Fair Credit and Loan Shark Prevention Acts Will Hurt the People They’re Supposed to Help
Economies have an equilibrium, where the market sets a price for a product based on the demand for its supply. When the supply is too high, the price goes down; when it’s too low, the price goes up. This is the most basic rule of economics, so simple that it shouldn’t even need to be explained.
And yet. We live in a world of ascendant Democratic Socialists Bernie Sanders and Alexandria Ocasio-Cortez, who are so “morally right” they don’t need to be “factually correct.”
Willfully obtuse about basic economics, Sanders, AOC, and their terrifyingly large group of fellow ideologues are behind two legislative proposals – HR 5050 (the Veterans and Consumers Fair Credit Act) and HR 2930 (the Loan Shark Prevention Act) – that would hurt the people they’re supposed to help.
HR 5050 would set a national “all-in” rate cap on credit card interest rates while restricting the ability of lenders to export interest rates across state lines, which could expose large swaths of consumers to lose credit access in several states. Meanwhile, HR 2930 proposes an even more stringent cap that would spur even greater losses of credit access among those who need it most.
See, there’s a slightly more advanced concept in economics called inelastic demand. So, if some activist in the government decides that prices are too highe, and enforces price controls on something, the result is shortages, long waits, price gouging, and black markets. There’s price elasticity only when there are substitutes for the product in question.
This isn’t just theory: before a unanimous 1978 Supreme Court decision deregulated credit card interest rates, illegal loan sharks preyed on the urban working class who suffered under a usury ceiling. The Obama administration tried to reinstate a similar ceiling and failed – the only options for many in need of credit is liquidating their assets at pawn shops or the mafia, as the good people at Freakonomics pointed out.
Bernie and AOC aren’t going to pay attention to facts, but some new research out of Chile might turn them around. Stanford economist José Ignacio Cuesta and Chilean regulator Alberto Sepúlveda have examined a period in Chile, from 2013 to 2015, where regulators instituted a 36% interest rate cap on small, unsecured consumer loans. Their research finds that such caps decrease access to credit and harm vulnerable consumers.
Enacted in hopes of protecting some consumers from high short-term borrowing costs, interest rate caps end up harming the very consumers they’re supposed to help by reducing their access to credit.
The rate caps in Chile hurt almost everyone: 82% of consumers were worse off under the rate cap, facing major financial setbacks, while just 16% benefited. Consumers who benefited saved only 32 cents per month in lower interest rates, while those harmed lost around $100 per month. Those who lost credit access were also more likely to reduce spending or fall behind on education, healthcare, housing, and other essentials.
Interest rates are typically set higher for borrowers with below-average credit histories because of the increased risk of lending to them. So, when rates are forcibly limited, credit card issuers may – instead of taking the risk – just tell them no. In this instance in Chile, loans to higher-risk borrowers declined 24%.
Other studies confirm Cuesta and Sepúlveda’s findings, one in 2018 and another in 2019, examined the same period in Chile and concluded that this kind of government coercion most hurt the youngest, poorest, and least-educated families. Back here in the U.S., a 2010 study analyzing the effect on consumers of a regulatory change in Oregon found that rate caps damaged household financial conditions, while a 2008 study of U.S. consumer credit found that rate caps warp credit markets and damage consumer welfare.
The research is clear: interest rate caps are bad for consumers — particularly lower-income consumers.
When authoritarians roll the dice with social experimentation like this in a small Latin American country, the effects are bad, whether its interest rates in Chile or the disastrousness of Venezuelan socialism. But if this kind of thing takes root in the United States, the impact would be devastating. Tens of millions of subprime borrowers could lose access to credit cards entirely, freezing financial markets and sending the economy into a tailspin.
Unfortunately, given the rise of Bernie Sanders and AOC, the supply of economic stupidity appears to be unlimited. Let’s hope the demand runs out real soon.
Jared Whitley is a long-time Washington, D.C., politico, having worked in the U.S. Senate, the Bush White House, and the defense industry. He is a graduate of Hult International Business School in Dubai.