Shavers, Sharks and Payday Lenders
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Westerners have long harbored a love-hate relationship with lenders, and their ambivalence shows no sign of abating anytime soon. What has changed over time is the perception of what constitutes “bad” types of lenders or loans. In various times and places, it was illegal/immoral to charge any interest at all, to exact interest from kinsfolk, to charge rates considered too high or to use violent collection methods. Today, it is lawful, and even somewhat morally acceptable, to charge any rate of interest to anybody willing to pay it. Reformers, however, want to protect borrowers from being cajoled, forced or tricked into borrowing at high rates for long periods.
The King James version of Exodus (22:25) states that “If thou lend money to my people poor by thee, thou shalt not be to him as a usurer, neither shalt thou lay upon him usury.” Usury here is usually taken to mean taking any interest whatsoever, though at least one recent translation reads instead: “If you lend money to one of my people among you who is needy, do not treat it like a business deal; charge no interest.” If the traditional interpretation is correct, perhaps early Jews lamented lost profit opportunities because Deuteronomy (23:19–20) clearly allows some lending at interest: “Unto a stranger thou mayest lend upon usury; but unto thy brother thou shalt not lend upon usury.”
Stranger is usually taken to mean a nonIsraelite or non-Jew, which was the general interpretation when Shakespeare penned The Merchant of Venice and Hamlet. The former featured an anti-Semitic caricature of an avaricious moneylender while the latter contained the most infamous anti-financial line of all time: “Neither a borrower nor a lender be.”
In David Copperfield, Charles Dickens warned that even a small annual budget deficit could lead to ruin: “Annual income 20 pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.” Clearly, the Western world has had a long and complex relationship with debt.
By the 18th century, charging/paying interest was a quotidian activity in most of Europe and America. Benjamin Franklin, writing as Poor Richard, tried to persuade readers that “the borrower is a slave to the lender,” but what early Americans deprecated was exacting excessive interest, or “usury” in the modern sense of charging unlawfully high interest rates. That sentiment was perhaps best expressed by South Dakota banker Porter P. Peck. The first lenders on the frontier had very bad reputations, he explained, because they were “the genuine old money shark who went on with the first axman or prairie schooner.” They did no good except to “pave the way for the more liberal class who followed. This latter class came on and charged only 5% a month for money. They were, of course, much better thought of, and the pioneers voted to let them remain on sufferance.”
In other words, lending/borrowing was acceptable in America only if rates were not too high, a line that varied dramatically over time and place depending on the level of economic development (higher in less developed areas) and financial development (lower in more developed systems) and the type of monetary system (higher under inflation-prone fiat regimes).
Regardless of the location of the “too much” line, lenders willing to lend at usurious rates could always be found, although not until recently in sufficient numbers to keep rates near a competitive level. Before the Civil War, usurious lenders were typically called “note shavers” because they purchased promissory notes (the note) at steep discounts (the shave) from the face values on which interest was calculated.
“I cannot [lawfully] lend money on bond and mortgage at a rate exceeding 7% per annum interest,” explained one New Yorker in 1837, “but I may buy a bond and mortgage at 20, 30 or 40% less than the face of it; which gives me actually an interest of 9, 10 or 12% per annum.”
Antebellum banks generally charged rates at or below the legal maximum because lending at usurious rates could endanger their charters (their licenses to issue lucrative bank notes) and also (due to adverse selection) their capitals. So instead of servicing the illegal high riskhigh return market themselves, banks lent to note shavers who, in turn, made the usurious deals. Note shavers were attracted to high returns and the low expected cost of getting caught (the probability of being successfully prosecuted times the penalty imposed).
After the Civil War, the term “note shaver” began to give way to “loan shark.” Sharks were later cast as entrepreneurs providing a much needed service, but at the time they were almost uniformly castigated as bloodhounds, charlatans, leeches and worse because their tactics were so unpalatable. Unsurprisingly, most usurers remained unincorporated and changed names and addresses frequently in order to remain as innocuous as possible. To garner some economies of scale, they formed interstate networks of agents, the largest of which operated in more than 60 cities.
By the early 20th century, the term loan shark was in common use, and its negative connotation—sharks were then considered “evil” predators—was considered “unmistakable.” In 1911, for example, Vaudevillian Harry Lauder sang, “Think of the sharks that we see in the sea, and think of the sharks that are not in the sea, that ought to be in the sea!”
