An epidemic of economic illiteracy seems to have inflicted both parties. While Republicans suffer from President Trump’s fixation on taxing imports to make America great again, Democrats, eager to prove that they also fail to understand basic economic principles, have unveiled a proposal for price controls on credit cards.
The proposal is the brainchild of the Democratic Party’s two leading democratic socialists, Sen. Bernie Sanders (D-Vt.) and Rep. Alexandria Ocasio-Cortez (D-N.Y.) and is targeted at what the pair call “exorbitant credit-card interest rates” in a statement. Their “Loan Shark Prevention Act” would a 15-percent federal cap on interest rates and empower individual states to establish lower limits.
Channeling Ron Paul’s references to “banksters,” Sanders said, “The reality is that today’s modern-day loan sharks are no longer lurking on street corners breaking kneecaps to collect their payments. They wear three-piece suits and work on Wall Street, where they make hundreds of millions in total compensation and head financial institutions like JPMorgan Chase, Citigroup, Bank of America and American Express.”
Per the statement, the pair claims that the median credit card interest rate is currently 21 percent and argues that there is no reason for banks to charge such a high interest rate.
“There is no justifiable reason that a person—no matter their background—should be charged an interest rate higher than 15 percent,” Ocasio-Cortez said. “Rates higher than 15 percent are predatory debt traps, designed to keep working families underwater and allow predatory companies to enrich themselves off the misfortune of others.”
Like many bad ideas, this one sounds good on the surface. Bankers make an easy target for populists and everyone hates paying credit card bills.
In reality, however, high interest rates on credit cards do serve important purposes. One of the most important purposes is to discourage consumers from carrying even larger amounts of revolving debt. By March 2018, Americans carried $1.027 trillion in debt on their credit cards. Without high interest rates, the amount of indebtedness would be even higher.
By making revolving credit expensive, banks encourage consumers to only charge to their cards what they can pay off at the end of the month. If you pay off your balance every month, you don’t pay any interest at all.
High interest rates also signal the risky nature of credit card loans. Credit card default rates are down from a high of 6.7 percent during the Great Recession, but credit card payments are often one of the first things to stop when times get hard. With an average balance of $6,354, banks can be left on the hook for many thousands of dollars when credit card holders default.
Even though credit card debt can be hazardous to your financial health, credit cards are a near-necessity of modern life. The availability of high interest rate cards allows many people who are considered credit risks to get a card that would not be available to them otherwise. If the Sanders-Ocasio-Cortez bill becomes law, the effect would be a shortage of credit for many Americans. It is axiomatic that price controls, such as an interest rate cap, lead to market shortages.
In the early days of credit cards, the now-ubiquitous plastic payment devices were used almost exclusively by the wealthy. It has only been in recent decades that credit cards became commonplace among the middle- and lower-income groups. Under the Democratic proposal, it’s likely that the trend of easily available credit for the common man would be reversed.
Some would argue that reducing credit card use would be a good thing. I have sympathy for this argument as a guy who has paid off thousands of dollars in credit balances more than once. Credit cards are a financial tool that can be very destructive if used improperly.
The problem with the Bernie-AOC solution is that government intervention in the markets would inhibit people who need access to credit from getting it. Rather than reducing credit card use overall or capping interest rates, a better solution would be to teach consumers to use credit responsibly.
Until then, I'm sure that Bernie and AOC would give voters the guarantee, "If you like your credit card, you can keep your credit card."
Originally published on The Resurgent