Senator Bernie Sanders and Representative Alexandria Ocasio-Cortez have announced plans to introduce legislation that would limit the interest rate that credit card companies are allowed to charge customers. Although there is currently no federal limit, some state governments have limits. Sanders and Ocasio-Cortez propose capping the annual rate of interest on credit card debt at 15 percent.
What could go wrong with this idea? Lots. Such limits, called usury laws, will make it harder for people without a good credit rating to get credit. That will move some of them to using the much less efficient layaway plans and pawn shops, and might even cause some people to borrow from loan sharks. The credit card caps will also push some people without a good credit history to get even higher-interest payday loans.
These are the opening two paragraphs of my latest Hoover Defining Ideas article, “A Progressive Plan That Aids Loan Sharks,” May 15.
In the piece I tell my own story about how usury laws made my life difficult in 1973:
I’m an example of someone hurt by usury laws in the early 1970s. I moved to California from Canada in September 1972 to go to graduate school at UCLA. Shortly after arriving, I started a checking account at the Bank of America branch near UCLA. In early 1973 I applied for a credit card. To maximize the probability of being approved, I asked for the minimum credit limit: $250. I was always good at handling money but, at age 22, I had never taken out a loan. So I had no credit record. I bet you can guess what happened: I was turned down. I was upset but I was also well along to becoming an economist: I had already learned a lot in a year of self-study in economics and one intense quarter of economics at a great graduate school. So I had learned, as economists do, to put myself in the other guy’s shoes.
I realized that the credit card company that turned me down didn’t know much about me. I knew that I was a good risk. But how would the credit card company know? I had had to state some background information on the application form and that included the fact that I had lived in Canada until a few months earlier and so it would probably be hard to collect from me if I moved back to Canada. How had I gone through college without accruing debt? I had gone for a three-year degree in Canada and financed it with savings, earnings, scholarships, and penurious living. When I had completed my second year of college, my net worth was down to $20. So, to finance my last year of college, I hitchhiked from Winnipeg to northern Manitoba, where I worked for three months in an underground nickel mine and worked every hour of overtime I could, including double shifts. It paid off, and I graduated with zero debt.
But how was a credit card company to know all that? All it knew was that I had never repaid a loan.
One main way a credit card company can deal with the risk of lending to someone with no credit history is to charge a higher interest rate. There’s the rub. I was applying for a credit card in California, and California’s usury laws restricted the rate that could be charged. Given the risk, it simply wasn’t worth a credit card company taking the chance.
A few months later, my inability to get a credit card with even a modest credit limit made my life difficult. In the spring of 1973, I applied for, and accepted, a position as a paid summer intern with President Nixon’s Council of Economic Advisers. When I arrived in Washington, D.C. early Monday morning on a redeye, I had spent all but my last $20 on airfare. I was negotiating with various people I had contacted by mail to rent a room from them in D.C. or in Alexandria, Virginia, but nothing was firm. I was desperate. I pleaded with one of them, successfully, to let me stay with him and his roommates in Alexandria Monday night. I persuaded his roommates to let me stay a few extra days, but because I was responsible for my own food, I remember being very careful while shopping. My $20 left had to cover food and bus fare from Alexandria to the Old Executive Office Building until a few days later, when I managed to borrow another $20 from one of my Alexandria roommates.
Think about what I could have done with a credit card and a $250 limit. Room rentals at so-so hotels were going for well under $40 per night in those days. But, because I had no credit card and little cash, that wasn’t an option for me. Of course, as I built a work record, paid taxes, and lived in the United States longer, I finally qualified, in 1974, for a credit card. But I couldn’t get one when I most needed it.
My favorite part was my discovery, in researching the article, of the details of the 1978 Supreme Court decision. I particularly appreciated Justice Thurgood Marshall’s questioning of the lawyer whose client was trying to prevent competition in the credit card market.
Read the whole thing.