Mafia loans

And by mafia I mean the Hollywood version mafia... I don't know the mafia, but I've seen movies where it was featured prominently. From what I gathered watching movies and TV I noticed a few things

- The mafia makes cash loans
- The rates are insanely high
- The default probability is high
- The recovery rate is close to 100%

This strikes me as odd... the default risk is essentially 0 to the mafia because even if the guy wants to default, they always manage to get the money back, by using kneecaps as collateral. In this case, why the high rates? There are a few possible explanations all of which are linked

- There are costs incurred in recovering the money, paying goons, bullets, renting huge empty warehouses with a single chair, fixing the chainsaw once in a while... True, but one would assume the mafia has so much dissuasive power no one dares to default *, keeping the costs fairly low. ( *which contradict the high default observation from movies).

- The mafia maintains a coercive monopoly on underground lending. The bank won't lend you money to bet on a fixed boxing match but the mafia will and there's only one boss in the area.

- There is a huge demand for mafia loans but the mafia only has so much money. This means the mafia cannot really borrow from the bank to meet the adequate supply.

-  Mafias have humongous returns on their ventures and therefore will only lend at very high rate. (This also means the mafia cannot borrow from the bank)

 

Any thoughts ? What about the actual mafia ? Could they fix the subprime loan crisis the medieval way ?

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In this case, why the high

In this case, why the high rates

Moderate principals, combined with short terms, require high interest rates to produce any significant level of absolute returns.

 Regards, Don

 

In addition to Don's comment,

you'll find in places where the market is cornered by a single entity, prices are not set by demand (or risk, even). Rather, they are set to the highest level the provider can get away with without competition (successfully) arising. Consider the price of (some) pharmaceuticals.

Thanks, I think I did

Thanks, I think I did mention that possibility though.

As for Don's comment, it's true (though turned strangely, as if the price wasn't set by supply and demand...)

Mafias have fixed cost in providing loans, therefore they won't provide short-term low principal loans unless the rates are extremely high. However we do see in movies mafia loans with very high principal that go on for years before the guy gets cornered.

Similarly, most of the cost incurred for a loan are shared over various loans (employing a full time goon) except maybe bookkeeping and the occasional enforcement.

Monopoly

In the mafia movies and news reports, there is always a lot of emphasis on establishing territory (or negotiating territory between rivals if they decide the cost of a turf war is too high).

I would think that having a coercive monopoly is the easiest explanation for high loan rates.

A legitimate bank could compete for home loans, but if the loan involves anything the government has declared illegitimate (gambling, prostitution, drugs, alcohol, ...) there is only one source of loans available.

Transaction Costs

"In this case, why the high rates" Transaction costs. As you say must cover the cost of those empty warehouses. If only they'd learn to outsource to a cheap collection agency.

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