The Origins of Mandatory Disclosure Rules: Small Loans and State Law

The history of mandatory disclosure rules, and debates over the design of those rules, begins in the 1910s, when small-dollar loans were essentially outlawed in most states by rigid usury laws that limited the rate of interest that lenders could charge on all types of loans. Most states set the maximum rates at 6 percent or 7 percent per year—too low for lenders to profitably lend small sums of money given their fixed administrative costs. So, in 1916, a group of small-sum lenders formed a national trade association, the American Association of Small Loan Brokers, to professionalize and legitimize their business through the creation of better lending laws.^{Footnote 14} The lenders’ association appointed a delegation to meet with a group of reformers from the recently established Russell Sage Foundation, to put the business under a new scheme of regulation that would allow it to operate openly and profitably.

Based on its own research, the Sage Foundation shared the lenders’ belief that legal reform was necessary. Established by Olivia Sage in 1907 and named after her late husband, the foundation had a broad mission: “the improvement of social and living conditions in the United States.” It was among the first to fund the study of the small-sum lending industry and its regulation and, in the decades to come, would become the preeminent source of small-sum lending research and policy proposals. To address the “loan shark problem,” the foundation did not want to exterminate the small-sum lending business, which offered a valued service to low-wage workers. Rather, beginning in the 1910s, it sought to devise a new scheme of regulation that would drive out those lenders who charged excessively high rates, while encouraging “honest capital” to enter the business. The foundation worked with the lenders’ association to draft a mutually-acceptable model law that would include both limits on how much lenders could charge and rules for how they must disclose their charges to borrowers. The law, which became known as the Uniform Small Loan Law, could then be introduced and enacted in state legislatures across the country.^{Footnote 15}

To design the disclosure rules, the drafters of the law needed to identify the goals they hoped to achieve through price disclosure, and which of the many “true” methods of disclosure best achieved those goals. The debate that ensued between the Sage Foundation and the lenders’ association was the first of many fights over the form of disclosure mandates. As in the conflicts that would later arise, both sides agreed on the need to disclose the cost of credit. The dispute was over the question of how, not if, lenders should present this information to borrowers.

The lenders preferred a method of calculating their charges and disclosing their rates that both tracked their current business practices and made their charges sound “better” than the alternatives.^{Footnote 16} At the time, most lenders calculated and stated their charges in terms of a “discount” rate plus an origination or investigation fee.^{Footnote 17} This method made the rate of charge seem smaller than if the lender disclosed the cost of the loan as a single, all-inclusive rate.^{Footnote 18} As one lender explained, “2% and fees of $1 or $2 sounds better than 3-1/2% or 4% per month, though it may actually yield a greater revenue.”^{Footnote 19} They predicted that “the legislature is more likely to permit [interest plus fees] than to permit a flat rate of interest yielding an equivalent revenue.”^{Footnote 20} In addition, separating out fee charges also would allow lenders to split a loan into multiple smaller loans so as to “gain a larger revenue through repetition of the fee charge.”^{Footnote 21}

The Sage Foundation rejected this method, however. Instead, it demanded that lenders calculate and disclose their charges as a single, all-inclusive monthly rate to be applied to the declining loan balance. This method of disclosure served two purposes. First, it offered lenders a means to “overcome the stigma which has long been attached to the small loan business.”^{Footnote 22} By using a different method of cost disclosure, lenders licensed under the law could distance themselves from their “loan shark” precursors in the eyes of borrowers and, more important, investors. Indeed, transparent cost disclosure was one of several features of the law that lenders later advertised to potential investors, along with minimum capital requirements and state supervision. The law also required lenders to disclose both the borrower’s interest rate and the legal maximum rate, to further police against deception and overcharging.^{Footnote 23}

Second, in addition to burnishing the lending industry’s tarnished reputation, the all-inclusive rate method of disclosure alerted consumers to the total (high) cost of borrowing. It ensured that borrowers understood that the lenders’ charges were greater than usually allowed under state usury laws, and so lessened the potential for deception. It also stated the cost of credit in the least flattering terms, treating every fee the lender received from the borrower as part of the interest charge, and thereby discouraging borrowing. Reflecting back on the uniform law’s history in 1960, one lender’s attorney observed that the “all-inclusive” method of rate statement was the law’s “most important innovation.” It yielded a “highly overstated rate of charge” that “was designed to shock the borrower and deter him from non-necessitous loans.”^{Footnote 24}

Spurring price competition was not among the goals of the drafters of the Uniform Small Loan Law. Although the all-inclusive rate disclosure bears some resemblance to the modern Truth in Lending Act’s APR metric, stated in monthly rather than annual terms, the drafters of the Uniform Law did not intend that this method of price disclosure would keep down prices by encouraging borrowers to comparison shop. It would not have been worthwhile for borrowers to comparison shop among licensed lenders because almost all of them charged the legal maximum rate of 3.5 percent per month in the 1910s and 1920s. The Uniform Law set the legal maximum rate lenders could charge, rather than rely on disclosure to spur price competition. Borrowers were also unlikely to compare prices between licensed lenders and other types of lending institutions because there were few other lenders that offered small loans.^{Footnote 25}

In the 1910s, when the Uniform Law was drafted, the licensed lenders’ only real competitors were pawnshops and Morris Plan banks, also known as “industrial banks.” Both offered small loans to ordinary people, like licensed lenders, but each required borrowers to provide a different form of security to ensure the loan was repaid. Pawnshops required borrowers to hand over some type of valuable collateral to the lender, such as jewelry, and generally did not cater to the same clientele as licensed lenders.^{Footnote 26} The Morris Plan banks likewise expected each loan applicant to provide a specific form of security—namely, one or two co-signers on the loan who would be jointly liable for the borrower’s debt and from whom the bank could seek repayment if the debtor defaulted. The Morris Plan banks also used their own method of cost disclosure, which they argued was superior to the Uniform Law method.^{Footnote 27}

Other Lenders, Other “Truths” in Lending

As the number of consumer lending institutions grew over the first three decades of the twentieth century, each type of lender devised its own system of cost disclosure that best served its interests and each pursued the passage of special legislation that would sanction its disclosure methods. Each method incorporated different assumptions about what knowledge consumers needed to decide if and where to borrow, and which choices the law should promote. Disclosure rules never traveled alone, however. They were always paired with substantive constraints on the cost of credit.

