Let's Compete with Loan Sharks

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Criminal loan sharking is a thriving black-market activity which contributes importantly to the operations of organized crime and hurts legitimate business in many ways. Most Americans know that loan sharking exists, but how, why, and in what ways it exists are mysteries to many people. These questions are analyzed from the economic standpoint for the first time in this article. The author describes the operation of supply and demand for loan-shark funds, showing what factors create a growing market for loan sharks, and examining the implications for society. Following this economic analysis, he looks at the public policy question: What should be done about loan sharking? He examines and rejects a number of possible approaches, then urges the establishment of open, legal competition with loan sharks.

For this article, Captain Seidl draws on an extensive study of criminal loan sharking which he made in the course of completing his doctoral dissertation at Harvard University. On active duty in the U.S. Air Force since 1961, he teaches courses in government and economics at the U.S. Military Academy at West Point. In the summer of 1969 he served with the Department of Community Affairs in the State of New Jersey. He was assigned to the John F. Kennedy School of Government at Harvard from 1965 to 1968.

Sitting at a small, littered desk, Mark puffed on his cigarette. We were at his office, a new car agency in Philadelphia. Mark is a 32-year-old auto salesman, and his picture was prominently displayed across the room announcing to employees and customers alike that he had been the top salesman for the previous three months. He was talking about his experiences as a loan-shark borrower:

"You just don't understand what a good friend Jimmy [his loan shark] was. Let me give you an example. Just over a year ago—I guess it was about three days before Christmas—I was pretty well tanked up in one of our favorite hangouts in North Philly. It was around eleven or midnight. My luck wasn't running too well; I'd just bought the last round of drinks and was out of cash. I called Jimmy and told him I needed a couple hundred bucks to keep me going until the first. Thirty minutes later Jimmy arrived. He'd driven from South Philly through the snow that had been falling since early afternoon. He handed me $200 and left. Where else could I get that kind of service? I'd gladly pay extra for the couple hundred, wouldn't you?"

Mark's story highlights two key aspects of organized crime's activities—supplier service and consumer demand. Ironically, however, these aspects are seldom mentioned in discussions of organized crime.

Most discussions are submerged in the moralistic fervor of "crime busting" experts. This fervor leads to hang-ups which seriously impair one's ability to analyze the phenomenon of organized crime in our society. For example, writers are often mesmerized by dramatic but irrelevant details which obscure the hard realities of organized crime. Some writers are fond of theories of national or international conspiracy, exotic names for criminal organizations and staff functions, ethnic membership requirements, ritualistic initiation ceremonies, nicknames for criminal entrepreneurs, and the character flaws of black-market consumers. Here are some samples from one prominent national magazine:

? "Call it the Mob. The name fits, although any of a half-dozen others—the Outfit, the Syndicate, La Cosa Nostra, the Mafia—serves about as well. Whatever it's called, it exists, and the fact of its existence is a national disgrace."[1]

? "The Mob is a fraternity of thugs, but it holds such power, wealth, and influence that in one way or another it poisons us all. It rigs elections and in so doing destroys the democratic process. More and more it is muscling into legitimate business—local, national, and international—to the extent that nearly every American is paying into its treasury in countless unsuspected ways."[2]

? "The most shocking truth about organized crime in America is that all of us, one way or another, one time or another, pay tribute to the Mob. Out of ignorance, greed, easy tolerance, or fear we help it to grow fat with our money—whenever we deal with the Mob's businesses, its agents or those beholden to it: when a housewife buys the product of a Mob-controlled company; when a teenager feeds a Syndicate-owned jukebox; when a businessman negotiates a quick loan with a Mob userer; when a slum dweller plunks down 50 cents and hopes his lucky number will come up."[3]

What I propose to do in this article is to analyze one enterprise of "organized crime"—the loan-shark industry—from a different perspective. Using economic analysis, I will describe the industry and then attempt to answer the two central policy questions related to loan sharking: 1. What is it about loan sharking that offends [or pleases] society? 2. What policies and approaches might the United States adopt to deal with loan sharking, and which one would be most effective?

ANATOMY OF AN INDUSTRY

At the outset, let us define our key term. Criminal loan sharking can be identified by the following essential characteristics:

? Cash is lent at very high interest rates—generally 20 to 100 times higher than rates charged by legitimate lending institutions.

