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The best two sentences I read this morning
Charge 80% per year on a loan in the U.S. and you're called a usurer. Charge 80% on a loan in Latin America or Africa and you can be a poverty-alleviation charity.
That is Dean Karlan and Jonathan Zinman, in today's WSJ, "In Defense of Usury," p.A18. Karlan and Zinman discuss their study showing that micro-credit borrowers in South Africa are better off for receiving the money, even when they pay very high interest rates.
Posted by Tyler Cowen on November 1, 2007 at 09:09 AM in Economics | Permalink
Comments
I agree with both the statement and it's seductive wording. BUT I think there is something to be said for
acknowledging the differences that lead to US institutions (in the broadest sense) having access to more
liquidity and access to better technology to assess risk. Insofar as loans at the same rate made abroad
are riskier for lenders, one can argue that they are more charitible.
Posted by: Daniel Lurker at Nov 1, 2007 9:48:04 AM
Is that true if you deduct the inflation rate from the interest rate?
Posted by: Floccina at Nov 1, 2007 10:16:22 AM
How about some honesty in phrasing interest rates?
When you get a mortgage, the interest rate is expressed relative to the amount the bank loans you, ignoring
all the fees you have to pay the bank for the privilege. In reality, of course, you are only truly borrowing
money *net* of those bank fees. If the bank loans me $80,000 and I pay it a $1000 processing fee, I really
just borrowed $79,000, and the true interest rate is higher than the one quoted (which looks like I
borrowed $80,000.)
What they call "interest" on these microloans is really just to cover fixed fees, like in the above, that
become significant for such small loans. So if you loan someone $100, and he has to pay $80 in interest
the first year, you could play the same game as on the mortgage: make the interest rate "40%" but require
the borrower to pay an "application fee" of $40 over the course of the year.
Problem solved!
Posted by: Person at Nov 1, 2007 10:33:03 AM
Why is this surprising? 80% is far above the prevailing rate in developed countries, and below the prevailing rate in developing countries, when people living there can borrow at all.
Posted by: jb at Nov 1, 2007 11:46:40 AM
I agree this has to do with relative rates. If 80% is what's available then it would be beneficial to offer more availability.
If there are better rates than 80% available it is, in metaphor if not always in fact, criminal to offer 80%.
Posted by: talboito at Nov 1, 2007 1:29:43 PM
I agree that the culprit in the apparent usury of micro-credit is the fixed fees. When I read about micro-credit, I realized there had to be a labor issue -- it takes labor to write/manage all those mini-loans and this is going to add significantly to costs.
I read Yunus's book about the development of the Grameen bank. At first, I thought the key idea was that a poor person should be attributed a better credit rating than a poor business (e.g., the credit market to people was inefficient). But now I think the genius of his approach may be more embedded in the social structures he built to manage the loans ("branches" consisting of 5 local village women who work as a group to manage the banking incentivized by their own ability to get loans) than the observation that there was an underserved group that could productively use credit.
Looking at US Payday/Title loan companies who are sometimes reviled/criticized for usurious rates, the labor cost of making a loan pops back up again. Utah passed a law restricting total costs on payday loans to veterans and that industry responded by saying they couldn't lend to vets and cover their costs.
This makes one notice that if you borrow $100 dollars for one week at 20% annual interest, the interest is only $.38. You can't cover the costs of making/collecting the loan on 38 cents, much less cover the cost of occasional defaults. This is a problem if we want to try to use micro-credit to enhance the productivity of very poor people.
Some days I wonder if there is a potential technological solution. Could you automate the loans so much that you could reduce the overhead costs to next to nothing? I'm not sure. Would a payday loan ATM be a good thing?
Other days, I think there's something wrong with measuring everything in percentages. Interest, return, commissions on sales -- these all make sense to treat as percentages for some values. But they seem to break down at the ends of the scale. Not only do they look wrong for micro-credit, but I wonder at commissions/management fees at the very high end. A good hedge fund manager on a 2-and-20 incentive scale gets a *lot* more money to manage 10 billion dollars than to manage 1 billions dollars. Is it 10 times harder or more skilled? I can't shake the sense we're simply doing the math wrong.
Posted by: Paul J. Reber at Nov 1, 2007 3:35:16 PM
As others have said -- the fixed costs in micro-loans are what cause the high interest rates. This is very mis-leading, *cough* should know better *cough*.
Posted by: Jor at Nov 1, 2007 7:26:19 PM
Person:
When you get a mortgage, the interest rate is expressed relative to the amount the bank loans you, ignoring
all the fees you have to pay the bank for the privilege.
Actually, no. The bank is required to tell you the APR, which I believe is defined to be the interest rate at which the net present value of all future payments is equal to the amount of money they give you. The problem is that the transaction costs of a home mortgage are fairly small compared to the cost of capital, whereas the transaction costs of making a small short-term loan are comparatively huge.
Posted by: Brandon Berg at Nov 2, 2007 12:56:22 AM
> Could you automate the loans so much that you could reduce the overhead costs to next to nothing?
I believe that's called a credit card.
Posted by: Brian Slesinsky at Nov 2, 2007 2:19:09 AM
It is time to ban usury. The Bible bans it. The government should loan everyone money for no more than two percent. High interest is an unfair tax on the poor. People would be a lot better off if they only borrowed for housing and education. Credit cards and payday loans are a cancer on the budgets of the poor.
Posted by: centans at Nov 2, 2007 5:32:03 AM
Maybe centans missed this quote in the article: "Rolling over payday loans repeatedly might cost you big bucks; but it can turn out to be a good deal if you need the initial loan to fix your car, hold on to your job and avoid losing even bigger bucks in after-tax earnings."
Regardless, the state in most developing nations has no inherent ability to lend money to the thousands of small groups that groups like Grameen can and has.
Posted by: Alex Ambroz at Nov 2, 2007 8:53:05 AM
Brandon_Berg: Actually, no. The bank is required to tell you the APR, which I believe is defined to be the interest rate at which the net present value of all future payments is equal to the amount of money they give you. The problem is that the transaction costs of a home mortgage are fairly small
I'm not sure you understood my point, with all due respect. I understand that how the APR is calculated.
The problem is that the relevant interest rate would set the
1) NPV of future payments
equal to
2) the amount they give you minus all costs the bank charges you in the process
The APR does not include the bolded part, or if it does, you didn't address that in your response, which
was the whole point.
Posted by: Person at Nov 2, 2007 11:10:29 AM
Posted by: 鑽石 at Apr 2, 2008 11:04:58 PM
Posted by: Alii at Apr 3, 2008 10:01:08 PM
