A proposal to cap credit card interest rates at 10% is gaining support from politicians on both the left and the right. Advocates argue that this policy will work to the advantage of potential borrowers who will no longer be charged rates of 25% or higher.
But things aren’t so simple. For one, there’s a straightforward economic argument against a cap on credit card interest rates: companies simply won’t extend credit to higher-risk borrowers if they aren’t able to secure a higher potential payout to offset the risk of default. (By analogy, you’re unlikely to invest in a high-risk tech startup instead of blue chip stocks unless the potential payout is high enough to offset the increased risk.) And this outcome would be bad for those borrowers since they would no longer be offered credit at all. Surely, an offer of a high interest credit card is better than no offer at all—more on this below.
But many advocates of price controls on credit card interest rates make a moral argument. They worry that credit card companies that charge high interest rates are taking advantage of borrowers’ lack of options. Generally speaking, you’d be unwilling to accept a 25% interest rate unless you ran out of alternatives. Credit card companies are therefore exploiting the vulnerability of high-risk borrowers.
However, price controls are a misguided solution. Remember that the problem here is that many borrowers lack good options to acquire the money they need. Reducing borrowers’ options by one doesn’t solve that problem—in fact, it makes the problem worse. Borrowers now have even fewer options than they had before. To take a similar case, it would be perverse for the state to ban the sale of low-cost tents to those in need of permanent housing on the grounds that these sales exploit their lack of housing options.
Consider also the following moral argument against price controls on credit card interest rates (it’s similar to one I’ve lodged against “price gouging” restrictions):
If you may offer no credit at all, you may offer credit with high interest rates.
You may offer no credit at all.
So, you may offer credit with high interest rates.
Let’s break this down. First, take the claim that if you may offer no credit at all, you may offer credit with high interest rates. The argument here is simple enough: Receiving an offer of something is potentially better, and certainly not worse, than receiving an offer of nothing. If the offer is better than nothing, the borrower will take it and thus be better off. If it’s worse than nothing, she can reject it and thus be no worse off for receiving the offer.
Critically, borrowers themselves are in the best position to know whether they should accept the offer of a high interest credit card because they know their particular economic needs and prospects better than anyone else. An outsider may not understand why someone would be willing to use a credit card with a 25% interest rate, but they are likely to be unaware of the particular circumstances that motivate the borrower to do so. Along the same lines, an outsider may not understand why someone would quit their job for one with a significantly lower salary, but here we’re happy to defer to the employee’s own judgment of their economic situation.
Lastly, the claim that you may offer no credit at all simply follows from the fact that potential creditors have the right to make their own decisions about their money. If your neighbor knocks on your door and offers to pay you $1,000 at the end of month if you’ll give her $950 today, you’re under no obligation to agree. You’re certainly under no enforceable obligation to agree—that is, no one may compel you to do so.
While the push for caps on credit card interest rates may be motivated by a laudable impulse to prevent the exploitation of the economically vulnerable, such a policy both interferes with economic freedom and is likely to harm the very people it intends to help.
Christopher Freiman is a Professor of General Business in the John Chambers College of Business and Economics at West Virginia University.