? The borrower-lender agreement rests on the borrower's willingness to pledge the physical well-being of him and his family as collateral against a loan. The corollary of the borrower's willingness is the lender's willingness to accept such collateral, with its obvious implications for what he may have to do to collect.

? The borrower believes the lender has connections with ruthless criminal organizations. That fact and his expected need for future loans induce him to repay.

Our definition of criminal loan sharking raises a useful question: What is illegal about a loan-shark transaction? The laws most often violated in loan-shark transactions are state usury laws. It is the lender and not the borrower who acts illegally. Violation of these laws is almost always punishable as a misdemeanor. The loan shark may violate the law in two other ways: he may be prosecuted for conducting a loan business without a license or proper authority; or, if he explicitly uses the threat of force or violence to make collections, he may be prosecuted for extortion. Two states have passed special criminal usury statutes in an attempt to make loan sharking itself a serious offense. In Illinois and New York it is now a felony to lend money at interest rates in excess of 20% and 25% per year respectively.

SOURCE OF FUNDS

Large-scale criminal organizations provide most loan-shark funds. These organizations derive the biggest share of their profits from exploiting the black market in goods and services created by the legislation of moral standards of conduct. But while they thus may be involved in gambling, narcotics, loan sharking, racketeering, and fencing stolen property, they may engage in legitimate business as well.

Loans from legitimate lending institutions direct to loan-shark borrowers provide a second source of funds. This type of lending does not depend on thoroughly corrupted lending institutions but merely on one or two loan officials who flaunt company regulations for sizable kickbacks from loan-shark organizations. This is how it works:

Loans supplied to borrowers by legitimate lending institutions are first negotiated by the loan shark and his customer. A lump-sum charge for the service of securing the institution's money is agreed to by the borrower. The borrower then may sign a note payable to the loan shark for the total amount of the transaction—usable principal plus charge. Or he offers the loan shark worthless or fraudulent collateral equal to the amount of the transaction. In either case, the collateral or the note is given to a specific loan official and discounted; the proceeds are then paid directly to the borrower. The borrower, in turn, pays the lump-sum charge "off the top" to the loan shark, and repays the total amount plus normal interest to the lending institution.

INTEREST RATES

The interest paid for loan-shark funds is at traditional rates which have been established over time.

There is a small-loan rate which is charged by sharks who work industrial plants, docks, construction sites, and neighborhoods catering to blue-collar and lower-middle class borrowers. Individual loans ranging from $50 to $1,000 are common, and the average loan is probably somewhere between $ 150 and $400. Borrowers use the money for a wide variety of purposes ranging from the paying of gambling debts to the buying of household necessities.

The street corner loan-shark racket of the 1920's and 1930's was known as the "six for five" racket. "Six for five" means that the interest on a $5 loan for one week is $1. Thus if the borrower repays the principal and interest in one week, he hands back $6. If he does not desire to repay the principal, he pays weekly interest which is $1 or 20% per week. That rate continues to be widely accepted for small loans. It is equivalent to 1,040% per year. The interest charges—called "vig," "vigorish," or "juice"—are due each week as long as the principal is outstanding. The principal can be reduced only in lump-sum, or in some cases, half-lump-sum payments.

In some urban areas, the rate is 20% for a six- or ten-week period, with interest charges added to the principal and the total repaid in equal weekly installments. For example, 20% for six weeks means that a $200 loan costs $240 and is repaid in six weekly installments of $40 each. The borrower receives full use of the total principal for only one week, and the amount of principal available to him decreases each week as he makes a payment. The 20% add-on interest rate for a six-or ten-week period is equivalent to 200% to 350% per year.

There is also a large-loan market. Large-loan customers differ in educational and occupational backgrounds from small-loan borrowers, and they usually deal with a higher echelon of the loan-shark industry. Little can be said about the general characteristics of large-loan borrowers, except that they appear to fall into three categories with three different types of credit needs: 1. Smaller-company businessmen who need working capital. 2. Speculators, promoters, and producers who need venture capital. 3. Individuals who need personal funds to satisfy spending habits or cover illegal business activities.

