In Canada, the criminal code limits interest rates to 60% per year. But in the United States, it is left up to states to put caps on interest rates, and in Montana the cap is currently at 400% per year. Thus, a coalition in Montana is trying to get the the cap reduced to 35%. They are circulating a petition, and if they get the signatures of 24,337 registered voters in Montana, citizens will get to vote on reducing the cap on Nov. 2.
The law would target payday loan companies, which, since they are dealing with very short-term loans, tend to charge very high levels of interest. Proponents of lower caps argue that they help protect poor, vulnerable people. Opponents argue lower caps could put payday loan companies out of business and prevent people who really need a payday loan — and are willing to accept the higher interest rates — from getting money.
As an economist, I like to think that people are rational and thus are smart enough to know what they're getting into before they agree to a loan. If this were true, we wouldn't need any caps on payday loans since everyone would be a consenting adult and no one would be exploited.
But if people don't realize what they are committing to when they take out a payday loan, then perhaps it's appropriate for some kind of cap. But how on Earth do you determine the optimal cap?
Interestingly, the reason the 60% cap was introduced in Canada was to give the justice system a vehicle for getting loan sharks off the streets, who were committing violent crimes which were difficult to prosecute. It's only in the past few years that payday loan companies have been targeted. I'm sure Dad would be happy to tell you all you want to know about it.
ReplyDeleteThis issue is related to the more serious problem of a lack of financial knowledge in society. With or without a cap on interest rates, lending companies will take advantage of uneducated borrowers. I think we, as a society, need to better educate our youth about how the financial system works. Because it involves math many people seem to be content to know nothing about it, but this comes back to haunt them (and society) when they don't properly understand how their home mortgage works. These topics could be incorporated into Social Studies 9 or 10 to relieve the boredom of Canadian history.