There’s a problem with competition in the credit card market. But rate regulation, like a 10% usury cap, is not the way to fix it. The problems in the credit card market are informational: consumers cannot see precise interest rates when they apply for cards, so there isn’t competitive pressure on rates. Instead, card issuers compete based on opaque, but much more salient, rewards programs.

Since when is rate regulation the way we go about fixing informational problems? It’s the wrong tool for the job. Slapping on a 10% rate cap is a lot sexier and simpler than the sort of under-the-hood regulatory craftsmanship required to fix informational problems, but that doesn’t mean it’s the right solution. There are better ways to fix the consumer credit card market than a blunt tool like a rate cap that is likely to have a lot of unintended consequences.

I. What’s the Problem in the Card Market?

The President’s proposal for a temporary 10% rate cap stands on nothing but a political attempt to show he’s doing something relating to affordability. But the more thoughtful proposal for a 10% rate cap from Brian Shearer stands on the argument that credit card issuers are able to achieve a supracompetitive return on assets (the standard measure of bank profitability) because credit card interest rates are not set competitively.

Specifically, a consumer cannot readily shop for credit cards based on interest rates because card pricing is risk-based, meaning it is set more-or-less individually, so you cannot see a rate offer until you’ve applied. Prior to applying, you will only know a range of rates you might qualify for if you are approved. That makes it impossible to know if a card from issuer X with a range of rates from, say 19.99% to 28.49%, will have a lower rate than a card from issuer Y, which advertises a range of rates from 18.99% to 29.99%. Additionally, there are costs to applying for multiple offers: not just the time and effort involved, but also a ding to the borrower’s credit score because there is a “hard pull” on their credit reports, such that applying to multiple issuers simultaneously can actually end up raising the rates a consumer ultimately be offered. (Of course, there’s also a subset of consumers who don’t care about interest rates because they don’t revolve balances and another subset who don’t care because they overoptimistically don’t think they will revolve balances…)

The lack of price transparency upfront means that consumers tend to focus on other features of cards, such as the rewards program or the picture on the front of the card (Capital One tried playing with that a lot—you can put your dog’s photo on the front of the card, which will make you more likely to use that card…) To be sure, rewards programs are also not the most transparent, as there are frequently limitations on cash back rewards, and in-kind rewards like frequent flier miles or airport lounge access are hard to value.

I agree with this diagnosis of the competition problem in the credit card market. Card issuers aren’t competing on rates, but on perceived value of rewards, and that lets them charge higher interest rates, even as they are incentivized to make rewards look more generous than they really are. (For example, a card might advertise 5% cash back, but the fine print limits it to $1,000 per year, which means after charging $20,000 in a calendar year, there’s no more cash back.)

II. If the Problem Is Lack of Price Competition Due to Informational Problems, Why Is a Rate Cap the Solution?

But if you agree with this diagnosis, that the problem in card markets is the lack of price competition due to informational problems, why is the proper remedy a blunt, imprecise, and ultimately arbitrary tool like a 10% rate cap? There’s really no way to defend what makes 10% right, but not 9% or 11% other than that we have ten digits on our hands. There’s no objective metric about the proper usury rate when it is being used in this fashion.  

Rate regulation is really only a proper policy response in situations in which markets cannot be made to work with some regulatory loosening or tightening. For example, we do rate regulation for utilities because they are natural monopolies—there’s only one set of pipes or wires in town. And we have usury laws as a consumer protection for high-cost situations in which borrowers cannot protect themselves through shopping or negotiation because they are so desperate that they will take any terms offered (in part because they’re likely to be denied). We can’t put down a second set of sewer pipes and we can’t change a desperate consumer’s situation when they need cash fast to pay for a funeral or to repair a broken car to get to work and the kids to school.

Thus, the way usury limits are currently used is as a safety guard against consumers getting in over their heads with credit at rates that no reasonable person would accept if they had alternatives–they’re sort of an application of unconscionability. Reasonable minds might differ on exactly where to place the safety rails, but that’s what they usury laws are. Usury laws are not tools for generally increasing consumers’ consumption capacity across the economy, and if we start misusing them in such a fashion, which will cause all sorts of unintended effects, we are likely to endanger usury laws altogether. 

