Senator Bernie Sanders and Representative Alexandria Ocasio-Cortez have announced plans to introduce legislation that would limit the interest rate that credit card companies are allowed to charge customers. Although there is currently no federal limit, some state governments have limits. Sanders and Ocasio-Cortez propose capping the annual rate of interest on credit card debt at 15 percent.
What could go wrong with this idea? Lots. Such limits, called usury laws, will make it harder for people without a good credit rating to get credit. That will move some of them to using the much less efficient layaway plans and pawn shops, and might even cause some people to borrow from loan sharks. The credit card caps will also push some people without a good credit history to get even higher-interest payday loans.
These are the opening two paragraphs of my latest Hoover Defining Ideas article, “A Progressive Plan That Aids Loan Sharks,” May 15.
In the piece I tell my own story about how usury laws made my life difficult in 1973:
I’m an example of someone hurt by usury laws in the early 1970s. I moved to California from Canada in September 1972 to go to graduate school at UCLA. Shortly after arriving, I started a checking account at the Bank of America branch near UCLA. In early 1973 I applied for a credit card. To maximize the probability of being approved, I asked for the minimum credit limit: $250. I was always good at handling money but, at age 22, I had never taken out a loan. So I had no credit record. I bet you can guess what happened: I was turned down. I was upset but I was also well along to becoming an economist: I had already learned a lot in a year of self-study in economics and one intense quarter of economics at a great graduate school. So I had learned, as economists do, to put myself in the other guy’s shoes.
I realized that the credit card company that turned me down didn’t know much about me. I knew that I was a good risk. But how would the credit card company know? I had had to state some background information on the application form and that included the fact that I had lived in Canada until a few months earlier and so it would probably be hard to collect from me if I moved back to Canada. How had I gone through college without accruing debt? I had gone for a three-year degree in Canada and financed it with savings, earnings, scholarships, and penurious living. When I had completed my second year of college, my net worth was down to $20. So, to finance my last year of college, I hitchhiked from Winnipeg to northern Manitoba, where I worked for three months in an underground nickel mine and worked every hour of overtime I could, including double shifts. It paid off, and I graduated with zero debt.
But how was a credit card company to know all that? All it knew was that I had never repaid a loan.
One main way a credit card company can deal with the risk of lending to someone with no credit history is to charge a higher interest rate. There’s the rub. I was applying for a credit card in California, and California’s usury laws restricted the rate that could be charged. Given the risk, it simply wasn’t worth a credit card company taking the chance.
A few months later, my inability to get a credit card with even a modest credit limit made my life difficult. In the spring of 1973, I applied for, and accepted, a position as a paid summer intern with President Nixon’s Council of Economic Advisers. When I arrived in Washington, D.C. early Monday morning on a redeye, I had spent all but my last $20 on airfare. I was negotiating with various people I had contacted by mail to rent a room from them in D.C. or in Alexandria, Virginia, but nothing was firm. I was desperate. I pleaded with one of them, successfully, to let me stay with him and his roommates in Alexandria Monday night. I persuaded his roommates to let me stay a few extra days, but because I was responsible for my own food, I remember being very careful while shopping. My $20 left had to cover food and bus fare from Alexandria to the Old Executive Office Building until a few days later, when I managed to borrow another $20 from one of my Alexandria roommates.
Think about what I could have done with a credit card and a $250 limit. Room rentals at so-so hotels were going for well under $40 per night in those days. But, because I had no credit card and little cash, that wasn’t an option for me. Of course, as I built a work record, paid taxes, and lived in the United States longer, I finally qualified, in 1974, for a credit card. But I couldn’t get one when I most needed it.
My favorite part was my discovery, in researching the article, of the details of the 1978 Supreme Court decision. I particularly appreciated Justice Thurgood Marshall’s questioning of the lawyer whose client was trying to prevent competition in the credit card market.
Read the whole thing.
Update: Nice analysis from The Onion. HT2 Jonathan Meer.
READER COMMENTS
Kevin Erdmann
May 15 2019 at 8:22pm
Isn’t it strange that loans with much lower rates and far less onerous terms that are secured by the borrowers’ homes have been regulated out of existence? I appreciate your argument here, but it is an odd discontinuity in the regulatory apparatus, and it is odd that there seems to be more political support for unsecured loans at 20% than for secured loans at 9%.
