Will Colorado Deny Its Residents Access to Credit?
If good intentions pave the road to hell, Colorado Attorney General Cynthia Coffman’s office appears poised to lay some additional asphalt. Colorado is suing two innovative Internet firms that help people get credit on the dubious grounds that the loans violate state law. Legally, this suit is wrongheaded. But, even worse, it also risks cutting Coloradans off from much-needed capital without protecting anyone.
The two companies being sued, Avant Inc. and Marlette Funding, are “marketplace lenders” who use the Internet as a delivery mechanism for credit. Both compete with banks for customers, but also provide credit to borrowers who don’t qualify for traditional bank credit. These loans can help borrowers consolidate existing debt. They can also serve as an attractive lifeline for borrowers who can’t get a credit card or bank loan but need credit to deal with a pressing need, such as home or car repair or medical bills.
These firms also partner with banks, which are allowed to make loans nationwide under the laws of their home state. Banks provide these loans, set their parameters, and retain a financial and regulatory interest in how they perform. Avant and Marlette then purchase the loans and collect payment from the borrowers. This arrangement allows the firms to offer a consistent nationwide product and gives Colorado borrowers — especially those who can’t get traditional loans — more options.
Unfortunately for these borrowers, the Attorney General’s office has decided they need to be protected from themselves. Notably, no one has alleged that Avant or Marlette lied to borrowers about the terms of the loans being offered — only that as non-banks, they are subject to a Colorado law that does not apply to out-of-state banks.
However, Colorado’s law is needlessly restrictive. All of the loans made by Avant and Marlette are under 36 percent, the traditional (though arbitrary) upper interest rate limit supported by consumer advocate groups.
The suit also cites a controversial decision by the U.S. Court of Appeals for the Second Circuit, which states that even legal bank loans become invalid when sold. Banks have the undisputed right to make such loans to Colorado residents, but the Attorney General’s office is ignoring their role by claiming Avant and Marlette are the real lenders.
In reality, banks are empowered to make and sell loans to non-banks. This was affirmed by the U.S. Department of Justice and the Office of the Comptroller of the Currency last year in a filing to the Supreme Court. As for the state’s assertions, the banks retain a significant interest in the loans.
The Attorney General’s office has the law wrong, but, more importantly, restricting access to credit is a terrible policy that will hurt Coloradans.
In the wake of the aforementioned Second Circuit decision, borrowers with lower credit scores had significantly less credit access from innovative lenders. Yet these are the borrowers most in need of more credit options. The ruling didn’t protect them; it prevented them from accessing the loans they preferred, forcing them to consider worse options.
Whether, in response, these borrowers took loans with worse terms, went to loan sharks, or simply couldn’t get loan to fix their problems, they were left worse off. This action will likely cause similar harm in Colorado.
If the Attorney General really wants to benefit her constituents, she should drop the suit and encourage lenders to compete for their business. The borrowers who were able to secure loans thanks to Avant and Marlette decided freely that these were their best options given their circumstances. They deserve to have their Attorney General support a more robust credit market, rather than try to shut part of it down.
Brian Knight is a senior research fellow at the Mercatus Center at George Mason University.