Morris Plan banks, which first appeared in the 1910s, calculated and expressed their charges in the same form used by many small-sum lenders in the era before the Uniform Small Loan Law: as a discount rate plus fees. This method of disclosure, along with the banks’ clever, two-part structuring of their loans, allowed them nominally to charge no more than “6%.” Unlike lenders licensed under the Uniform Law, the banks structured each loan and its repayment as two separate transactions, one for a loan and the other for the sale of stock certificates on credit.^{Footnote 28} This structure was designed to sustain a useful legal fiction: the claim that the borrower had use of the full loan principal for the entire length of the loan, rather than possessing an average sum of only half the principal amount. For example, imagine a loan with a rate of charge stated as “6% discount plus fees.” For a $100 loan at a discount rate of 6 percent, plus a $2 fee, repaid over the course of a year, the borrower would receive $92 at the outset ($100 minus the $2 fee and $6 interest) and then repay the bank a little each month.^{Footnote 29} In total, he would pay $8 for the use of an average monthly balance of $46. In contrast, if the cost of the loan ($8) were instead expressed as a percentage of the average outstanding loan balance ($46), it would be more than twice as large—over 17 percent. Thus, by expressing their rates as a “discount plus fees” and pretending that the borrower had use of the entire loan amount for the duration of the loan, Morris Plan banks could disclose to prospective borrowers a “6%” rate of charge, the legal limit in many states.

Commercial banks began making small-dollar loans later, in the 1920s and ‘30s, after gradually overcoming their reluctance to extend lesser amounts of credit to individuals.^{Footnote 30} In the absence of enabling legislation, commercial banks employed devices similar to those used by the Morris Plan banks to keep their disclosed rates at “6%.” One method was to apply the borrower’s payments to a savings deposit account, rather than immediately applying them to reduce the outstanding principal balance. Like the Morris Plan banks’ sale of stock certificates, the savings account device helped to maintain the fiction that the borrower had use of the full amount loaned for the entire loan term. At maturity, the bank would apply the sum collected in the borrower’s savings account to pay off the loan in full.^{Footnote 31}

Both Morris Plan banks and commercial banks pursued legislation to allow them to calculate and express their rates in terms of a discount rate plus fees. Both wanted to avoid operating under the Uniform Small Loan Law, which would have limited the size of their loans to $300, eliminated their separate fee charges, and required them to disclose the cost of credit in terms of an all-inclusive monthly rate.^{Footnote 32} In New York, for example, Morris Plan banks initially operated under the general law governing “investment companies,” which sanctioned the “discount plus fees” method of calculating the rate, allowing a discount of “six per centum per annum.”^{Footnote 33} The banks later secured an amendment to the law that specified the maximum fees they could charge in addition to discounted interest.^{Footnote 34} In other states, the banks operated under the general corporation law or the banking law.^{Footnote 35} By the late 1960s, about half the states had adopted legislation specially drafted for industrial banks, which included price ceilings and permitted the banks to calculate and express their charges using the “discount plus fees” method.^{Footnote 36} For commercial banks, most states likewise adopted rules that limited credit charges and either explicitly or silently sanctioned the banks’ preferred rate calculation and statement method.^{Footnote 37}

Retailers who sold goods on credit adopted yet another method of disclosing their charges: as an “add-on” rate. When a customer bought something on credit, the credit charges were “added on” to the cash price at the time of the sale.^{Footnote 38} (In contrast, in the case of a discount rate, the credit charge was deducted from the loan principal at the outset of the loan.) Like a discount rate, the add-on rate would be expressed in dollars per hundred or as a percent. For example, if a retailer charged a 6 percent annual add-on rate, an item that cost $100 in cash would cost $106 if purchased using a twelve-month installment contract. Of course, a retailer could easily manipulate the size of its add-on rate by including some of the finance charge in the cash sales price. In the above example, a retailer might claim that it charged nothing for credit by selling the item for $106 to all customers, both those paying cash and those buying “on time.”

The add-on method of rate calculation and disclosure provided several advantages to retailers. First, it was relatively easy for a retailer to compute the credit charge using the add-on method. Second, many retailers would immediately sell the buyer’s debt to a company that specialized in buying installment sales contracts. These debt buyers, known as sales finance companies, purchased installment contracts from retailers at a discount, and recommended that retailers use the add-on method because of its simplicity.^{Footnote 39}

Unlike bans, retailers did not need to seek legal sanction for their add-on method of price disclosure because they operated under very limited state oversight. Before World War II, credit sales were essentially unregulated because they were not legally recognized as loans. Retailers often charged different prices for “cash” sales and for customers buying “on time,” but the law did not recognize the difference between the “cash” and “time” prices as interest.^{Footnote 40} According to the “time-price” doctrine, the transaction was outside the scope of state usury laws because the seller was not making a loan.^{Footnote 41} Thus, retailers were free to charge whatever they wished for financing, and had no obligation to disclose these charges to borrowers in any particular way.

