Like everything else in life, BALANCE is key. Credit cards are good for convenience, but some people don’t have any self-control when it comes to usage. A lot of people, in my experience, say “I’ll wait until tomorrow to deal with it”. Well, tomorrow usually comes…
There is plenty of blame to go around for this. On the other end, some of the credit card companies policies on interest rates are bad and should be restricted.
A couple of months ago, I suggested that all lenders should be prohibited from making any loans from 10 basis points above prime. It was surprisingly controversial, especially considering the profound debt problem we’re facing.
Banks claims that they need to be able to “price for risk” in order to make credit available to the consumer. They use this tactic on Congress, to scare them into not backing any substantive reforms in this area. If they do pass reform, the line goes, they’ll simply reduce the flow of credit into the market en Mass.
I’d argue that if a bank is giving out loans above 10% prime, they are likely doing so with the expectation that it’ll never be repaid. That by itself is the definition of predatory lending– is in part why this credit crisis occurred. These practices must be prevented. A 10% cap on interest is certainly not onerous for the banks, and in fact, it represents prudent risk management. That interest rate represents a net interest margin of nearly double of what the banks are currently earning now on loans. It also would prevent almost all of the abusive practices that have occurred over the past 10 years or so.
Regulating the bank’s interest rate risk alone isn’t enough. Indeed, such regulations have been in the books throughout this mess, yet it failed to prevent anything. The banks were able to stretch the meaning of “credit-worthy” to unknown bounds!! A straightforward restriction on interest rate risk can’t be spun. If you can’t make a profit on a loan at a 10% net interest margin, then you shouldn’t be able to make the loan. Since the Fed Funds rate (the percent interest that the Federal Reserve charges on lent money) changes over time, the top interest rate can also vary across time. So it would be flexible enough to meet different risk environments.
The credit bubble came about because banks and other financial institutions were making loans that they had no reasonable belief could be repaid. So the banks relied on the ability to pass off these loans to others in the form of securitization. This allegedly removed the risk of default from their balance sheets and passed it off to others. Making the originator bank hold a piece of the scrutinized product doesn’t solve the problem, as the process can still be gamed.
Capping interest rate margins though would make gaming the system impossible, and that is really at the base of the problem. Either the loan can be made at a profitable rate of return or it can’t be. Predatory lending practices are a real problem and it must be curtailed.