Senator Bernie Sanders, currently running to become the Democratic nominee for President, and Representative Alexandria Ocasio-Cortez, have proposed to reform the way credit cards work in the United States.
Calling banks “modern-day loan sharks” they are calling for a 15% limit on credit card interest rates and they also want the US Postal Service to enter the banking business, to offer “loans and checking and savings accounts.”
Access to Banking is a Real Problem for Low Income Americans
Free checking accounts aren’t as ubiquitous as they once were – for very good reasons – but they still exist. NerdWallet has a list of several but it’s far from exhaustive.
Banks have added fees, or required minimum balances or direct deposit or other transactions, because it’s no longer profitable to just offer free checking. That’s because of the Durbin Amendment to Dodd Frank financial reform legislation, which effectively outlawed banks earning a profit off of their debit cards. This is also why you no longer earn debit card rewards, banks aren’t making money on the transactions so aren’t competing for your debit business.
Financial institutions used to want checking account business because it would get them consumers’ debit card transactions. Once they no longer made money off debit charges, the subsidy for free checking was gone.
The broader point though is that banks want wealthy customers with lots of different service needs because there are more opportunities for them to profit. Giving a free checking account to someone without much money means it’s hard to cover costs, and so banks turn to fees.
Encouraging the Postal Service to enter banking seems both foolhardy and unnecessary. Sure they already own real estate (‘branches’) but they’re neither known for service nor financial savvy. Assuming federal deposit guarantees are extended to postal banking the policy would create huge liability. It would be simpler and cheaper to simply repeal the law that reduced access to free checking in the first place.
Senator Sanders and AOC Promise the End of Rich Credit Card Rewards
Banks make money off of fees charged to consumers (such as a card’s annual fee), merchant swipe fees (the percentage they and the payment network take from each transaction), and interest charged to consumers.
Cards like Chase Sapphire Reserve are rich enough that they appear to be giving the entire interchange amount back to the consumer in rewards and benefits. The only way it makes sense to offer is on the bet that they’ll attract business lending money, not just processing payments. Without that products like this, and expensive co-brand deals generally, aren’t sustainable.
To be clear, credit card rewards wouldn’t disappear entirely. Capping APR at 15% would support products more like what credit unions offer today — at least until Senator Sanders and AOC cap interchange rates, too, which will do to credit card rewards what that same policy did to rewards for debit card spending.
As a matter of public policy that might seem desirable if it meant helping the least well-off pay less for access to credit. But it’s going to have the exact opposite effect.
Capping Credit Card Interest Rates Means Consumers Will Pay Higher Interest Rates — Not Lower Rates
If you limit what banks can charge for credit, you’re also limiting whom they’ll lend to. Senator Sanders and AOC observe that the average APR today is over 17%. They want the maximum to be lower than today’s average. That may support lending to customers with the lowest default risk, although even there these are still unsecured loans. It won’t support lending to customers who aren’t as well off, or with a history of late and missed payments or defaults.
This policy does nothing to remove the need that people have to borrow. Instead it forces them to use their next-best lending alternative after credit cards, once credit card lending is no longer available to them.
People choose credit cards because they’re a better option than the next choice they could make, whether it’s payday lending or a loan shark. And since the Sanders-AOC policy as-proposed would apply to payday lenders too… The Onion actually put it best 18 years ago.
Not so long ago, the loan shark flourished, offering short-term, high-interest loans to desperate people with nowhere else to turn. Today, however, Pistone and countless others like him are being squeezed out by the major credit-card companies, which can offer money to the down-and-out at lower rates of interest and without the threat of bodily harm.
It’s Hard to Imagine a Policy More Designed to Hurt the Poor
If poor (and poor credit) customers can’t get credit cards, they won’t be able to move out of high cost lending ro build their credit.
Credit card companies, looking to make up lost revenue, will raise annual fees. That’s what happened in Australia when interchange rates were capped. That will make credit cards too expensive for many poor customers to afford.
And by the way it’s not the rich who will be harmed from the elimination of credit card rewards, it’s the middle class whose rewards make a difference for quality of life – whether cash back or trips that would otherwise only be the province of the wealthy.
Imagine you wanted to develop a policy that would erect the greatest barriers possible between the poor and middle classes and the already wealthy, and prevent income mobility, what would that policy look like? It would probably include limiting access to credit along the lines proposed here.