Smith, Reginald Heber

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What Lies Ahead in the Field of Small Loans

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WHAT LIES AHEAD IN THE FIELDOF SMALL LOANSREGINALD HEBER SMITH*The amazing growth of consumer credit is. one of the outstanding economicfacts of our times just as the Uniform Small Loan Law, prepared by the RussellSage Foundation, has proved to be one of the most successful pieces of remediallegislation enacted in our generation.This effort to take a look, even a partial look, into the future is necessarily basedupon a thoughtful consideration of the past. But, as H. G. Wells once observed, ifa student knew all the past facts he could, in some fields, foretell the future withfair accuracy.I do not know all the facts. I believe nobody does because the subject is too vastand complex. Consumer credit, and particularly the small loans field, deals withpeople and no one mind can grasp all their motivations-their plans, ambitions,hopes, and fears.My own knowledge is strictly limited; but it does extend over nearly forty years.Those of us who can go back that far have this advantage. We have seen whatconsumer credit was when banks frowned on such loans, when there were no li-censed small loan companies, when the whole field was the exclusive domain of theloan shark with his usurious rates of interest and his harsh collection methods thatforced his victims into a form of peonage.In i914 when I became counsel for the Boston Legal Aid Society the mostcommon type of case was the small loan based on a wage assignment.. The typicalloan was $io.oo; the maximum was $5o.oo; the security was an assignment of allthe borrower's future wages; the one thing the lender did not want the borrowerto do was to repay the principal of the loan; the "charge" for the loan (politely calledan accommodation) was 20 per cent per month. We entered these cases on the LegalAid records as loan shark cases.In 19i6, the Boston Legal Aid Society backed by all the social welfare agencies inBoston and with the skillful help of Arthur Ham of the Russell Sage Foundationsecured legislation that gave Massachusetts one of the earliest well-conceived set ofstatutes enacted in any state, many of whose provisions were later incorporated inthe first draft of the Sage Foundation's Uniform Small Loan Law.In 1919 I resigned from the Legal Aid Society and entered private practice. Afterthat, and for nearly a score of years, one of my clients was the Massachusetts Associa-tion of Small Loan Companies composed of most of the licensed lenders in thestate. I have always believed their coming to me was an act of sheer desperation.*Member of the Massachusetts bar.WHAT LIES AHEAD IN THE FIELD OF SMALl LOANS 121At that time just as no bank would make small loans, so no lawyers knew or caredanything about the small loan problem. The licensed lenders needed help in manyways, particularly in dealing with the legislature. To state their case required anintimate knowledge of the facts about the business. Then the lawyer found thathe had the type of case that challenges his best efforts: to defend a party consideredguilty by the entire community, but who, on the basis of the lawyer's own investiga-tion, was clearly innocent.For younger people it will be virtually impossible to realize that in those days amoral stigma attached to any small loan and to both parties to it. As for the lender,the public did not know the difference between licensed lender and loan shark;partly because the licensed lenders themselves took a defensive attitude, but chieflybecause their rate of charge was, and always must be, substantially higher than theconventional bank rate for a commercial loan which, as we all learned in the sixthgrade, was 6 per cent per annum. As for the borrower, public opinion generallycondemned any borrowing by him as immoral. Even the economists abetted thisimpression: when a businessman borrowed that was "a constructive loan"; but whenthe little man made his little loan the transaction was given the rather terrifying tideof "a consumptive loan."Let us now take a long jump forward and arrive at the middle of the twentiethcentury. The United States Department of Commerce gave us in its "Survey ofCurrent Business" of February 1953 (Table S-i6) its carefully checked figures for1950.Also let us confine the issue from consumer credit in general to cash loans: thatmeans leaving out charge accounts at stores, installment purchases of automobiles,etc., which the law regards as time-sales and not loans.Total volume of loans outstanding at the end of i95o was $5,964,oooooo.And who made these loans aggregating nearly six billion dollars? Here are thelenders ranked according to volume of their loans:Commercial Banks $2,So,ooo,ooo Industrial Banks $301,000,000Small-loan Companies 1,268,ooo,ooo Industrial-loan Companies 229,000,000Insured repair loans 938,ooo,ooo Miscellaneous 176,ooo,oooCredit Unions 542,000,000You will notice that whereas, at the beginning, the banks frowned on small loans,they now make about 40 per cent of all cash loans in the consumer credit field.,That is a revolution in itself. It is a revolution in economic thinking.On May 4, i953, The National City Bank of New York used large advertise-ments to point with pride to the twenty-fifth anniversary of its personal loan de-partment as "the first Personal Credit Department established by any large com-mercial bank in the United States. Since then, more than six million people haveborrowed 2/2 billion dollars. These loans are for a wide variety of useful purposes,such as: medical, dental, hospital, household, educational expenses. . .That illustration will enable you to understand the significance of these words inLAW AND CONTEMPORARY PROBLEMSthe long-established Boston financial weekly, "United States Investor." In its issuefor November 29, 1952 (Vol. LXIII, No. 48) the leading article was titled "Success-ful Consumer Credit!" Here are the relevant words:Here is what is described as the major development in American bank operationsin the next decade, and here is a new bank service for more and more people.Of course we all remember something about consumer credit-even if only the "follyof installment buying" school of thought. Because consumer credit, you know, is by andlarge responsible for the success of mass production in the United States and has held outa helping hand to millions of people in their struggle to improve their standard of living,consumer credit has played its part in giving Americans the highest standard of livingin the world.Before moving on to a scrutiny of the figures for small loan companies let usmake a digression (which will turn out not to be a detour after all) to ask howthe transaction of lending-borrowing deemed almost immoral not so many years agois now considered a potent factor in our standard of living.If you or I want something that costs $3oo and we do not have $300 we could(a) borrow $3oo to be repaid over a year and at once buy the desired object or (b)save $25 a month for a year and then buy the object for cash, thereby saving our-selves all interest and carrying charges. If the American people had followed thelatter course, would we be where we are now (with a lag of one year) or wouldthe pump never have been primed? This sounds like the ancient riddle of whetherthe hen or the egg came first. I lack the wisdom to give a definitive answer; butthe pragmatic conclusion is clear enough.For psychological reasons the American people want the incentive to save whichthey get by first obtaining possession of their object-be it a home, household fur-nishings, an automobile, or just to be clear of a lot of bills.In my opinion, this psychological law will continue far into the future.The clearest proof I can submit is as follows: A person with a savings bankaccount of S,ooo wishing to purchase something costing $3oo will borrow $3oo fromthe savings bank, using the bank book as collateral; but will not withdraw $3oo.I have come to the conclusion that is psychologically sound.If any of my readers in higher income brackets are disinclined to agree, let meask them to ponder this question. Should you need $3,ooo to add on to your homeor to meet a pressing obligation, do you honestly prefer to borrow from a lendinginstitution or to borrow on your life insurance? Do you not have a deep-rootedfeeling that to borrow on your life insurance is the first step towards losing it?Your feeling is not wide of the mark. Life insurance statistics show that loans alltoo commonly result in forfeiture of the policies.We have seen earlier that the volume of cash loans made by licensed small loancompanies and outstanding on December 31, i95o, totalled in the aggregate$i,268,ooo,ooo. The essential fact is this: The small loan business at the end of 195owas at least a thousand times greater than any of the pioneers in the field everdreamed of.122WAT Lms AHEAD rN THE FmLm oF Sm u LOANS 123In my opinion, what the small loan companies have won they will hold andcontinue, to expand. This will be true in spite of apparent competition by banks.The competition is more apparent than real.Competition as to rates of charge the small loan companies have faced for years.First it was the credit unions. Next the Morris Plan Companies now denominatedIndustrial Banks. Government has made loans of many types. All these havecarried rates of charge lower than what the small loan licensed lenders must charge.The reason they have survived and grown is that they-by and large-deal with adifferent group of borrowers and render a different type of loan