Trump’s credit card interest rate cap: Method in the madness?

Source: The White House

In a post on Friday, US President Trump said he wanted an interest rate cap on credit card debt to begin on 20 January.  It follows his proposal for a 10% interest cap in his presidential campaign. The post referred to the public being ‘ripped off by credit card companies charging interest rates of 20 to 30%.  Average US credit card rates are currently around 23%, the Wall Street Journal reported, based on Federal Reserve data. 

Paradoxically, this closely follows actions by Trump to drastically scale back the Consumer Financial Protection Bureau (CFPB), that aims to protect consumers in the US consumer credit market, with reduced funding and pressure to scale-back regulation.

The credit card cap, alongside other announcements, is intended to address concerns about the high cost of living in the US, the Journal reported.  Trump is expected to set out more details in a speech at the World Economic Forum in Davos next week.

Representatives of the financial sector in the USA have pointed out the harm that the proposals would cause, including restricting availability of all types of consumer credit and driving consumers to loan sharks.

Could Trump’s proposals work in making US households better-off? Could there be any read across to the UK?

Across the European Union most countries cap rates for consumer credit to levels not hugely different to Trump’s proposed 10%.  This follows national and European consumer credit regulation, including the new version of the Consumer Credit Directive (CCD2) that requires member states to “ensure that consumers cannot be charged with high rates or total cost of credit”. Often, it’s deep-rooted, based on long-standing principles of law and on national culture.

In many ways, European loan caps appear to work. They effectively avoid there being a sub-prime credit market. Loans that are made are more likely to be affordable. Lenders (mainly banks) are cautious, lending small amounts until a customer demonstrates their ability to pay. Bad credit history is rare because borrowers just haven’t had the loans on which to default.

But most importantly, there is a deep-rooted culture in many European Countries that points to living within the household’s means. Credit is used to manage timing of income and expenditure flows, particularly for larger items, but through the joint efforts of lenders and borrowers, keeping a clear view of long-term affordability.

There appears to be limited evidence of loan sharks existing in the larger European markets. Exclusions from the caps for micro-loans in some countries may have helped, although these are now being clamped down on too.

Caps in the European Union work because they typically fit the culture in member states.  They address extremes of market behaviour, not norms.  The alternative of conduct regulation, as employed by the FCA in the UK and the US CFPB - covering affordability, treating customers fairly, and ensuring good consumer outcomes - creates bureaucracy and its effectiveness is unclear.

If there's a theoretical argument in favour of shifting towards the European model, the challenge is how to get there. The solution that Trump has proposed seems madness at first sight. In his typical unsubtle fashion, Trump is however forcing a debate about whether higher rates are necessary and in anyone’s long-term interests.

Is there a better solution than Trump's for how to shift from a US consumer credit culture to a European one?  Here's one that has thousands of years of precedent - the biblical concept that requires any debts owed to be forgiven (written-off) every seven years.   

Reverting to a biblical concept might seem far-fetched, but perhaps no more so than Trump's price cap.  Forgiveness would promote shorter term affordable lending that is unlikely to go into arrears, without a need for FCA or CFPB conduct regulation.

It seems right to question whether loan rates for poor households should be as high as they sometimes are, whether that is for credit cards or instalment loans. Several new for-profit lenders in the UK market are proving that more moderate rates can be viable, alongside credit unions and Community Development Finance Institutions.

If Trump's pronouncement draws attention to the role of better value lenders, there could be method in the madness.