Who could oppose something called the Loan Shark Prevention Act? Sure, the fact that it was introduced by Sen. Bernie Sanders (I–Vt.) and Rep. Ocasio-Cortez (D–N.Y.) may give many on the right considerable pause. Yet even Tucker Carlson declared their bill, which would cap interest rates on credit cards and other consumer loans at 15 percent, “absolutely, indisputably right.”
Not so fast. Their approach doesn’t stand up to scrutiny.
Besides capping interest rates, the bill also allows states to impose lower limits on national banks operating within their state. Because Sanders and Ocasio-Cortez know this will put private companies out of business, their bill enables the U.S. Post Office to provide an expansive array of banking services, including checking accounts and loans.
The real problem with the Loan Shark Prevention Act is that price controls simply do not work. The caps will hurt low-income borrowers, making it costlier to both borrow and lend.
Price Controls Are Bound to Fail — Badly
Examples of the abject failures of price controls are found throughout history. Ancient Egypt endured economic mayhem 2,100 years ago after being subjected to price and wage controls. Likewise, detailed controls promulgated by King Hammurabi 3,800 years ago led to long-term economic problems for the Babylonians. In ancient China under the Chou dynasty (spanning nearly 1,000 years, ending in 221 BC), price controls failed to manage supply and demand.
Chinese scholar Dr. Huan-chang Chen notes, “Whenever the government adopted any minute measure, it failed, with few exceptions.” In ancient Greece, rulers sought to enforce controls on the grain market. Violators faced capital punishment. Yet prices continued to fluctuate in response to supply.
Thousands of years later, price controls in France in 1793 on grain, flour, and meat led to shortages and riots. In Venezuela today, shoppers often face empty shelves five years after the Fair Price Law set price controls and prohibited hoarding. Likewise, rent control creates a shortage of affordable, well-maintained supply of housing in many cities.
Attempting to control the price of credit is also hardly a novel concept. As an example, the Romans banned usury by 342 BC. But hundreds of years later, circumvention of the ban was commonplace. The government of Julius Caesar tried to rein this in with a 12 percent cap on usury. Official bans on usury imposed by the Roman Catholic Church were shrewdly evaded by financiers of the Middle Ages.
In the late 17th century, a debate raged in England over whether to lower usury limits. With an eye towards history, philosopher John Locke warned, “Tis in vain therefore to go about effectually to reduce the price of Interest by a Law; and you may as rationally hope to set a fixt Rate upon the Hire of Houses, or Ships, as of Money.” Not until 1854, did England at least heed his advice by repealing usury limitations. These restrictions denied resources to those in most dire need while spurring the creation of black markets.
Higher Interest Rates Reflect Risk
As it turns out, the laws of economics work in financial markets just as they do in others. Suppliers of credit base the price of their product—the interest rate of the loan—in large part on the risk of the borrower. Lenders issue loans with the understanding that the principal and interest payment term will not be honored in all instances. In some years, more than one million individuals file for bankruptcy protection. Simple defaults occur as well. A higher interest rate reflects the varied nature of the costs of these risks.
A government-mandated interest rate cap presents a dilemma to lenders: either extend credit at a rate that doesn’t include all the default risk, or deny credit to a large swath of potential borrowers. Neglecting to appropriately price risk—undercharging the product—may lead to fiscal insolvency of lenders, harming investors while threatening the economy. Interest rate caps on home mortgages led to the savings and loan (S&L) crisis in the 1980s. To avoid a similar disaster, lenders will withhold credit from those with relatively worse credit histories and fewer assets.
In defiance of the lessons of history, Ocasio-Cortez confidently insists, “There is no reason a person should pay more than 15 percent interest in the United States.” The fact is, many good reasons exist why someone might pay more than 15 percent interest. Neither Ocasio-Cortez nor anyone else can possibly know the proper rate to impose on everyone.
Oftentimes, access to credit is needed to maintain short-term liquidity. Without a credit lifeline, a temporary loss of income, health problem, or other unexpected expense may force an individual into a default on pre-existing obligations. An impounded vehicle, a bankruptcy, or even foreclosure could result from the inability to obtain credit in a time of severe need.
The government-caused shortage of credit will also deny families a chance to establish or re-establish credit. Due to increased risk of nonpayment, those establishing a credit record or emerging from financial turmoil typically pay higher rates. Obtaining a credit card at a higher rate gives them a chance to demonstrate financial solvency and responsibility.
Denying Credit Access Is Just a Tax on Poor People
Individuals not qualifying for credit within government-imposed interest rate limits may pursue illicit lending alternatives at unlawfully high interest rates out of sheer desperation. Far more serious repercussions than a lien could result from defaulting on such a loan.
Unfortunately, the people who need higher-priced loans in the first place—those with the least amount of wealth and income—will be the ones denied access to the credit market by the 15 percent cap. If the price of credit (the interest rate) is lowered artificially, a shortage will follow. Denying credit by imposing these limits acts as a tax on poor people.
What of the proposal to have the government provide banking services through U.S. Postal Services offices? This is unnecessary and ill-advised. Sen. Sanders claimed, “Many poor people don’t have access to banking services because the big banks are not worried about somebody who makes 10 bucks an hour … so we’ve got to move towards universal banking through the postal system.” However, no widespread shortage of banking services exists. A Federal Reserve report shows 95 percent of adults “have a bank or credit union account,” including 90 percent of blacks and Hispanics.
Choices for low-cost banking abound for the small fraction of adults with no such accounts, even those with small account balances. For instance, Wells Fargo waives the $10 monthly service fees with just 10 debit card transactions in one month or at least $500 in direct deposits. The congresswoman complained about the lack of banks in densely populated urban areas such as Brooklyn. Yet a simple search shows more than 300 bank branches in Brooklyn—nearly five per square mile.
Government Warps Incentives Through Foolish Mandates
Furthermore, when the government caps rates associated with a service through a government monopoly, they lose money and end up providing a subsidy financed by taxpayers because of the political pressure to keep rates artificially low. In fact, that’s exactly what happens now at the Post Office with direct mail.
Congressionally mandated services, compensation levels, and rates all contributed to last year’s $3.9 billion net loss on revenue of $70.6 billion. This was hardly an anomaly. The Postal Service last turned a profit in 2006.
When permitted to compete with the USPS, private delivery services have bested their counterpart in customer satisfaction and profitability. Why should a money-losing government monopoly with lackluster performance attempt to compete with a banking sector already demonstrably servicing individuals of all income levels nationwide?
Government restrictions in the form of an interest rate cap will inadvertently harm the poor by denying them access to credit and exacerbating the financial challenges of those in need of this credit. Nor will subsidized credit through the Postal Service yield the intended results. Instead, eliminating barriers to innovation and competition in the lending market place will best benefit consumers.