service.The licensed small loan companies make the small loans. For that reasonthey deal with far more American families. Their customer is the average citizenon Main Street. They understand him and they have won his confidence.The great test came in the depression that began in 1929 and continued through1932. While big banks found many big loans uncollectible, the small loan companiesfound that the small loans owed by the average American family were beingsteadily repaid. Defaults were due, not to unwillingness to repay, but to unemploy-ment. Even so, the reserve for losses set aside by well-run companies did not exceedio per cent of outstanding loans and that reserve proved to be more than ample.On sober reflection, the reason is plain. There is no mystery. We are nowspeaking of borrowers who come from the income groups that constitute a majorityof our people. We trust them to elect the President of the United States, the mem-bers of Congress, our Governors, members of our State Legislatures. Why not trusttheir judgment, family by family, when they decide that it is prudent for them toborrow $ioo or $200 or $300.The record of the American people for integrity in honoring their debts wassuperlative.In my opinion, this record will continue and on this score I have no doubtswhatsoever.The banking epigram attributed to J. P. Morgan is that "The only worth-whilesecurity for a loan is character." In lenders' terminology that means "the desireto repay.'After the demonstration of character by the American borrowers of small loansthe lenders reacted and began asking for no other security than character.Before I give you statistics let us go back once more to the beginning. The loanshark liked the wage assignment for security. It gave him a vice-like grip on hisborrower. As if that were not enough, most employers made it worse because,believing that small loans were immoral, they threatened to discharge any employeewho had a loan. Hence the lender merely had to threaten to enforce the assignment-which meant notice to the boss-and the borrower would do anything in hispower to prevent being fired.When the licensed lenders entered the field they relied on chattel mortgages onthe household furniture. At the time this was as good a security as could have beenLAW AND CONTEMPORARY PROBLEMSdevised. It worked well both ways. The lender never wanted to foreclose and re-possess the furniture because second hand furniture is almost worthless. Yet, fromthe borrower's point of view, it had a high going value not only because one becomesattached to one's own things but also because it would be quite expensive to replace.Today a majority of small loans are made on character and without any security.For statistical evidence I submit the figures for Massachusetts because the BankCommissioner's figures go back in detail to 1937 and because I have worked enoughwith these figures to believe there are no substantial "catches" or inaccuracies inthem. These figures come from Official Document No. 95 and are ba~ed on thelicense year which, in Massachusetts, ends on September 30.TOTAL LOANS MADE $300 oR LEss UNSECuRED LOANSLicense YearNumber Amount Number % of Total1937 ............ 236,066 $35,000,503 41,186 17.611938 ............ 205,228 29,743,192 37,839 18.431939 ............ 262,911 37,599,085 63,917 24.311940 ............ 282,723 40,750,287 83,832 29.651941 ............ 312,442 46,892,693 114,680 36.701942 ............ 271,985 41,668,089 124,891 45.921943 ............ 228,103 33,796i398 114,509 50.201944 ............ 233,817 35,359,623 123,145 52.671945 ............ 231,748 36,544,117 130,593 56.351946 ............ 259,843 42,706,182 146,844 56.511947 ............ 265,155 46,014,185 147,330 55.561948 ............ 267,196 49,229,525 141,079 52.801949 ............ 250,443 47,506,393 128,388 51.261950 ............ 243,598 47,154,980 122,161 50.151951 ............ 234,266 45,342,471 125,246 53.461952 ............ 229,259 45,077,696 126,135 55.02So far so good. Now, however, we come to a problem which gives me realconcern but which, so far as I can learn, has received almost no attention in theliterature on this subject.In this article, the term "small loan" has been used to mean a loan of $300 orless. That is the limit used in almost all of the small loan laws. The banks havealways preferred loans over $300. The licensed lenders, until recently, confined theirloans to $300 or less.My concern is about the "little loan" and by that I mean a loan of $50 or less.Bear in mind that $5o was the maximum loan-shark loan. The loan sharkdomain is loans of $ro to $50. If the licensed small loan companies abandon thatterritory the loan shark will return. The law that nature abhors a vacuum operateswithout fail in this territory.Because in the great majority of our American states the licensed