Capping credit card interest rates could lead to worse outcomes for risky borrowers.
By Steven Maxwell
At first glance credit cards with high interest rates seem predatory. They primarily affect the working class who are already struggling to make ends meet. Big bad banks create the credit out of thin air and are profiting off the borrower’s suffering. And it violates usury laws in holy books! It’s easy emotional fodder for politicians to drum up support for laws that cap interest rates. But will government-enforced interest rate caps actually help risky borrowers?
Congresswoman Alexandria Ocazio-Cortez (AOC) and Senator Bernie Sanders recently introduced the Loan Shark Prevention Act to cap credit card rates at 15%.
“Under the legislation we are introducing today, we would establish a national usury rate to make sure that no bank or store in America could charge an interest rate higher than 15 percent,” Senator Sanders said in an announcement for the proposal.
“The reality is that today’s modern-day loan sharks are no longer lurking on street corners breaking kneecaps to collect their payments,” said Sanders. “They wear three-piece suits and work on Wall Street, where they make hundreds of millions in total compensation and head financial institutions like JPMorgan Chase, Citigroup, Bank of America and American Express.”
Representative Ocasio-Cortez stated, “There is no justifiable reason that a person—no matter their background—should be charged an interest rate higher than 15 percent. Rates higher than 15 percent are predatory debt traps, designed to keep working families underwater and allow predatory companies to enrich themselves off the misfortune of others.”
Politicians dictating what economic prices “should be” always creates unnatural market incentives that usually result in worse outcomes for the very people these proposals seek to help.
In an op-ed, Diego Zuluaga, a policy analyst at the Cato Institute’s Center for Monetary and Financial Alternatives, points out flaws in their proposal:
The ostensible aim of their proposal is laudable: to make credit more affordable for American households at a time when they carry a collective balance of $870 billion, with an average credit-card APR of 17.73%. But the consequences of a cap would be disastrous, removing access to credit for millions of low- and moderate-income households and forcing them to rely on family members, tighten their belts or seek higher-cost forms of credit.
Forcing them to “rely on family members” and to “tighten their belts” seems like a benefit to me. Isn’t that the advice a financially responsible person would give to those who borrow beyond their means? Maybe it will also spur credit customers to do more research to find the absolute best interest rates available to them.
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The fact is banks will not lend to risky customers because the interest rate is capped. They will simply stop issuing unsecured credit to the people AOC and Sanders aim to help. And those high-risk borrowers will be forced to seek dangerous forms of credit if banks are prevented from offering legal products to them.
Zuluaga points out:
Back in the early 1900s, Progressives helped drive loan sharks out of business by lobbying to lift state usury caps. Those caps had barred lenders from charging interest above 6% to 10% a year, forcing low-income Americans to seek credit in the illegal market.
Popular free-market economist and investor, Peter Schiff, also emphasized this point on episode 468 of his podcast starting at the 22-minute mark below:
If somebody really needs a loan and they can’t get one within the legal statutory limit, then they end up having to go to the mafia. They have to go to a loan shark. They have to borrow the money illegally because they can’t borrow it legally.
So what the government does when they fix the price, is they create a shortage. They create a shortage of credit and then the black market is delivering the solution.
When you borrow money from a loan shark and he’s charging you a rate of interest that exceeds the statutory limit, he has no recourse in the courts to enforce the loan. So the only way he can enforce the loan is through violence.
As Senator Sanders celebrates the absence of loan sharks on street corners, this legislation creates the incentives (fewer legal credit products at a time of increasing demand) to put them back in business.
I think high-risk borrowers who voluntarily accept terms of loans would prefer a bruised credit score to broken kneecaps when they fail to pay it back.
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