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The Credit Crisis and the Mafia:

I've noted on a couple of occasions that the credit crisis in the United States has made credit card and other similar credit less available to consumers and small businesses, leading them to substitute to lenders like layaway, pawn shops, and payday lenders.

In Italy, the impact of the credit crisis has been somewhat more alarming--the inability to get bank credit has generated a rapid growth in the market share of the mafia:

At a time when businesses most need loans as they struggle with falling sales, rising debt and impending bankruptcy, banks have tightened their lending to them.

Italian banks, which for years had been widely criticized for lending sparingly to small and medium-size businesses, now have "absolutely closed the purse strings," said Gian Maria Fara, the president of Eurispes, a private research institute.

That is great news for loan sharks. Confesercenti, the national shopkeepers association, estimates that 180,000 businesses recently have turned to them in desperation. Although some shady lenders are freelancers turning profits on others' hard luck, very often the neighborhood tough offering fat rolls of cash is connected to the Mafia, the group said.

"Office workers, middle-class people, owners of fruit stands, flower stalls are all becoming their victims. . . . We have never seen this happen," said Lino Busa, a top Confesercenti official. "It is as common as it is hidden."

Many experts say organized crime is already the biggest business in Italy. Now, Fara said, the untaxed underground economy is growing even larger. "Certainly I am worried," he said. "The banking system doesn't work, and the private one that is operating is often managed by organized crime."

In the United States we have a buffer of lending institutions in between formal bank loans and illegal loan-sharks, such as payday lenders and others. I don't know for certain, but my impression is that these fringe lending institutions are less-available in Italy (or Europe generally), where there are much stricter paternalistic limits on consumer lending, than here. Although the history of loan-sharking in America is sketchy (or at least I've never found a good source on it--please recommend it if you know of one), my sense is that mafia-controlled loan-sharking was much more prominent in the United States in the early 20th Century than it is today. Over time in the United States the light regulation of consumer credit enabled a range of lending institutions to develop, thereby reducing consumer demand for illegal loan-sharks.

PersonFromPorlock:
You have to wonder, though, how much defaulting there'd have been if mortgages were written by the Mafia.
3.2.2009 7:52am
smitty1e:
If the mafia own everyone, do they own anyone?
If all of the people on the the wrong end of the loans form their own organization, then what?
3.2.2009 7:52am
John Armstrong (mail) (www):
In the United States we have ... payday lenders.

Yes, we're much better off than Italy, because we've legalized loan sharking.
3.2.2009 9:39am
John Armstrong (mail) (www):
If all of the people on the the wrong end of the loans form their own organization, then what?

Smells like a union to me. Wow, that is a conundrum... who gets a slice of that action? The mafia's clearly out...
3.2.2009 9:45am
KenB (mail):
Yes, we're much better off than Italy, because we've legalized loan sharking
This seems to imply a moral equivalence between a payday lender and the mob. If you default, payday lenders deny further credit advances and may take you to court. The mob breaks your knee caps and may decide to dump you in the East River to make an example for the benefit of its other borrowers.

Is that really equivalent?
3.2.2009 9:53am
Erick:
And loan shark rates are well above payday loan rates as well. Mob loans can't be discharged in bankruptcy. Mobsters can come into your house and take random items to satisfy the loan. It really is a stupid comparison.
3.2.2009 10:00am
DiversityHire:
John Armstrong, you made me laugh. Isn't Gary Coleman MoneyTree's "enforcer"? He's not exactly Luca Brasi.
3.2.2009 10:49am
PLR:
At least in my area, the majority of the payday loan places are owned by the megabanks, who don't like to talk about them.
3.2.2009 10:54am
Chris 24601 (mail) (www):
Yeah, the United States, they have a lots of buffers.
3.2.2009 11:51am
smallrock:
Why do you persist in referring to layaway as a "lender" or as a form of credit?

