Chadwick: The Tyranny of Rising Credit Card Interest Rates

I never thought I would find myself in the same camp as the self-acclaimed “democrat socialist” Senator Bernie Sanders of Vermont. But last evening on the Kudlow Reporthe made a very legitimate case for Government capping interest rates on credit card balances.

I am a free market capitalist and abhor unnecessary Government intervention in the private sector, but the harm that is being done to credit worthy consumers is seriously detrimental to our economy and I fear that the only way to end it is through Government intervention. What we are dealing with is usury of the worst sort. Usury laws go back at least as far as the Bible – let’s say since human kind began keeping written records. They have a solid basis in good economics.

With all due respect to Larry Kudlow, whom I have known professionally for over 25 years and who is a personal friend, I must disagree with him and his two guests on the Kudlow Report last evening.

The argument they made that Congressional interference in setting a ceiling on credit card interest rates will be a disaster for the economy is specious. In fact the ability of the banks to raise interest rates with no limit is what will be a disaster for the economy.

Let’s do a quick analysis of what is happening out there in credit card land. All credit card debt outstanding on any bank’s books can be categorized into four buckets, which reflect the condition of the borrowers.

At the top of the heap are those people who pay off their balances in full. They, of course, are the most credit worthy, but the banks don’t make any money from their balances, so they are not part of the problem.

At the other end of the spectrum are those borrowers who have defaulted so significantly that the banks have to write off their balances and take the loss. Those are ‘toxic assets’ and they are the result of poor credit practices on the part of the banks, and the banks are now reaping what they have sown.

What remains are two other classes of borrowers. There are those who are paying the minimum amount the bank requires each month. They are obviously overextended and their balances are already carrying interest rates of 25% to 35%. Chances are they are heading into the bottom group, and over the next few quarters their balances will likely have to be written off.

And finally, there is the fourth group that consists of balances owed by those individuals who use their credit cards responsibly, often as a means of running their businesses. They pay far more than the minimum monthly requirement and are never late with their payments. The interest charged on their balances has traditionally been somewhere between 7% and 10%. Now suddenly and with no provocation, i.e. no incident of late payment or underpayment, the banks are informing these GOOD customers that their rates are going up by as much as 1000 basis points. They are doing this because it is the only place they CAN raise rates. If they raise rates on the marginal customers, that surely will tip them over the edge and their balances will become toxic. By punishing their very best customers, the banks are draining capital that could better be spent by those customers to stimulate the economy.

The credit card industry seems to be the only business that can actually raise rates endlessly in a crippling recession. (Maybe I should add the cable industry to the list, but that is about it.)

Hardworking Americans are outraged and scared by what is happening to them. They are bombarding their representatives in Washington and with good cause. The banks should not be allowed to make their best customers pay for their own lax credit standards. The banks minted money for years in the credit card business.

Let them now suffer the consequences of their own making.


Patricia W. Chadwick has had more than 35 years of investment experience. She is the founder and president of Ravengate Partners LLC, a consulting firm that provides advice on financial markets and global economics.