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The Unforeseen Consequences of Credit Legislation

Mises Daily: Friday, January 22, 2010 by

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A hallmark of state failure is its incapacity to predict the market's response to the policies it puts forth. Indeed, on many levels the state is powerless to change the market's ends, instead only serving to redirect its means.

Credit-card legislation passed last December sets forth a glut of regulations governing the ways in which credit-card agencies may transact with their customers. Various rules set to come into effect in July 2010 will

  • Limit interest rate hikes on existing credit card balances.
  • Keep a fixed interest rate on new purchases for the first year of a card and increase rates afterward after giving 45 days' notice. The old rules allowed rate changes at any time for any reason, with just 15 days' notice.
  • Discontinue universal default.
  • Give cardholders at least 21 days to pay monthly bills.
  • Allocate payments in excess of the minimum amount due each month to items with the highest interest-rate balances.
  • Limit over-the-limit and subprime credit-card fees.
  • More clearly disclose terms such as due dates and times, year-to-date totals on interest and fees, and the implications of making only the minimum payments on credit card bills each month.

Yet, in view of the fact that the July legislation has capped annual credit-card fees at 25 percent of the card holder's line of credit (see here), card companies have responded — as one may expect — by increasing their introductory rates of interest. One such company, First Premier, has actually raised its introductory annual-interest rate to 79.9 percent.

Clearly, to any reasonable observer this type of unintended response is completely rational, indeed predictable. But our governments — instead of viewing the supposed consumer crisis in terms of the question of why such potential card holders are, in fact, a risk, or from the reference point of moral hazard (via Federal Reserve protection) — have become duped into thinking that they can change market fundamentals.

The fact remains that deserving creditors demand to be rewarded for such reliability, and competition (via low interest rates, cash-back rewards, etc.) is the vehicle that delivers these rewards. Likewise, uncreditworthy recipients carry with them a liability that can only be compensated by higher yearly fees or rates of interest.

There is no hidden racial agenda or vast conspiracy on the behalf of the bourgeoisie. There are simply lenders and borrowers engaging in what they deem to be mutually beneficial transactions. Whether these transactions are, in actuality, beneficial or not is not a political question at all. Instead, it is an educational question, and a function of time.

A healthier question may perhaps be why such risky creditors are pursued at all? And why, when they are pursued, do lenders halt at annual-interest rates of 79.9 percent interest? Surely if consumers are bathing in ignorance, as we are led to believe, they would be willing to accept annual-interest rates of 100 or 1000 percent. Who, then, do we believe has saved consumers from this fate? Surely not our legislators, for they are just now taking notice of these issues. It must be the benevolence of the lenders themselves.

Alas, even if the legislative body subsequently turns their attention to capping annual-interest rates, these profit-seeking companies will only creatively engineer a supplementary way to provide credit to the less creditworthy. Thus, like the inmate who has 24 hours a day to contemplate his best route of escape; these card companies have 24 hours a day to contemplate their best route toward profit maximization. Our legislators are merely displacing mutually beneficial transactions.

Therefore, whether it is disproportionally hurting African-American teen workers with minimum-wage laws or further endangering already-endangered species, the state is no match for market mechanisms. It remains a slave to unforeseen consequences.