Hawley/Sanders Credit Card Interest Cap Is a Gift to Payday Lenders and Loan Sharks
A bill that purports to lower borrowing costs will instead drive many people to more expensive lenders.
It would be nice if one of our two major political parties was consistent in its advocacy for free markets—for all freedom, for that matter. Instead, we get two senators, a Republican and a socialist who sits with the Democrats, teaming up to condescendingly save Americans from their own desire to borrow money. Their proposal to cap credit card interest at 10 percent is supposed to shield people from "exploitative" borrowing costs. Instead, it's bound to cut off higher-risk borrowers from traditional credit and drive them into the arms of payday lenders and loan sharks.
Saving Borrowers From Themselves
"Working Americans are drowning in record credit card debt while the biggest credit card issuers get richer and richer by hiking their interest rates to the moon. It's not just wrong, it's exploitative. And it needs to end," Sen. Josh Hawley (R–Mo.) huffed this week in a press release. "Capping credit card interest rates at 10%, just like President Trump campaigned on, is a simple way to provide meaningful relief to working people. Let's do it."
"During the campaign, President Trump pledged to cap credit card interest rates at ten percent," Sen. Bernie Sanders (I–Vt.) chimed in. "Today, I am proud to be introducing bipartisan legislation with Senator Hawley to do just that."
It's said that great minds think alike. So, apparently, do the minds of economic ignoramuses with supposedly competing political brands. Hawley and Sanders peddle salvation from expensive credit, but instead they offer a world of hurt to the people they say they want to help.
Obviously, credit card issuers want to make as much money as they can from their business, but they compete with other banks, card issuers, and sources of credit for customers. So, they can't just name a random high rate—essentially the price of loaning money—and expect people to pay. Instead, they set interest rates they expect will make them money without pricing themselves out of the market. They do so, largely, by assessing potential customers' ability to repay loans.
Putting Price Caps on Credit
"Credit risk is the probability of a financial loss resulting from a borrower's failure to repay a loan," notes Investopedia. "Consumers who are higher credit risks are charged higher interest rates on loans."
If the Hawley–Sanders legislation passes, the government will set a price cap on what credit card companies charge for loaning money. If the companies perceive that the price is too low to offset the risk of loaning to some customers, they'll probably stop offering any credit to those customers.
Some people argue that's great news; high-risk people shouldn't be borrowing money at high prices, they argue. But that's not how it works. Setting a cap on credit card interest and effectively denying credit to higher-risk customers doesn't eliminate those customers' need and desire to borrow money. They'll find other sources.
Coincidentally, this week the Center for Responsible Lending put out a breathless press release announcing that "high-cost vehicle title lending is illegal in 33 U.S. states and the District of Columbia (DC). Through a new survey and analysis of anonymized checking account transactions, Under the Radar reveals title lenders flouting the law in 22 of those states and DC with both in-person and online loans."
The Under the Radar report argues that title loans are risky, expensive (up to 300 percent annual percentage rate), and perversely thriving despite their illegality in many places. Why are Americans keeping such lenders in business by borrowing from them? It's for the same reason that they go to payday lenders, loan sharks, and other alternative or illegal lenders: cheaper traditional credit is unavailable to them.
Regulations 'Created an Almost Adversarial Credit Environment'
In 2017, I reviewed a book that explored why millions of Americans use non-traditional and relatively expensive financial institutions like payday lenders and check cashers. Many of them find banks, credit card companies, and other mainstream institutions rigid, uninterested in their business, and too closely aligned with snoopy government officials. Often, the costs and requirements imposed by government regulations make doing business with higher-risk, lower-income customers unattractive to mainstream finance.
"The regulators are causing the opposite of the desired effect by making it so dangerous now to serve a lower-income segment," JoAnn Barefoot, a former federal official, including a stint as deputy controller of the currency, told the book's author. She emphasized red tape that makes serving many potential customers a legal minefield.
In 2015, the Albuquerque Journal's Richard Metcalf found that more than a third of households around that city do little or no business with traditional banks.
"Banking regulations stemming from the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the Patriot Act of 2001 have created an almost adversarial credit environment for people whose finances are in cash," Metcalf wrote, citing a bank official.
Driving Borrowers to 'Alternative Financial Products'
"The upshot is that 35.5 percent of the metro's households turn at least occasionally to alternative financial products," he added. "Frequently, these products provide emergency financing to households living paycheck to paycheck. The terms of the loans commonly have exorbitant interest rates and rollover provisions that critics say can lead to chronic indebtedness."
That is, government intervention in finance has already raised the cost of doing business with lower-income, higher-risk customers to the point where many traditional financial institutions believe it's not worth the hassle or expense and turn them away, leaving less pleasant options. Putting a price cap on credit card interest rates isn't going to magically secure affordable credit for customers whom lenders consider to be risky. Nor is cutting higher-risk borrowers off from credit cards going to force them to live without borrowing, as some moral scolds believe they should.
No, capping credit card interest rates at 10 percent is going to have a very predictable effect. It's going to drive borrowers to riskier, more expensive, and sometimes illegal lenders who are willing to do business with people turned away by credit card companies.
Josh Hawley and Bernie Sanders falsely claim their legislation will save "hard-working Americans" from high costs and financial hardship. What they're really doing is offering a very generous gift of new customers to payday lenders, title loan companies, and loan sharks.
