The campaign against loan sharks that legalized 42 percent a year

The problem

In the early 1900s a wage-earner who needed $25 before payday had almost nowhere lawful to borrow it. Most states capped interest at rates no lender would accept for a loan that small. The gap was filled by lenders who ignored the cap, charged whatever they could collect, and enforced with threats. The press called them loan sharks.

The reformers

The Russell Sage Foundation, set up in 1907 with a fortune from a railway financier's widow, took the problem on. In 1908 it gave a fellowship to a young researcher, Arthur Ham, who chose the small-loan business as his subject. The Foundation's campaign ran from 1909 to 1941.¹ Its answer was not to abolish small loans but to legalize them at a rate high enough to attract honest capital, in exchange for licensing and supervision.

That answer became the Uniform Small Loan Law. Its first draft was completed in 1916, and it was drafted at the request of the lenders' own association, formed the same year.¹ The law let a licensed lender charge up to 3.5 percent a month, 42 percent a year, on loans up to $300. By 1930 at least 25 states had adopted a version, and by 1932 about 36.²

The alliance

The reformers and the lenders needed each other. The Foundation's staff consulted repeatedly with the lenders' association and with the largest lender, Household Finance. One Foundation economist persuaded Household to share its internal data so that he could estimate what a small loan cost to make.¹ A study of the episode puts the result in one sentence: "lenders became dependent on the foundation for legitimating their political lobbying and their business activities."³

The lenders' association said what it was for in 1916: to "standardize, dignify, and police the small loan business".¹ Dignify is the word to notice. The campaign against loan sharks gave the small-loan trade a legal rate, a license, a trade association and, by 1929, a new name: the American Association of Personal Finance Companies.⁴

What the households got

They got a lawful place to borrow $300, at 42 percent a year, from a supervised lender, instead of an unlawful place at more. That is a real improvement, and the reformers were right that the alternative was worse. By 1931 the industry lent about $500 million a year at 30 to 42 percent.⁵ The largest lender charged below the cap, at 2.5 percent a month, and made a point of it.⁶

What the households did not get was any measure of what that rate contained. The Foundation's economist had estimated the cost of making a small loan from the lender's own books. That number, the lender's cost against the lender's price, was the one piece of arithmetic the whole campaign turned on, and it stayed inside the Foundation and the industry. The household was told the rate was fair. It was not shown the sum.

The pattern this set

Almost every later institution in personal finance follows the shape of this one. A practice hurts households. A reformer appears. The remedy legalizes, licenses and names the practice, with the industry's cooperation and often at its request. The industry gains respectability and a rate. The household gains a lawful supplier and a word. And the arithmetic of what the supplier keeps stays on the supplier's side of the table.

The same shape recurs at every founding moment in the field from 1889 to 2026. This is the first, and the clearest.