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By Root 1188 0

mail for second and third home equity loans. There were no “payday lenders,” no “live checks,” no “instant money,” and certainly no offers to “consolidate” all that debt by moving it from one credit card to another. A generation ago, a family that wanted to borrow money had only a handful of options. Instead of running up debt anonymously, a prospective borrower was forced to meet a stern-looking banker, face-to-face. Families were asked to produce past tax returns and pay stubs, credit references, and projected budgets that showed how they planned to repay the money. If they wanted to take out a mortgage for a new home, they were typically required to come up with a 20 percent down payment from their own savings.10 If they wanted money for any other purpose, they were required to give a detailed account of their spending plans, and the banker had a fairly narrow set of answers he wanted to hear: building an extra bedroom on the house, buying a new car, sending the twins off to college. Some retailers offered credit to move their merchandise, but cash loans and lines of credit for “making ends meet until John finds a new job” or “putting groceries on the table until the child support checks begin” were not in the lending lexicon.

The reason for the lenders’ cautious approach was not that the bankers of yesteryear were thriftier or that Americans hadn’t yet developed a taste for “unbridled consumption.”11 The reason was a far more powerful one, and it affected every lender and every borrower in the country: The law was different. In those days, the banking industry was highly regulated, and usury laws created ironclad limits on how much interest a bank could charge on a loan. As a result, banks’ profit margins were modest, and families that wanted to borrow money had to prove they had a very high likelihood of repaying it. 12 The judgment was not moralistic; it was supported by stubborn financial reality. Unlike today, bank vaults were firmly closed to families already in financial trouble.

From the founding of the Republic through the late 1970s, interest rates had been a matter for states to determine, and the states had imposed limits on the amount of interest that could be charged on consumer loans.13 The logic behind the laws was straightforward: State governments wanted to protect their citizens from back-alley loan sharks and aggressive lenders who would cost families their homes.

But the states’ authority to regulate lending within their borders was wiped out by an obscure federal regulation. In 1978, a Supreme Court opinion interpreting some ambiguous language in a little-known federal statute opened the door for banks to “export” interest rates from one state to another.14 This meant that a bank with lending operations in South Dakota—where the interest ceiling was 24 percent, at a time when the rates in most states were capped at 12 to 18 percent—would have a distinct advantage. A South Dakota bank could now issue loans at 24 percent interest to a family living in New York (where rates on most loans were capped at 12 percent), without worrying about the corporate officers ending up in a New York prison next to loan sharks who collected by breaking people’s fingers until they paid. Under the new law of the land, South Dakota banks could collect their profits from New York families, and there wasn’t a thing the New York legal system could do about it.15

The race was soon on. Local politicians across the country quickly figured out that all they had to do was raise the interest rate ceiling, and lending institutions would flock to their states. Suddenly there was a new way for states to attract clean, white-collar jobs, and even grab a share of corporate taxes in the process. Sure, there might be some hardship for families that stumbled into high-interest loans they really couldn’t afford. But most of the hardship would be exported to the residents of other states, while the benefits—jobs and tax revenues—would stay local. By way of analogy, consider America’s drug laws. Suppose that South Dakota passed a law