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 driving consumers to loan sharks. But could Trump’s proposals work in making US households better-off? Could there be any read across to the UK? 

There are many reasons why the policy could fail. Households may respond to lower interest costs by spending more on their cards, leaving them no better off in financial terms.  Lenders are likely to restrict lending to riskier customers, not only for credit cards but for any other finance. Loan sharks could fill the gap between legal supply and market demand.

Yet Trump might have a point. Look at Europe, where across the European Union most countries cap rates for consumer credit to levels not hugely different to Trump’s proposed 10%.  This is partly based on current 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”. But in many countries, it’s far more deep-rooted than the CCD2, 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 obviously 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 scant evidence of loan sharks existing in the larger European markets.

If moving to a European model is deemed a good thing to do (with significant emphasis on the ‘if’) is Trump going about it the right way?  Clearly the solution he has proposed seems madness at first sight. But in a typical Trumpian unsubtle way, he is forcing a debate about whether high consumer credit interest rates are either necessary or in anyone’s long-term interests.

The challenge is how to change the culture of consumer credit. 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 and the US CFPB, and covering affordability, treating customers fairly, and ensuring good consumer outcomes, may be well-intentioned, but it leads to masses of bureaucracy and seems to move the market only very slowly.

How to shift from a US consumer credit culture to a European one?  If the President Trump can propose a mad idea, then I don’t see why I can’t too. Mine has the bonus of thousands of years of precedent behind it. It’s the biblical concept whereby debts owed must be forgiven every seven years. This was (slightly!) pre-accounting standards but consider that as fully writing off the entire book.  

What better way to promote shorter term affordable lending that's unlikely to go into arrears?  And if the deal was that it removed most or all other consumer credit regulation, well maybe it’s not quite as far-fetched as it sounds.