In 2021 the Illinois-based Woodstock Institute supported that state’s 36% rate cap on many forms of consumer credit, including small dollar loans, claiming the cap would shut down predatory payday lenders without hindering access to credit for Illinois consumers. More than a year after the rate cap was imposed, Woodstock released a poll showing a majority of Illinois citizens support a rate cap and have access to credit.
It’s perhaps not a surprise that consumers support lower interest rates for their credit cards, home mortgages or other loans. Who wouldn’t? But the real question is: are all Illinois’ consumers better off with a rate cap in place on a credit product – small dollar loans – that is often the only form of credit available to those with poor or no credit histories or little to no savings?
We don’t need a poll to answer that question; academics have actually done the math. “Imposing the interest-rate cap in Illinois limited credit access to high-risk borrowers,” write economists J. Brandon Bolen (Mississippi College), Gregory Elliehausen (Board of Governors, Federal Reserve), and Thomas Miller (Mississippi State University). Their study, using credit bureau data, found that the Illinois rate cap decreased the number of loans to subprime borrowers by 36 percent and the number of loans to deep subprime borrowers by 57 percent.
To some that outcome should have been obvious. When artificial prices are imposed as a way of deterring the market’s natural migration to even higher prices, it’s only natural that shortages will result for certain classes of borrowers.
The study, however, does confirm that in attempting to solve one perceived problem – “predatory lenders – the Illinois 36% interest-rate cap created a worse problem: significant numbers of Illinois consumers today cannot qualify for loans that they could qualify for prior to 2021.
Which brings us back to the motivation of Illinois legislators in 2021 to place a cap of 36% on unsecured loans. The argument then was “predatory lenders” seek to injure the presumably hapless, uneducated, and struggling borrower for the sake of injuring the borrower. The goal was to hinder the predatory and thereby reduce the risk of injured parties. The goal wasn't very compelling.
No individual actively pursues a loan with an eye on not being paid back, so to pretend that businesses comprised of individuals pursue what is injurious to them is hard to countenance. Regardless of whether they’re public or private, businesses have owners. To pretend that money is so dumb that its owners would actively support lending based “not on the borrower’s ability to repay” insults reason.
Rather than hinder what's logically not a problem, it’s apparent that the rate cap has placed an artificial ceiling on prices and the number of financial products Illinois consumers can avail themselve of. And the result today is a shortage of credit for those in the subprime and deep subprime credit spectrum who truly need a short-term financial fix..
As Bolen, Elliehausen, and Miller detail in their report, “the most common reason for obtaining a personal loan is to pay utilities, followed by debt consolidation, car payment/car repair, and rent/mortgage.” What this tells us is that artificial interest rates for those most in need compromised the financial well-being of those most in need. In surveys, the researchers found that credit shortages born of price controls resulted in, “I paid bills late and generated fees.” Put another way, reduced access to credit worsened the financial situations of Illinois residents whose finances were already challenged as their subprime status would indicate.
It’s something to consider, as this multi-faceted study does. On the one side, there are those like the Illinois’ legislature and the Woodstock Institute that believe that limits on lending prices lift those who will allegedly enjoy lower rates, and similarly lift them by shielding them from demon lenders. The former presumption doesn’t stand up to basic market reason, while the latter most certainly doesn’t bring about the desired result. Quite the opposite, actually.
