to correct perhaps illegal business activities they are involved in, also make up part of the large loan market.

In the normal large loan, the rate is 5 percent per week, or about 260 percent per annum.

Let me turn to the third question: "Why does the black market in loans exist?"

I would suggest it exists because loanable funds and loan services available in the loan shark industry are not available in the upper world or in the legitimate credit field. I think this is true for two reasons: One of the reasons is the ceiling placed on interest rates by usury laws; and the second reason is traditional banking practices. I will deal briefly with each of these.

By placing a legal constraint on interest rates, usury laws limit the risk taking ability of a lender. This means that individuals who may desire a high risk loan and are willing to pay something like a free market price for them are denied this credit because of the interest rate ceilings. This, of course, leads to a black market demand for loans.

Now, the role of usury laws in creating a black market demand is not an uncommon phenomenon. Whenever we outlaw a commodity or service that is demanded, the law automatically provides market protection for those who desire to supply the goods or services and are able to operate illegally.

For example, this is clearly what happened with the passage of the 18th amendment, which was reversed on the repeal of the prohibition amendment.

Now, let me turn to traditional lending practices very quickly.

Upper world lending procedures are unduly formal and involved when compared with loan shark lending services. There are really two aspects of upper world lending practices that we ought to talk about. Secrecy, informality, speed, convenience, and availability are the characteristics of underworld lending which attract borrowers. This type of service is simply not available today in our lending bureaucracies and thus borrowers who seek this type of service must turn to the underworld for the lending procedures they desire.

The second aspect is that a lack of high risk credit in the upper world is an important factor which sustains and shapes the loan shark market. High risk capital is not available, and some borrowers are forced to seek their high risk funds from loan shark operations. The crux of the problem is that interest rates are viewed by creditors within a narrowly constrained range of values. Narrow risk standards are developed for this range of interest rates, and borrowers are accepted or rejected based upon their ability to meet narrow risk criteria. That means, then, that the fluctuating interest rates reflect the dynamics of the scarcity or abundance of capital, the supply and demand, much more than it reflects the repayment risks facing bankers. It still may not be clear as to why I have differentiated between usury laws and traditional banking practices. I am attempting to show why we have a black market in loans. One might argue that the nonavailability of high risk loans is strictly a function of usury laws. Many States, however, permit any specified interest rate agreed to by two parties bargaining for consideration. In other States, usury laws do not apply to borrowings by a corporation. In these cases, it is not usury laws, but lending practices, that exclude the making of high risk loans, especially to small businesses and small businessmen.

Let me deal briefly with the last question: "What can we say about the extent of the loan shark market?"

First of all, it is impossible to assess accurately the extent of the loan shark market. That is because the necessary statistics and data are just not available.

It is fair to say that criminal loan sharking is a growing industry; that there is more money on the street today in large metropolitan areas; and, that criminal organizations are devoting more time and effort to the making of illegal loans.

There are some statistics which are available that begin to give one a feel for the size of the market, but this is only true if you make a number of meaningful assumptions. Let me give you a couple of examples.

A study of five large and medium sized consumer finance companies from 1957 through 1964 showed that these companies rejected slightly more than 50 percent of all of their new loan applications. All this indicates is that 50 percent of the new loan applications were turned away from a borrower of last resort. I can say nothing about the percentage of these people who went to the loan shark. I can make some interesting assumptions about the percentage of these borrowers who did turn to the illegal market. We must remember this is only a small portion of the small loan market, but it is interesting to know that many people have been turned away from legitimate creditors, and it gives one a feel for the size of the potential market that a loan shark is dealing with.

Another interesting fact is that in New York City there are between 30 and 45 large loan organizations operating, that is, large loan shark operations those people who make large loans, illegal loans, for borrowers.

The number of small loan organizations is anybody's guess. But, again, I think that this begins to give one a feel as to the loan shark industry and the extent of its market.

This concludes my oral statement.

I will be glad to answer any questions that any member of the committee, or you, Madam Chairman, may be interested in directing to me. (The prepared statement of Captain Seidl follows:)

PREPARED STATEMENT OF CAPT. JOHN M. SEIDL, U.S. MILITARY ACADEMY,

WEST POINT, N.Y.

I am very honored to have been asked to appear before this distinguished and important subcommittee of the House Banking and Currency Committee.

Let me begin by introducing myself. I am John Michael Seidl, a captain in the USAF assigned as an instructor in the Department of Social Sciences at the U.S. Military Academy, West Point, N.Y. I graduated from the Military Academy in 1961 and am presently completing my degree requirements for a Ph. D. in political economy and government from Harvard University. It must be understood that my remarks today are strictly my own opinions and conclusions. They do not reflect, in any way, the views of the Department of Defense, the U.S. Air Force, the U.S. Military Academy, or the Department of Social Sciences.

