying tho reduction in consumer
home purchases. This unnecessary postponement of home pur-
chases resulted in the computed high cost to Minnesota resi-
dents. Since this law neither protects the interests of the
consumer nor permits a rational allocation of the resources
of Minnesota~ it should not be retained.

THE IMPACT OF THE MINNESOTA USURY LAW

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics