New Proposed Rate Caps Would Create Adverse, Unintended Consequences

The following is an op-ed by AFSA President and CEO Bill Himpler on new proposals and discussions to cap interest rates.

In Washington it’s not uncommon to have policy proposals that lack common sense. The same can be said for well-intentioned policies that create adverse, unintended consequences. It’s less common that a single proposal achieves both. But that’s what has happened with a congressional proposal that would cap consumer loan interest rates at 15 percent and allow the U.S. Postal Service to enter the consumer-loan business.

 Sen. Bernie Sanders (D-VT) and Rep. Alexandria Ocasio-Cortez have put forward a plan that they claim would end what they see as high and unfair interest rates on consumer loans and credit cards, by capping the highest rate a bank, credit card company or other consumer loan business at 15 percent. Their argument: all these lenders can borrow funds to underwrite those loans from the Federal Reserve at a rate of 2.5 percent, so an interest rate passed on to consumers over 15 percent is unfair. 

This proposal is not only misguided, it’s based on faulty or incomplete information about how lending works and on the regulatory processes that Senator Sanders himself has over the past decade helped impose on consumer lending and financial services. 

 For example, banks and other lenders may be able to borrow from the Federal Reserve at a 2.5 percent rate, but the costs associated with underwriting and servicing the loans with those funds adds significant costs to the loan itself. There are fixed costs to lending, just as there are for manufacturing cars. Fixed costs for any business include: staff salaries, rent, insurance, and to cover the costs of federal regulations they must follow. Today, according the Mercatus Center, lenders must operate under almost 30,000 new regulations imposed on them since 2010. More than a few may be in response to the 2008 financial crisis, but still, the imposition of these regulations has real costs that are inevitably passed along to consumers.

Why do these costs matter?  Because the expenses must be factored into the bottom line for lenders when consumers come to them for a loan. And at the proposed rate of 15 percent, the very types and sizes of loans Senator Sanders is targeting – small-dollar loans under, say $1000, for car repairs or a new refrigerator – would become a thing of the past. 

 According to a study using loan data, to cover just the cost of a loan – without a profit – the loan would have to be no less than $2,600 and at a 36 percent interest rate. For a loan to be profitable at 36 percent, the loan would have to be between $3,500 to $4,000.

 So what happens when you cap interest rates at 15%? Finance companies and banks stop making small-dollar loans. And credit card companies?  That industry would adjust as well. Senator Sanders noted how many young people use credit cards to pay for gas or groceries or any number of other everyday items. But most people use those cards because of the cash rewards or other benefits they receive in return. With increased costs for underwriting those cards, banks and credit card companies would likely end such benefits, while also raising fees for using the cards, and limiting access to credit for consumers who have poor credit scores.   

With all of that said, the need for small-dollar credit doesn’t get eliminated. Consumers will still need to find ways to pay for car repairs or to fix their air-conditioning. Under this proposal, consumers would be forced to either borrow more money they don’t need (and may not be able to pay back) or they go to unlicensed or predatory lenders, the very thing this proposal claims it wants to avoid. How does either outcome help consumers? 

Members of our association provide loans to everyday main street Americans to help pay for things like their small business, housing repairs, medical expenses, weddings, cars, and other unexpected expenses. Americans having access to this type of credit has been essential for over 100 years, and the Sanders-AOC proposal would leave many Americans out to dry when getting a traditional installment loan.  

These are the unintended consequences I referred to, but what about simply bad ideas?  Well, this is the second part of the Sanders-AOC proposal: allowing the U.S. Postal Service to offer and underwrite small-dollar loans at the 15 percent rate.

There is a reason the U.S. Postal Service has essentially been a bankrupt entity for more than 25 years: it cannot compete against the more reliable and more cost effective deliverers of packages and mail, whether it’s Federal Express, the United Parcel Services or even Amazon. Taxpayers have been “loaning” funds to the postal service to keep it afloat for years, with no repayment in sight.  The U.S. Postal Service can’t perform its core business well or profitably, and now we think it can manage perhaps tens of millions of dollars in loans responsibly? 

Senator Sanders and Representative Ocasio-Cortez are right to say that consumers should have access to credit and small-dollar loans at fair terms, but their proposal would achieve neither goal, and, in fact, harm the very people they are seeking to help.