Interestingly, early sharks rarely resorted to violence but rather took advantage of their borrowers’ ignorance of the law. Most ensnared their victims by having borrowers sign papers that they did not understand, often replete with blanks that were filled up later. Sharks collected the sums due not through the courts but by bluffing legal action and other methods that were said to “cause prolonged worry, destitution and sometimes suicide.”
Many collectors were females who verbally berated defaulters in public places to shame them into paying. Sharks also threatened to tell employers about wage assignments, which was often grounds for immediate dismissal. Other times, as a loan condition, sharks had borrowers draw a bad check and then threatened to turn the borrower over to authorities and prosecute them for fraud unless they immediately paid up. Or, they pointed to irregularities in the loan application (usually in a form detailing present indebtedness) and threatened to press fraud charges.
Loan sharks largely remained under the sonar of Progressive reformers until the early 20th century, when contemporaries came to see “the utterly inhuman methods prevalent nowadays of handling what should be a legitimate business.” Reformers likened the small loan business to a “new system of slavery” or debt peonage because many borrowers found it impossible to extricate themselves from the jaws of the shark because the principal had to be repaid in a lump sum rather than in installments. One widely reported study, completed a few years before World War I, revealed that about one in every three poor working families borrowed from sharks, enough to support one shark for every 5,000 or 10,000 people in urban centers like Pittsburgh.
Such statistics energized an extermination effort led by the Russell Sage Foundation and comprised of publicity campaigns, new regulations and the formation of substitute lenders. Substitutes included non-governmental organizations (NGOs) like fraternal orders that charged no interest, Remedial Loan Societies that produced profits capped by law, mutuals and co-ops like credit unions owned by borrowers, and for-profit businesses that adhered to state usury laws. To encourage the formation of substitutes, some reformers cognizant of the high costs associated with making numerous small loans advocated raising legal interest for small lenders into the 20–40% per year range. Russell Sage Foundation lawyers also drafted a Uniform Small Loan Law that eventually was passed, albeit often in diluted form, in about 35 states.
Despite those efforts, the number, geographical reach (even into small agricultural towns in the heartland) and business volume of loan sharks increased markedly, from about $21 million in 1923 to $72 million in 1939, which brought them under the increased scrutiny of governments and NGOs. Penalties remained minimal, however, so the effectiveness of legislation was limited as “wily and ingenious” usurers developed sophisticated new scams, some involving automobile titles. Unlike corporate lenders and pawnbrokers, however, sharks looked primarily to their borrowers’ incomes, not collateral, for security. They thrived more on middling wages and bad luck or improvidence than on abject poverty, as it was difficult to exact high rates of interest from somebody who had no money.
As the Depression gave way to World War II, a few states had largely exterminated their sharks. In most states, however, sharks continued to thrive so alternatives, especially credit unions, again touted themselves as the way to “keep away from loan sharks!” In a 1940 pamphlet, proto-Keynesian economist William Trufant Foster (1879–1950) exposed the “modern loan shark,” men who could turn $20 into over $1,000 in just nine years by becoming a “bootlegger of small loans” in states—like Florida, Georgia, Missouri, Oklahoma, Tennessee, Texas and Washington—that prevented legitimate lenders, like banks and credit unions, from flourishing. “Never has a campaign to enforce a 10% usury law,” he explained, “prevented wage earners from borrowing money at 240%” because the demand for small consumer loans was so pervasive.
Foster claimed that loan sharks lobbied in favor of maintaining or even lowering usury rates because “low legal interest keeps out legitimate lenders” like “legal, stringently regulated personal finance companies” that could lend profitably at rates between 24–42% per year. Foster was particularly peeved at well-meaning but uninformed persons who unintentionally aided loan sharks by pushing for lower usury ceilings or repeal of the Uniform Small Loan Law. “Persons who are uninformed, but of good intent,” he lamented, “cooperate with persons who are wellinformed, but of evil intent.”
Payday lending began in a tentative way during the Civil War, was common by the 1910s and was pervasive by the early 1940s. In order to avoid anti-sharking legislation, early payday lenders bought the right to collect a part of the borrower’s wage on his or her next pay day, kept no books, blacklisted people who asked for receipts and did business across state lines through the use of agents. As Foster explained, “this often means that only the agents can be reached, not the culprits higher up and farther away.” The agents claimed to own no assets, “not even their office desks.”