My appearance before the subcommittee today is a result of my Ph. D. dissertation which deals with the economics of the loan-shark industry of “organized crime." My dissertation is the result of 11⁄2 years of research and writing which included a study of the Boston, New York, Philadelphia, Cleveland, Detroit, and Chicago underworlds. My testimony will attempt to answer four questions: What is criminal loan sharking? What are the interest rates paid by loan shark borrowers? Why does a black market in loans exists? And, what is the extent of loan shark market?

The criminal loan sharking that I will be discussing today can be identified by three necessary characteristics. The first is the lending of cash at very high interest rates by individuals reputed to be connected with underworld operations. With few exceptions, interest rates are much higher than those available at legitimate credit institutions. The second characteristic is a borrower-lender agreement which rests on the borrower's willingness to pledge his and his family's physical well-being as collateral against a loan. The corollary of the borrower's willingness is the lender's willingness to accept such collateral with its obvious collection implications. The third characteristic is a belief by the borrower that the lender has connections with ruthless criminal organizations. The borrower is induced to repay his loans based on this reputation and his expected needs for future loans. If loan shark reputations and future loan needs are inadequate repayment incentives, however, the lender is willing to resort to criminal means to secure repayment.

Interest charges which borrowers pay for loan shark funds are traditional prices which have been established over time. There is a small-loan rate which is charged by loan 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 for these small (in capital assets) loan sharks; an average loan is probably somewhere between $150 and $400. The proceeds of these loans are used 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 "6 for 5" racket. "Six for five" means that the interest on a $5 loan for 1 week is $1. Thus, if a borrower repaid the principal and interest in 1 week on a $5 loan, he repaid $6. If he did not desire to repay the principal, he paid weekly interest which was $1 or 20 percent per week. Twenty percent continues to be an important element in the small-loan charge today. The rate in some urban areas for small loans is 20 percent per week-"6 for 5." The interest chargescalled "vig," "vigorish," or "juice" by borrowers and lenders alike-is 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. Since truth in lending requires statement of interest rates in percent per annum, it will be apparent that 20 percent per week is 1,040 percent per annum.

In other urban areas, the rate is 20 percent for a 6 or 10-week period with interest charges added to the principal and the total repaid in equal weekly installments. For example, 20 percent for 6 weeks means that a $100 loan costs $120 repaid in 6 weekly installments of $20 each. Actual interest rates in cases of installment lending and a quoted charge of 20 percent for a given period is about 40 percent for that period; the borrower receives full use of the total principal for only 1 week and the amount of principal available to him decreases each week as he makes a payment. Twenty percent add-on for a 6- to 10-week period produces from approximately 200 to 350 percent per annum.

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 level of the loan-shark industry. Little can be said about the characteristics of large-loan borrowers. Their general credit needs appear to be of three types: Small businessmen who need working capital; speculators, promoters, and producers who need venture capital; and individuals who need personal funds to satisfy spending habits or correct 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. Five percent per week is the standard rate for large loans in all the metropolitan areas that I visited. There is no installment lending in the large-loan business and principal reduction is usually negotiated by the borrower and lender. Five percent per week simple interest produces approximately 250 percent per annum.

The loanable funds and loan-shark services provided by loan-shark organizations are not available in the upperworld. This nonavailability is the basic cause for the existence and development of the loan-shark market. Two key factors explain this nonavailability-usury laws and traditional lending practices. 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. Thus, individuals or firms that desire high-risk loans, and are willing to pay something equivalent to a free-market price for them, are denied this type of lending in the upper world. Such a situation automatically leads to black market demand for high-risk loans.

The role of usury laws in creating a black market in loans and criminal loanshark organizations is not a peculiar 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 of the 18th amendment and which was reversed by the repeal of that amendment.

The above considerations do not imply that usury laws, alone, are responsible for loan-shark markets and criminal loan-shark organizations. There is another important factor which underlies their extensive. Traditional upper world lending practices, which are partly dependent upon usury laws, also shape small-loan and large-loan borrower demand. Two different aspects of these lending practices play an important role in creating a loan-shark market-lending procedures and nonavailability of high-risk credit.

Upper world lending procedures are unduly formal and involved when com pared with loan-shark lending services. Secrecy, informality, speed, convenience, and availability are the characteristics of underworld lending which attract borrowers. This type of service is simply not available in upperworld lendng bureaucracies. Thus, borrowers who seek this type of service must turn to the underworld for the lending procedures they desire.

