Give back interest rate controls to the States

There is a lot of discussion about cutting taxes and government services in order to reinvigorate the economy. This is a simple subject since anyone paying taxes generally believes they are paying too much. The reasoning behind cutting taxes normally centers around the assumption that the government spends too much and that when people pay less tax they run out and buy consumer goods. It is also assumed that when taxes are cut for higher income individuals, they all run out and expand their businesses. This may be an odd discussion for an Infrastructure blog, but we need to make sound decisions on taxation in order to properly fund our Infrastructure programs.

I think there is an easier way to get more money back in the hands of consumers. This would be by simply better managing the amount of interest the average Americans are paying. I find it criminal that banks can obtain money at the federal prime rate of about 3.25%, then lend the same money out to consumers at rates that can exceed 30%. Recall that when the banks were in financial crisis, the Federal Reserve provided many of the bail out loans at 0%. I am certainly oversimplifying these facts. To walk a mile in the banking industry’s shoes, I should go out and try lending money to one of my neighbors to better understand the risks. The interesting part is that by State of New Hampshire law, I can only charge 10% interest.

For individual State rates see http://www.lectlaw.com/files/ban02.htm

Further research shows that most States have statutory usury laws that prevent individuals from charging much more than about 15%. Since many of the laws were set during the runaway inflation of the 1970’s and 1980’s several of the States have a higher maximum rate, but are then indexed to Treasury bill rates or prime. They were trying to be fair to the banks while home mortgage insurance rates were up around 18%, but the indexes are about 5% over prime or less than 10%. Since then prime has dropped, but the maximums were never adjusted.

So why can banks charge so much for interest rates? Again in the runaway inflationary period of the late 1970’s first the Supreme Court in Marquette vs. First Omaha Services, allowed banks to import the credit laws from the State where they were chartered, then in 1980, Congress passed the Depository Institutions Deregulation and Monetary Control Act. Along with other things this allowed federally charted institutions to effectively override state usury laws. With high inflation this provided some parity to the banks at the time, but the intent clearly isn’t the usury, even predatory, practices that are going on today. Again in 1996 the Supreme Court in Smiley vs. Citibank further limited the power of the states to regulate credit cards.

In 2009, the US Census showed that the average American owed about $8400 in credit card debt. Federal Reserve studies show the revolving debt of American families to be about $793.1 billion dollars with the number of households that carry revolving debt more than 30 days being 50.2 million households. That would place the average household using credit cards at about $15,800 in debt. The average credit card interest rate is about 13%, with a range from a 0% introductory rate to about 36% for default rates. Interestingly, default rates were once based upon the history of the actual credit card account. New regulations now allow for banks to raise rates on accounts when the borrower is late on any of their debt, including accounts not managed by the lender!

So here is my incentive program. For the 50.2 million American households paying 13% interest on $15,800 balances or about $2054 per year in interest, and everyone else, let's provide a national interest structure that is fair. It would be best to allow States to dictate the rates, but since the Supreme Court has already ruled that the bank’s home state can dictate the credit terms (allowing banks to relocate to the states with the best terms anyway!), let’s set allowable national rates indexed to prime. The average rate should be closer to about 5% above prime. With the maximum rate about 10% above prime (today the average works out to a little less than 10% above prime with some of the maximum rates over 30% over prime). Note that right now there is no maximum interest rate on credit cards as long as the bank has a repeatable formula and that the formula is detailed in the small print of the credit card application. If the average credit card interest rate was reduced to 8%, the average credit householder as stated above would receive an additional $790 per year. This would provide the same stimulus as a major tax reduction, without deferring critical investments such as infrastructure.