This variety of disclosures concerned the Russell Sage Foundation and lenders licensed under the Uniform Law, who worried that expressing prices in terms of an “add-on” or “discount” rate would confuse borrowers. Some also feared that their “idealistic form” of rate disclosure, required by the Uniform Law, had saddled them with “a very severe handicap in attracting business as well as in fighting off annual attacks from legislative sources.”^{Footnote 42} To overcome this imbalance, they urged other lenders to tell the “truth,” by adopting the Uniform Law’s all-inclusive method of disclosing their prices. As one lender explained, “The burden of telling the truth may be a cross we bear, but surely it will lead to a much longer existence.”^{Footnote 43} The meaning of “truth” was not so easily decided, however.

The Uniform Law Method Under Attack

Arguments soon broke out within the lending industry over which group of lenders provided the most “truthful” form of cost disclosure. As a wider array of lenders began offering small loans, licensed lenders and the Russell Sage Foundation launched a campaign to convert other lenders to the Uniform Law method of disclosure. In support of this effort, they emphasized the original rationale behind their chosen form of disclosure: avoidance of deception, and the advancement of “truth” and transparency. On occasion, they also mentioned that disclosure would aid competition, but never proposed that better, more truthful disclosures could substitute for direct price controls. Rather, the question at the heart of these debates was the meaning of “truth” and its inverse, deception.

The fight that ensued over the Morris Plan bank method of disclosure captures the arguments on both sides. Almost as soon as Morris Plan banks began operating, the Sage Foundation and the lenders licensed under the Uniform Law came out strongly against the banks’ method of disclosure. The Foundation doubted the “truth” of the Morris Plan banks’ “discount plus fees” rate disclosure. “The fee is one of the bulwarks of the loan shark,” a Sage Foundation official warned in 1916.^{Footnote 44} The following year, the official wrote to one of the early investors in the Morris Plan scheme, outlining his concerns about the banks. The problem was neither the absence of disclosure nor the high rate of charge, which was actually less than licensed lenders demanded. Rather, the foundation official objected to the Morris Plan method of disclosure. He argued that the rate on the Morris Plan loans was “considerably more than 6 per cent”—“the real interest rate is over 19 per cent.”^{Footnote 45} Furthermore, he added, “any company doing a loan business, especially when it is dealing with persons who have not had much business experience and training, should be required to state in the clearest possible way what the real charge to the borrower is.”^{Footnote 46} Calculating and stating charges in terms of a discount and fees was likely to mislead borrowers, the foundation contended.

Morris Plan officials responded that their methods were truthful and more accurate than those employed by the licensed lenders. One Morris Plan banker seemed puzzled by the Sage Foundation’s objections to the lending scheme. As he put it, the foundation did “not criticize the cost of loans under the Morris Plan System, but only the mode of stating it.”^{Footnote 47} While acknowledging the logic of the Sage Foundation’s total rate calculation, the banker insisted that the assumptions on which it relied were faulty. The rate that Morris Plan banks disclosed was correct because the loan and the sale of the stock certificates were “separate and distinct” transactions, he claimed.^{Footnote 48} Furthermore, he argued that the “interest cost” should not include the investigation fee, which is “an expense to the borrower” but not part of the “interest” on the loan.^{Footnote 49}

The Sage Foundation engaged in a slightly different version of the same debate with commercial banks after the foundation drafted a model bill in the early 1940s that followed its preferred disclosure method. In response, the American Bankers Association (ABA) drafted its own competing bill, which permitted rates to be stated on the discount and fee basis.^{Footnote 50} As with the Morris Plan banks, both sides claimed the mantle of the defenders of “truth” in lending.^{Footnote 51}

The Sage Foundation presented its proposal for bank disclosures in terms of the consumer’s interest in transparency, raising many of the same arguments deployed against the Morris Plan banks. A foundation official accused the bankers of refusing “to tell the truth about their interest rates.”^{Footnote 52} The president of Household Finance Corporation wrote an open letter to the ABA, extolling the benefits of the “Simple Interest Method.”^{Footnote 53} The “Discount-Plus Method” “conceals the rate,” he explained.^{Footnote 54} Furthermore, its use would drive other lenders to state their charges in the same disguised manner, to remain competitive for borrowers’ business. The banks would set off a race to the bottom, with all lenders “dragged toward the level of the worst.”^{Footnote 55} Academic William Trufant Foster backed the licensed lenders’ position, arguing that other methods provided “easy possibilities of clouding or evading the simple truth.”^{Footnote 56}

Advocates also occasionally referenced the link between “truth” in labeling and effective competition, as a secondary rationale for uniformity. Household Finance claimed that “honest weights and measures and honest labeling” were necessary to make “competition effective.”^{Footnote 57} A Sage Foundation official likewise compared its proposal to laws mandating the labeling of goods for sale: “It requires those who make loans to consumers to use the same scales in weighing out and pricing their wares.”^{Footnote 58}

The American Bankers Association also claimed to represent the best interests of borrowers, however. According to the ABA, the discount and fees method was “the only method whereby the exact cost of a loan can be clearly understood and computed in advance” by the borrower.^{Footnote 59} They deemed the foundation’s all-inclusive method “deceptive” and “confusing” because “it does not and cannot tell the borrower how many dollars the loan will cost him.”^{Footnote 60} Stating the rate in terms of dollars discounted fulfilled the banks’ responsibility to “tell the public the truth.”^{Footnote 61} In contrast, the licensed lenders’ method “does not tell the whole truth,” a state banking trade association explained.^{Footnote 62} Another banker argued that the licensed lenders were the ones guilty of deception because “the public believed 3 per cent a month mean[s] 3 per cent a year.”^{Footnote 63}

