Credit card interest rate caps are the answer to the U.S. debt crisis

BankThink re: Credit Card Rate Caps
Without rate caps to restrain them, credit cards became the perpetual debt machines we recognize today, writes Sean Vanatta.

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American households are drowning in credit card debt. In recent months, aggregate credit card borrowing has surged past $1 trillion, while credit card interest rates have been rising on the back of the Fed’s tightening monetary policy. Last week, Missouri Sen. Josh Hawley took action, introducing legislation that would cap credit card interest at 18%. “Americans are being crushed under the weight of record credit card debt,” Hawley argued, adding that “working people” need relief.

Hawley is right. The question is whether he is serious. At present, his bill is a legislative sound bite: 19 lines of headline grabbing text. It can — and should — be much more.

For decades, state-level price caps protected American households from expensive, high-risk debt. Reviving that policy requires a more comprehensive approach than Hawley’s bill now offers. It is a policy worth pursuing. Unrestrained debt poses a fundamental danger not only to the millions of American households struggling to pay their bills, but to the whole American economy. Interest rate caps offer a proven path to get household borrowing under control.

Hawley’s rate cap is not a novel idea. Interest rate restrictions are a longstanding bipartisan approach to protecting consumer households. Before the 1980s, state-level limits on credit card interest were nearly universal, most at or below the level Hawley has proposed.

Interest rate restrictions are not a moralizing or paternalistic policy — biblical exhortations against usury aside — but an economic one.

Interest rate caps work by shifting interest rate risk from consumers onto lenders. Banks, for example, borrow money at one price and lend it at another. When the Federal Reserve raises interest rates to fight inflation, as it has done in recent months, the cost banks pay to borrow goes up. Without price caps in place, banks simply pass their higher costs to consumers, who are less price sensitive or who have to borrow to make ends meet. In contrast, with rate caps in place, banks hold the risk of rising prices. If the cost of money goes up, so do their costs, which they cannot easily pass on to borrowers.

In the past, when state interest rate caps forced banks to hold the interest rate risk, they kept repayment periods short to limit their exposure to interest rate swings. As a result, credit cards offered consumers short term credit, not long-term, high-interest debt. Without rate caps to restrain them, credit cards became the perpetual debt machines we recognize today.

If rate caps worked so well, what happened to them? In the early 1980s, bankers relocated their credit card operations to states — South Dakota and Delaware — that had repealed their credit price controls. These states effectively traded financial industry jobs for favorable regulation. From offices in Sioux Falls and Wilmington, bankers distributed high interest cards across the country. Although consumers and state policymakers sought to retain local rate caps in the years that followed, they could not hold mobile financial institutions accountable to local rules.

The banking industry will oppose rate caps. Indeed, the American Bankers Association has already responded to Hawley’s bill with its usual boilerplate: “Price controls don’t work. … This proposal would harm consumers by restricting access to credit for those who need it the most and driving them toward less regulated, more costly alternatives.”

Supporters of credit card rate limits should take the bankers seriously, if not literally. On the one hand, banks know what they’re talking about. Before the introduction of credit cards, banks tended to offer a variety of relatively low-cost installment and personal loans. Over time, they have gradually shifted consumers toward higher-cost forms of borrowing. This trend, coupled with the elimination of rate caps, helps explain the massive expansion in credit card debt over the past generation.

It is also no coincidence that credit card lending has long been an exceptionally profitable business for banks.

But the ABA is also right that constraining credit card interest rates will restrain access to credit card loans, and that in the short term this may challenge households who rely on borrowing. In the past, rate controls did limit the credit card market to affluent — primarily white — households. This is why, if Hawley is serious about his proposal, he needs to offer more than a credit card price cap, which on its own would distort consumer credit markets with many unwelcome consequences.

A serious proposal would have at least two additional elements. First, it would make a more holistic attempt at consumer credit market reform, taking on not only credit card rates, but the whole sweep of consumer loans up to and including the forms of predatory lending that plague working-class and minority households. This would involve not only restrictions that limit predatory rates and charges, but also affirmative support for lending institutions — for-profit and not-for-profit — which seek to meet households’ credit needs at fair prices.

Second, such a proposal would look beyond credit markets, to consider why American households rely so heavily on debt in the first place. That’s a larger conversation than any one bill can carry. But it’s one Americans must have, before their debts come due.

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