Donald Trump and Bernie Sanders each want to pass federal legislation to cap credit card interest rates at 10 percent. If those two very different guys agree on something, it must be a good idea. Either that, or it is a very, very bad idea.
Capping credit card interest at 10% is a very, very bad idea. Price controls always are.
An estimated 171 million Americans carry a combined credit card balance of $1.1 trillion, paying an average rate of 21.7 percent. Cutting rates to 10% would save borrowers $130.5 billion a year.
However, if credit card issuers become limited in what they can charge borrowers, they will only issue cards to customers for whom the risk of default or delinquency is low, thus eliminating one of the only forms of credit available to higher risk borrowers. That is, by limiting the price (interest rate) that a lender can charge, credit card issuers will reduce both credit limits and the number of cards they issue.
When you put an artificial cap on prices, shortages ensue. Ask anyone who was around for Richard Nixon’s 90-day wage and price freeze in 1970.
The same principle applies to controls in other markets, including during and following a natural disaster. Consider the devastating California wildfires. In the same way price caps on credit card rates would limit access to credit cards, price caps on construction materials similarly limit the supply of building materials and services, slowing the process of rebuilding and recovery.
If carpenters and Los Angeles area Home Depot stores could increase their prices to seemingly exorbitant levels, many fire victims would not be able to afford those higher prices. In the immediate weeks (or months) after the fires, this wouldn’t pose a practical problem because a lot of things must happen before people can rebuild their homes. But if the prices of construction materials and workers increases by 50%, Los Angeles would be flooded with out-of-town framers, concrete trucks and trainloads of 2x4s. And as the local supply of those things increased, prices would decline, and both the amount and pace of construction would increase.
Now imagine a scenario in which construction prices are legally prohibited from increasing above pre-disaster levels. With no financial incentive to move inventories of construction materials to California, suppliers and contractors would stay where they are, creating shortages of critical materials. Without the additional supply of materials and services, people will be homeless longer – creating the exact opposite result the price controls compassionately seek to create.
On the surface, price controls may appear to be compassionate, but they often lead to unintended consequences – creating scarcity instead of relief.
David Moon is president of Moon Capital Management. A version of this piece originally appeared in the USA TODAY NETWORK.