What Happens When Loans Become Legally Void? Evidence from a Natural Experiment

Abstract

We use a natural experiment — an unexpected judicial decision — to study how the legal enforceability of consumer loans affects borrower behavior. In May 2015, a federal court ruled that the usury laws of three states — New York, Connecticut, and Vermont — were enforceable with respect to a subset of consumer loans that market participants had previously assumed were exempt from those laws. The decision was important because, in New York and Connecticut, borrowers on usurious loans have no obligation to repay any interest or principal. Using proprietary data from three marketplace lenders, we use a difference-in-differences design to study the decision’s effects. We find no evidence that consumers engaged in strategic default. However, upon examination of secondary market trading, we find that delinquent loans issued above usury caps trade at a discount. We also show that the decision reduced credit availability for riskier borrowers, who are more likely to borrow at rates above usury limits.

Keywords: usury law, strategic default, consumer lending, marketplace lending, Madden v. Midland

JEL Classification: D12, G18, G21, G38, D18