Loan sharks who lend to large-loan borrowers are capable of making loans from a few hundred dollars to more than $50,000. The standard rate for these loans is 5% per week or approximately 250% per year. There is no installment lending in the large-loan business, and principal reduction is usually negotiated by the borrower and lender.

COLLECTION PROCESS

A loan-shark organization's reputation for violence and ruthlessness is the most important factor inducing borrowers to repay their loans. The lender may convey that reputation by his physique, appearance, temperament, outlook, willingness to carry arms, and connections with criminal organizations, whether real or imagined. In addition, the borrower's perception of the loan-shark industry hinges on his previous contacts with the underworld and his exposure, through communications media, to criminal organizations and their enforcement methods. A formidable industry reputation makes the individual loan-shark's job easy by removing many of his potential collection problems.

Actual violence is minimized. Fear and anxiety about it are used instead to motivate delinquent borrowers. Actual violence is likely to be counter-productive from an organization standpoint, for it may bring increased scrutiny of loan-shark activities by public, law enforcement, or underworld elements. In addition, it hampers lending profitability. It makes repayment more difficult for the individual who is victimized and discourages new or continued borrowing by making customers more apprehensive.

DEMAND FOR LOAN-SHARK FUNDS

The keystone of the loan-shark industry is borrower demand. Without it, the industry could not exist. This is because the combination of funds and services provided by loan-shark organizations is not available in the "upperworld." Two factors account for this unavailability:

1. Usury laws—By placing a legal constraint on interest rates, usury laws limit the risk-taking ability of lending institutions generally, and more particularly during periods of tight money. Consequently, individuals and firms that desire high-risk loans and are willing to pay something equivalent to a free market price for them, are denied opportunities to borrow in the upperworld. Thus they become potential prospects for the black market.

The role of usury laws in creating a black market for criminal loan-shark organizations is not a unique phenomenon. Whenever a commodity or service is declared illegal, the law automatically provides "protection" to those who desire to supply that service or commodity and who are willing and able to operate illegally. The law creates the necessary conditions for criminal monopoly by destroying legitimate competition. For example, this is clearly what happened with the passage in 1919 of the Eighteenth Amendment prohibiting liquor sales.

2. Traditional lending practices—Upperworld lending practices, which are partly dependent on usury laws, also shape demand. For one thing, the procedures for transacting loans are unduly formal and involved when compared with loan-shark lending services. In the case of the latter, secrecy, informality, speed, convenience, and availability are characteristics that attract borrowers. No one needs to know about the loan, including the borrower's family, neighbors, employers, or creditors. The borrower need not wait, subject himself to interview by stuffy loan officials, or fill out long, complicated forms which are particularly embarrassing for individuals without language facility. Customers who have successfully borrowed from loan sharks can secure successive loans just as quickly as they can contact their shark. Hours of operation are not a problem; loan sharks lend money every day and night of the week.

Such service simply is not available from upperworld lending bureaucracies. If it were, the market for criminal loan sharking would not be nearly so big.

In addition, high-risk capital simply is not always available from traditional lending institutions; some borrowers are forced to seek such funds from loan-shark organizations. The crux of the problem is that banks and finance companies consider interest rates only within a narrow range. Strict risk standards are developed for this range, and borrowers are accepted or rejected according to whether they can meet these standards. Cyclical economic fluctuations do not appreciably alter the credit selection processes. In fact, tight-money periods work to the advantage of creditors by allowing them to be more selective in accepting borrowers. The fluctuating interest rate reflects the dynamics of the scarcity and abundance of money much more than it reflects varying repayment risks facing lenders.

To illustrate the impact of the factors just described, let me refer to the case of a small businessman whom I shall call Harold. He runs an antique shop which is located in the center of downtown Philadelphia. In a talk with me he explained his borrowing from loan sharks this way:

"Look, in my business I need a continuing line of credit. When I hear or read about a sale or an attic filled with 'junk,' I want to take off right away with the necessary cash to make the purchase if the stuff pans out. I went to a number of the Philly banks trying to get a line of credit. Everyone put me off. They said they couldn't evaluate my inventory. They were all ready to lend me $10,000 with a regular payback, but that's not what I need. My buying is too lumpy. One day I met Ed. He offered me $2,000 in a pinch—no questions asked. From then on I did business with him. Whenever I heard about a sale I wanted to attend, I called Ed. I'd meet him at Fifteenth and Chestnut. He'd show within 30 minutes if I was in a rush. The transaction was simple. Ed would hand me an envelope, and I'd be on my way. I seldom even checked the contents; I could trust Ed always to give me what I asked for."

