President Donald Trump has proposed capping credit card interest rates at 10% during his address at the World Economic Forum in Davos, a move that aligns with a legislative effort already introduced by Senator Bernie Sanders. This proposal has generated significant attention, reflecting widespread public dissatisfaction with current economic conditions, including rising inflation and stagnant wages.
Trump’s suggestion, while popular among many Americans, has drawn criticism for its potential long-term implications on the credit market. As a former chief economist at the Office of Management and Budget during Trump’s first term, I find this shift towards price controls particularly concerning. The previous administration’s economic strategies relied heavily on free-market principles, which fostered growth through deregulation and competition.
Capping interest rates at such a low threshold could inadvertently harm the very individuals it aims to help. The current average annual percentage rate (APR) for credit cards stands around 20%, reflecting a significant variation based on borrower risk. While prime borrowers may secure rates as low as 14%, subprime borrowers often face rates exceeding 25%. Lowering rates indiscriminately could push lenders to withdraw from higher-risk markets, ultimately denying access to credit for those who need it most.
According to the American Bankers Association, an estimated 137 million cardholders could lose their credit cards if such a cap is enacted. Those affected are often those who rely on credit to manage emergencies or to build their credit histories, potentially forcing them towards predatory lending options that charge exorbitant rates beyond regulatory reach.
Historical precedents provide cautionary tales about the effects of interest rate caps. In the 1970s, similar measures severely restricted consumer credit availability until legal changes permitted interstate banking. France’s stringent usury laws have perpetuated a cycle of exclusion for many, while Japan’s 2006 rate caps led to a collapse in consumer finance, driving borrowers into the hands of organized crime.
Critics argue that the notion of curbing ‘excessive’ profits in the credit card sector does not hold up under scrutiny. Despite high nominal rates, credit card issuers operate with thin margins due to substantial default rates. For instance, JPMorgan Chase reported a return on equity of 27% in recent years, a figure that, while healthy, reflects the genuine risks involved in lending.
Innovative solutions to the current credit landscape should focus on promoting competition and enhancing financial literacy rather than imposing price controls. By removing regulatory barriers for new market entrants, mandating clearer disclosure of terms, and encouraging alternatives like credit-builder loans, access to credit can be expanded.
The previous administration’s approach trusted in market mechanisms, which proved effective. Transitioning to strict interest caps does not enhance economic compassion; rather, it risks creating a more constricted and less accessible financial environment for those in need.
In conclusion, while the intentions behind capping credit card rates may appear noble, the economic realities suggest that such measures could exacerbate financial exclusion. The laws of economics, akin to the laws of physics, remain unchanged by legislative efforts. Individuals struggling financially will likely find that a credit card with a high rate they can obtain is preferable to an unattainable low-rate option. As policymakers consider the implications of these proposals, it is critical to prioritize strategies that genuinely foster economic growth and accessibility.