After World War II, banks, credit unions, finance companies and specialized small loan companies began to offer substantial quantities of short-term signature loans to America’s increasingly affluent working class, and their competition forced the old school loan shark far offshore. Nevertheless, the civil penalty for exacting usurious interest remained very low, ranging from loss of excess interest to loss of all interest and principal; it was a criminal offense in only a few states, and even in those places it was just a misdemeanor. Unsurprisingly, then, loan sharking came to be dominated by gangsters.
This new breed of shark, which evolved in the New York City underworld during the Great Depression but did not increase its range nationally until the early 1950s, treated the body of the borrower and the lives of his family members as the ultimate security for loans and interest payments on the order of 5% per week. Organized crime sharks also lent to small businesses and, when necessary, sucked business inventories dry in order to recoup their capital and “vigs,” much as depicted in the HBO series The Sopranos.
By 1966, loan sharks tied to organized crime lent an estimated $1 billion at rates between 250 and 2,000% per year. Although their reputation for violence often rendered the actual breaking of thumbs and limbs unnecessary, violent loan sharks were considered such a pressing social problem that in 1968 Republican presidential candidate Richard Nixon made attacking them a “significant part” of his campaign. Congress responded by passing the Consumer Credit Protection Act of 1968, which outlawed “extortionate credit transactions” in an effort to undercut the “economic foundations of organized crime.”
The act imposed stiff penalties (up to a $10,000 fine and 20 years imprisonment) for the use of violence, or the threat thereof, in credit collections. By degrees, the government largely killed off the organized crime shark, partly by vigorously suppressing organized crime syndicates and partly by fostering lawful alternatives.
The result of the latter policy was the modern payday loan industry, a rapidly growing beast that made $14 billion in loans out of about 10,000 offices in 2000 and $27 billion out of 22,000 locations in 2012. Many experts argue that the modern industry is highly competitive and hence the rates charged, high as they are, are fair because they represent the risks and other costs associated with making numerous small loans. High rates on small sums for short periods do not amount to much money, they note, so many borrowers are actually better off getting a payday loan than having their electricity, heat or water turned off or paying bounced check fees.
Other experts, however, retort that many borrowers (more than half in many states) roll over their loans from paycheck to paycheck because they cannot repay the principal or because the lender makes it difficult for them to do so. As a consequence, borrowers end up paying far more in interest and fees than they anticipated. State payday loan regulations vary greatly, providing researchers with clues about the extent to which specific regulations, like rollover prohibitions, help to prevent borrowers from falling into the maw of this most recently evolved species of shark.
The debate, in other words, is no longer over the price of borrowing but the exact terms of the loan and its repayment. “Debt trapping ought to be prohibited,” as Robert Mayer put it.
–Robert E. Wright is the Nef Family Chair of Political Economy at Augustana College in South Dakota and a member of this magazine’s editorial board. He is the author of more than 15 books including One Nation Under Debt (2008) and is the co-author, with Museum Chairman Richard Sylla, of Genealogy of American Finance (Columbia Business School Publishing, Spring 2015).
A Familiar View of the Operation and Tendency of Usury Laws (New York: John Gray, 1837).
Foster, William Trufant. Loan Sharks and Their Victims (New York: Public Affairs Committee, 1940).
Geisst, Charles R. Beggar Thy Neighbor: A History of Usury and Debt (Philadelphia: University of Pennsylvania Press, 2013).
Haller, Mark and John Alviti. “Loansharking in American Cities: Historical Analysis of a Marginal Enterprise.” American Journal of Legal History 21, 1 (April 1977): 125–56.
Malcolm, Walter D. and John J. Curtin, Jr. “The New Federal Attack on the Loan Shark Problem.” Law and Contemporary Problems 33, 4 (Autumn 1968): 765–85.
Mayer, Robert. Quick Cash: The Story of the Loan Shark (DeKalb: Northern Illinois University Press, 2010).
Shergold, Peter R. “The Loan Shark: The Small Loan Business in Early Twentieth-Century Pittsburgh.” Pennsylvania History 45, 3 (July 1978): 195–223.