Writing the rules for sales finance disclosures proved equally contentious. The push for greater regulation of sales finance charges began in the 1930s among consumer advocates working within the National Recovery Administration, or NRA, the New Deal agency charged with writing codes of conduct for various industries. The agency included a Consumers’ Advisory Board, which urged inclusion of cost of credit disclosure rules in the retail trade codes. Among the Consumer Advisory Board members who backed this proposal was Paul Douglas, then-economist and future author of the federal Truth in Lending Act.^{Footnote 64} The board’s proposed rules would have required retailers and finance companies to adopt the Uniform Small Loan Law method of rate disclosure, expressing their charges for credit as “a given percentage on the current unpaid monthly balance.”^{Footnote 65} The proposal failed, however. Industry dominated the code-making process and the Consumer Advisory Board had little influence within the NRA.^{Footnote 66} The NRA “retail trade” code included only a brief mention of disclosure, requiring that sellers not “misrepresent” their “credit terms” in advertisements; the finance company industry did not approve a code before the NRA was disbanded in 1935.^{Footnote 67} A handful of state legislatures did adopt some form of credit sales regulation in the 1930s. These laws included ceilings on credit charges, but did not specify a particular form of price disclosure.^{Footnote 68}

The Federal Trade Commission introduced some of the earliest restraints on sales finance rate disclosures in 1939, after the FTC investigated the rate-disclosure practices of several major American car manufacturers and their affiliated finance companies. It was common practice for car dealers to state their finance charges in terms of a “discount rate,” much like commercial banks used.^{Footnote 69} The FTC concluded that advertisements for buying a car on the “six percent plan” were likely to deceive consumers, since many buyers would not understand that the rate was a discount rate. (Advertising the discount rate made the cost of credit appear to be lower than if the rate were stated as an “equivalent annual rate,” a metric invented by the FTC.)^{Footnote 70} The FTC had no authority to require that car dealers use a particular form of rate disclosure and could not regulate their charges directly. It did, however, demand that dealers stop using the discount rate in their ads beginning in 1939.^{Footnote 71}

A year later, in 1940, the Sage Foundation drafted a model state law that would have required sales finance charges to be disclosed using the Uniform Law method.^{Footnote 72} The law met with stiff resistance from the sales finance industry, however, and failed to garner legislative support.^{Footnote 73} After World War II, perhaps to quiet demands for its adoption of the Uniform Law method of disclosure, the sales finance industry supported a requirement for mandatory disclosure of its credit charges, but stated in terms of the dollar amount of the charge.^{Footnote 74} More broadly, lenders and retailers continued to employ a multitude of methods for disclosing their rates of charge and evidenced little willingness to jump on the Uniform Law bandwagon.

Indeed, by 1960, the Uniform Law method and the campaign for uniform cost of credit disclosure seemed to be in retreat. The campaign faltered for several reasons. First, fractures within the association of lenders licensed under the Uniform Law weakened the calls for the spread of their method of disclosure, which some licensed lenders had come to oppose.^{Footnote 75} Second, the Sage Foundation, which might have brokered a compromise among the competing factions of lenders and their methods of disclosure, largely withdrew from policy advocacy work in the mid-1930s, and closed its lending division entirely in 1946, following the sudden and unexpected death of the lending division director.^{Footnote 76} (Even without the director’s untimely death, the foundation would likely have closed the division as part of its reorganization in the late 1940s, and to avoid further conflict with commercial bankers who vocally opposed the Foundation meddling in their business affairs.^{Footnote 77}) Third, the drafters of a model set of state commercial laws, called the Uniform Commercial Code, decided to avoid the sticky issue of rate disclosure altogether when they hammered out their proposed code in the 1940s and early 1950s.^{Footnote 78} Fourth, by the end of World War II, commercial banks and other lenders had formed powerful trade associations, which each advocated for their own practices to continue.

Finally, consumer groups were not pushing for uniform cost disclosure rules by the early 1960s, focusing instead on other concerns related to credit sales.^{Footnote 79} Although borrowers lacked a uniform, all-inclusive metric that would allow them to compare the price of different types of loans, few consumers lobbied for such a measure in the late 1950s or early 60s. This may be because many lenders already operated under some form of state regulation governing how much they could charge and how they must disclose their charges to borrowers—either in terms of absolute dollars or in dollars per hundred. If lenders complied with these regulations, borrowers would know how much each type of loan would cost them in dollars, and could rest assured that lenders’ charges would not exceed certain limits. For example, by 1960, almost all states had adopted some form of retail installment sales regulation that mandated the disclosure of both the cash sales price and the amount of the credit service charge.^{Footnote 80} These laws also often placed limits on the amount of the charge, stated in terms of an add-on rate in dollars per hundred.^{Footnote 81} A handful of states also regulated a new form of sales credit—revolving credit—that provided borrowers with greater flexibility, allowing repayment of a debt in irregular amounts over time with no set payment schedule or end date.^{Footnote 82} As one scholar described, these laws attempted to limit rates of charge “not by providing buyers with a uniformly applied yardstick of credit costs,” but by granting the government authority “to limit and watch overcharges.”^{Footnote 83}

By 1960, consumers’ more pressing complaints were about shady sales practices, such as false or misleading advertising, bait-and-switch sales tactics, high prices, and retailers’ substitution of inferior goods for those ordered. Furthermore, consumers complained, credit sellers commonly included a provision in their sales contracts that insulated finance companies and other entities that purchased the consumer’s debt from liability for the seller’s misdeeds.^{Footnote 84} Consumers also objected to abuses involving wage garnishment and the repossession practices of some creditors, who encouraged customers to make a new credit purchase just before their older debts were fully repaid so as to increase the likelihood that the creditor could repossess the merchandise.^{Footnote 85} Mandating a uniform method for disclosing the cost of credit solved none of these problems. Thus, consumer groups were not the primary impetus behind the introduction of federal cost of credit disclosure regulation in the early 1960s. Rather, as legal scholar Edward Rubin concluded, the origins of what became the Truth in Lending Act “can be definitively traced to a single person, Senator Paul Douglas of Illinois.”^{Footnote 86}

