Banks: The New Loan Sharks

By AL LEWIS
A DOW JONES NEWSWIRES COLUMN

Terry Smiljanich was an Assistant U.S. Attorney in Tampa, Fla., in the 1970s, prosecuting loan sharks.

“Just like in the movies, guys would come down from New York to collect,” he recalls.

A deadbeat borrower in one of Smiljanich’s cases even survived the cinematic cliche:

“They went into a bar and grabbed him, took him for a little ride, and told him that if he didn’t find a way to pay them off within 24 hours they were going to break his legs.”

Terry Smiljanich

High-interest loans with terrifying consequences is such a lucrative business that America’s banking industry lobbied for years to make them legal.

“Bank of America doesn’t break your legs, but they will ruin your credit and they will hound you to death,” Smiljanich said.

Banks from Citigroup and Wells Fargo on down have raised interest rates on some of their credit card customers to as high as 36%. At that rate, an unpaid balance nearly doubles in two years.

“These are rates that the mob was afraid to charge,” Smiljanich complains.

Banks are suffering losses from mounting credit defaults. And they are racing ahead of new credit laws that take effect next month, restricting the fees they can charge and the ways they can jack up rates.

Taxpayer bailouts, and the ability to borrow nearly free money from the Federal Reserve, apparently weren’t enough to pay for their mistakes. So banks are sticking it to their most debt-dependent customers.

It used to be called usury.

At 62, Smiljanich is the semi-retired partner of Tampa law firm, James Hoyer Newcomer & Smiljanich, and the managing editor of a Web site called the Consumer Warning Network. In a recent video post, he offers a summation of how we as a society virtually abandoned the word, “usury.”

Proscriptions against unjust lending go back to ancient times when even some of history’s biggest despots feared the rich would take advantage of the poor.

In the 16th century, Henry VIII departed from Vatican law, capping lending rates at 10%. This became common law in the United States. And for much of U.S. history, those charging more could be prosecuted.

In the late 1970s, Congress relaxed usury laws so that banks could keep pace with runaway inflation. When inflation died, the laws remained relaxed at 18% to 21%. In 1999, usury laws were loosened further when Congress passed and President Clinton signed the Gramm-Leach-Bliley Act.

(Remember when former Sen. Phil Gramm called us a nation of economic whiners?)

This act allowed banks to charge whatever their state of operation permitted. So the frosty hell known as South Dakota–already permissive of usurious rates–did away with usury laws altogether as an economic development strategy. That’s why when you look at your credit card statement, you’re likely to see a South Dakota address.

“The banks just love South Dakota,” Smiljanich said. “From there, banks can charge you any interest rate they want. But if you or I charged interest rates that high, we’d be in jail.”

Which brings us to the 79.9% card from First Premier Bank. Which is based, where? Sioux Falls, S.D.

First Premier bills itself as the nation’s 10th-largest issuer of Visas and MasterCards. Clearly, its 79.9% special is a subprime offer for those whose credit history is so bad their only alternative is the neighborhood loan shark.

A representative of the bank sent me a two-page statement explaining its rationale for what appears to be the highest rate of any credit card in history.

Essentially, First Premier claims it is trying to help out the hapless victims of our economy, but I’ll let the bank say it in its own words:

“Our approach is much like high-risk auto insurance. If you have a bad driving record, you have to pay more and once your driving record has improved, your premiums will come down…

“People are looking for solutions…Personal bankruptcy filings are soaring, and more and more people are finding themselves affected by a negative credit history…

“Good credit takes years to build but it can be damaged very quickly. Divorce, medical situations and job loss are some of the main causes…We need to price our product based on the risk associated with this market…

“Because of the new regulations that limit the fees on a credit card to 25% of a credit card’s line, we will need to shift the premium from upfront fees on risk to the interest rate…

“We are conducting a variety of limited tests to gauge interest in various products. Some of these limited tests include offers of 79.9% and 59.9%. The 79.9% card has an upfront fee of $75. Individuals can avoid any interest charges on purchases by paying off their balances each month…

“We will be in full compliance with the new regulations Feb. 22, 2010.”

Don Lucchesi, a character in the 1990 film, “The Godfather Part III,” said, “Finance is a gun. Politics is knowing when to pull the trigger.”

Smiljanich put it this way: “Banks have better lobbyists than the mob.”

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–Al’s Emporium, written by Dow Jones Newswires columnist Al Lewis, offers commentary and analysis on a wide range of business subjects through an unconventional perspective. The column is published each Tuesday and Thursday at 9 a.m. ET. He can be reached at 212-416-2617 or by email at al.lewis@dowjones.com, or on his blog at tellittoal.com.