President Trump has returned once again to the well of half-baked populist economic proposals in his quest to tackle affordability. His latest idea is straight from the brain trust of Elizabeth Warren, Bernie Sanders, and Alexandria Ocasio-Cortez: capping the interest rate that credit card issuers can charge borrowers at 10 percent.
If Trump could achieve this policy, it would be a disaster for American consumers. Fortunately, he has no authority to do so.
Usurping private terms of credit between willing lenders and borrowers is not a legitimate role of our federal government of limited powers, regardless of the branch that pursues it. But if any branch could enshrine such a policy nationwide, it must be Congress. No statute permits the president to wield such essentially legislative power. That may be why Trump hasn’t even bothered to publish an executive order yet to codify his demand — typically one of his favorite activities.
If having no authority wasn’t bad enough, there is also no compelling impetus for this policy. Changes in credit card interest rates have tracked changes in underlying rates that banks pay to borrow reserves, which are then lent out to consumers. The credit card issuer market is highly competitive, with innumerable banks and non-bank lenders challenging each other on borrowing limits, cardholder rewards, and, yes, interest rates.
The reason that credit cards have much higher interest rates than other loan types is the high risk of nonpayment that must be compensated for. As of last year, 12.4 percent of credit card balances are severely delinquent, or more than 90 days past due — the highest level since 2011. Unlike mortgages and auto loans, credit cards are not secured by any real property that can be seized and sold if borrowers default. The only way to cover such losses is through interest payments.
If a credit card interest cap were enacted, as progressive legislators in both parties would like, it would devastate the borrowers it is intended to help. Credit card issuers are not blind; they take note of borrowers’ income, assets, and credit history when deciding whether to lend to them. If companies cannot charge interest commensurate with a borrower’s risk profile, they simply will not let him take out additional funds.
A harsh maximum interest rate of 10 percent would ensure that only the most trustworthy borrowers could get their hands on credit cards, cutting the poor off from the credit ladder entirely. Those needing credit will instead need to turn to unregulated payday lenders, pawn shops, or worse. Higher-income borrowers might be able to keep their plastic but would likely see their borrowing limits decreased and their cherished rewards evaporate. There is no free lunch to be had here.
This is how price controls work, and interest rates are no different. Limiting what providers can charge for their services inevitably constrains supply. In this case, the supply of consumer credit.
We know what will happen not just from the laws of economics, but from experience. Two states, Arkansas and Illinois, have already capped interest on certain consumer loans at significantly higher levels than 10 percent. In both states, evidence showed that the policy resulted in lenders rationing credit, especially for the riskiest borrowers. Capping interest rates may be a populist policy, but that’s hardly a populist outcome.
Trump says he wants to improve affordability, but instead of easing government burdens to mutually beneficial economic transactions, he is waging war against them by inserting himself in the middle. Good thing consumers don’t have to buy what he’s selling.