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Pawn Shops Serve a Public Function

November 11, 2004

In the typical unregulated pawn transaction in modern America, a money-hungry pawnbroker charges an annual interest rate of 300 percent on a fully-collateralized $80 loan. "Highway robbery," we are told. "That’s taking unfair advantage of the already disadvantaged in the most egregious way possible!"

And yet, day in and day out, for hundreds of years,[1] pawnbrokers have engaged in the legitimate business of lending very small amounts of cash to anxious (if somewhat desperate) borrowers on mutually agreeable terms. And steady growth for the pawn industry throughout the past century suggests that, all things considered, the "disadvantaged" pawn borrowers have arguably been quite satisfied with their dealings with these "consumer lenders of last resort." After all, they seem to keep going back for more.

In attempts to constrain pawnbrokers who dare to make these high-interest loans, 28 states (including Washington DC) have legal rate ceilings ranging from 24 percent to 300 percent annual interest on pawn loans. In addition, 10 jurisdictions have some form of a regulation where lenders are required to return the proceeds from the sale of the collateral item (above the loan amount—including interest) to the original borrower in the case of default.[2]

Before condemning pawnbrokers for taking unfair advantage of unfortunate situations, however, a sense of fairness requires that we ask a very important question: Does the lending activity of the pawnbroker cause or contribute to the bad situation in which the borrower finds himself, or does the pawnbroker’s action tend toward alleviating the bad situation in some way?

Logic would tell us that if—in the mind of the borrower—the pawn loan being offered were deemed to worsen his situation, then the borrower would not agree to the loan. He would turn the loan down and walk away as a dissatisfied non-customer. Only to the extent the borrower feels that the loan will at least partially alleviate his problem (his "felt uneasiness" in academic parlance) will he go through with the loan. Murray Rothbard explained this simple but essential principle perhaps better than anyone, when he said:

"Let us now consider exchanges on the free market. Such an exchange is voluntarily undertaken by both parties. Therefore, the very fact that an exchange takes place demonstrates that both parties benefit (or more strictly, expect to benefit) from the exchange. The fact that both parties chose the exchange demonstrates that they both benefit."[3]

Recent empirical research seems to support this praxeological and deductive statement from Rothbard by showing that the regulatory restrictions placed on modern pawnshops may lead to a reduction in several aspects of the supply of pawn loans in statistically significant ways. Basically, in state-by-state research recently completed, I have found that the pawnshop regulations noted above seem to have significant effects on (1) the number of pawnshops per capita and per square mile in each jurisdiction, (2) the number of hours per week pawnshops are open for business, (3) the dollar value of collateral needed for a specific loan amount, and (4) the willingness of pawnshops to make very small loans.[4]

In short, as interest ceilings are put into operation, pawnshops tend to leave town or otherwise restrict their output. It is interesting that the changes in each of these aspects of supply that are apparently brought about by the restrictive regulations tend to work against the interests of the disadvantaged poor that the restrictions are presumably supposed to assist. Apparently the law of unintended consequences is alive and well in the pawn industry.

Whether the harm done by these reductions in supply is actually greater than the benefit bestowed upon any particular person or group by the regulatory restrictions, we can’t say for sure, of course. After all, no one to my knowledge says that it is impossible to bestow net benefits on any certain group of people through the rearrangement of property rights in society. But there is one thing that does need to be made clear: The arbitrary shuffling of property rights—through price controls and other restrictions on trade—will always have costs, and these costs will often show up in a variety of ways that are likely to not be in the interest of the ostensible beneficiaries of the shuffling.

Those who support pawn interest rate ceilings seem to have some kind of "gut feeling" that certain unrestricted rates are just "too high." Gut feelings and other similar criteria for decision-making and for making moral judgments may have their place in life in certain circumstances. We all may use these kinds of methods from time to time due to various constraints in our ability to use more reasoned methods. But we might question the usefulness of these kinds of methods in the argument for using the force of law to override the simple desires of economic actors as they are demonstrated in market transactions. On what moral basis can we proceed in doing so?

Perhaps the most bizarre argument put forth by those in favor of interest ceilings for pawn loans is the suggestion that high interest rates are not fair because borrowers don’t have much choice in the matter because they are typically in somewhat desperate situations. This argument starts with the somewhat sensible suggestion that the plight of pawn borrowers may be related to the number of pawnshops that are competing for the borrowers’ business. A situation where there is only one pawnshop in town, for example, obviously creates more opportunity for that existing pawnshop to charge higher rates.

But what do interest ceilings do for this perceived "monopoly" problem? As noted previously, interest rate ceilings further diminish borrowers’ choices by effectively shrinking the number of competing pawnshops. This is especially disconcerting for the poor who live in rural areas where traveling to another town to get a pawn loan further increases the overall cost to an extent that may indeed (by a long shot) more than offset any possible benefit of a lower interest rate on a small loan. Thus interest rate ceilings are not an effective means of controlling any threat of "monopoly" power by pawnbrokers. This "monopoly" argument is apparently one that plays well on people’s emotions, but carries little logical weight in this situation.

In summary, if we believe that people do have a moral right to enter into economic transactions in ways that they think will benefit their own lives, and if we appreciate the proposition that a proper sense of fairness requires that both sides of an economic exchange must benefit, then we can see interest rate ceilings on pawn loans as a hindrance to that sense of fairness in the marketplace. Perhaps paying closer attention to the economic consequences of price controls in the pawn industry—as well as in other industries—would provide us with a better understanding of the plight of the poor in society.

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Glen Tenney teaches economics at Great Basin College, in Elko, Nevada. He recently completed his doctoral dissertation at Touro University International entitled, The Effects of Government Regulation on Competition and Supply in the Pawn Industry: A Quantitative and Qualitative Study. Any views expressed herein are the views of the author, and not necessarily the views of either of the institutions with which he is affiliated. Send him mail, and post comments on the blog.

   

[1] Caskey, John. Fringe Banking: Check-Cashing Outlets, Pawnshops, and the Poor (New York: Russell Sage Foundation, 1994), p. 16.

[2] Tenney, Glen. The Effects of Government Regulation on Competition and Supply in the Pawn Industry: A Quantitative and Qualitative Study. (Touro University International Doctoral Dissertation, 2004), pp. 200–02.

[3] Rothbard, Murray N. The Logic of Action One (Cheltenham, U.K.: Edward Elgar, 1997), p. 240.

[4] Tenney, Glen. The Effects of Government Regulation, p. 146.

 


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