A lack of high-risk credit in the upperworld is the second aspect of traditional lending practices which sustains and shapes the loan-shark market. High-risk capital is not available; and some borrowers are forced to seek their high-risk funds from loanshark organizations. The crux of the problem is that interest rates are viewed by creditors within a narrowly constrained range of values. Narrowrisk standards are developed for this range of interest rates, and borrowers are accepted or rejected based upon their ability to meet narrow-risk criteria. Cyclical fluctuations do not appreciably alter credit selection processes. From a risk standpoint, they work to the advantage of creditors by allowing them to select even lower risk distributions from potential borrowers during periods of tight money. The fluctuating interest rate reflects the dynamics of the scarcity and abundance of capital much more than it reflects varying repayment risks facing bankers.

It still may not be clear why I have differentiated between usury laws and traditional lending practices in discussing the existence of a black market in loans. One might argue that the nonavailability of high-risk loans is strictly a function of usury laws. Many States, however, 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 that exclude the making of high-risk loans, especially to small businesses.

It is impossible to assess accurately the extent of the loanshark market except to say that it is large and growing larger all the time. A few statistics which portend a potential loanshark market do exist, however. The statistics themselves do not outline the extent of the market. Many assumptions about the relevancy of these statistics and about borrower behavior must be made if the data are to be at all meaningful. A study of five large-size and medium-size consumer finance companies from 1957 through 1964 showed that these companies rejected slightly more than 50 percent of all new loan applications. These rejected applicants form a part of the potential small-loan market. Certainly not all or most of these borrowers would be likely to turn to a loan shark, but the figures do give one a feel for the large number of borrowers who fail to secure consumer loans in the upperworld. An example of the extent of the large-loan market can be surmised from the fact that between 30 and 45 large loan-sharks organizations operate in New York City. The number of small-loan organizations is anybody's guess. These figures begin to give one a feel for the size of the loan-shark industry and the extent of its market.

This concludes my prepared statement. I will be glad to answer any questions that the chairman or other members of the subcommittee desire to ask.

Mr. PIERCE. Professor Braucher.

STATEMENT OF ROBERT BRAUCHER, VICE PRESIDENT, NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS, AND PROFESSOR OF LAW, HARVARD LAW SCHOOL

Mr. BRAUCHER. Madam Chairman, I am Robert Braucher, professor of law at the Harvard Law School. This year I am on leave and teaching at the University of Minnesota Law School.

I have been in the business of teaching law in this field for 23 years, and I have been with the consumer credit activities of the Conference of Commissioners on Uniform State Laws since 1958.

Mr. Malcolm's prepared statement gives the history, going back that far.

Since last August, when the national conference promulgated the Uniform Consumer Credit Code, I have been a member of a small working group which was charged with (a) fixing it so that the Code was "substantially similar" to the truth-in-lending law, as the Federal Reserve Board viewed the meaning of "substantially similar"; (b) preparing official comments to the various sections of the Consumer Credit Code; and (c) work still in progress of preparing model State regulations which could be submitted to the Federal Reserve Board in the hope that they would find that the State regulations were substantially similar to regulation Z which the Federal Reserve has now promulgated.

As our project went along, after it was well along and truth in lending became something which looked as though it might be enacted at the Federal level, our people established some contact with the staff of the Senate Banking and Currency Committee, and with the people on the Federal Reserve Board staff, and so forth, and I recognized in the Consumer Credit Protection Act a certain number of words which I actually think I invented myself. I take particular pride in thinking that I am the person who actually coined the phrase "substantially similar," although I think when I coined it, I thought it meant something a little less than the word-by-word sameness which the Federal Reserve Board now seems to think it means.

As the truth-in-lending law took shape, of course, the suggestions that were largely technical were refined, revised and polished, in the heat of controversy, and then we generally yielded and copied our own words back into the Uniform Consumer Credit Code. We did not go quite far enough, and during the fall, through a lot of communication with the Federal Reserve Board staff, we found that there were certain things we had not done. One apparently serious discrepancy between our act and the Federal Reserve Act and regulations was this business of arranging for credit.

By the time that we got the message that that was regarded as critical, it was too late, because we already had bills introduced around the country and we could not catch up with everybody who was in charge of each of those bills, to make detailed numerous revisions. We took care of it, I think, pretty well as far as disclosure goes, because we did make one single amendment in all of the bills saying that the State administrator was authorized to issue regulations not inconsistent with regulation Z, which would cover the subject of arranging for credit.

So, I think on that we will be in full harmony.