The unintended consequences of the interest rate cap

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Last week the senator Bernie sandersBernie SandersSunday shows – Manchin says he won’t vote for $ 0.5 trillion bill Sanders says Manchin doesn’t support Biden’s spending program is “not acceptable.” Democrats see 0.5 T spending target move away MORE (I-Vt.) And Rep. Alexandria Ocasio-CortezAlexandria Ocasio-CortezWarner Says $ 500 Billion Package “Not Responding” to Manchin Housing Assistance Responds to Ocasio-Cortez Tweet: “Continue to Divide, Divide, Divide” Ocasio-Cortez Raises Over 0K for Texas Pro-Choice Groups PLUS (DN.Y.) introduced the Loan Shark Prevention Act amid a litany of references to executive compensation, payday lenders and credit card “scams”.

They even invoked the Bible’s warnings against usury. The bill would create a national annual percentage rate (APR) cap of 15 percent on interest rates on all consumer loans and credit cards supposedly to put money back in the pockets of consumers .

The concept sounds good. Frankly, no one likes high interest rates. Commentators from various political persuasions applauded him.

Unfortunately, actions that politicize and regulate one aspect of a competitive market have rarely worked. More frequently, they have caused even more financial hardship and credit dislocation.

Sponsors point to the apparent injustice of a median credit card interest rate of 21.36%, while the economy is still comfortably nestled in a low interest rate environment.

In response, the bill adopts provisions of another law already in effect that limited the interest rate on consumer loans and credit union credit cards to 15 percent APR.

This rate may be changed if the appropriate federal regulator decides to do so after “consultation” with the appropriate committees of Congress, the Treasury Department, and other federal bank regulators.

Sanders and Ocasio-Cortez suggest that the proven record of success of that 15 percent cap on credit union loans over the past decades should be replicated for all consumer loans.

Unfortunately, credit unions hardly ever lived under this 15% cap. Their regulator eliminated it in 1987, replacing it with an 18 percent rate in effect today. The exception for payday loans hovers around 28 percent.

Credit unions are inadequate models for the feasibility of interest rate caps on all consumer loans across the country. America’s credit unions together are about half the size of JP Morgan. In addition, credit unions do not pay federal income tax, a government grant that allows them to charge lower interest rates.

If exemption from federal income tax in exchange for an interest rate cap that banking regulators could change were also on the table, perhaps banks and credit card companies would be willing to participate in this conversation.

The biggest problem is that interest rate caps have rarely worked. In a competitive system, interest rates reflect a variety of financial factors, including credit history, customer defaults, transaction size, credit limits, rewards programs, collection procedures. and fraud. Median credit card rates also tend to hide the real facts.

As the sponsors of the bill effectively recognize, anyone can compare the terms offered by dozens of credit card issuers online to decide which one is best for their financial situation. I just did that.

Credit card issuers currently offer online rates as low as 8.5% for variable rate credit card and higher APR cards which vary based on terms, credit limits, rewards programs and more. the applicant’s credit history.

Most cards offer 30 days of free credit if the statement is paid on time, a feature that might disappear, as well as rewards programs if interest rate caps were created.

The critical issue is Economy 101. When caps are imposed and market rates rise, lenders simply adjust their customer eligibility profile based on the interest rates that can be charged.

As a result, lower-tranche borrowers no longer have access to credit. Since the passage of the CARD Act in 2009, which regulated many aspects of credit card terms and rates but did not impose interest rate caps, approximately 14 million at-risk cardholders have been kicked out of the credit card market.

Whenever markets are distorted by non-economic factors, be they policy or regulatory interventions, they react to that distortion and produce unintended consequences. Sometimes the result is good, sometimes bad and sometimes catastrophic.

The savings and loan crisis, for example, was brought to us by the combination of the enactment by Congress of a deposit interest rate cap at 5.5% in 1966, followed by laws condition on wear of about 8%.

The collision of these two rate controls proved fatal when long-term market interest rates reached over 21% and policymakers failed to act, took too long to act, or took action. took the wrong steps.

In this regard, the provision in the bill that would allow interest rate caps to be raised after consultation with a host of congressional and regulatory authorities is hardly reassuring that a similar crisis could be avoided. .

A research paper published by the Federal Reserve Bank of Chicago in 1982 stated that the weight of economic evidence supports the conclusion that “[u]Security laws can only be successful in keeping interest rates below market levels at the cost of reducing the supply of credit to borrowers.

Another article presented this year on the use of interest rate ceilings in Chile reiterates the direct compromise between consumer protection and the availability of credit. The paper found a direct link between lower interest rates through caps and a proportional reduction of almost 20% in the availability of credit.

Considering the fact that the country has the highest levels of regulation and the highest frequency of financial crises of almost any country in the world over the past two centuries, lawmakers should be reluctant to tinker with the economy until that they took full account of historical precedents and rigorously analyzed the likely range of economic responses and alternatives.

As attractive, popular, and politically expedient as interest rate caps may seem, such actions are ultimately a painful remedy for those who really need help. When it comes to running the world’s largest economy, more care and deliberation would go a long way in making it work better for everyone.

Thomas P. Vartanian is Executive Director and Professor of Law in the Financial Regulation and Technology Program at the Antonin Scalia School of Law at George Mason University.



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