In a show of bipartisanship, Senator Josh Hawley reshared a post from Senator Bernie Sanders hoping to work with incoming President Donald Trump on capping credit card interest rates at 10 percent.

An anti-usury bill capping outrageous credit card rates ought to be a top priority of the next Congress https://t.co/rPGfSEgVsB

— Josh Hawley (@HawleyMO) November 16, 2024

All parties involved are rightfully concerned about Americans struggling with debt payments. A recent survey of Americans shows that the average household’s credit card balance is $9,706, just $1,416 below the record high in 2008. In addition, 40 percent of households now rely on credit cards to pay bills. All the good intentions in the world, however, do not guarantee good outcomes. An interest rate cap is going to hurt Americans by limiting their access to credit. The poorest Americans will be hit the hardest.

Some Basic Definitions

Before we dive into the debate, it’s important to clarify what’s being discussed. Interest is the price people pay to have resources now rather than later. An interest rate measures the price that borrowers pay to have resources now and the reward a lender receives for delaying consumption of resources to a future date (expressed as a percentage).

Interest is a natural result of human interaction. The late George Mason University economist Walter Williams explained this to myself and others who took his microeconomics class: Imagine you were to visit a country that has effectively outlawed all lending and borrowing. Despite the prohibition on lending and borrowing, you could still get a rough estimate of the market rate of interest by comparing the present price of present goods to the present price of future goods. One can get a sense of the interest rate by looking at the difference between the price of milk and the price of cheese. If we have to use milk to make cheese, then milk is a present good and cheese is a future good. Further, if the price of milk rises relative to cheese, then we know that the interest rate must have fallen. If the price of cheese rises relative to milk, then we know that the interest rate must have risen.

Both Senators Hawley and Sanders mention usury. Definitions of “usury,” whether from Merriam Webster, US Law, and even The Catholic Church tend to label usury as charging “exorbitant interest.” Unfortunately, “exorbitant” is in the eye of the beholder.

Like all other prices, interest rates are determined by supply and demand. People’s willingness to save impacts the supply of loanable funds. If the inflation rate is expected to rise, lenders will ask for a higher interest rate to compensate. The riskiness of the borrower and the length or duration of the loan also determine the interest rate as well as the rate at which interest income is taxed. Allowing these and other factors to influence interest rates uninhibited allow credit markets to adjust to changes in supply and demand.

Interest Rate Caps Are Price Controls

A cap on interest rates is a price control and, like all other price controls, end up failing miserably. Price controls are appealing because they claim to protect the low income people who struggle to afford price increases. A price, however, provides information about the relative scarcity of a good or service and motivates buyers and sellers to adjust their behavior accordingly. What’s truly amazing is that this information gets updated in real-time. Price controls, therefore, prevent the information about relative scarcity and buyer/seller behavior from being portrayed accurately. This means that decisions about how to consume and produce are made on non-price margins.

Capping credit card interest rates would play out in the same way. As Heritage Foundation Research Fellow Joel Griffith discusses, lenders will be stuck between a rock and a hard place: “Either extend credit at a rate that doesn’t include all the default risk, or deny credit to a large swath of potential borrowers.” Although the senators lambast credit card companies for “record profits,” the annual return on assets (ROA) has fallen for the second straight year in a row, down from 4.7 percent in 2022 to 3.33 percent in 2023. The record-high ROA of 6.93 percent in 2021(beating the previous twenty-first century high of 6.73 percent in 2003) appears to be more of an anomaly than an indicator of where profits are headed.

As I mentioned earlier this year, profits are a sign that a business is providing people with a good or service they want at a price they are willing to pay. Both parties that engage in a transaction do so because they are better off than if the transaction had never occurred. Whenever the ability to profit is inhibited, it is likely that the business will stop providing the good or service because the cost of doing so exceeds any potential benefits.

In the same respect, lenders will opt to not offer a line of credit at all instead of taking on additional risk by being forced to charge an interest rate that doesn’t accurately reflect the risk of engaging in the transaction. For those who already have a credit card and are paying interest rates above the cap, credit card companies can reduce credit limits at will in response to changing economic conditions.

These results will end up hurting many Americans, especially the nearly 2 in 5 cardholders who have maxed out a credit card or are near their credit limits. As many of the poorest Americans are cut off from the already limited sources of credit, they will likely turn to illicit sources of income or black-market lending via organized crime. Alternatively, many may choose to pay bills late or not pay them at all, which will cause them to either lose services or get entrapped in the welfare system to cover those necessities.

The efforts exerted by politicians to save struggling Americans with price controls will inevitably result in Americans being kicked while they’re already down.