The issue with credit cards is not a problem of a natural monopoly or of consumers whose demand for credit is price inelastic because they have an immediate problem and will worry about the cost at some later point. The problem is that card issuers do not compete on price because of (1) informational problems preventing consumers from price shopping and (2) rewards bundling. Shouldn’t the proper policy response be along the lines of changing price disclosure to facilitate price shopping and to prohibit rewards bundling?

III. Solutions

A. Solution Part A: Fix Informational Problems So Consumer Can Shop on Interest Rates

For example, why not require card issuers to hold offers open for a set period of time (compare mortgage loan estimates, which are good for 10 days) and prohibit consumer reporting agencies from negative reporting for a limited number of applications made within a limited time period? One can imagine a tech solution here, wherein consumers submit their application data to a fintech loan broker that pings card issuers for offers and then presents the offers to the consumer to select. That could all happen within minutes, if not seconds. It’s a market solution, not a heavy-handed rate regulation. That’s the way to address the lack of rate transparency, not a blunt and kind of random 10% cap.

B. Solution Part B: Discourage the Bundling of Rewards Programs by Facilitating Competition for Merchants’ Business

As for prohibiting rewards bundling, the idea that a consumer gets frequent flier miles or some other sort of in-kind benefit for making a payment via a card is kind of weird; there’s no inherent efficiency to the bundling. You can conceptualize the bundling as a way of offering the consumer a discount—and why should we care if it is in cash or in-kind—but by and large the level of discount depends on the fee imposed on the merchant in the form interchange rates: cards with more rewards have higher interchange.

The Credit Card Competition Act would be at least a step in addressing the rewards issue by making card networks have to compete for merchants’ business by giving merchants the ability to choose the routing of a payment card transaction by requiring all four-party cards (i.e., not Amex or Discover) to be capable of routing payments on at least two unaffiliated networks. No price cap as with the Durbin Interchange Amendment, just the “multi-homing” to facilitate competition. If networks have to compete for merchants’ business, the result should be to push down interchange fees, and that in turn will probably result in a reduction in rewards, which are traditionally accounted for a reduction in from interchange revenue).

III. Have We Lost Our Faith in Markets? 

What troubles me the most about seeing the political horseshoe embrace of a 10% rate cap is that it reflects a loss of faith in markets. Parts of the left seem to see any market-driven as some terrible “neo-liberal” cop-out and would prefer either direct government provision of services or price controls, placing more faith in government’s ability to manage the economy than markets. We know how well that tends to play out, but somehow this time will be different. Meanwhile the President has set his course on gangster capitalism.

I don’t think markets are perfect; market failures exist. But there’s a decent toolbox for addressing market failures that aims to have the minimum necessary intervention. It’s possible to have free markets that are also fair markets, but it takes the occasional regulatory curation. Both left and right seem to have given up on that. It saddens me to see how some friends who once approached policy issues from a markets perspective have now surrendered to the “government good, markets bad” viewpoint with little tolerance for disagreement. 

I will say that you can see the tension between the “improve markets” and “rate regulation” approaches in the CARD Act of 2009. The CARD Act has some loose rate caps, such as requiring that late fees be reasonable and proportionate to actual costs. But the CARD Act also worked overall to force more of the price of cards into more salient price points, which resulted in overall cost savings for consumers. The latter approach is the one that should guide policy, rather than the rate caps (and regulators have never really known how to set the caps properly–what is a “reasonable” fee? It’s a standard, not a bright line…). 

IV. So What Would Reforms to Facilitate Price Competition Mean?

Given that all cards operate basically the same and are just tools for advancing money, the most fungible thing in the world, one would expect price competition to result in a substantial reduction in interest rates—cards would basically be commoditized. Would it result in the same savings as a 10% rate cap? Probably not, but it would result in prices set by the market, which is a much more sustainable economy than one in which prices are set by Presidential tweet or pandering legislators.