May 19, 2019
In 1978, the Supreme Court essentially gutted all state usury laws, freeing interest rates and sparking a credit card boom. Around that time, 38 percent of U.S. households had a credit card; as of 2014, 71 percent did. Total revolving debt rose from $48 billion in 1978 to $1 trillion today.
The first thing to understand about the new 15 percent credit card interest cap proposal from Sen. Bernie Sanders, I-Vt., and Rep. Alexandria Ocasio-Cortez, D-N.Y., is that it would reverse this court ruling, effectively substituting a federal usury law for the previous state ones–and would authorize states to set their own caps lower than the federal one. Therefore, it would also reverse the 1978 ruling’s consequences, both the ones consumers dislike (higher rates for consumer credit) and the ones they do like (greater access to credit cards), although, to be sure, the precise magnitude of these effects is unknowable.
The Sanders-Ocasio-Cortez bill posits that the costs to consumers of the 1978 ruling have outweighed the benefits–that banks exploit market power to charge exorbitant interest rates.
No doubt credit card issuers are driven by profit, not compassion; equally undoubtedly, thousands of Americans have gotten in over their heads with high-interest, revolving credit card debt. But does mitigating these risks justify jeopardizing the benefits of the credit card boom–such as convenience, rewards programs and increased liquidity–for millions of households, probably the majority, who manage debt well?
The answer is less clear than the bill’s sponsors claim. For big banks, the credit card business is indeed more profitable than others; yet much of the large spread between their cost of funds and interest rates they charge reflects overhead, including such costs as managing billions of transactions and covering unsecured losses. Meanwhile, only 2.5 percent of customers are delinquent on their cards, well below historical rates. Sanders and Ocasio-Cortez tout cards issued by nonprofit credit unions, whose rates are capped at 18 percent under federal law, as proof of their concept. Actually, it’s not an apples-to-apples comparison, because credit-union cards often impose conditions, such as certain forms of collateral or membership in a credit union, that banks don’t.
Popular as the rate cap may be, credit card holders might develop second thoughts if it means lower credit limits, higher fees–or forfeiting access altogether. The Sanders-Ocasio-Cortez measure’s proposed workaround–empowering the Federal Reserve to grant banks temporary waivers to the 15 percent cap, if economic conditions require–would make the Fed the direct arbiter of household debt burdens, an inappropriate role for a politically independent central bank. Excessive regulation may push marginal borrowers to pawn brokers and payday lenders or, at the far margins, stimulate a black market for credit, making the bill’s title, the Loan Shark Prevention Act, ironic indeed.