Doing so demonstrates that you lack a basic understanding of what the word "credit" means.
3.2.2009 12:08pm
Bob White (mail):
Nicely done, Chris 24601.
3.2.2009 12:16pm
Allan (mail):
The mafia is essentially a government. Certainly not an elected government and not a recognized government. However, they have an economic system based on taxes (extortion money) and an internal revenue collecting mechanism (perhaps a slug to the knee). And they provide protection. Imagine if someone from outside the mafia tried to rob a mafia-protected business.

I argue that the mafia is a local government run by a despot. I further argue that the the correct disagreement with the mafia is not what they are doing (providing local government), but how they are doing it.
3.2.2009 1:13pm
painlord2k (mail) (www):
I'm italian.
The article is mainly sensationalist.
For what I know there are less legal restrictions of loans in Italy than in the US. But the banks here are much more stricter than the US ones to lend money.
100% mortgages are an innovation of a couple of years ago for example. Usually, a 25% down payment is the minimum required to have a mortgages.
The problem is in the civil laws courts and the time they need to rule. 3-5 years are common and much more is not uncommon. So, recovering a big bad loan is not easy.

The same is for normal loans for little business. They often go for the "extralegal" lending because, at the end, it is the only way to obtain a loan (and usually the terms are not so bad compared to the banks). If the Mafia or other mobster want a business they have many way faster and easier to obtain it than lending money to the owner.
3.2.2009 1:53pm
Randy R. (mail):
"I argue that the mafia is a local government run by a despot. I further argue that the the correct disagreement with the mafia is not what they are doing (providing local government), but how they are doing it."

Read Jane Jacob's slim book, Systems of Survival. She makes this exact point, and further explains why such quasi-gov't organizations are so dangerous. Whenever you mix profit making with governmental enforcement powers, you get what she calls a dangersous hybrid, and her main examples are communist governments and the mafia.
3.2.2009 2:01pm
painlord2k (mail) (www):
I must agree with Allan. Mafia (and other similar organizations) behave as a government. They control a territory in exclusive. Whoever want to do illegal business inside the zone must pay a tax; if they don't, they give out stern punishments to teach others to behave.
And, for sure, they don't take well when someone mess around in their territory.

From a economist point of view, their way of lending money is much more better than the way of the bank. There is no "fractional system". So, they are always solvent or they are dissolved in the acid by their business partners.
3.2.2009 2:08pm
SecurityGeek:
This certainly would improve the financial stimulus debate in the US...

"Cramdown me? You said cramdown ME?? No, cramdown you! You mother-cramdowning mother-cramdowner!"

I'm waiting for a website that automatically mashes up Scorsese dialog with mortgage terms substituted for the profanities.

"John Thain? You made me pop your eye out of your head for John Thain??"
3.2.2009 2:18pm
ShelbyC:
smallrock:


Why do you persist in referring to layaway as a "lender" or as a form of credit?

Doing so demonstrates that you lack a basic understanding of what the word "credit" means.



Or at least one of you does. I have the same lack of basic understanding, since layway is just a loan to purchase an item with the item being held to secure the loan.
3.2.2009 2:32pm
Tritium (mail):
In order to secure the war loans, the Federal Reserve intenetionally inflated the market. Because of over spending, the real estate was inflated more and more. Meanwhile, the banks were involved in the inflating oil on the speculative market. Problem with this banking situation is, taxpayers have to front money to protect the banks so that the loans are left as they are. If the banks were to fail, Congress loses all that tax money.

The excessive rates were basically a taxation upon people wishing to own a home. So if you got a loan recently, thank you for supporting the war... and don't worry, you'll be burdened with debt for the rest of your life.