(Re)Defining the Form and Function of “Truth” in Congress

Although Douglas’s interest in disclosure dated back to his work in the National Recovery Administration in the 1930s, new calls for disclosure in other areas of consumer law likely inspired him to put forth his credit “labeling” bill in 1960, nearly a decade after he had joined the U.S. Senate.^{Footnote 87} Only two years prior, in 1958, Congress enacted the Automobile Information Disclosure Act, which required that all new cars display a window sticker that provided certain price and cost disclosures, nicknamed “Monroney stickers” after the senator who authored the bill.^{Footnote 88} The 1960 Douglas “Consumer Credit Labeling Bill” similarly would have granted consumers the right to receive certain information prior to completing a transaction.^{Footnote 89} It required lenders to disclose to borrowers two pieces of information: the total finance charge in dollars, and the relation of that charge to the unpaid loan balance “expressed in terms of simple annual interest.”^{Footnote 90} The second requirement was novel and ultimately proved to be the most controversial; no jurisdiction, including the District of Columbia, required price disclosure in this form.

According to scholar Edward Rubin’s research, Douglas’s legislative assistant drafted this original version of the bill, without the advice of industry or consumer-interest groups.^{Footnote 91} In 1960, Douglas introduced the bill in the Senate Banking subcommittee that he chaired, on Production and Stabilization. In the course of the ensuing debates, Douglas hoped to win the support of other powerful subcommittee members, including committee chairman Senator A. Willis Robertson, a Dixiecrat from Virginia, and Senator Wallace Bennett from Utah, who became the committee’s highest ranking Republican after the departure of Republican Homer Capeheart in 1962.

What goals did Douglas hope to achieve through disclosure? Originally, Douglas conceived of the benefits of disclosure in then-familiar terms, as advancing the same objective as the Uniform Small Loan Law: avoiding deception and warning borrowers of the high cost of credit. Douglas also briefly mentioned a secondary goal: encouraging “price competition” in the consumer credit market.^{Footnote 92} But Douglas did not originally intend that the “simple annual rate,” later renamed the “annual percentage rate,” would provide an exact measure of the cost of credit so as to aid consumers in making precise cost comparisons. As he wrote to one banker in 1961, “We do not expect great accuracy in the annual percentage rate.” Rather, Douglas hoped to impress upon borrowers a more general sense of the high cost of credit, furthering his primary goal of avoiding deception and preventing excessive borrowing. “We are concerned with letting the borrower know that the rate is 12 percent rather than 6 percent, or 18 percent rather than 1½ percent,” he explained. He fully agreed that the agency administering the bill should provide a “little leeway” for creditors, allowing rounding to the nearest whole number.^{Footnote 93} In 1962, he proposed an amendment to the legislation that would allow “some flexibility or ‘approximation’ of the annual rate.”^{Footnote 94}

At this time and during the years that the bill was under debate, Douglas viewed disclosure as a complement to price ceilings and other consumer protection laws, not a substitute for them. In 1964, four years into the long congressional debate over the Douglas bill, Douglas remained convinced of the value of legal limits on the price of credit. He wrote to the Illinois attorney general in regard to a constituent’s credit problem, noting that Truth in Lending would provide a “much stronger arm for enforcement” against high-rate lenders, especially organized crime, assuming that these lenders failed to disclose the “true annual interest” rate “on the face of the contract.” He advised the constituent that Truth in Lending would provide grounds for federal prosecution of those lending at “exorbitant” rates.^{Footnote 95} Two years later, in 1966, Douglas noted that his bill would “require uniform listing of credit costs,” but it would still be “up to the States to provide protections for most of the many other abuses” in the credit field.^{Footnote 96}

The stated goals behind Douglas’s disclosure legislation shifted over the course of the eight years that Congress debated the bill, however. As Edward Rubin concluded, Douglas became fixated on advancing disclosure for its own sake, rather than on achieving a goal or set of goals through disclosure. The subcommittee that debated the legislation did not explore other methods of regulating consumer loans, but “was willing to consider alternative goals by which its chosen methods could be justified.”^{Footnote 97} In Rubin’s words, “The bill began as a disclosure statute, and a disclosure statute it remained.”^{Footnote 98} In an inversion of the usual relationship between means and ends, the means remained fixed, while the purported ends and rationale linking ends and means changed. It took nearly seven years, but supporters of the bill eventually hit upon a more appealing “ends” for their chosen “means.” Rather than curtailing excessive use of credit and combating deception, they instead emphasized the goal of spurring price competition.

The original framing of the “purposes” for the measure yielded Douglas few supporters, but he quickly amassed an army of critics.^{Footnote 99} These included Republican Senator Wallace F. Bennett. Bennett’s family had numerous connections to the business community, and Bennett himself was the former president of the National Retail Merchants Association. Viewing the law from the creditor’s perspective, Bennett argued that expressing credit charges in terms of a simple annual rate would require complex calculations and would place a huge burden on business. To illustrate the difficulty, Bennett asked a few experts to calculate the simple annual rate on a basic transaction: a $20 battery sale with a $2 finance charge, repaid over two months. Their answers ranged from 118.9 to 129.5 percent, and the task reportedly took at least twenty-five minutes to complete.^{Footnote 100} After Bennett showcased the problems with Douglas’s “simple interest” metric, the bill failed to emerge from committee and Douglas struggled over the next two years to rally support for the measure, which he renamed the Truth in Lending Act.^{Footnote 101}