One might argue that the nonavailability of high-risk loans is strictly a function of usury laws. Many states permit any specified interest rate agreed to by two parties bargaining for consideration. In other states, usury laws do not apply to borrowing by corporations. In these cases, it is not usury laws but lending practices which exclude the making of high-risk loans, especially to small businesses.

HOW BIG IS THE MARKET?

It is almost impossible to assess the extent of the loan-shark market except to say that it is large and growing larger. A few statistics do exist which allow one to speculate about a potential loan-shark market, but many assumptions about their relevancy and borrower behavior must be made before the data are at all useful.[4] For example:

A study of five large- and medium-size consumer finance companies from 1957 through 1964 showed that these companies rejected slightly more than 50% of all new loan applications. These rejected applicants—about 12.5 million people in 1958—form a part of the potential small-loan market. [5]

Certainly not all or most of these rejected borrowers would be likely to turn to loan sharks, but the figures do give an indication of the large number of borrowers who fail to secure consumer loans in the upperworld.

Trying to get an estimate of the size of the large-loan market is even more difficult. There are few useful statistics in this regard. An example of the extent of the market can be surmised from the fact that between 30 and 45 large-loan organizations operate in New York City alone. For the country as a whole, there are hundreds of such lenders. While the number of large-loan borrowers rejected by legitimate lending institutions must be far less than the number of small-loan rejects, there still must be a bountiful list of prospects here for loan sharks.

ECONOMIC ANALYSIS

Evaluating costs and benefits from criminal loan sharking is a difficult task because of limited data, incommensurables, and uncertainty. It is impossible to consider all costs and benefits in terms of a common denominator—for example, dollars. How does one assign a dollar cost to the role of loan sharking in maintaining large-scale criminal organizations that corrupt or undermine government, as appears to be the case in New Jersey? Or how does one assign a dollar cost to the degradation of family morale and solidarity that results from the threat of violence in loan sharking?

Nevertheless, economic analysis is helpful for two reasons. It provides an orderly, comprehensive presentation of the important considerations in loan sharking in a manner that forces one to consider tradeoffs and alternatives. Further, it helps us distinguish different costs and benefits and thus make better judgments about policies and programs.

OFFENSIVE ASPECTS

Now that we have an understanding of the nature of supplier service and consumer demand in the loan-shark industry, let us attempt to answer the first of the two key policy questions raised earlier. What is it about loan sharking that offends [or pleases] society?

We should first attempt to answer this question in terms of what "the law" itself does not like about loan sharking? The answer is not clear. Loan-shark transactions are crimes without victims; the borrower merely purchases a black-market service, although inherent in that purchase is the risk of victimization should he become a delinquent borrower. But, more importantly, the borrower is purchasing a service to which no sin is attached. Therefore, this case is different from most other black-market services. The outlawing of gambling, prostitution, and narcotics is aimed at denying the consumer the satisfaction of wants considered immoral or antisocial.

Usury laws, on the other hand, exist to protect the borrower in a lending transaction where it is believed that he possesses unequal bargaining power vis-a-vis the lender. Thus usury laws are analogous to fences around swimming pools, locks on medicine cabinets to keep children from poisoning themselves, laws regulating the disposal of wornout refrigerators, and food and drug laws enacted to protect consumers.

In loan sharking, however, there is often no "victim" to protect. Why, then, is it generally thought of as a victimization process? Probably one reason is that the law only becomes formally aware of those loan-shark transactions which do involve victimization. Also, the loan-shark industry is operated and controlled by large-scale criminal organizations. If loan sharks secured their funds from legitimate organizations, such as The Ford Foundation, and if the money were clean and the entrepreneurs not intimately connected with the underworld, maybe the law would not be so concerned with the problem of loan-sharking. Perhaps, too, high-risk lending itself would not be considered so bad.

HAZARDS TO SOCIETY

From the standpoint of social norms and values, what is offensive about the loan-shark industry?

