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.
Both of their ideas will be horrible for most consumers especially those in the lower middle class and poor.
Both are in a competition to bring down America. If they are in charge, America will go down before 2025.
Just here for the political comments that will be sure to hit soon 🙂
Confused by the uproar in this. If you have good credit it won’t effect you and if you have marginal credit it will be a benefit- for current credit customers. New issuance of credit could be problematic but it is anyway. Further. aren’t credit unions currently capped at 15%? They seem to be doing ok. Not sure why big banks are getting so much love for charging up to 30% foe credit cards..
Economics degree from Boston University. LOL. I’d be embarrassed if I was an alum.
I wouldn’t worry too much about it. These 2 are just throwing whatever outrageous nonsense they can come up with at the wall to see if they can get the kind of press AOC got for the Green New Deal. The more unachievable, the better.
Let’s not encourage and enable those further down the ladder to move up. No, let’s bring everyone down to the level of the lowest common denominator and try to keep them there.
Sounds familiar — there was an echo in history but who can remember that?
Yeh another blog post by someone who thinks he understands a lot more than he actually does. Stick to airplanes, which you barely also understand.
Bernie Saunders and AOC think they have all the answers and know what’s best. But they’re both wearing rose colored glasses and cannot foresee all the unintended consequences.
@Donald Trump – care to suggest what i have wrong here, then?
@Frank the credit profile of a credit union customer can support those rates, often people gain access to credit unions through their jobs. My point isn’t that this is bad for the well off, this is bad for folks who aren’t as well off.
I am deep in the credit card/award ecosystem and travel well thanks to the current scheme. However, I support legislation to bring affordable banking to a broader swath of consumers. Unless you have a better alternative to the status quo, it’s easy to be an armchair quarterback and not worry about impacts that you will never feel.
Gary – this isn’t meant as a dig but you really need to talk to a macroeconomist. Your analysis is simplistic and essentially wrong. You could also search for journal (academic) articles that have researched this for years and please stay away from “econ reporters” who write for popular press. A recent Noble prize was awarded for interest rate study. I know you are not fanning political flames on purpose and from what I can tell, you do care about getting things right.
Agreed. It is sad to see how often politicians identify problematic situations (here: some people have lots of credit card debt at high interest rates) but then propose government “solutions” which don’t solve the problem and end up hurting the very people they were designed to help. (see also: student loans, Fanny Mae, etc.)
Wow, OK, Let’s play hypothetical:
Summary of this article if I understand correctly is –
By Capping interest rates at a lower percentage, poor will suffer because they will not be able to borrow as much.
Might I remind you the reason for the 2008 crash was that “poor” people borrowed more than they should or more than they could have been able to. These loans were pushed and expedited by banks.
So I would like to argue that between poor people and the banks, for the past decade the “poor” people have been more responsible.
There was a recurrent theme in the evidence presented to, and the findings of, the Australian Royal Commission into the banking industry: that banks are arrogant, deceptive, sly, uncaring, manipulative, at best…negligent, deceitful, criminal on a regular basis. We will soon see some banking executives in prison as a consequence of some of the malfeasance.
There is no compelling reason to believe US bankers are any different or better; indeed significant reason to suspect they are worse.
@Parag I don’t think there’s a particularly strong claim that the 2008 financial crisis was driven by the poor borrowing too much
@Economy If you’re going to tell me that I’m ‘essentially wrong’ you sort of have a burden to say what it is that you think is inaccurate in what I’ve written, right?
There are several journal articles that found the Durbin amendment reduced access to free checking accounts. Here for instance is a paper from Federal Reserve economists on the topic https://t.co/4UXxy7pb1U
What am I getting wrong here exactly?
@Darin I’m a huge proponent of greater access to affordable banking, I offer a solution in this very blog post (remove the legislation that made access to financial institution out of reach of so many Americans)
@parag, @Gary
But…wasn’t it called the subprime mortgage crisis? I thought subprime = poor, Prime = normal, super prime = rich?
Gary, I read about this (especially about post office banking) and keep thinking about the Amex Bluebird experiment and its failure.
I’m not knowledgeable enough to articulate thoughts on this, but do you have any input on it? Seems like Bluebird’s failure is a good canary-in-the-coal-mine for post office banking.
@Rob
Subprime = bad credit, not necessarily poor. While I don’t doubt a correlation, these are not synonymous.
It is rhetorically irresponsible not to mention the other reason to oppose this policy:
As someone whose income comes in part from referring people to credit and banking products, if those products become less lucrative, you will lose revenue and you may have to find another job.
Giving access to credit to people that do not have the means to repay is a recipe for disaster. See government takeover of the student loans. Can you imagine:
Paraphrasing Tennessee Ernie Ford:
“You work all day and what do you get?
Another day older and deeper in debt
Saint Peter don’t you call me cause I can’t go
I owe my soul to the government dole”
Think about it, if I owe my soul to a bank, then I can declare bankruptcy and my soul is free. In its wisdom and compassion, the US Government has exempted student loans from discharge in bankruptcy. How long to you think it is before the US Government exempts government credit cards from bankruptcy. Your soul is never free when you borrow from the US Government.
