§4. Risk and Small Loans

Where the borrowing takes place in pawn shops, the rate of interest is usually very high, not so much because of the inadequacy of the security as because of its inconvenient form. The pawnbroker will need to charge a high rate of interest, if it is to be called interest, partly because he needs storage room for the security he accepts, partly Edition: current; Page: [214] because he needs special clerks and experts to appraise the articles deposited, and partly because, in many cases, when not redeemed, he has to make an effort to find markets in which to sell them. He is, moreover, able to secure these high rates partly because pawnbroking is in bad odor, so that those who go into the business find a relative monopoly, and partly because of the fact that the customers usually have, either from poverty or from personal peculiarity, a relatively high preference for present over future income. While the effect of their accommodation at the pawn shop is to reduce their impatience to some extent, it will not reduce it to the general level in the community, because these persons do not have access to the loan market in which the ordinary business man deals. To them, undoubtedly, the fact that they cannot borrow except at high, or usurious, rates is often a great hardship, but it has one beneficent effect, that is, the discouraging of the improvident from getting unwisely into debt.

One of the very greatest needs has always been to sift out the relatively safe and sane from the relatively risky and reckless loans of the poor in order to encourage the one and discourage the other. When this has been more fully accomplished, the scandal of the loan shark will be largely a thing of the past. A loan which, to the shortsighted or weak willed borrower, seems to be a blessing, but which is really sure to prove a curse, ought certainly to be discouraged no matter what may be the rate of interest. The Russell Sage Foundation has studied the loan shark problem intensively and as a result has formulated a model small loans act which has been adopted by the legislatures in a large number of our States. This model act recognizes the greater risk and Edition: current; Page: [215] trouble involved in small loans for short periods, by permitting a maximum rate per month of 3½ per cent.

Only in the present generation has the age-long curse of the loan shark been met by constructive measures on a large scale. These are based on the simple principle that a man's friends and neighbors possess the necessary knowledge whereby to distinguish between a safe and unsafe extension of credit to him. The Morris Plan banks are founded on that principle. More effective are the Credit Unions founded by Edward Filene and others in America somewhat on the models of the Raiffeisen and other plans in Europe. Labor banks are rendering a similar service. These are enabling the poor to make effective use of personal character as a substitute for collateral security and are thereby greatly reducing the rate of interest on the loans of the poor. In 1928 one large bank in Wall Street instituted a similar system for loans without collateral to salaried employees. These devices and others are doing much to solve the problem of accommodating the reliable man of small means with loans at rates comparable with those ruling in the markets for the well-to-do.