Re-creating the Consumer Credit Market for the Poor in the U.S.

Abstract

This study empirically explores the origin of the two-tiered credit system in the U.S. While mainstream financial institutions, such as banks and credit unions, serve the middle-class and the wealthy, fringe banking serves those in the low-income bracket. One of the striking examples of fringe banking is payday loans, which typically incur a finance charge of $15 to $20 per $100 loan for two weeks. These financial charges result in interest rates ranging from 391% APR to 521% APR, which has led to a serious social problem since 2000.

Extending consumer credit to the wider social class, especially black people living in poverty-stricken areas, had been recognized as an issue to be addressed in the late 1960s. This was partly because riots broke out in many cities, and rioters burned and looted merchants in ghettoes. Consequently, the National Commission on Consumer Finance (NCCF) was established by Title IV of the Consumer Credit Protection Act of 1968. The NCCF consisted of nine members from the Senate, the House of Representatives, and the public at large. The NCCF submitted the final report, Consumer Credit in the U.S., on December 31, 1972.

The report had over 90 specific recommendations. It also had a great influence on the reform debate in the financial system over 10 years. This led to the enactment of the Equal Credit Opportunity Act of 1974, which prohibits discrimination solely based on sex and marital status. The focus of the report, however, has been dismissed among scholars in modern credit history. It was recommended that each state should consider raising or repealing interest rate ceilings. It was argued that higher interest ceilings or the removal of interest rate ceilings would increase the availability of credit to low-income, high-risk borrowers.

In this article, we clarify some of the reforms that the report and its opponents envisioned regarding the removal of the interest rate ceilings. Among others, Democratic Representative Leonor K. Sullivan and Democratic Senator William Proxmire opposed them. They argued that higher interest rate ceilings, which enhanced credit availability, hurt low-income consumers rather than benefit them. They also noted that a relatively high interest rate would only benefit the consumer credit industry. According to Sullivan and Proxmire, the poor was not creditworthy, so that they should “save and then buy” rather than “buy now, pay later.”

Contrary to the concept of market forces and competition, Proxmire believed that limited-income credit unions, which are funded by the Office of Economic Opportunity, could help build self-sufficient financial institutions in poverty-stricken areas. However, the economic outlook for limited-income credit unions was not encouraging. On the other hand, the NCCF viewed “small small” loans in Texas (loans of $100 or less, which incur alternative interest rates ranging from 108.75% APR to 240.00% APR) as a promising arrangement for providing cash credit to the poor.

In retrospect, the report’s recommendations to raise or abolish interest rate ceilings in each state would be realized in the high inflation of the 1970s. Just as “small small” loans became a predecessor of today’s payday loans, we find the origin of the two-tiered credit system in the debate over the recommendation in the report.