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For Release on Delivery
Expected at 9:00 a.m., EST
April 12, 1983

Statement by
J. Charles Partee
Meraber, Board of Governors of i-he Federal Reserve System

before the
Committee on Banking, Housing and Urban Affairs
United States Senate
April 12, 1983

I am pleased to appear before this Committee on
behalf of the Federal Reserve to discuss a federal preemption
of state usury laws governing interest rates on business,
agricultural and consumer loans.

As you know, a temporary

preemption of business and agricultural rate ceilings, which
was passed as a provision of the Depository Institutions
Deregulation and Monetary Control Act of 1980, expired on
April 1 of this year.

The preemption had authorized lenders

to charge a rate up to 5 percent above the Federal Reserve
discount rate on business and agricultural loans of $1,000
or more in those states with ceilings less than this variable

Rate ceilings on consumer loans were not subject to a

federal preemption under the Act.

Rate ceilings on mortgage

credit were preempted permanently except in those states that
acted to override the preemption prior to April 1.

The bill

currently before this Committee recommends a permanent federal
preemption of state usury ceilings on business, agricultural,
and consumer credit without imposing an alternative federal
limit tied to the discount rate or any other interest rate.
The Board has long been concerned about the adverse
impact of usury ceilings on the availability of funds in local
credit markets.

Usury laws that impose unrealistically low

limits tend to reduce the supply of credit to local borrowers
by encouraging lenders to channel funds into other investments
or to geographic areas where they can earn market rates of

Alternatively, to compensate for the low interest


rates that are legally permissable, lenders may tighten non­
rate lending terms and credit standards, thus in effect
rationing available credit in socially undesirable ways.
Also, financial institutions can often restructure the types
of loans they make without altering the use borrowers make of
the funds.

For example, rather than offer traditional con­

sumer loans subject to an interest rate limit, lenders may
offer junior mortgages which typically are not subject to a
usury law, but which nevertheless add to the generalized pur­
chasing power of consumers.
In sum, since money is fungible, it will tend to
flow, in one way or another, to the credit markets offering the
highest economic rates of return.

Given the rapid deregula­

tion of interest rates paid by depository institutions, more­
over, the cost of funds to financial institutions in local
communities has become increasingly sensitive to national
money market developments.

This creates an even stronger

incentive for these institutions to earn a competitive return
on their assets.
Despite the Board's basic opposition to artifical
constraints on interest rates, we have had reservations about
federal intrusion into an area traditionally regulated by the
individual states.

In this regard, retention of a provision

clearly permitting states to override a federal preemption of
their ceilings seems an important minimal protection of state

Information collected by Board staff indicates


that, as of the middle of last year, a dozen states had at
least partially overriden the federal law imposed on them by
the Depository Institutions Deregulation and Monetary Control
Act of 1980.

Among these twelve states, however, usury ceilings

on business and agricultural loans either were unspecified or
fixed at levels where they had no effect on credit flows.
Those states that were most restricted by usury
ceilings generally did not act to override the preemption.
In fact, many states have moved to relax their regulation of
interest rates following the passage of the Deregulation Act.
Those states that have not relaxed or were slow to relax their
usury ceilings, particularly ceilings on consumer loans, fre­
quently have suffered certain costs, as financial institutions
increasingly have shifted some lending operations to other
states that have no usury constraints.
The Board believes that interest rates are best
determined in markets unconstrained by arbitrary rate ceilings
of any kind.

In the past, we have considered a variable rate

ceiling as a preferable alternative to fixed-rate state usury

However, the Board has viewed the use of the

Federal Reserve discount rate as an index inappropriate for a
variable interest rate ceiling at either the federal or state

Thus, the current bill is to be commended for not

tying a federal variable ceiling to the discount rate.
To summarize, the Board continues to believe that
state action rather than federal law should prevail whenever


possible in dealing with the problem of fixed-rate usury

Many states have acted since 1980 to reduce the

constraining effect of their usury ceilings on credit avail­
ability, and financial conditions have eased recently to the
point where usury ceilings generally are not now a binding

Although these factors weaken the current urgency

of the matter, they do not eliminate the underlying need for
further action to relax interest rate ceilings.

If the Con­

gress determines that this should be done through Federal pre­
emption, the Board would urge, first, that the states continue
to be permitted whatever degree of override their circumstances
seem to dictate and, second, that the Federal Reserve discount
rate not be used in any variable ceiling rate scheme.