Markets can be messy, but they usually get things right if left alone. That applies to financial markets – including loans. Even high-interest, short-term loans. Well-meaning pols sometime seek to limit interest rates on loans, especially short-term, high-interest “payday loans.” While those loans are, financially, ill-advised, some people do use them to help with sudden, unexpected expenses; and a law limiting those can dry up that market.

Alaska’s state legislature is considering such a bill right now. The bill’s summary reads:

“An Act relating to loans in an amount of $25,000 or less; relating to the Nationwide Multistate Licensing System and Registry; relating to deferred deposit advances; and providing for an effective date.”

The bill proposes to set an annual percentage rate cap on all loans under $25,000, that rate being 36 percent. Now, 36 percent is still considerable. But the “payday loan” industry routinely ends up with loans being set much higher; for example, a loan of $1,000 with a flat fee (as opposed to a percentage) of $25, outstanding for one week, would result in an APR of 130.35 percent.

In 2019, the Cato Institute, a libertarian think tank, did an analysis on these laws, based on one in Congress in that year that Cato referred to as the “Sanders-AOC Protection for Loan Sharks Act.”

“Usury ceilings,” as interest-rate price controls were traditionally labeled, began as a paternalistic effort to protect low-income and supposedly vulnerable consumers from exploitation by greedy bankers. Yet, as well-intentioned regulations so often do, usury ceilings backfired spectacularly, primarily harming those they were intended to help. And far from shutting down loan sharks, history shows that usury ceilings have been the primary catalyst for the loan sharks that have preyed on low-income and vulnerable Americans throughout history.

And:

Liberal politicians and consumer advocates were finally forced to admit that usury ceilings ended up hurting those they intended to help. In 1964, the New York state legislature opened an inquiry into the state’s billion-dollar loan-sharking racket. Sen.-elect Robert F. Kennedy, in a statement filed with the committee, recommended “altering the state laws on usury so an insolvent person who needs money for legitimate purposes might borrow it at rates that were not exorbitant.”

Kennedy’s sentiment echoed the economic and sociological consensus of the time. A year before becoming the first American to win the Nobel Prize in Economics, Paul Samuelson had appeared before the Massachusetts legislature to testify that “[f]or 50 years” research demonstrated that “setting too low ceilings on small loan interest rates will result in drying up legitimate funds to the poor who need it most and will send them into the hands of the illegal loan sharks.”

Every action has an equal and opposite reaction, even in finance markets.