Lenders Look for Usury Help for Relief From Usury Limit

Amendment 60 to the Arkansas Constitution was adopted by voters in November 1982, a matter of days after the Federal Reserve’s discount rate dropped below 10 percent for the first time in three years.

In the 20 intervening years, the interest rate pendulum has swung from historic highs to historic lows, revealing a critical flaw in the amendment that modernized the state’s constitutional limit on usury: It placed a ceiling on interest rates — 5 percentage points over the discount rate — but it didn’t anticipate the need for a floor.

“No one ever dreamed … that the discount rate would ever get down below 5 or 4 — certainly not 1.25,” said Ken Hammonds, executive director of the Arkansas Bankers Association.

Since Dec. 13, the highest interest rate allowable under the state constitution has been 6.25 percent, just one and a half points over prime, and a rate that many lenders consider too low to cover the risk of lending to borrowers with less-than-spotless credit histories. The Arkansas Automobile Dealers Association claims that 70 percent of would-be car buyers in Arkansas are being turned down for credit.

Commercial banks received relief from the constitutional usury limit in the form of the federal Gramm-Leach-Bliley Act of 1999, which allows banks chartered in Arkansas to match the interest rates that their interstate competitors can “import” from their home states.

Now, other lenders are also looking to Congress for help. At the behest of a group calling itself the Arkansas Fair Credit Coalition — led by Dennis Jungmeyer, executive director of the auto dealers lobby — U.S. Rep. Mike Ross, D-Ark., has introduced a measure that would remove virtually all that is left of the state’s constitutional limit on interest rates.

Ross’ amendment to House Resolution 3951, the Financial Services Regulatory Relief Act of 2002, was approved last month by the House Financial Services Committee, of which Ross is a member. The entire act is characterized as “technical corrections” to Gramm-Leach-Bliley, and Ross’ amendment would extend the relief the 1999 act offered banks to non-bank lenders. (Payday lenders and check-cashers would not be exempted from the state constitutional usury limit. See story below.)

Getting his amendment through the committee, Ross acknowledged, is “just one small baby step” in a long process. The House Judiciary Committee has until July 22 to decide whether to move the bill forward, and then the Senate would have to pass a companion bill. Sen. Blanche Lincoln, D-Ark., has introduced stand-alone legislation that would accomplish the same goal, but it has yet to be heard by any committee.

“The problem in Washington is the issue itself becomes secondary to politics … We have our complete congressional delegation in support of this, but Congress has little interest in a state issue,” Jungmeyer said.

Populist sentiment

If Ross’ amendment, or language having the same effect, eventually does find its way into federal law, Congress will have done what Arkansas voters have been loath to do.

The state’s 1874 Constitution defined any annual interest rate above 10 percent as illegal usury. Amendment 60 — which also placed an absolute maximum rate of 17 percent on consumer loans, regardless of the discount rate — was the only successful one of at least five attempts to bring the state’s legal attitude toward interest more in line with the rest of the country.

Most recently, Arkansas voters turned down a 1990 replacement for Amendment 60 that would have instead tied interest caps to the rates being paid on one-year U.S. Treasury Bills and removed any interest limits on loans greater than $250,000.

As Hammonds said, “It is difficult to get people to go to the polls and pull the lever to say, ‘Hey, I’m just not paying enough interest.'”

Despite the voting public’s distaste for relaxing the usury limit, most of Arkansas’ political leaders seem willing to let Congress override the state constitution in this instance. Even populist Gov. Mike Huckabee has weighed in in favor of Ross’ proposal.

“This inflexible cap on interest rates has restricted economic growth and development, caused billions of dollars in investments to leave the state, and prohibited the extension of credit to many Arkansans. What was once a concern of discrimination is now a concern of credit availability,” Huckabee wrote in a letter to Ross dated Nov. 20, 2001.

“We must take immediate action to include non-bank lending institutions to the override provisions contained in the [Gramm-Leach-bliley] Act of 1999.”

(Huckabee’s office refused to release the letter, calling it a “working paper,” but a copy was provided by Ross’ office.)

Ross’ amendment has received similar endorsements from Reps. Marion Berry, D-Ark., and John Boozman, R-Ark.

A jobs bill?

Ross’ amendment would indeed put the federal government in the position of overriding a constitutional amendment adopted by the voters of Arkansas. But Ross prefers to think of his measure as a jobs bill.

“You’ve got to recognize that what the voters approved [in 1982] is no longer what the voters approved because there has been a federal fix for the banks and it’s made the playing field unlevel,” Ross said. “And it’s been devastating.”

Ross and Jungmeyer offered the same example of the effect the usury limit for non-bank lenders has had on the state: the virtual disappearance of such “captive” auto financing companies as General Motors Acceptance Corp. and Ford Motor Credit from the state.

“Fifteen years ago, the captive lenders owned by the auto dealers had in excess of 350 employees in Arkansas,” Jungmeyer said. “Chrysler Credit has pulled out; Ford Motor Credit only has about 10 employees left, and they are threatening to pull out. GMAC only has, I think, two employees left.”

