Falling Interest Rates, Heavy Debts

NEW YORK -- Over the last year and a half, Federal Reserve rate cuts have dramatically lowered interest rates on consumer loans, setting off a stampede of home refinancing, as well as new home and auto purchases. But such Fed inspired rate relief is not happening everywhere: credit card rates remain staggeringly high. It's almost inconceivable -- yet true -- that in 2001, the Federal Reserve cut interest rates 11 times, yet the average credit card rate dropped by less than 1 percentage point. Given that American households carry an average credit card debt of over $8,000 and are paying anywhere from 15% to 29%, these small loans quickly become heavy debts.

How is it that repeated Federal Reserve rate cuts have offered so little relief for so many indebted families? The answer lies in a complex story involving deregulation, vulnerable consumers, and outright greed and deception by some of America's largest financial institutions.

The story starts back in 1978 with a Supreme Court ruling allowing banks to export higher "home state" interest rates to accounts in other states. As a result, regional and national banks moved their operations to more lender friendly states, such as South Dakota and Delaware. In domino-like fashion, states began loosening their own usury laws, limiting the chances for consumers to get a better deal from a local, or state bank. Today 26 states set no limit on the rates in-state issuers can charge. The flurry of bank mergers and acquisitions in the last decade has narrowed the competition even further. In 1980, the top 50 credit card issuers only accounted for 60% of the US market. By 2002, the top 10 companies controlled 83% of the market.

The picture of consumer debt in this country mirrors the overall trend toward greater economic inequality. During the boom of the 90s, upper income families accumulated massive new wealth through capital gains in the stock market. Meanwhile, low- and middle-income families got pinched by stagnant wages and rising living costs. They saved less and less, making it through the 90s on a bubble of credit card debt. The card companies took advantage of the situation, quietly bilking consumers by jacking up interest rates for a late payment or two. Now all the major card companies raise rates to 22% to 29% for run-of-the-mill tardiness.

Also unsettling is the ordinary deception of the industry's pricing tactics. Unfettered by any regulation that says otherwise, card companies employ pricing schemes that prevent most cardholders, not just the tardy ones, from seeing any Fed-inspired rate relief. Two of the most common schemes are the use of floor and fixed rates which prevent the rate on the card from falling below a certain percentage. But the biggest deregulatory bonanza is the card companies' right to change the terms of the account at any time, for any reason.

The companies rationalize their avaricious practices by citing a higher risk pool and surges in credit losses. However, card companies are actually awash with increased profits because the Fed rate cuts have greatly lowered their lending costs which are now at a 40-year low. Yet almost none of these savings have been passed on to consumers. Because while the banks' lending costs declined by 73% in 2001, credit card rates declined by a mere 5.2%.

Fortunately, there are several policy reforms that could provide much needed relief to financially strapped consumers. The first is reinstating the tax deduction for interest rate payments on credit cards, which was phased out as part of the 1986 Tax Reform Act. Second, Congress should reexamine setting a national cap on credit card interest rates - legislation the Senate overwhelmingly passed in 1991. By charging rates that once would have been considered usurious, credit cards have become the most profitable sector of the banking industry. Our democratic institutions need to restore balance between their role in promoting free markets and their responsibility to protecting consumers. Rediscovering the concept of usury would be a great start.

 

How is it that repeated Federal Reserve rate cuts have offered so little relief for so many indebted families? The answer lies in a complex story involving deregulation, vulnerable consumers, and outright greed and deception by some of America's largest financial institutions.