Christmas is almost here, and that means it’s time to shop for presents. What could be better than showering your loved ones with gifts? However, for millions of Americans, it also means something else: credit card debt.
The typical American household has $11,000 in credit card debt. The holidays are by far the time when Americans take out the most debt, with one study from last December finding that nearly half of respondents will not pay the credit card debt incurred from Christmas shopping by the due date.
So, it is no surprise that a bill sponsored by senators Bernie Sanders and Josh Hawley is getting some attention. Sanders and Hawley’s legislation would cap credit card interest rates at 10 percent.
The problem is that this solution is no solution at all.
It is easy to understand why lawmakers want to cap interest rates on credit cards. All this borrowing is getting expensive: the average credit card interest rate stands at an eye-watering 24 percent, up nearly 5 percent over five years earlier.
So why not impose a cap? The short answer is that a cap on interest rates would severely limit access to credit. It would make the problem worse, not better.
If banks and credit card companies are going to lend, they need to be incentivized to take on the risk of default. Loans with lower interest rates, such as mortgages, are typically collateralized. Without collateral, interest rates are higher to account for the risk of default. With market-determined interest rates, lenders know they’ll receive significant interest if the borrower doesn’t pay on time, and if the borrower knows this too, they’re more likely to take that chance and approve a loan or a line of credit.
Capped interest rates change this calculus. Lenders have less incentive to offer credit in the first place. With an interest rate cap in place, they are going to become more risk-averse and offer credit only to households with pristine credit scores and high incomes. Such a change in lending practices would severely disadvantage families that need the flexibility and ease of a credit card to cover unexpected bills.
Imagine not being able to pay for a car repair with a credit card. The financial consequences could easily snowball. Subprime loans are made to those with lower incomes. If interest rates are capped, the poor will have a disproportionately harder time getting credit since loans to lower-income borrowers are inherently riskier.
This is not just theoretical. When states have experimented with interest rate caps, this is what has happened. When Oregon implemented a rate cap, research found that borrowing fell and the average household was left worse off. A similar cap in Illinois yielded similar results, decreasing the number of loans to subprime borrowers by 38 percent.
It would not be just subprime borrowers who are adversely affected by this law. Given that the American economy runs on credit — countless consumers and small businesses rely on it — we don’t want to see this become a broader trend.
If the Sanders-Hawley bill passes, Americans could see their credit limits cut dramatically or even have their credit cards canceled. That, in turn, would lead to less consumer spending and slower economic growth.
We’ve already seen an extreme case of what happens when the credit market contracts. After the 2008 stock market crash, lending froze, leading to the most protracted recession since the Great Depression.
We all stand to lose if the Sanders-Hawley bill passes. More than four in five Americans have a credit card, and the resulting credit is the lifeblood of our economy.
Ultimately, a rate cap on credit cards amounts to a price control, and research has found that price controls do more harm than good. There’s a reason we abandoned them after the 1970s — and why they’re synonymous with bad economic policy today.
Whereas price controls in the ’70s led to gasoline shortages, rate caps today would lead to credit shortages, which could prove even more damaging. With consumer confidence just hitting a seven-month low, this is not the time to take a hammer to the credit market.
Shoppers are preparing to buy gifts, and that means we need credit, not well-intended solutions that will only create more problems than they cure.
