The Effects of Usury Laws on Higher-Risk Borrowers

In this Article, we exploit a natural experiment -- an unexpected judicial decision -- to study the effects of state usury laws on consumer loans to higher-risk borrowers. In May 2015, the U.S. Court of Appeals for the Second Circuit issued a decision that, in effect, switched on the usury laws of three States, rendering those laws enforceable against owners of consumer loans that had previously been issued under the expectation that the usury laws were preempted by federal statute. Using proprietary data from three marketplace lending platforms, we study the decision’s effect on consumer credit markets.We find that the court’s decision significantly impaired credit availability for riskier borrowers, shrinking loan issuances to borrowers with the lowest FICO scores. We see no evidence, however, of strategic defaults by borrowers in these markets, despite the fact that the decision suggests that their loans are unenforceable. We also examine secondary market trading in notes backed by non-current, potentially usurious loans in the Second Circuit, and find that the decision reduced the prices of those notes. We do not, however, find evidence of a similar price decrease for notes backed by potentially usurious loans that the borrower continues to pay on time - suggesting that investors do not anticipate an increase in strategic defaults as a result of the court’s decision.