Douglas’s critics repeatedly scolded him for wasting time and money on legislation that no one wanted. Committee chairman A. Willis Robertson, for instance, derided Truth in Lending as one of Douglas’s “pet schemes.” Although President Kennedy publicly backed the bill, Robertson characterized the administration’s support as “lip service.”^{Footnote 102} Robertson strongly objected when Douglas requested authorization to hold field hearings on the bill in several cities across the country, and complained in 1962 about the mounting cost of debating a bill that Congress had twice rejected.^{Footnote 103} The monthly magazine of the Chamber of Commerce of the United States, Nation’s Business, asked in 1963: “Why, despite more than three years of lobbying, do even proponents concede that consumers are not excited about this legislation?”^{Footnote 104} Douglas eventually succeeded in scheduling field hearings over the fall and winter of 1963–64, which raised public awareness of the bill. But, shortly after the hearings concluded, the Boston Globe opined that there “is no deep-seated public backing” for the bill.^{Footnote 105}

Although Douglas attempted to portray his opponents as antidisclosure, the point of contention was not whether the cost of credit should be disclosed, but how. It was the same question that had animated prior wars over disclosure, such as the battle between the Morris Plan banks and the Russell Sage Foundation in the 1930s and ‘40s, as well as between the foundation and retailers selling goods on credit. Everyone agreed that creditors must provide information to borrowers about the cost of taking on debt. As Bennett explained in 1963, “I am not opposing the bill because I am opposed to truth.”^{Footnote 106} Rather than opposing disclosure, lenders objected to the method of disclosure that Douglas demanded, the APR metric.

Most creditors supported cost of credit disclosure, but with the cost stated in dollars rather than percentages. They insisted that there were many ways to express the “truth” about the cost of a loan and criticized Douglas for his single-minded pursuit of the APR method. Bennett objected to Douglas’s assumption that “there is only one way in which this information can be given and that somehow you are not telling the truth if you tell the buyer how much the credit will cost in dollars, or if you tell him the rate of interest he is paying by the month.”^{Footnote 107} Lenders argued that consumers were accustomed to budgeting in dollars and cents and did not think in terms of percentage rates.^{Footnote 108} Providing rates to customers would be costly for creditors and offer little value to consumers. Bennett warned that merchants selling goods “on time” might just add the cost of credit to the price of the goods, making the credit buying process even less—not more—transparent.^{Footnote 109} Some stores threatened that they would no longer be able to offer certain types of credit if the Douglas bill were adopted.^{Footnote 110} Bennett succinctly explained to a constituent that the bill “is one of these things where it sounds like a good idea, but it just won’t work out.”^{Footnote 111}

Creditors also complained that calculating the effective rate on “revolving” credit accounts was particularly difficult, and likely to yield an “untrue” result. One witness, a professor at Harvard Business School, explained how the interest rate would be calculated on a revolving account when the borrower made payments and new purchases at irregular intervals. As drafted, the bill required the creditor to disclose an 18 percent APR if a creditor charged a fee of 1.5 percent of the account balance at the beginning of each month (1.5 percent/month x 12 months = 18 percent/year). But, the witness explained, the “real” interest rate might be higher or lower, depending on how the account balance changed over time. Most stores assessed a monthly service charge based on the account balance at the beginning of the month, not based on the average daily unpaid balance. The effective rate might be higher than 18 percent if the borrower made a payment on her account early in the month and a purchase late in the month.^{Footnote 112} In light of these distortions, one opponent suggested that the bill would be more accurately called “Lies in Lending,” or “Approximate Truth in Lending.”^{Footnote 113} Another dubbed it the “confusion-in-lending” bill.^{Footnote 114} Bennett proclaimed: “I can’t support a law that would force businessmen to lie.”^{Footnote 115}

Opponents also argued that legislation focusing on disclosure alone was inferior to measures that followed a more holistic approach, such as the proposed Uniform Consumer Credit Code (U3C). The U3C was a project of the National Conference of Commissioners on Uniform State Laws (NCCUSL), which aimed to draft a comprehensive regulatory code that would address both disclosure and substantive limits on interest rates, loan terms, and debt collection practices.^{Footnote 116} Walter D. Malcolm, then-president of the NCCUSL, took a particularly dim view of the Douglas disclosure-only approach in his testimony on the Truth in Lending Act. After noting that the states had experimented with various methods of preventing creditor overreaching, he complained that the Truth in Lending Act “picks one of these methods, disclosure, and it adds to it a new feature; namely, requirement of a single simple annual rate plus a disclosure of dollars and cents.” In his view the drafters of the bill had ignored the wealth of information and experience gained by the states in their experiments with various techniques of credit regulation. Instead, the drafters selected “one of the techniques that has been developed from experience—namely, disclosure—and sa[id], this is it.” Moreover, the chosen disclosure metric, the APR, seemed to be “pick[ed] out of the wind, out of the wide blue yonder.”^{Footnote 117} Piling on, a banking industry witness also noted that requiring lenders to state their rates in terms of APR would raise difficult questions about whether the rates violated states usury laws, which were usually not framed in terms of APR but rather in dollars-per-hundred.^{Footnote 118}

Despite the many arguments raised against the bill, however, Wallace Bennett conceded that “the emotional appeal” was “all on Douglas’ side.”^{Footnote 119} One retailer and Douglas opponent complained in November 1963 that it was “apparent that Douglas has the popular side of the story, at least with the writers of Washington news.”^{Footnote 120} Douglas made the case for the bill by spotlighting general abuses in the consumer credit market, which had little to do with the lack of APR disclosures. (There were likely few customers with problems that arose because they knew the dollar cost of credit, but were unable to comparison shop using APR. Moreover, even if such witnesses existed, their problems would have been far less compelling than those that were presented at the hearings.) Some witnesses described instances of outright fraud, or of creditors who failed to make any price or credit cost disclosures whatsoever, contrary to the existing law in most states.^{Footnote 121} Consumers also wrote letters to Douglas, recounting similar woes that had little to do with the absence of an APR disclosure. Their testimony illustrates the power of what legal scholars Omri Ben-Shahar and Carl Schneider have called “trouble stories,” narratives of individual problems presented to prove the need for systemic legal reform.^{Footnote 122}