David Henderson
May 15 2019 at 10:42pm
How have they been regulated out of existence?
Kevin Erdmann
May 16 2019 at 3:00pm
It appears that one important component is that a tremendous amount of underwriting mandates have been imposed at the same time that limits on fees and rates have also been imposed.
Some claim that these loans are available. But, there are articles like this. And, clearly the focus of Congress and regulators has been to tighten standards, with the QM standard, etc. Along with the declining number of small mortgages originated, low tier prices remain much lower than high tier prices relative to any pre-2007 comparison, low and moderate FICO score originations remain very low, and sales of new homes under $200,000 is very low. The changes in these measures are generally pretty extreme.
There is no bill anywhere with President Obama’s signature on it titled, “No more mid-to-low-tier mortgages” bill, but the data make it clear that supply of these products has been mightily undercut.
Floccina
May 16 2019 at 11:13am
I think Carmen DiNunzio is for this bill, but I think you should talk a little about why the Post office offering banking services will not eliminate that problem.
Hazel Meade
May 17 2019 at 5:33pm
This would only result in fewer people getting credit cards. Plus, I bet the market would find a way around it such as charging higher fees, and or coming up with some other mechanism like “credit insurance” (like private mortgage insurance), to make people with poor credit pay more.
I suspect the net result of that is that people with no credit record would end up having to effectively pay up front to get credit, instead of being able to establish a good credit record by simply paying their bill off every month, like you should.
So, basically a net wealth transfer from young people with no credit, to older people with bad credit.
Michael Pettengill
May 19 2019 at 3:51am
But what is the problem with fewer personal loans?
Personal loans were rare in the 50s and 60s, secured in most cases by cosigners with bank assets. GDP grew faster, interest on savings was higher, rising from 2-3% when I got my first passbook at about age 12 and when to the bank to deposit $5 and get the interest recorded, rising to 4-4.5% when banks started sending statements in the mail in the 60s.
And I closed on my first house Dec 1980 at 19+% mortgages. Housing starts were way down, and it was harder to get a job, but that was as much from the flood of boomers into the job market in the 70s.
Then no one argued people without jobs needed more debt to stimulate job creation by consumer spending, but instead everyone was told to look harder for a job, which existed in most places.
Hazel Meade
May 20 2019 at 1:19pm
It’s not a huge “problem”, per se, but it is somewhat unfair to people who have not established credit yet, but are actually good risks. Getting a credit card is the easiest and fastest way to establish a credit record, which makes it easier to buy one’s first home, and get a lower interest rate. So ultimately it will unfairly cost people who are otherwise responsible and would have paid their debts money.
Michael Pettengill
May 19 2019 at 3:32am
In 1973 I was for the times a high income earner with five year employment history, a car loan taken and paid off just to establish a credit history, 6-10 months income in bank checking and savings.
And I was turned down for a travel card (Not credit) for the 3rd time. In my area, banks were not offering these new fangle bank credit cards. Personal loans required cosigners. Indiana bankers were very protective of Hoosier savers.
Only stores offered credit, like Sears, Wards, and gasoline companies, for consumption goods
But the economy had grown rapidly, workers became the middle class, became home owners, owned multiple cars, boats, cabins, working in factories, farming, retail, etc. Most people were determined to pay off secured loans and become debt free with cash in the bank.
1973 was the start of a tough economy because wages of existing workers weren’t keep up with new hires in some sectors.
But given workers/consumers could not go into debt except for productive assets like cars and houses, contractions did not result sharp consumer spending cuts when layoffs occurred or hiring slowed.
Of course, in 1973, defense spending cuts were just beginning to hurt lots of communities where pols had won contracts to spread the wealth around over the prior three decades. Autos factories were shutting down to retool away from gas guzzlers.
But interest rates in the 70s were higher than the 60s, which were higher than since 2000.
Banks were for most people where they cashed checks, deposited money, not where they put money in their pockets.
And the Bible was as likely quoted by bankers as politicians, and in defense of usury laws.
Comments are closed.