1. We do not like a lending system that rests on the threat of violence. Even though actual violence is seldom used to induce repayment, the threat of violence affects the morale, welfare, and solidarity of selected individuals and families by restraining their freedom of action and impairing their mental and physical capabilities. Note that this is not an evil inherent in high-risk lending, but an evil that stems from the nature of those who control it.

2. We do not like a high-risk lending system that is a criminal monopoly. It results in excessively high interest rates, since criminal entrepreneurs are "protected" from competition by usury laws and traditional lending practices. Moreover, loan sharking provides a basic organizational incentive for large-scale criminal organizations, and we do not like nor should we tolerate these types of organizations. They pose a threat to local pluralism because they are accountable to no one in the upperworld; they evade large tax bills; they create incentives which result in increased levels of predatory crime; and they undermine social morale and public morality because of their continual violation of the law. Note that, again, these are not evils of high-risk lending per se.

3. We do not like the corruption which buys "protection" for the loan-shark industry and its related activities. Corruption results from the fact that loan sharking is illegal. Presumably, we increase the probability of corruption whenever a transaction is made illegal or is taxed to the point that it is profitable (even after paying off public and law enforcement officials) to evade taxes.

4. We do not like a lending system in which borrowers can easily accept more debt than they ought to. This evil is probably inherent in any high-risk lending system. The real question is: To what extent should the state view its role as a paternalistic protector of certain individuals who have a propensity to borrow beyond their means?

Since we are not paternalistic with regard to consumer expenditures or consumer borrowing for such items as television sets and automobiles, it does not seem necessary to be especially worried about high-risk borrowers. In addition, if we are faced with a problem of individuals borrowing beyond their means, we would probably prefer that they do so from legitimate institutions that make their records public, not from criminal organizations that are shrouded in secrecy.

Having considered what it is about loan sharking that offends society, let us turn to the question: What aspects of the loan-shark industry do we desire to preserve? We want to preserve a high-risk lending system which is responsive to borrowers with legitimate needs for high-risk loans. To accomplish this, the lending service presently offered by the loan-shark industry must be duplicated by legitimate lenders. This point is crucial.

PROPOSED EXPERIMENT

We have seen that society suffers a number of undesirable costs as a result of criminal loan sharking. But we have also seen that underworld lending meets a need felt by many people. Let us keep in mind that there are trade-offs to consider between costs and benefits when we study different possible ways of dealing with loan sharking. Let me review briefly several options that I do not think are desirable.

The most obvious one is to do nothing more than is being done about the loan-shark industry. Some people may believe that present policies suppress enough—or perhaps too much. Increased effort may be considered unjustified in view of the costs required, the expected gains, and the opportunity costs for added expenditures. Also, there may be some who believe that we do not know enough about loan sharking to choose a new policy approach. They might elect to do nothing more until further research demonstrates a greater need to implement new policies and shows more clearly what should be done.

To other people, the loan-shark industry is the most effective institution for accomplishing high-risk lending. This belief could stem from the conviction that the threat of violence is essential to profitable high-risk lending. A second policy option, therefore, is to increase consumer awareness of loan-shark services and attempt to lower loan-shark prices. This is not an amoral choice of action if it is assumed that recognition of the activities of loan sharks might make society privy to more of their operations and reduce some of the uncertainties involved.

Such a policy might also appeal to those people who believe that loan-shark borrowing is an equitable mixture of service and punishment for persons who cannot manage their financial affairs within the reasonable constraints of upperworld lending. The trouble with this approach is that it leaves the industry in the hands of undesirable characters.

A third option is to attack the loan-shark industry and its attendant consequences with more efficient and effective law enforcement techniques. This means, in effect, that the legal tools of arrest, indictment, prosecution, conviction, and sentencing should be made more effective.

However, a legal strategy does not effectively attack the fundamental causes of the black market-usury laws and traditional lending practices. It does not establish an alternative method of high-risk lending but merely attempts to provide a continuous antidote for the illegal activities which are caused by the black market. Police bureaucracies cannot be expected to wage all-out war on the loan-shark industry because political and social pressures demand much more from them than attending to this problem.

