Bernie Sanders and AOC Want to Cap Credit Card Interest Rates: Why That Would Backfire Spectacularly
Bernie Sanders and Alexandria Ocasio-Cortez recently unveiled a bold plan to put a cap on credit card interest rates. The rate they would cap interest at is 15%.
This sounds great on paper, right? Who wouldn’t want to keep people from living under the burden of excessive interest rates?
As altruistic as Sanders’ and Ocasio-Cortez’s plan sounds, it would backfire spectacularly if it were ever implemented!
Read on to find out why this great idea is really a horrendous idea.
The Thing About Credit Cards…
Credit cards represent a voluntary agreement between the borrower and the lender. The bank or lender legally has to tell you upfront what interest rate they will charge you. In cases where they intentionally deceive consumers, I agree entirely with prosecuting them for fraud. However, these cases are few and far between.
Additionally, nobody points a gun to your head to make you accept this contract. Even if you have a credit card, you have to carry a balance first before you can start being charged interest. If you responsibly pay off your card every month, this is a non-issue. If you don’t pay it off, you know you’ll get smacked with interest rates that are likely far beyond acceptable.
How the Credit Card Business Works
The credit card business is an extremely competitive and low-margin space. If one company charges consumers usurous levels of interest, other credit card companies will quickly snatch away those customers with 0% balance transfers and lower rates.
If a credit card company is charging you 20% interest, it’s because that’s the level of interest that allows them to make money from a pool of people with your credit risk rating (FICO score). Banks are not non-profit entities; they exist to make a profit.
Credit card customers are split up into different tranches (levels/shelves) by their credit risk ratings. Those customers with the least amount of risk are offered the most competitive interest rates. All lenders would love to have these borrowers because they have stellar credit histories. To get these customers, they have to compete with very low interest rates.
Creditors with high interest rates are far more likely to default, causing the bank not only to lose their interest payments but the principal (the amount borrowed) too. Because of this fact, all the borrowers in that tranche pay an inflated rate to compensate for the likely losses from the less responsible creditors in their credit tranche.
So What Would Happen?
If AOC and Bernie Sanders’ proposal were passed, it would hurt the people they strive to help. Because lending to higher risk people would no longer be able to charge the over 15% interest rates needed, these people would see their access to credit wholly taken away.
This does not apply only to opening new accounts. Imagine if you had a 20% interest credit card now and you’re in dire financial straights. You’re paying at least the minimum every month, but you need that credit to be able to get groceries. Let’s say you typically have a spare $500 available to you on that card. If this law passes, suddenly banks would start losing money by not being able to charge you the 20% your credit rating commands. Instead of lowering your interest rate to 15%, they’ll close your credit account!
How About the Banks?
F*ck the banks, amirite? Nope. They’re a necessity, at least for the time being.
What would happen to the banks?
Well, let’s say 15% of the bank’s credit card revenue comes from the high interest rate cards. Again, the rates are enough to make it profitable for the banks to extend credit, but they can’t charge too much, or they’ll lose their customers.
If a bank requires a revenue of $100 million from credit cards and the 15% cap reduces its revenue below that, the bank may close down its credit business. The juice is not worth the squeeze.
If banks get out of the credit market, there is less competition for the surviving banks. To goose their revenue numbers, it’s highly plausible that the remaining banks could charge more of a premium to the prime customers to recover some of their lost revenue. With less competition out there, they run less of a risk of having customers stolen from them because they charge a higher than reasonable interest rate. While this state of affairs would be unlikely to last, would you, as a responsible (I assume) creditor want to be charged more? No!
The End Result
Instead of helping people with high credit card interest rates, the AOC/Sanders proposal would deny them credit. The remaining banks would potentially charge the people with better credit scores more as competition decreases for their business.
To affect “justice” on one demographic, it leaves them even worse off and spreads the injustice (higher interest rates) on the more responsible borrowers.
This type of moral solipsism is unfortunately common in politics and the legislation produced by parties. A basic understanding of economics and business should be a requirement for those who wish to tweak laws that affect those areas.
While I try to keep this blog as apolitical as possible, if I see something egregious, I have to chime in with my view. This isn’t a left versus right argument, but more of a dispute of knowledge versus lack of knowledge.
History is littered with examples of policies that sound just and fair that instead destabilized those whom they wished to help. This is one such policy that I hope remains a proposal and not a reality.
Related: Social Insecurity