Mortgage Backed War Spending Securities. The Adjustable Rate Morgages also became popular during the Iran Kontra. Taxing the American Dream, but casting the blame for ripping up the people onto the banks. (Who willfully cooperated to do such, cause they privately keep half the earnings after expenses.
3.2.2009 2:51pm
Allan (mail):
Two points:

1. Security Geek wins the comments hands down. (Todd please close the comments, nothing more useful can be added).

2. I have not read the book, but I shall gladly give credit to whomever. I never have had an original thought and I probably never will.
3.2.2009 2:52pm
Colin (mail):
layway is just a loan to purchase an item with the item being held to secure the loan

I don't follow this comment; what is the seller loaning? If I understand layaway correctly, the seller holds the item until the purchaser makes all the payments. Isn't the purchaser therefore effectively lending money to the seller, and then being repaid with the item the seller is holding? That would make the item more analogous to interest than collateral.
3.2.2009 3:19pm
ShelbyC:

Isn't the purchaser therefore effectively lending money to the seller, and then being repaid with the item the seller is holding? That would make the item more analogous to interest than collateral.

No. To the buyer it may seem that way, but if our understanding of layaway is correct, the only benefit the seller gets from holding the item is the use of it as collateral. He has to pay his supplier for the item, and can't sell it to anyone else. Now if the seller just commited to delivering an item at a future date and didn't have to hold the item the arguement might be different.
3.2.2009 6:25pm
Colin (mail):
Then the idea is that the seller is indirectly loaning the buyer the benefit of the carrying costs on the item? Abstruse, but interesting. It still looks to me as if the seller is the beneficiary of credit in the form of the time value of the prepayments.

This question comes up every time the professor posts on the topic of alternative credit. They're interesting posts, but his constant references to layaway as a form of usually results in a digression like this. I've never seen his answer to the question, though--has he explained in the past why he sees layaway as a form of credit? Is it for the reasons you mention?
3.2.2009 7:15pm
ShelbyC:
I haven't seen him answer the question. To me it seems like credit because the effect on the retailer's cash-conversion cycle is the same as if they handed the consumer the item and let him pay in installments. This only difference is that holding the item mitigates the risk of default.

The time value of the prepayments work against the retailer. He has to pay for the item, then after the transaction he doesn't get paid right away, he has to wait for the installments to come in.

If there an arrangement were the store could collect from the consumer, and not have to stock the item until he gets paid, then this would be credit from the consumer to the retailler, but that probably wouldn't be layaway.

I agree it would be intersting to hear the professor's take, though.
3.2.2009 7:34pm
Colin (mail):
If there an arrangement were the store could collect from the consumer, and not have to stock the item until he gets paid, then this would be credit from the consumer to the retailler, but that probably wouldn't be layaway.


That's actually more or less what I was envisioning. I assumed that most layaway transactions involve non-unique goods, of which the retailer will maintain a rolling stock. When a consumer buys an appliance on layaway, the retailer may take a specific unit and warehouse it until the payments are complete, but in many instances they may rely on their normal reserves of stock. That would minimize the ongoing costs, giving the retailer the benefit of the prepayment.

I don't know how most layaway transactions work, though. Your analysis is persuasive in any situation where the retailer's carrying cost isn't near zero. I suppose retailers want to keep their inventories as low as possible, so reserving layaway units will always impose some drag.
3.2.2009 8:20pm
Dan Simon (mail) (www):
I don't know whether the article's claim is accurate, but I'm extremely puzzled by Prof. Zywicki's negative reaction to it.

Prof. Zywicki has spent the last several years--a period that includes the largest, most reckless expansion of cheap high-risk credit in the history of the world--telling everyone who would listen that the main problem with the credit markets is that lenders are afraid to lend to high-risk borrowers as much or as cheaply as they otherwise would, because default has become too easy an option. His proposed solution to this supposedly urgent problem is to make default (via bankruptcy, for instance) more painful, so that lenders will be more confident that they will be repaid, and therefore willing to lend more money to higher-risk borrowers at lower interest rates.

Loansharking is simply a natural extension of this same idea. After all, even after all of Prof. Zywicki's "bankruptcy reform" ideas have been implemented, there will still be borrowers that no lender would trust to repay a loan--except, perhaps, if the lender reserved the right to, say, shoot the lender in the kneecaps in the event of default. Why on earth, then, would Prof. Zywicki object to Mafia loansharks serving this otherwise underserved market?
3.3.2009 9:11pm

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