Horrible ideas and horrible people. All this will do is force credit card companies to raise their lending standards and less people will have access to credit. They are less likely to give an unsecured loan when the credit risk can’t be accounted for in higher rates and fees. Would they really prefer people going to pawn shops or loan sharks off book or not having credit when they really need it or having access to credit with big banks.
The limit on interchange (swipe fees) is a more likely possibility as Europe has done this. This will mean the end to credit card rewards period. Already if people pay off their statement balance, credit cards are unprofitable for the bank as anything over 1 point per dollar cancels out the swipe fee of 1.5-2.2%. The banks do need to pay for overhead.
There is an awful lot of what scientists refer to as “hand-waiving” in this article — saying things that may or may not be true, but certainly are unproven, and acting as though they are. There is no evidence that charging interest rates above 15% means that the banks will extend more credit to the poor — that seems unlikely, because 15% APR is plenty of incentive to extend credit to anyone whom you think will pay you back. (The banks’ cost of funds is in the 2% to 3% range.) There is no reason to think that an attack on usury will be followed by an attack on interchange fees; merchants are the ones who pay interchange fees, and neither Sanders nor Ocasio has shown much love for merchants. (Everyone on Capitol Hill understands that interchange fees are a corporate vs. corporate issue.) Anyway, if Sanders wanted to ding interchange fees, he would have done it a long time ago. There is no reason to think that banks will raise their annual fees; like every other business in the world, they charge what the market will bear already.
In short, c’mon. These arguments don’t hold water. If you want banks to be able to charge whatever they want, then make that libertarian argument, but don’t resort to the ‘parade of horribles,’ much less position yourself as a champion of the needy.
In many other countries, the post office also serves as a banking location. Surely with all your travels, you’re aware of this, Gary?
Yikes, Gary. Stick to what you know and stay out of politics, buddy.
Fortunately, this has no chance of happening. Actually (and also fortunately), very little of anything that either of these two propose has any chance of happening.
I cant imagine it being controversial that credit will be limited. We can debate how much less credit will be available to the worst borrowers but it will be less. If you were investing in a pool of credit and you were currently earning say 9 to 10% and in the future with the cap that went down to 5 to 6% would you keep investing in that asset or just move to something with a higher return?
The other thing that needs to be mentioned is that for better or worse Americans have been using credit as a palliative to keep a certain standard of living as wages have stagnated due to the natural convergence if labor due to globalization…take away some access to credit in the midst of stagnant wages seems like a recipe for discontent.
Ocasio-Cortez is overrated and over exposed. She has been in Congress for only a few months. The media (and this post) exploit her good looks and controversial ideas to increase ratings. There are women and men who aren’t as pretty with ideas that are as good as or better than hers who merit more attention. People can’t resist looking at the shiny object. Trump is a master at that.
Ferdinand Magellan said: “The banks’ cost of funds is in the 2% to 3% range.” Plus credit losses. Losses on credit cards can be quite high. Why? Let’s take a common hypothetical case. Give someone a credit card with a credit line of $10,000. For 5 years, he is working and so never carries a balance. In fact, he might even have a 750+ credit score. Let’s say the bank makes all-in $1,000. He loses his job. For the next three month, he lives on his credit card, then defaults. That is a $10,000 loss, on $1,000 of revenue. Not a pretty picture.
It is easy to rag on the evil banks. However, bank margins are small.
@ Gary — Bernie Sanders and AOC are horrible, but no where near as bad as DJT.
Instead of paying taxes for the post office to lend funds, I should just lend money to my brother in law. A more efficient way to throw away money.
The issue with subprime mortgages is easy federal money (and greedy bankers willing to foist bad debt of onto Freddie and Fannie Mae).
If the government wasn’t in the home lending business, these subprime loans wouldn’t have been made. Now we’ll triple down and lend folks who can’t afford it money for SUVs, overpriced colleges and houses.
The rightwing diatribes here are sad and frequent. Worrying that our credit card rewards might be changed in some way to allow better checking account and debit card access to more people–wow, that’s some privilege. Apparently, being selfish and not caring about anyone else is not something limited to Wall Street and banks? This thread seems rife with such privilege and entitlement.
None of us are entitled forever to our credit card rewards. We can enjoy them for as long as they may last. Great!
Our author, nor anyone else, doesn’t have the slightest clue if or how the PROPOSED changes to banking laws MIGHT impact rewards credit cards.
This is nothing more than rightwing Fox News bashing and fearmongering propaganda intended to preserve the self-involved status quo.
It’s possible that changes can hurt us. It’s possible that changes can help us. Being afraid of change in and of itself is what the rightwing is counting on.
I could not stop laughing at Bill’s comment because I kept on imagining him Tootaally Freeeeaaaaking out at a Trump rally. Ha ha ha ha……. Why don’t you do another rant. I need another laugh before going to sleep.
