On July 29, the Senate Banking Committee held a hearing titled “Protecting Americans from Debt Traps by Extending the Military’s 36% Interest Rate Cap to Everyone.”
The title is a paragon of political rhetoric. It’s also completely misleading.
Who could possibly be against protecting Americans from debt traps? And what better way to do it than to hold everyone to the same standards that apply to the military?
The problem, though, is that this sweet-sounding language distracts from the real issue: Should the federal government control the interest rates that private lenders charge?
Given the fiscal mess that Congress has created in the last few decades, with no sign of caring about how much debt (and unfunded liabilities) it forces on future taxpayers, or how many low-equity long-term mortgages it pushes on “low-income” workers, this question might seem absurd. And it should.
A main goal of the American system of government is to limit what people can do to each other through their government. There is virtually no end to what ideas humans might come up with to help others, but when the ruling class uses the government to force compliance with their ideas, things typically go awry.
In the case of interest-rate caps, America has a long and sorrowful history of ignoring this principle. Those experiences show why the limited government approach is better.
A federal price ceiling on bank deposit rates was a primary cause for consumers pulling massive amounts of money out of banks during the 1970s, as well as the 1980s Savings & Loans debacle.
Before 1978, when they were federally pre-empted, a patchwork of state usury laws on consumer loans and credit cards restricted competition, resulting in fewer available credit cards and high annual fees to avoid the rate caps.
Despite all the evidence on rate caps, as well as what experience shows about the harmful effects of other kinds of price controls, some members of Congress just can’t let the idea go.
Now, Sen. Jeff Merkley, Oregon Democrat, and several co-sponsors want to extend an interest-rate cap that currently applies just to active-duty service members to pretty much everyone. Specifically, they want to extend to all Americans a federal law that forbids lenders from providing consumer credit to active-duty service members at an annual percentage rate (APR) greater than 36%.
In this case, the definition of consumer credit means that the rate cap will essentially apply to all credit cards, deposit advance loans, overdraft lines of credit and many different types of installment loans. It will also impose a standardized version of an APR to many forms of credit for which an APR is an inappropriate measure of cost.
No matter what the hearing title suggests, these policies will not protect consumers from problems associated with debt. They will, in fact, harm more consumers than they will help. Rate caps are price controls, and that’s what price controls do.
The rate caps will make it more difficult for those who most desperately need credit to obtain it, and they will ultimately raise the cost of credit for many other borrowers. People will develop alternate (more costly) ways to both supply and obtain credit.
Lenders will likely provide fewer small-dollar loans, freezing out some borrowers. They’ll also lend more money to some consumers for longer terms than they need. Credit card companies will likely drop their rewards programs. Of course, none of this—not the rate cap, and not the lenders’ efforts to stay in business—will reduce people’s demand for credit.
Compared to alternatives, private markets do an excellent job of satisfying people’s needs and wants, largely thanks to the decentralized price system. If Mr. Merkley and his colleagues truly believe that some lenders are charging “too much,” then they should compete with those lenders by providing less expensive loans.
That’s precisely how limited government allows people to help each other and protect themselves.
This piece originally appeared in The Washington Times