Thus this option would perpetuate the economic incentives to maintain criminal organizations and to exploit the black market in loans. There would still be incentives to corrupt public officials. And there would likely be continued violation of the law with its detrimental effects on social morale and public morality.

RESTRUCTURING THE MARKET

I want to propose another approach, an economic strategy that has received little public discussion. The strategy is to restructure the black market in loans. It means promoting a new high-risk lending system in the hope of preserving some features of loan sharking that borrowers like while discouraging the offensive aspects. Implicit in such an economic strategy is the elimination of usury laws and a loosening of traditional lending practices.

The aim of the strategy is to attack the organizational incentives of the loan-shark industry. It is not directed at particular individuals but at the economic motivations which support criminal loan sharking. It assumes that we would prefer to see a prospective borrower get his loan at a high rate than not get a loan at all. Moreover, it seems reasonable to expect that high-risk lending rates would come down (while other rates might go up a little) if usury laws were eliminated and if legitimate lenders were encouraged to compete with the criminal loan sharks.

In addition, if we desire to fight criminal loan sharking because it fosters corruption and disrespect for the law, we probably can best eliminate these evils by legitimatizing high-risk lending. As pointed out earlier, these evils are not inherent in all high-risk lending; they occur when it becomes well organized outside the law. If we view corrupted public officials as individuals who "sell" licenses to loan-shark organizations for a profit, we could deny them this franchising capability by legalizing high-risk lending.

Also, an economic strategy would have a built-in feedback system—i.e., the market mechanism. Providing legitimate high-risk loans means that a portion of the presently illegal black market would be revealed for public scrutiny and data collection; the existing shroud of secrecy would be less pervasive. Thus supply and demand data would be easier to collect, and legitimate lending policies could be revised and improved as market developments occur.

What about the dollar costs of such an economic strategy? Owing to much uncertainty, especially in the area of default rates, it seems feasible for government to initiate the restructuring of loan-shark markets and to absorb the initial short-run costs either through direct participation or subsidy. The ultimate aim, however, should be a profitable, high-risk lending industry which is privately owned.

A long-term goal may be the licensing and regulation of high-risk lending firms or perhaps the establishment of what is called judicial restraint for borrowers or lenders who complain they have been treated unfairly. [The British system of regulating interest rates is judicial restraint. No statutory maximum interest rate exists for any loan. Courts can declare any transaction usurious and decree a reasonable arrangement for the parties concerned. British statute reads that interest in excess of 40% per year will be presumed to be excessive unless proved otherwise. Thus freedom of contract subject to good faith and fair dealing is the British approach to interest regulations.) [6]

An essential element in an economic strategy is the design of the new lending service. This will determine whether new firms can compete with criminal loan sharks. Public or private firms could be the experimental lenders. In fact, there may be an advantage to having both types of lenders in an initial program. [My hunch is that public firms would be less effective because of stricter accountability requirements and more formal bureaucratic rules.]

Legitimate firms, whether public or private, will be at a competitive disadvantage, however, because they will not be able to accept a borrower's body as collateral, nor can they resort to the collection techniques of criminal loan sharks. Some might urge the reestablishment of debtor's prison or flogging, but these methods are impractical and undesirable. Bear in mind, though, that legitimate firms do have a potential competitive advantage. They can eliminate much of the risk that exists for loan-shark borrowers. The key is to duplicate the service elements in loan-shark transactions while eliminating the threat of physical violence in the collection process.

Secrecy, informality, speed, convenience, and availability must be incorporated in the new lending service, and many traditional lending practices must be put aside. The lender must rely on the borrower's needs for future loans to secure repayment, not on conventional credit criteria. Whether these needs will be a sufficient incentive is a question that can be answered only after experimenting with my proposal. But what is clear is that legitimate lenders cannot compete effectively in this business unless they can duplicate at least some of the service attractions provided by underworld lenders.

IS THE PROPOSAL WORKABLE?

Is an economic strategy politically feasible? An objective analysis of the costs and benefits to society from the loan-shark industry is improbable among legislators at any level of government. The repeal of usury laws is not likely to receive support from consumer groups, financial institutions, or legislatures. Certainly a legal strategy would be more acceptable to these groups, especially the legislators who, for the most part, are legalists themselves. Such considerations seem to condemn an economic strategy to an intellectual limbo. But there is a way to circumvent the problem. This is to sell a legislative body on a temporary strategy for a specifically defined area, and then expand the program bit by bit if results warrant it.