Meanwhile, Ross said, Arkansans with less-than-perfect credit histories or moderate incomes are crossing the state’s borders to buy cars where they can get financing.

“We are the only state — the only state — that has such a restrictive interest rate. I have a hard time believing that we’re right and 49 states are wrong,” Jungmeyer said. “Right now, we have a situation where there’s no option for many consumers in Arkansas, and we are a poor state and we do have a segment of our society who are being denied credit.”

Auto dealers aren’t the only merchants hoping the exemption from state usury limits will be extended to non-bank lenders. Also involved in the Fair Credit Coalition, Jungmeyer said, are sellers of farm equipment, motorcycles, recreational vehicles, jewelry and furniture.

Huckabee’s letter mentioned credit unions among non-bank lenders handicapped by the state’s usury limit, but that statement is only theoretic, according to Reta Kahley, president of the Arkansas Credit Union League. Federal credit unions are not bound by the state law, and the last two state-chartered credit unions merged with federal credit unions at the end of 2000. State-chartered credit unions are extinct, Kahley said, in large part because of the usury limit.

Ross said he is not at all concerned that removing the usury cap for non-bank lenders would result in inflated interest rates for Arkansas consumers.

“Competition is going to be there. [The amendment] simply allows the car dealers and the furniture folks to be on the same playing field as the banks,” he said.

In fact, Jungmeyer suggested that inflated prices already are hitting Arkansans because of the usury limits on non-bank lenders.

“Arkansas has an unusually high number of used-car dealers in the state, some of whom take advantage of the fact that they can’t charge interest to cover the risk, so the price of used cars is jacked up. Arkansas consumers obviously end up suffering for that,” he said.

Bankers concerned

Arkansas Business Publishing Group was unable to find any organized opposition to Ross’ attempt to exempt non-bank lenders from the restrictions of the state’s usury law. But banking interests have expressed some concern about Ross’ attempt to amend language in the Gramm-Leach-Bliley Act that already has survived a test challenge in federal court.

“We don’t have any problem with what they are trying to do,” Hammonds said. But, he said, banks would prefer stand-alone language for non-bank lenders that doesn’t mess with the exemption already extended to commercial banks.

Gary Garrett, a lawyer at the Rose Law Firm in Little Rock who specializes in banking law, said the original preemption addressed competitive disadvantages created by the interstate bank branching laws. Commercial banks do still labor under any usury limits imposed in the home state of interstate competitors.

But Ross’ amendment “goes beyond banks and defines competing lenders as more than banks,” Garrett said, which creates a “disconnect between the logic of the original preemption and the new one.”

“I don’t know if that was the intent of it, but the way it was written, it definitely removes the state-to-state nexus,” Garrett said.

“I think you would rapidly come to the conclusion that the interest rates were virtually unconstrained by anything except market forces.”

Sidebar

Check-cashers Get No Relief

With U.S. Sen. Tim Hutchinson, R-Ark., and his Democratic challenger Attorney General Mark Pryor accusing each other of being too friendly with check-cashers, U.S. Rep. Mike Ross has steered clear of those rocks.

Ross specifically excluded the short-term “payday lenders” from his attempt to override the state’s constitutional limit on usury for non-bank lenders.

“The kind of people we exempted from this are the kind of people who prey on poor people, not the car dealers,” he said.

Rent-to-own furniture outlets are not even addressed, the congressman said, because “they are already pretending it’s not lending.”

Ross’ proposed amendment to the House’s Financial Services Regulatory Relief Act of 2002 effectively would remove any limits on interest rates to finance consumer goods such as cars and furniture. But it “does not include any person or entity engaged in the business of providing a short-term cash advance to any consumer in exchange for … a consumer’s personal check or share draft … or … a consumer’s authorization to debit the consumer’s transaction account in the amount of the advance plus a fee …”

Check-cashers have been the subject of heated debate since 1999, when the Arkansas General Assembly legalized the practice of making short-term cash advances in exchange for hefty fees — something that previously had been prosecuted as a violation of the state’s usury law.

In March 2001, the state Supreme Court ruled unconstitutional the section of the Check Cashers Act of 1999 that said the fees could not be construed as interest. Determining usury, the high court said, was a “judicial function” that could not be usurped by the Legislature.

The Supreme Court has not, however, had an occasion to rule directly on the question of whether the fees charged by payday lenders are in fact usurious. Many lower courts have ruled that they are, but none of those decisions has been appealed, presumably because the lenders do not relish having the question answered once and for all.

Meanwhile, the interstate banking bills that have all but removed the question of usury for commercial banks have encouraged many payday lenders to redefine themselves as loan origination branches of national banks. This despite the fact that the Office of the Comptroller of the Currency has strongly discouraged national banks from engaging in the high-risk practice of payday lending.

The number of check-cashers registered with the state has slipped from 345 in September 2000 to 188 in August 2001 to 156 as of July 2, according to Peggy Matson, executive director of the Arkansas State Board of Collection Agencies, which also has oversight responsibility for check-cashers. Matson said the decline in the number was not because there were fewer businesses engaged in payday lending but because, as affiliates of national banks, they do not meet the legal definition of a check-casher and do not have to register.