Interest rate caps, like other price controls, hurt consumers
Government controls on consumer prices – the maximum or minimum that businesses are allowed to charge – are almost as old as recorded history. For so long, price controls have hurt people, especially those the controls are meant to help. Yet policymakers continue to promote and implement price controls as a way to help improve people’s lives.
While trying to help people is a laudable goal, a decentralized pricing system is a key feature of a free enterprise system that enables people to meet their wants and needs better than a system controlled by politicians. and bureaucrats who set arbitrary prices. Putting price controls in place because some people consider certain prices to be “too high” does not change this fact. Price controls destroy the efficiency of markets and ultimately reduce the chances of citizens to prosper. They can be particularly dangerous because they worsen the conditions that policymakers use to justify checks in the first place. Not surprisingly, some of the most prominent proponents of price controls are those who benefit the most from reduced competition.
These realities also apply to all forms of price controls, including the interest rate caps that several members of Congress are now proposing. Interest rates are just the price lenders charge borrowers for loans, and price controls have the same adverse effects in credit markets as they do in other segments of the economy. Congress should not impose price controls on the credit market, including those in the Fair Credit Act for veterans and consumers. If Congress is to help people provide and obtain credit more efficiently, it should remove the myriad regulatory barriers that stifle competition in the financial industry.
Price controls hurt those they are meant to help
Market prices represent information about how people value products and services. This information is displayed as objectively as possible and people use it to allocate (or ration) goods and services based on factors that include their own preferences, needs and production costs. Everything else constant, companies are willing and able to sell less goods at lower prices, while consumers prefer to buy more. Likewise, at higher prices, businesses prefer to sell more, but consumers are willing and able to buy less.
Price controls interfere with this process by replacing the price system with the subjective opinions of government officials. That is, instead of allowing consumers and businesses (the market) to allocate resources as objectively as possible, officials ration goods based on what they think prices should be. . Historically, spoofing the decentralized pricing system in this way has not worked. In the most egregious cases, such as those in the centrally planned economies of Eastern Europe, price controls have led to widespread shortages.
Because the experiment corresponds to the theoretical critique of price control, economists generally oppose it. For example, price caps create a legal maximum price. They tend to create shortages because business owners are no longer able to charge prices high enough to provide products and services, and because consumers demand more than they would at higher prices. high in the market. Floor prices, on the other hand, lead to surpluses because they prevent prices from reaching the lower level at which they would naturally settle. At artificially high prices, fewer consumers are willing and able to buy, while businesses are more than happy to sell.
Price controls have many unintended negative consequences, including bribery and corruption to evade controls, as well as rent seeking, which benefits the people who implement the controls, but it ultimately increases costs. for consumers and businesses. In addition, they cause market distortions that provide an additional pretext for increased price controls and government intervention, both of which tend to further hamper efficient markets and reduce overall prosperity. Price controls rarely help the people they are meant to help—some people invariably find themselves with fewer resources than they would have had in a market-based system, and the highest incomes usually suffer the least, while the lowest incomes suffer the most.
Adverse effects of interest rate caps
Interest rate caps (usury laws) are price caps imposed to prevent interest rates from exceeding an arbitrary maximum. Price caps on interest rates, like price caps in other markets, do not limit demand. In other words, while interest rate caps make the supply of credit more expensive, they do nothing to reduce the demand for borrowing. As a result, people develop alternative (more expensive) ways of both providing and obtaining credit, fewer people end up getting credit than they otherwise would, and others pay more for loans than they do. they get.
State usury laws have their roots in colonial times, and the United States has a long and unsuccessful history of various types of interest rate caps. A federal price cap on bank deposit interest rates, for example, was one of the main causes of massive bank disintermediation during the 1970s. and the savings and lending debacle of the 1980s. Likewise, prior to a 1978 Supreme Court ruling that preempted them at the federal level, a patchwork of state usury laws on consumer loans and credit cards limited competition in these markets. As a result, companies provided fewer credit cards and (among other workarounds) charged annual fees to avoid price caps.
Latest federal attempts to impose cap rates
Many states still have their own usury laws, but these maximum rates typically only apply to relatively small consumer loans, resulting in a relatively small effect on more consumers. Nonetheless, on the basis of the misconception that short-term private lenders tend to “trap” consumers in high-cost debt, many federal officials have stepped up their efforts to restrict the ability of lenders to provide credit. The badly named Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 authorized the Consumer Financial Protection Bureau (CFPB) to impose new regulations on these lenders, and it also created a variety of taxpayer subsidized alternatives to low dollar private lenders.
Congress has imposed these regulations despite the fact that consumers want, need and value credit providers in these markets. The combination of regulating private lenders while providing government-funded alternatives to short-term loans virtually guarantees a long-term reduction in consumer welfare. Congress is also trying to impose generalized cap rates by extending (among other efforts) the price controls in the Military Loan Act to the larger credit market.
Price Controls in the Fair Credit Act for Veterans and Consumers
The Fair Credit for Veterans and Consumers Act (S. 2833) amends the Loan Truth Act extend the ceiling rates (and other restrictions) on certain loans for active-duty military personnel to all consumers. These characteristics, promulgated by the 2006 Law on Military Loans, prohibit suppliers from Consumer credit active duty members (as well as their spouses and dependents) to charge an annual interest rate greater than 36%.
Consumer credit, on the other hand, is defined by regulations prescribed by the US Department of Defense. Currently, these regulations define consumer credit as “credit offered or granted to a borrower covered primarily for personal, family or household purposes, and which is: (i) subject to finance charges; or (ii) Payable by written agreement in more than four installments. The law on military loans also provides for several exceptions, so that the maximum rates do not not apply to residential mortgages, auto loans, or loans for other personal property when those assets are used to secure the loan. The law applies the interest limit at a rate that includes all fees and charges, including those for single premium credit insurance.
If Congress enacted Section 2833, the new rate caps would apply to all credit cards, deposit advance loans, overdraft lines of credit, and various installment loans. However, the bill would exempt loans made by federal credit unions. Congress should not impose price controls on credit markets, and it should avoid interest rate caps such as those included in the Veterans and Consumers Fair Credit Act. Price controls force businesses to impose higher costs on consumers and reduce the number of people getting the goods and services they need.
The best way to ensure that people get the credit they need is to improve the competitiveness of private credit markets, not to cap the rates charged by lenders. Interest rate caps are price controls, and history has shown time and time again that they don’t help the people they are meant to help.
Imposing interest rate caps, such as those in the Fair Credit Act for Veterans and Consumers, will limit the supply of credit to those who need it most and, ultimately, will increase the cost of credit for many other borrowers. Putting price controls in place on such a widespread basis will worsen the problems in credit markets, thus reinforcing a false pretext for more price controls and government-provided credit. This political path will eventually increase people’s dependence on government and prevent them from prospering.
Norbert J. Michel, PhD, is director of the Center for Data Analysis, Institute for Economic Freedom, at the Heritage Foundation.