How Sanders' Bank Plan Would Kill Credit Availability for the Poor

WASHINGTON — Sen. Bernie Sanders' victory in the New Hampshire primary will undoubtedly provide fresh momentum for his campaign against Hillary Clinton, but is also likely to subject many of his proposals to a harsher spotlight as his credibility as a candidate grows.

One idea that has escaped scrutiny to date is an ambitious plan to cap interest rates on credit cards and all consumer loans at 15%.

"In 1980, Congress passed legislation to require credit unions to cap interest rates on their loans at no more than 15%," Sanders said in a speech last month. "And that law has worked well. Unlike big banks, credit unions did not receive a huge bailout from the taxpayers of this country. It is time to extend this cap to every lender in America."

Like many of Sanders' other proposals, it is appealingly simple, casting big banks as the bad guys who "need to stop acting like loan sharks and start acting like responsible lenders."

Yet also like many of Sanders' other ideas, it betrays a startling ignorance about how the credit system actually works and what the impact of such a cap would be on low-income consumers and those with poor credit histories. They would almost certainly be denied credit as a result or forced to go to unregulated lenders for help. Here's how:

The entire premise of Sanders' proposal is deeply flawed

Congress passed the Depository Institutions Deregulation and Monetary Control Act in 1980, which raised the cap on interest rates that federal credit unions can charge from 12% to 15%. But despite Sanders claim that the law has "worked well" since then, credit unions have never — at any point — actually had to live under that cap. That's because the law also gave the National Credit Union Administration the power to raise the cap due to market conditions.

As a result, the NCUA has set the rate well above 15% since the law's enactment. Between 1981 and 1987, it was set at 21%. Since then, it's been at 18%. Sanders is effectively promoting a 15% cap that doesn't actually exist.

It's not clear who would benefit in the short term.

Sanders' proposal appears to be a solution in search of a problem. Despite a small hike in the federal funds rate last year, interest rates for all types of consumer loans — credit cards included — remain at historically low levels.

The average credit card interest rate on Tuesday for prime cards was 9.02% for credit unions and 10.77% for banks, according to Informa Services Research Rates. For reward cards, it was 10.39% for credit unions and 14.35% for banks.

A search of Google shows a wide variety of card rates, many of which start with a 0% interest rate for an introductory period and then rise as high as 23% depending on different factors. Still, even for those with poor credit scores below 660, several issuers advertise rates at or below 15%, although those often come with annual premiums and other fees attached.

But overall, it's not clear that high interest rates on credit cards are a problem, especially when compared to, say, the level of student loan debt, which Sanders (to his credit) has also criticized. Under President Obama in 2009, Congress already passed a law, the Credit Card Accountability, Responsibility and Disclosure Act, which is widely credited by consumer groups and the Consumer Financial Protection Bureau with rooting out many abuses in the credit card market.

So it's difficult to understand why Sanders is suggesting a cap on credit card interest rates is necessary now or even what he specifically sees as a problem. (The Sanders campaign did not return requests for comment.)

The one area where consumer groups and others have been warning about excessively high interest rates are on payday and other short-term, small-dollar loans, where annual percentage rates can shoot above 300% depending on the terms. Yet even if that were the case — and there's no sign Sanders was specifically referring to such loans — a 15% cap would be ludicrously low.

Credit unions' current cap on such loans is 28%, according to rules set by the NCUA. Consumer groups are lobbying the CFPB to set a national 36% cap, a level at which many lenders would likely only break even. No one is seriously contemplating a 15% cap, because it would mean no one would offer such loans.

"For mainstream financial institutions to try to offer an alternative to a payday loan, they can't do that at under 15%," said Bill Hampel, the chief policy officer for the Credit Union National Association.

If Sanders plan were enacted, it could wreak havoc on low-income people in the long term.

As hard as it is to find someone Sanders' plan would help, it's relatively easy to foresee a situation in which it would hurt precisely the people Sanders is trying to protect.

The history of price caps is a long and unsuccessful one because they almost always result in the same thing—the loss of credit availability, particularly for those who are low income or who have poor credit histories. It's easy to understand why: Lenders need to make their money back.

"If 10 people borrow $10 and nine out of 10 repay, the other nine repaying have to make up the $10 that the 10th person doesn't repay," said Nessa Feddis, senior vice president at the American Bankers Association. "If you are limiting revenue so it doesn't cover the costs of default, the lender has to be more strict about the people they are lending to. The rich and people with a lot of credit history may be able to get credit, but people with low income or poor credit histories will struggle."

History has borne that out. Arkansas had a strict usury law of 10% that it set in 1874. At the time, interest rates were low enough that the usury limit didn't matter, but when rates spiked decades later, the state scrambled to raise the cap. It eventually raised it to 17%. Even the 15% credit union rate that Sanders was praising was put in place only because the previous rate of 12% had proved unworkable.

"Legislation is a blunt instrument — pricing credit is a very dynamic exercise that is dependent on a lot more factors than a number in a bill," said Ed Mills, who helped work on the CARD Act while a staffer for the House Financial Services Committee in 2009, and is now an analyst at FBR Capital Markets. "There are consequences to having a hard cap, some of which can lead to shutting off credit to individuals that you want to have credit."

Even consumer groups acknowledge that setting a cap is difficult and could have unintended consequences if it's set too low.

"At an abstract level, prices impact supply and demand," said Lauren Saunders, associate director at the National Consumer Law Center. "The question is where is the right place to draw the line."

If Sanders' proposed interest rate cap were enacted now (a challenging task considering Republicans' resistance to such an idea), it would have a negligible impact until rates went up, and then lenders would cut people off.

"Anytime you place a cap on price or, in this case, interest rates, you ultimately limit supply," said Jill Castilla, president and chief executive officer of the $250 million-asset Citizens Bank of Edmond in Oklahoma. "As a result of limited availability, consumers may be driven to unregulated credit providers."

Indeed, that is the biggest danger of Sanders' plan. Though the Vermont Democrat clearly distrusts banks, experience has shown that consumers will turn to far less scrupulous lenders if they need money badly enough.

"If you were to set a law that would arbitrarily cut off the ability of Main Street financial institutions to make loans," Hampel said, "those borrowers are thrown at the mercy of potentially predatory lenders."