If it practical to try to establish legitimate high-risk lending firms? Departure from traditional lending practices will be difficult to accomplish. Bureaucratic changes of this type in the financial community will be slow, painful, and tedious. Perhaps the best approach is to create new lending services through, say, innovations in credit card usage or looser instant check credit; they might also be developed by giving lending officials vans and weekly routes through different neighborhoods and industrial areas, thus taking them out of the traditional institutional environment and into that of prospective borrowers.

Another possible pitfall is that legitimate high-risk lending which incorporates secrecy, informality, speed, convenience, and availability may create attractive incentives for loan officials to make good "bad" loans. If a lending institution is willing to accept the higher default rates inherent in high-risk lending, it may be unable to keep loan officials from giving away their funds for sizable kickbacks. The underworld eliminates this potential problem with its rigid discipline. But legitimate lending institutions would not be free to use the threat of violence against employees who break the rules.

Nevertheless, I feel that it is possible to overcome this problem by careful selection of loan officials, payment of high salaries, and establishment of reasonable bookkeeping checks. Only an actual experiment, however, can prove or disprove this belief.

We could not hope to entice all loan-shark customers to borrow from legitimate lenders if competing high-risk lending institutions ware established. Our factual data do not support such cavalier notion. What we can hope is to destroy a portion of the loan-shark black market, and to significantly reduce the economic incentives which give rise to profitable underworld money ending. To restructure the loan-shark market is to attack large-scale criminal organizations. But since we do not know how these organizations will react, nor are we positive that legitimate high-risk lending is feasible, limited restructuring is the most practical way to begin.

It is important to establish feedback procedures so that upperworld lenders can adjust to the competitive tactics of criminal loan sharks and their parent organizations. Administrative procedures must provide for continual reassessment of policy aims in the light of underworld reactions to competition. In addition, surveys of borrower attitudes could help the new lending agencies to adapt to market demands.

CONCLUSION

We should try to compete with underworld loan sharks by establishing legitimate lending institutions, beginning in an experimental way in some specific area. Such an approach would allow for the testing of our assumptions and ideas about loan sharking and the general aspects of black-market crime. It would enable us to determine, with a minimum of risk, whether legitimate lending institutions can be designed to compete favorably with loan-shark organizations, and, if so, how.

It would help to answer other questions as well. Can these institutions operate on a profitable basis without government subsidy? If required, what level of subsidy is needed? How does lending competition affect the incentive structures of loan-shark organizations and large-scale criminal organizations? What adjustments will be made in the underworld if we restructure loan-shark markets in the manner described?

More generally, an experiment in competition should provide data for future policy decisions related to all types of consensual crime. For instance, is the restructuring of markets a feasible and effective strategy for combating other forms of black-market crime—especially, gambling and prostitution? If competition with loan sharks results in sizable losses for underworld organizations, the next step should be competition in gambling—one of their basic money-makers. But we are getting ahead of ourselves; what is needed now is an attempt to compete with loan sharks.

Copyright 1970 by the President and Fellows of Harvard College; all rights reserved. This article originally appeared in the May/June 1970 issue of HARVARD BUSINESS REVIEW and is reprinted by permission.

NOTES AND REFERENCES

[1] "The Mob," LIFE, 1 September 1967, p. 15.
[2] Ibid.
[3] "The Mob," Life, 8 September 1967, p. 91.
[4] For a more detailed discussion of the extent of the loan-shark market see my paper, "Upon the Hip"—A Study of the Loan-Shark Industry (Washington, Department of Justice, Law Enforcement Assistance Administration, 1969), pp. 138-57.
[5] John Chapman, "Role of Consumer Finance Companies in a Credit Economy," in THE CONSUMER FINANCE INDUSTRY: ITS COSTS AND REGULATION, edited by John Chapman and Robert Shay (New York, Columbia University Press, 1967), p. 22.
[6] See Raymond M. Conner, "Usury—An Analysis of Usury Legislation and the Mississippi Corporate Exception Statute," MISSISSIPPI LAW JOURNAL, March 1967, p. 347.

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