Lawmakers in Washington have recently taken aim at the credit card industry, and whether you agree with the spirit of the law, we believe the outcome will be less credit available to consumers. Last week the Senate passed new limits on debit-card “swipe” fees; fees which are charged by card issuers to merchants to processes transactions. This reform seems to be reasonable, although potentially damaging to credit card companies who received nearly $20 billion in such fees last year.
Yesterday Sheldon Whitehouse, a Rhode Island Democrat, proposed legislation that would allow individual states to enforce interest rate limits on credit cards, which he hopes will continue the momentum of recent “swipe” reforms. His proposal has attracted 16 co-sponsors among them one Republican. In speaking about his proposal he said the bill will help protect consumers who have been “screwed by out-of-state banks gouging them out of 30-percent interest rates.” Populism aside, we think that this reform deserves greater inspection.
Of course, we are not in favor of Joe Consumer being gouged by credit card companies through excessively high rates. Surely, some people have felt preyed upon by lenders as they struggle to climb out of debt, and in the end sometimes fail. “Predatory lending” is a hot button issue following the financial meltdown, and many Senators may find it difficult to vote on the side of banks and credit card companies as opposed to the states’ ability to cap rates. However, in reading about this debate in the last couple of days, we have yet to see the other side of the story.
The American economy has benefited greatly from the largely unfettered flow of consumer credit, especially in the last quarter century. Make no mistake, the expansion of credit is a double edged sword; when times are tough overextended consumers face a rougher time than did they not have as much debt. Hopefully, politicians will not let reactionary policies dominate the discussion at a time that the economy is still very fragile. We are emerging from the worst recession since the Second World War, yet we are in danger of making backward-looking laws that will crimp consumer credit into the recovery.
We are of the opinion that if credit card interest rates do in fact get capped on a state by state basis, banks will extend less credit overall. The effects will be particularly noticeable among the least creditworthy Americans. Like it or not, interest rates are a risk management tool for lenders and if a borrower has become delinquent on a loan they need to have a last line of defense. Now some may think that practice is “punitive”, but the end result of such legislation will be less credit for those with shaky credit histories.
Investors in any of the largest credit card issuers must take note as the proposed reforms will impact their stocks. Already, both Visa (V) and MasterCard (MA) have fallen more than 21% in the last 30 days as lawmakers have turned their attention on credit and debit cards. These companies are coming off a very difficult period as defaults and delinquency rates are finally rebounding from record levels. However, we think this legislation may have wider reaching consequences than just lenders, as the America consumer has been the undisputed engine of our economy for many years and credit has undoubtedly lubricated the spending. We fear this proposal, if it makes it through both the Senate and the House (admittedly a big if), will create a different set of problems all together.