Douglas’s opponents recognized that the testimony offered at the 1963–64 hearings had emotional appeal, but failed to establish the need for a federally mandated APR disclosure. They then grew frustrated as the “horror witnesses” helped Douglas garner more popular support. As Bennett observed in late 1963, “Ninety per cent of the examples of credit abuse that have been brought to the committee involve violations of present law and depict situations which would not be affected if [Truth in Lending] were passed.”^{Footnote 123} Alfred A. Buerger, a member of the NCCUSL, likewise noted that “many of these stories may be true, but on the whole they seem to involve abuses in selling practices rather than in credit practices.”^{Footnote 124} To draw attention to this issue, in November 1963, Bennett asked an attorney at Arnold, Fortas and Porter to help him draft questions “to get [the] Douglas horror witnesses who [testified that they] would not buy ‘if I had only known the interest rate,’ to also admit that they would not buy if ‘I had only known the dollar charges.’”^{Footnote 125}

The 1963–64 hearings on the bill carried Douglas further along the path to its enactment, but the real turning point came a few years later, after Douglas had left the Senate. By the time Douglas lost his reelection bid in 1966, he had managed to get the bill voted out of subcommittee, but the measure failed to emerge from the full committee over the course of his six-year struggle.^{Footnote 126} The breakthrough came after Douglas left office in 1967, when his ally, Senator William Proxmire, took up the charge, reintroducing a revised version of the bill.^{Footnote 127} By this time, the composition and dynamics on the Banking Committee had shifted in favor of the measure.^{Footnote 128} Furthermore, Massachusetts had adopted its own “truth in lending” legislation, which proved that such a law could work in practice, without disrupting the consumer credit market.^{Footnote 129} The Department of Defense had also adopted a rule requiring lenders extending credit to military service members to disclose their charges in terms of dollar cost and a simple annual interest rate.^{Footnote 130}

Perhaps most important, Proxmire was willing to compromise with his opponents on the most contentious issue: the treatment of revolving credit accounts. Rather than a one-size-fits-all rule, Proxmire agreed to exempt certain revolving credit plans from the annual rate disclosure requirement, allowing those lenders to disclose a monthly rate instead. This compromise garnered Wallace Bennett’s approval of the bill, after a seven-year “stalemate.”^{Footnote 131} Under Proxmire’s guidance, the Truth in Lending bill cleared the Senate in 1967, shortly before the House passed its own version, in 1968.^{Footnote 132} After the two chambers reconciled the differences in the two bills, the final version of Truth in Lending was signed into law in May 1968, as Title I of the Consumer Credit Protection Act.

The final bill did not include the Proxmire compromise on revolving credit, however. Instead, it required all creditors to disclose the cost of credit as an annual percentage rate, with special calculation instructions for revolving accounts.^{Footnote 133} It also took an exacting approach to disclosure accuracy, contrary to Douglas’s original idea that lenders should have a “little leeway” in the APR disclosure, rounding to nearest whole number percentage.^{Footnote 134} The final bill specified that the tolerance for error in the APR disclosure was ¼ of 1 percent for most loans.^{Footnote 135} Such precision was unnecessary to meet Douglas’s original objectives, but this approach better served the new stated purpose of the bill: strengthening “competition among the various financial institutions and other firms engaged in the extension of consumer credit.”^{Footnote 136}

Yet, even as the bill’s stated purpose shifted, lawmakers made no mention of removing price ceilings for credit charges, which continued to exist at the state level. Congress expected that the states would continue to regulate other aspects of consumer lending, just as they had before TILA.^{Footnote 137} Federal legislation would govern the form of cost disclosure, while state law would continue to police the substance of loan agreements. TILA was born into a world with usury laws and other state-level limits on loan terms, and did little to alter the protections in place in the states. Indeed, TILA specified that the APR had no bearing on state definitions of “interest” and that the APR did not constitute an interest rate for the purpose of state usury laws.^{Footnote 138}

The 1970s and Beyond: Disclosure and Substance Drift Apart

Thus, after 1968, the states and federal government divided responsibility for form and substance in consumer credit regulation. Before the Truth in Lending Act, under state law, disclosure rules had traveled hand-in-hand with substantive legal limits on loan terms. The same legal authority determined both the form and substance of lending agreements, including constraints on the rate of charge. Now, federal law dictated the form of cost disclosure, and state law policed the amount lenders could charge. States also continued to govern the process of debt collection, while federal law now set a nationwide ceiling on the amount a creditor could deduct or “garnish” from a worker’s wages each month to repay a debt.^{Footnote 139}

Since the Truth in Lending disclosure rules did not grant borrowers any new substantive protections, a number of scholars and government officials predicted that they would be of little use to many consumers, particularly the poor. These critics observed that disclosure of a uniform price metric, to facilitate comparison shopping, was no help to those with limited access to credit or ability to shop around for a bargain.^{Footnote 140} The more significant problems for poor consumers involved fraud and price gouging. Studies conducted after the law went into effect supported the skeptics’ claims. After TILA, consumers were, at best, slightly more aware of the cost of credit and middle-class consumers showed the greatest improvement in awareness.^{Footnote 141} Furthermore, even for middle-class consumers, the disclosures were provided too late in the borrowing process to encourage comparison shopping.^{Footnote 142} Six years after TILA’s adoption, law professor William Warren concluded that the idea of disclosure as an “aid to credit shopping” was “simple and appealing,” but “it appears that the idea probably doesn’t work.”^{Footnote 143}

Yet, the TILA disclosure rules ultimately proved valuable to low-income borrowers, as well as middle-income ones, for a purpose other than discouraging excessive borrowing or comparison shopping: they offered a strong defense to debt collection lawsuits. The real value of Truth in Lending to these groups became apparent on July 1, 1969, or “Z-day,” the effective date for the regulations adopted by the Federal Reserve Board to implement the Truth in Lending Act, known as Regulation Z.^{Footnote 144} On Z-day, consumer advocates immediately filed a TILA violation lawsuit in New York, after the Harlem Consumer Protection Union sent a representative into a furniture store on 125th Street to buy a television on credit. When the store disclosed the credit charge in dollars, but not as an APR, attorney Philip Schrag of the NAACP sued on the buyer’s behalf in federal court.^{Footnote 145} Other consumer advocacy organizations followed suit.

