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Credit Card Interest Cap Would Create Consumer Credit Bread Lines

Last Thursday Rep. Alexandria Ocasio-Cortez (D-NY), and Sen. Bernie Sanders (I-VT) teamed up to introduce a bill that only two democratic socialists could have dreamed up.

The proposal seeks to impose an annual percentage rate (APR) cap of 15 percent on all consumer credit products across the country—a “radical” proposal, to say the least. This is well beyond the standard APR cap commonly proposed by Democrats. As I wrote earlier this month when a similar proposal was introduced to cap the APR at 36 percent, “The legislation would destroy large swaths of the country’s consumer credit market, especially for those living on the financial fringe.”

The AOC-Sanders plan, however, would be far, far worse. While the 36 percent proposal is targeted at “alternative” forms of credit, such as payday and installment loans, it largely steers clear of traditional forms of credit, such as credit cards and personal loans. A 15 percent cap, however, would hamper even those mainstream products. Given that the average credit card APR is around 17 percent, it is safe to assume that anyone with a less than stellar credit score or without significant collateral to secure a loan would be denied credit. Indeed, the state of Arkansas, with a constitutionally imposed 17 percent interest rate cap, is a cautionary tale for being simultaneously a “credit desert” and the pawn shop capital of the nation.

The sheer economic illiteracy of capping interest rates so low is astounding. By now, it should be obvious that setting a price ceiling below the market clearing rate will create a shortage. The market for credit is no different than any other market—supply and demand still control.

In doing so, an APR cap will solve precisely none of the problems AOC and Sanders want to solve. I know, for instance, that it wouldn’t help me. I am an immigrant without strong ties in the United States or a lengthy credit history. Lacking such information, it’s hard for a lender to tell if I am good credit risk or not. As David R. Henderson points out with his own personal story, 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. Without the ability to do so, no lender would take a chance on someone like me.

The AOC-Sanders proposal makes obvious that they fundamentally do not understand how credit markets work. The two politicians claim that because banks can borrow from the Federal Reserve at less than 2.5 percent interest, it is “predatory” to price credit above 15 percent.

This is misleading, for a number of reasons. To start with, the cost of producing credit is not zero. As Diego Zualaga of the Cato Institute made clear:

[T]he business of banking is expensive. Banks spend time and resources screening borrowers to assess their creditworthiness. They invest in physical and virtual facilities to ensure the safety of customer funds and their personal information, online and offline. Banks also employ hundreds of thousands of staff to help customers find the products they need, understand the terms of each product, and service mortgages, small-business loans and credit-card debt.

Even further, as The Wall Street Journal editorial board pointed out:

[C]redit cards are primarily payment networks. They process countless $5 transactions, send monthly bills, offer 24-hour customer service, scan for fraud, resolve disputes with merchants, and more. The cost of daily operations is high. Yet swiping is free for millions of Americans who pay their balances each month.

The expenses that go into providing credit are high. But the price of credit is not determined by the cost of its inputs alone. It is also priced according to risk.  

Credit pricing and risk management work together. A high risk of default will be reflected in a higher price as a way of accounting for potential losses and communicating to the borrower the implicit risk of lending to them. If lenders are prohibited by law from pricing risk accurately, a lender will respond in a number of predictable ways: adjusting the contract terms and length (such as charging higher annual fees), requiring higher collateral, or restricting access to credit altogether. Lenders will not magically make the same loans to the same consumers at a lower rate. Rather, the end result is that consumers will be left with less credit or credit on worse terms than before.

But as it turns out, that is the entire point of the legislation: to eliminate the private market for consumer credit. The second part of the proposal, then, is to nationalize the rest of the credit industry under the U.S. Postal Service—a bankrupt idea periodically floated by Democrats.

To think that USPS could simply layer on such expertise to profitably bank millions of Americans is comical. The most obvious case against getting the post office into banking is that the USPS is terribly inefficient at the one job it is specifically designed for—delivering mail. It lost $3.9 billion last year and has reported twelve consecutive years of financial losses. This is for a government monopoly with an $18 billion advantage over similar private sector companies, who all make healthy profits. The problems are so bad that the USPS has repeatedly attempted to cut operating costs by stopping Saturday delivery, only to have Congress force them to continue.

Further, with millions of Americans having to apply to, and have their loans underwritten by, the post office, it is almost certain that waiting at the Department of Motor Vehicles would be quicker. Remember the Soviet Union bread lines? Picture that, but for credit.

It is hard to refer to such a scheme as creating “unintended consequences” from “good intentions” when the outcome is so blatantly obvious. Providing otherwise high-risk individuals with unsecured credit at a rate that cannot possibly break even ensures taxpayer bailouts on an enormous scale. This is precisely what happen during the mortgage crisis. In short, Rep. Ocasio-Cortez and Sen. Sanders proposal to eliminate the private credit market and replace it with taxpayer funded banking and lending services is nothing short of reckless. Anyone who cares about financial stability and the poor should oppose it at every turn.