Jeff: do you think there should be no limits on interest rates? Should banks be able to charge whatever the market will support?
Unless the answer is yes (i.e. you’re a libertarian crank) then your argument with Sanders and AOC is one about where to draw the line, not whether to “end credit cards as we know it”.
By the way, if anyone is interested in some actual evidence about what rule changes like these might do to access to credit then, rather than going around in circles in the comments section of a website about frequent flier programs, you could do worse than read this thread https://twitter.com/ProfNoto/status/1126644299075133440.
Sorry, not “Jeff”! That comment was adressed to Gary! 🙂
Gary, political posts need to stop. Your recent postings have clearly shown a political bias, and while entitled to that, I don’t come here to read your political opinions.
The rest of the world doesn’t have credit cards like we do. We mileage gamers look at credit card rewards as a positive but for every person that is like you and me who signs up for a 50,000 credit card bouns and games the system by using the points and closing the card before the annual fee is due, there is another American on the other side of that equation who gets the same card, goes into debt and pays for it for years. The banks only offer cards because it is profitable to them because people go into debt. You can say people need to take personal responsibility, but banks are luring people to sign up for these cards with the big bonuses knowing full well that many of them will over extend themselves and pay exobadent fees. Most other countries would consider that predatory lending but we call that capitalism. I love credit card rewards and the travel it has given me but when the average American has $5,808 in credit card debt maybe it it time to look at the system that is fueling this problem.
Fee-free checking account access at the bigger US commercial banks was already under assault by the bigger banks, and it was disappearing slowly but surely even before debit card revenue became a casualty of sort to regulation in the manner this blog is suggesting above.
Comrades, I say let’s have the government nationalize the entire banking sector and give no interest credit to whoever asks (including the undocumented workers). Guaranteed to stimulate the economy.
@colleen – Bluebird on paper was an absolutely brilliant play that would have done a ton for the unbanked, and it seemed like american express was doing a good job finding customers where they already are. I was genuinely surprised when it didn’t work.
My gut reaction to the proposed rules is to dislike them, but they are a reaction to a real problem – a problem that the entire country will benefit from being solved.
The problem with the proposals is that they are backwards looking and ignore the changes to banking occurring elsewhere in the world, and particularly in poor countries with a large unbanked population. In my view, it is elsewhere that you need to look for a solution.
But you do need to legislate to ensure that the existing providers don’t kill off nascent markets and the Fed needs to act to ensure that new players are not squashed before they start. Notable in the USA is that internet banking is barely happening – and it’s internet banking which drives costs down so that free banking is available to all. If you eliminate checks, eliminate paper, eliminate bank branches and significantly reduce cash handling, the cost-basis for consumer banking is transformed. The only remaining significant cost is money transmission and that’s where the Fed can stand in to create a much cheaper system. Note how the US banks have tried to eliminate real internet banking by providing services such as Zelle (which is a convoluted and expensive way of handling a simple interbank transfer) and put limits on what people can do so they are forced to pay extra for wire transfers. All of these are unnecessary and designed to kill off new competitors.
So, create a level playing field, eliminate anti-competitive behavior and introduce systems for money transfer and you’ve solved your problem.
And, remember, banks make the most money on interest rate spreads and multipliers – that will still happen.
For everyone saying Gary is off base, needs to consult an economist, etc. here is a scholarly article linked at Marginal Revolution (run by two PhD economists…if you need an appeal to authority) showing magnified negative effects for riskier borrowers when credit markets are capped:
https://marginalrevolution.com/marginalrevolution/2019/05/price-regulation-in-credit-markets.html
@NB:
1) legislation overwhelmingly favors incumbent firms who have the staffing and infrastructure necessary to comply with a myriad web of regulation. Good intentions will not save this bill from going through the sausage grinder and emerging in a form that punishes start up firms.
2) honest question: how is Zelle expensive? I am charged nothing for transfers. Are there some limits on transfer amount, bank account minimums, etc. what is making this an expensive workaround?
Can’t stand this moron cummunist antisemitic biach.
FWIW, professional economist with PhD and lots of publications here. Gary has it right. And this isn’t “political posting,” at least not in the sense of partisan politics. This is an issue that matters for Gary’s readers and it is totally in-bounds for him to comment on it.
And he is also correct that this policy will harm the young and poor (and people of color) the most. It’s not a pose. It’s the correct economic analysis. It’s not Gary’s fault, or mine, that it’s so hard for people to believe that when politicians and governments try to do things that they think will help those groups that their ignorance and poor analysis may end up harming those they intend to help.
As a philosopher friend of mine likes to say “If your primary concern is that your heart is in the right place, it isn’t.”
Freaking socialists…. and stupid people actual listen to what they say….
@ Gary – “I’m a huge proponent of greater access to affordable banking.” Then you might want to check out what Aspiration has to offer. They address all the issues you’ve raised here. Every poor person can get a checking account and debit card – AND earn bonuses for using that card.