The Yearning for Cushy Retirement Rejects ‘Predatory Lending’ Narrative
As seen in RealClearMarkets.
“He who understands it, earns it; he who doesn’t, pays for it.” The previous words are said to be those of Albert Einstein commenting on the genius of “compound interest,” but it’s difficult to find real evidence tying him to the well-put statement, nor the claim that he proclaimed compound interest the 8th wonder of the world. The main thing is that whether Einstein uttered any of the quips attributed to him or not, they’re correct.
The power of compound interest is in many ways mesmerizing. Money saved in prudent fashion has a way of growing and growing over time. Perhaps paraphrasing Einstein, he who understands the multiplicative aspect of long-term saving has the chance to retire in reasonable splendor for doing just that. He who doesn’t pays dearly for not understanding what is so basic.
The remarkable power of compound interest has come to mind a lot while thinking about the state of Illinois, and its imposition of the Predatory Loan Prevention Act in 2021. Passed to prevent non-bank and non-credit union financial institutions from “charging high interest and imposing harsh terms” on subprime borrowers, the law predictably proved a burden on the very borrowers it was billed to help.
Price ceilings in theory result in shortages, but also in practice. Economists J. Brandon Bolen, Gregory Elliehausen, and Thomas Miller chose to study the effects of the law, only to find out that the 36% interest cap that headlined the Predatory Loan Prevention Act resulted in a 30 percent decrease in the number of loans to subprime borrowers in Illinois. Notable about the decrease is that it occurred in concert with an increase of lending to subprime borrowers in neighboring Missouri. Missouri’s legislators didn’t impose the same rate cap.
On its face, the Predatory Loan Prevention Act “worked” precisely because it didn’t. Markets always have their say, and when legislators decided to substitute prices of their own making for those of the markets, there was a predictable decline in lending to those most in need of credit.
More important for the purposes of this piece concerns how superfluous the Illinois law’s imposition was, and is. To see why, consider the seemingly apocryphal description of compound interest care of Einstein. Einstein was describing a market phenomenon. Money saved prudently multiplies over time. Basically, returns build on returns. There’s incredible wealth to be gained from wisely putting wealth to work, and at the same time there’s potential for an impressive lack of wealth accumulation when it’s put to work in careless fashion. Please consider all this with “predatory lending” top of mind.
The very notion of lending with a predatory mindset is rooted in the idea of foisting cruel lending terms on those lacking the means to repay funds borrowed. Figure that the thinking ahead of the legislation in Illinois was based on the seemingly gallant idea of protecting “needy individuals” or “subprime” individual borrowers from lenders charging high rates of interest for capital.
Ok, but as evidenced by the imposition of a 36% interest rate cap, the loans made to “needy individuals” had and have a high default rate. The latter isn’t a speculation as much as it’s a statement of the obvious. Borrowers with well-established means to repay funds borrowed clearly don’t have to pay such high interest for funds. That some borrowers in Illinois were paying above 36% for cash pre-legislation was powerful evidence of a broad market view that they wouldn’t necessarily be able to repay. In other words, high market rates of interest aren’t predatory as much as they’re a way of protecting wealth accumulated. CompoundCOMP interest is a wondrous market reality, and savers willing to put wealth at risk will only do so if suitably rewarded for doing just that.
Looked at in retirement terms, those saving for the future want to be compensated for endangering some, or part of their nest egg. The financial intermediaries lending out the wealth of savers (including future retirees) are not acting in “predatory” fashion when they charge high rates of interest for loans as much as they’re at least implicitly acknowledging the power of compound interest. A failure to generate returns with wealth saved is wildly expensive, period. No saver goes out of his or her way to lose money.
It’s something to think about as legislators wrap their lawmaking in allegedly noble rhetoric about protecting the “needy” from the “greedy.” Not only do their actions bring harm to those they were supposed to help, their actions are a direct attack on the savers aggressively pursuing a better tomorrow through prudent, non-predatory lending today.