One lawyer, Mark Pettit, later described the process of raising a TILA defense as the “disclosure defense game.” As he described, a low-income borrower might have other defenses to a debt collection suit based on the lender’s misconduct or the quality of the goods sold on credit, but disclosure-based claims were often superior for a few reasons. For one, the remedies for disclosure violations were more generous, including minimum damages and attorneys’ fees. In addition, proving a disclosure claim did not require an elaborate fact-finding expedition; the violation appeared on the face of the loan documents. Finally, creditors had few defenses to borrowers’ disclosure claims.^{Footnote 146} Disclosure claims were “almost always available” because of the difficulty for creditors of complying with TILA.^{Footnote 147} Although borrowers often had substantive complaints, TILA claims were easier to assert, offering borrowers a “rough sense of justice.”^{Footnote 148} Congress later enacted the Truth-in-Lending Simplification and Reform Act in 1980, to address lenders’ difficulties in complying with the law and also stem the rising tide of TILA litigation.^{Footnote 149}

Meanwhile, in the decade after the passage of the Truth in Lending Act, the composition of the lending market was changing. The bank-issued credit card, a form of revolving credit, was a relatively new product at the time that Congress began debating the Truth in Lending Act in 1960.^{Footnote 150} But credit card usage increased dramatically in the decade between 1967 and 1977, when consumer use of all varieties of credit cards increased at an average annual rate of 12.2 percent.^{Footnote 151} Although the credit card system was a “legal infant” in 1960, its growth prompted the states to begin regulating this new species of credit, either interpreting their existing rules on revolving credit to apply to bank-issued cards or drafting new card-specific rules.^{Footnote 152} By the mid-1970s, most states set limits on how much card issuers could charge (1 percent or 1.5 percent per month).^{Footnote 153} The Truth in Lending Act then required issuers to disclose this rate in terms of an APR.

This regime of state-level substantive interest-rate regulation and federal disclosure rules soon started to unravel, however. About a decade after passage of the Truth in Lending Act, judges and lawmakers began to limit the reach of state-level interest-rate caps. Changes in the American economy and in ideas about economic regulation set the stage for the rollback of rate caps in the late 1970s and ‘80s. The prosperity of the 1960s had given way to the rampant inflation and rising unemployment of the 1970s. Legislators feared that restrictive state usury laws were hindering consumers’ access to credit, especially mortgage loans, as market rates soared above state rate ceilings. Several recent studies by economists validated these concerns, finding that usury laws were inefficient and burdensome on growth.^{Footnote 154} More generally, Democrats and Republicans both pressed for deregulation in a variety of markets. Their push was backed by the research of economists like Alfred Kahn and George Stigler, who documented how poorly designed regulation could hinder competition and how industry could “acquire” regulation for its own benefit.^{Footnote 155}

The system of state-level price controls began to crumble in 1978 with the Supreme Court’s landmark decision in Marquette National Bank of Minneapolis v. First of Omaha Service Corporation. Interpreting the National Bank Act of 1864, the Court held that the law allowed a federally chartered bank to export the usury law of its home state when lending to residents of other states.^{Footnote 156} This meant that federally chartered banks could escape unfavorable state interest-rate caps by relocating to states with more permissive usury laws. Congress further limited the reach of state usury laws in 1980, with the passage of the Depository Institutions Deregulation and Monetary Control Act (DIDMCA).^{Footnote 157} DIDMCA preempted the application of state usury laws to loans secured by a first lien home mortgage, and granted state-chartered federally insured banks the same ability as national banks to “export” their home-state’s interest rates.^{Footnote 158}

Together, Marquette and DIDMCA set off a regulatory race between the states, many of which vied to create the most attractive interest-rate climate for banks.^{Footnote 159} South Dakota and Delaware were the leaders in this contest.^{Footnote 160} New York eliminated its interest-rate cap in 1980, but it was too late to prevent Citibank from relocating its credit card operations to South Dakota. Even after some states reintroduced rate caps, once the inflationary pressures of the late 1970s abated, they were unable to control lending by national banks to their residents under the Marquette doctrine. To put state-chartered financial institutions on the same footing as their federal counterparts, the vast majority of states enacted parity laws, also called “wild card statutes,” which allowed state institutions to engage in the same activities as national banks.^{Footnote 161} Legal scholar James White aptly described the state usury laws that remained on the books as “trompe l’oeil,” creating the illusion of cost of credit regulation for most financial institutions without any substance.^{Footnote 162} Accordingly, within little more than a decade of TILA’s adoption, disclosure became the principal means of controlling the cost of credit for all but the small subset of loans still subject to state-level interest-rate caps.

Developments in the study of economic regulation in the 1970s and ‘80s further bolstered the case for allowing legally mandated disclosure to substitute for direct price controls. The 1970s witnessed the flowering of research on the “economics of information,” which provided a theoretical foundation for legally mandated disclosure.^{Footnote 163} Truth in Lending also resonated with the ideas of economists and politicians who wanted to free markets from government meddling. When framed as an aid to market-based competition and substitute for command-and-control regulation, Truth in Lending exemplified the latest thinking about good regulatory design. It seemed to anticipate economist Milton Friedman’s exhortation in his 1980 PBS television series, Free to Choose: “Let the government give us information, but let us decide for ourselves what chances we want to take with our own lives.”^{Footnote 164}