TCS Daily

Hard Cases Make Bad Law

By Sean Gabb - November 22, 2004 12:00 AM

In 1989, Tony and Michelle Meadows of Southport in northern England borrowed £5,750 to pay for home improvements. They agreed to repay the loan over the next 15 years at a rate of 34.9 percent. They were unable to keep up their agreed payments, and compound interest had brought the sum repayable to £380,000 by the middle of 2004.

At a hearing in Liverpool county court in October 2004, Judge Nigel Howarth declared that a combination of high interest rates, legal fees and insurance costs had made the loan "extortionate", and he ruled that the loan company should be unable to force repayment of the loan. In other words, the debt was cancelled.

The British media responded with sympathy for Mr. and Mrs. Meadows and calls for further regulation of the consumer credit market to prevent similar cases in the future.

Now, it is easy to share this sympathy for Mr. and Mrs. Meadows. Borrowers who get into trouble with repayments are usually rather pathetic, and those who stand out for repayment are usually both rich and slightly unpleasant. This being said, the judgment in Liverpool county court was bad both for civilization in general and for all borrowers.

A civilization depends for its viability in the long term on the enforcement of contracts. If a contract can be effectively voided for reasons not made clear at its making, the security of property and of all commerce is brought in doubt. These are things on which we all depend for our lives.

There is also the moral impairment that follows from any declaration that consenting adults are not fit judges of their own interest. Mr. and Mrs. Meadows knowingly signed that loan agreement. All its terms were given to them in writing. They were able to calculate the effect over 15 years of the high rate of compound interest offered them. They were able to understand what might happen if they did not keep up the payments. There is no reason to suppose they were deceived at the time of making the contract. During the next 15 years, they probably had many opportunities to refinance the loan at the lower interest rates that became available. All this, and they still allowed the loan to accumulate to more than a third of a million pounds. Their situation was unfortunate, but it was one of their own making, and it was grossly unjust for a court to rule in their favor.

But let us turn to the specific effects of the ruling in their favor, and the possible further regulation of the consumer credit market. Lenders offer credit at interest rates that contain two elements. First, there is the underlying rate set by the monetary authorities or by the market. Credit will not be offered at any rate lower than this other than in exceptional circumstances. Second, there is the element of individual risk. Where the chance of repayment is good, the rate will be low. It will be higher according to the perceived risk of default.

If the authorities start regulating the rates of interest offered openly on consumer credit, at least one of two consequences will follow. First, credit will not be offered to those whose perceived risk of default is not covered by the allowed rate of interest. In this case, those rejected will have to choose between not being able to borrow at all and being forced to do business with criminals who will not rely on legal judgments to collect. Second, if lenders are forced to offer credit on easy terms to all who apply, they will cover their risk by charging higher rates to all borrowers. In all likelihood, both consequences will follow - everyone will pay more, but there will still be those who are somehow refused credit even within the strictest rules.

The Meadows case is sad, but also interesting. It is sad for the obvious human reasons. It is interesting so far as it illustrates a general rule of politics. When politicians try to do good by intervening in the choices made by consenting adults, they fail - and often they bring about far greater evils than those that prompted the original intervention. As the lawyers say, hard cases make bad law.


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