Last December, I wrote about Senators Hawley and Sanders’ call to cap credit card interest rates at 10 percent. This cause was recently taken up by Representatives Alexandria Ocasio-Cortez and Anna Paulina Luna in the House of Representatives, reminding Americans that even President Trump pitched this idea on the 2024 campaign trail. Their stated goal is to help the growing population of Americans struggling to make credit card payments.
No matter which party or branch of government pitches this idea, the result will be the same: Hard-working Americans will lose access to credit. Good intentions do not guarantee good outcomes.
Interest, like any other price, is a natural result of human interaction. Although I’ve told this example from the late economist Walter Williams before, it bears repeating:
Imagine you were to visit a country that has effectively outlawed all lending and borrowing. Despite the prohibition on lending and borrowing, you could still get a rough estimate of the market rate of interest by comparing the present price of present goods to the present price of future goods. One can get a sense of the interest rate by looking at the difference between the price of milk and the price of cheese. If we have to use milk to make cheese, then milk is a present good and cheese is a future good. Further, if the price of milk rises relative to cheese, then we know that the interest rate must have fallen. If the price of cheese rises relative to milk, then we know that the interest rate must have risen.
Interest is the price people pay to have resources now rather than later. An interest rate measures the price that borrowers pay to have resources now and the reward a lender receives for delaying consumption of resources to a future date (expressed as a percentage).
Like all other prices, interest rates are determined by supply and demand. People’s willingness to save impacts the supply of loanable funds. If the inflation rate is expected to rise, lenders will ask for a higher interest rate to compensate. The riskiness of the borrower and the length or duration of the loan also determine the interest rate as well as the rate at which interest income is taxed. Allowing these and other factors to influence interest rates uninhibited allows credit markets to adjust to changes in supply and demand.
When an interest rate is capped at a certain percentage, the cap prevents the information about relative scarcity and buyer/seller behavior from being portrayed accurately. When that happens, credit card companies will fall back on less accurate proxies for insight.
Credit card companies may choose to deny credit cards to those in lower income percentiles. While being in the lowest income percentile does not guarantee that someone will end up in delinquency, lenders will be aware of data that show the poorest households tend to have the highest rates of credit card delinquency. They may end up denying a credit card to someone with a low income who may otherwise have had a reputable history of paying off debt on time.
Additionally, credit card companies can raise or lower credit limits. Many credit card holders may end up unpleasantly surprised when credit card companies lower their credit limit to reflect a 10-percent interest rate cap.
As I stated before, politicians attempting to “save” Americans with price controls will inevitably result in Americans being kicked while they’re already down.