President Donald Trump has called on Congress to implement a cap on credit card interest rates at 10%, a proposal that echoes legislation previously suggested by Senator Bernie Sanders. This announcement, made during the World Economic Forum in Davos, Switzerland, comes as many Americans grapple with rising inflation and stagnant wages. While the proposal has garnered immediate popularity among some constituents, critics argue that it could lead to significant negative consequences for those it aims to help.
Many Americans currently feel the financial strain of increasing costs. As a former chief economist at the Office of Management and Budget under President Trump, I find this shift towards capping credit card rates particularly troubling. The economic framework that characterized the Trump administration was largely based on deregulation, competition, and respect for market signals. During that time, policies aimed at fostering a free market environment facilitated access to credit, reduced costs, and spurred economic growth.
Implementing a cap on credit card interest rates represents a sharp departure from these principles. Price controls have a historical tendency to restrict access to credit, particularly for lower-income individuals with less-than-perfect credit histories. If Congress approves a 10% cap, lenders may stop extending credit altogether to higher-risk customers, leaving millions without viable options for borrowing.
The average annual percentage rate (APR) for credit cards currently hovers around 20%, but this figure masks a wide disparity among borrowers. Prime borrowers may secure rates as low as 14%, while those with subprime credit histories often face rates exceeding 25%. Such higher rates reflect the risk involved in lending, as some borrowers default at rates significantly higher than others. A cap on interest rates does not eliminate risk; it merely prevents lenders from factoring it into their pricing models.
The American Bankers Association estimates that approximately 137 million cardholders could lose access to credit if this cap were enacted. These individuals often rely on credit for emergencies, managing expenses between paychecks, or establishing credit histories. Without access to traditional credit, many may turn to high-cost alternatives, such as payday lenders or unlicensed loan sharks, which could charge exorbitant rates far beyond the legal limits.
Historically, attempts to impose interest rate caps have led to similar negative outcomes. In the 1970s, such caps severely restricted consumer credit availability until a Supreme Court ruling allowed for interstate banking. In France, stringent usury laws have created an environment where a significant portion of the population is denied legal credit. Likewise, Japan’s introduction of rate caps in 2006 precipitated the collapse of its consumer finance sector, forcing desperate borrowers into the hands of organized crime.
Furthermore, the argument that these policies would curb excessive profits does not hold up under scrutiny. Credit card issuers typically operate on thin margins, as high default rates consume much of their profit. For instance, JPMorgan Chase has reported a return on equity of 27% in its credit card division—healthy, yet reflective of the inherent risks involved in credit lending.
The focus should instead be on promoting competition and financial literacy. Easing regulatory barriers for new entrants into the market, enhancing transparency in terms of credit agreements, and encouraging alternatives such as credit-builder loans and secured credit cards would expand access. The first Trump administration recognized the efficacy of market-driven solutions, trusting that a competitive environment would yield positive results.
Politicians advocating for credit card interest rate caps are, in effect, at odds with fundamental economic principles. Just as the laws of physics govern the natural world, the laws of economics dictate market behavior. Those who are financially vulnerable may discover too late that a credit card with a 25% interest rate is far more beneficial than a 10% rate that is inaccessible.
While the intentions behind capping interest rates may be well-meaning, the potential consequences could lead to greater financial exclusion for those who need credit most. Instead of pursuing policies based on popularity, it is crucial to embrace market-oriented solutions that have proven effective in driving economic growth and expanding access to credit.