small loancompanies have operated effectively and decently for so long, there is a disposition onthe part of the general public to think that the loan shark is as dead as the dodoand is now utilized only as a ghost to freighten legislative and other bodies.The truth is otherwise. Look, for example, at the October 5, 1953, issue ofWHAT LIEs AHEAD IN THE FIELD OF SMALL LOANS 125Newsweek which on page 2 under the heading "Shark Hunt" reports on prosecu-tions in Georgia resulting in 15 convictions. In two of the cases the facts were:"A man borrowed $io from a loan company in Atlanta. Every two weeks for nineyears he paid back $I. Then he died. The company tried to force his widow torepay the original $io." In the second case "A laborer reported that 46 months agohe borrowed $25. After paying $3.75 each month since December 1949 and a totalof $168.75 the laborer, who was supporting a sick wife and two grandchildren, stillowed the full $25."The Massachusetts figures show a decided trend away from the "little loans."Here are the figures, year by year, from Public Document No. 95.TOTAL LOANS MADE$300 OR LESS LOANS MADE $25 op LESS LOANS MADE $25.01 TO $50LicenseYear %of %of %of % ofNumber Amount Number Total Amount Total Number Total Amount Total1937 ..... 236,066 $35,000,503 4,402 1.86 94,886 .27 32,593 13.80 1,500,642 4.291938. 205,228 29,743,192 5,482 2.67 127,514 .43 28,453 13.86 1,308,114 4.401939 ..... 262,911 37,599,085 10,407 3.96 247,449 .66 39,299 14.95 1,810,915 4.811940 ..... 282,723 40,750,287 10,352 3.66 246,278 .60 42,449 15.01 1,972,772 4.841941 ..... 312,442 46,892,693 11,782 3.77 284,813 .61 44,848 14.35 2,101,522 4.481942. 271,985 41,668,089 9,005 3.31 216,984 .52 33,858 12.45 1,555,397 3.731943 ..... 228,103 33,796,398 7,198 3.15 172,929 .51 26,937 11.81 1,238,212 3.661944 ..... 233,817 35,359,623 5,508 2.36 133,847 .38 24,686 10.56 1,148,867 3.251945 ..... 231,748 36,544,117 4,350 1.87 105,244 .29 20,916 9.02 977,751 2.671946 ..... 259,843 42,706,182 3,330 1.28 81,133 .19 21,254 8.18 999,625 2.341947 ..... 265,155 46,014,185 1,818 .68 43,420 .09 13,875 5.23 658,195 1.431948 ..... 267,196 49,229,525 1,315 .49 29,393 .06 9,449 3.53 441,864 .891949 ..... 250,443 47,506,393 744 .29 17,773 .04 6,024 2.41 278,502 .581950 ..... 243,598 47,154,980 530 .22 15,739 .03 4,733 1.94 215,298 .461951 ..... 234,266 45,342,471 545 .23 12,974 .03 5,159 2.20 236,178 .521952 ..... 229,259 45,077,696 446 .19 10,623 .02 5,306 2.31 246,510 .55Two factors have accelerated this trend away from the "little loans." It is un-questionably true that inflation has converted many a $5o loan into a $ioo loansimply because the object the borrower wanted to acquire had increased in price.The second factor is the disquieting one. There is a steady legislative pressureto reduce rates of charge on loans under $300. The rates of charge have alwaysbeen stated awkwardly and so are peculiarly vulnerable. If rates are reduced un-wisely, the lender must increase the average size of his loan if he is to survive.In the rate structure-even in that advocated by the Russell Sage Foundation-there has always been an uneasy compromise resulting in a disequilibrium.When you mix sociology with economics to produce a statistic to be embodied ina law you may expect trouble.Stated as simply as possible, the root difficulty in this. The "little loans" are thenecessitous loans. They are the loans that justify the state in using its police powerto prevent the lender from overreaching and thus they constitute the ground onwhich all courts have held the Uniform Small Loan Law constitutional.126 LAW AND CONTEMPORARY PROBLEMSBut it costs just as much to make, service, and collect a loan of $25 as one of$250. Except for pure interest, the costs are identical. Yet on any flat rate ofcharge the income to the lender on the $25o loan is ten times that on the $25 loan.What the Sage Foundation decided to recommend and what-within limits-may well be the best practicable solution was to let the larger loans carry the "littleloans." The uneasiness of this equilibrium is self-evident after a fioment's re-flection. It assumes that there must be actual losses on the "little loans" but thatthose losses should be compensated by a little extra on the larger loans.To make this plan work, two things are essential. First, that the legislaturesthoroughly understand the facts and realize that they must authorize rates that willmake the "little loans" possible. Second, the licensed small loan companies mustcontinue to make the "little loans" which means that if they are, to continue to besuccessful in the small loans field they must continue to render a full loan service.

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What Lies Ahead in the Field of Small Loans

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