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Credit Card Game – History Lesson on Rate Caps

Credit Card Game

One score, one decade and seven years ago the credit card game was ready for a national prime-time launch. Before this period banks issued one plain vanilla Visa (f/k/a BankAmericard) or one plain vanilla Mastercard (f/k/a Mastercharge) to their respective general banking customers. But this began to change in the mid-1980s as banks started to expand beyond their footprint, issuing cards nationally, competing vigorously against one another.

Nearly all of the ten largest bank credit card issuers charged the same “one-size-fits-all” fixed annual interest rate of 19.80% with a $20 annual fee, on a national level. However, they were subject to the usury laws of each state which, in a few states, capped the interest rate at 18% and/or the annual fee at $15. For example, the Arkansas annual interest rate limitation was the lowest (6%) and later at 8%.

Rate Cap Roadblock

Because of the necessary compliance with state lending restrictions many of the nation’s top issuers would not accept applications from restrictive states, as it was not profitable and producing expensive litigation headaches.

After pursuing the issue in federal courts, including the U.S. Supreme Court, it was ruled banks would only be subject to the state usury laws in the state where the card was issued from. So the big banks moved their credit card businesses to the friendly states with little or no regulation, primarily South Dakota and Delaware.

The author, Robert McKinley, provided extensive background and interviews on the “Secret History the Credit Card” produced by the PBS FRONTLINE program. McKinley says this program will help consumers understand how the credit card business evolved, remaining one of banks’ most lucrative products today. View or Read Transcript

Competition Explosion

With the removal of state pricing barriers, competition took off in the credit card game, with the introduction of the Gold card, offering a $5,000 minimum credit line and a much higher fee. Followed by the 1985 introduction of the Discover card offering no annual fee with cash-back rewards, but with some a creative interest rate calculation. The 1990 launch of the AT&T Universal Card offering no-annual-fee for life set off the entry of more non-bank issuers. The 1992 launch of the General Motors Mastercard offering a much lower variable interest rate and rebates towards future GM purchases, another watershed event in the development of the credit card game. This gave way to more cobranded cards, more elite colors, more cash-back, rewards, air miles, perks, etc.

Fast Forward

Recently, proposals are being floated by lawmakers to cap credit card interest rates on a national level at 15%.

Average credit card rates currently charged by issuers of Visa, Mastercard, Discover, and American Express are now at the highest level since 2001 and the spread between the prime rate and credit card interest rates is the highest point since 2011, according to CardData.

The current credit card APR charged by the Top 100 banks stands at 14.22%, compared to 12.89% for 2017 and 12.35% for 2016. Eighteen years ago average credit card APRs hit 14.89% and steadily declined as the prime rate froze at 4.00% from 2008 to 2014.

In terms of the spread between average credit card rates and the prime rate, the current spread is 922 bps (basis points), compared 864 bps for 2017, and 860 bps for 2016. The highest recorded spread was 1992 when the average credit APR was 18.22% and the prime rate was 6.00% for a spread of 1222 bps, according to analysis by RAM Research.

Therefore, if short-term interest rates rise, a significant portion of consumers would be paying APRs in excess of 30%.

A somewhat silly survey was conducted by LendingTree and its CompareCard division, a credit card agency, finding more than 8 in 10 American credit cardholders would support some version of a credit card interest rate cap. This is about the same number who support free college tuition, saving Social Security, affordable healthcare, a cleaner environment, $15 minimum hourly wage, four day workweek, etc.

But the survey did discover support for a rate cap diminished to 50% as consumers understood some of the ramifications.

Future Ramifications

While a 30% APR rate cap would not be considered unreasonable, a 15% rate cap would totally upend the credit card business as we have come to know it today.

Unlike the one-size-fits-all business of 35 years ago, today’s credit card market is priced-to-risk. Consumers with highest credit scores get the lowest rates and vice versa. Virtually anyone in the U.S. with a FICO score as low as 550 can qualify for an unsecured card with a very high interest rate along with high fees. Twenty years ago, anyone with a credit score below 660 was considered bottom fishing.

While credit card lending is lucrative it is also a loan with a high degree of risk, including counterfeiting, fraud and customers who default. In addition, nearly all credit cards are issued without any security interest, relying on only stated income and a credit report. A car loan is usually issued with stated income and credit report but there is a large security interest. Other bank loans typically require verified income, sometimes asset verification, credit report and in some cases, a security interest.

The current average loss rate for the top credit card issuers is 3.68% and heading upwards. Add funding costs, administrative costs and fraud losses, some banks, mostly community banks and credit unions, may be forced to exit the business to avoid future losses.

Therefore, a 15% credit card rate cap, would greatly impact the availability of credit to a very large number of Americans. For those who qualify with a good credit score, credit limits would be significantly lower. As previously noted Arkansas had a rate cap of 8% in 1985 and as a result the maximum credit line would generally run about $800.

A 15% rate cap would also bring back humungous annual fees, higher punitive interest rates, the resurrection of other fees and the invention of new fees.

When it comes to perks, rewards, air miles, points, etc — FUHGEDDABOUTIT. This is a very competitive and expensive area for credit card issuers and their partners. While interest rates are pegged to creditworthiness, cardholder givebacks, in whatever form, rely on the cardholder spending volume, interest charges and annual fees to be sustainable.

A 15% rate cap was introduced in Congress in the late 1980s and failed. The ramifications then would have been severe but in today’s mature, saturated credit card market wherein card programs are tailored for thousands of cardholder segments, a 15% credit card rate cap would cripple, not just consumers, but also the American economy with ramifications globally.

Credit Card Issuer Sins

Even though a 15% rate cap is unreasonable and bad for banks and consumers, credit card issuers have over the course of one score, one decade and seven years ago, engaged in some bad, borderline fraudulent, business practices. The credit card industry still needs regulatory oversight for consumers.

By the way, the sequel to the PBS FRONTLINE “Secret History of the Credit Card” is “The Card Game” which explores the establishment of the Consumer Financial Protection Bureau (CFPB). The author, Robert McKinley and Senior Analyst of CardTrak, CardFlash and CardData, was extensively interviewed for this program and correctly predicted in 2009 Congress would establish the CFPB. (View or Read Transcript)

It is likely credit card rates have already peaked for the next several years as the Fed considers cutting interest in tandem with a slowing economy. Furthermore, short-term interest rates may drop sooner than necessary if the current administration successfully politicizes the Fed.

The Credit Card Game Continues — Watch This Space