WASHINGTON -- Capping credit-card interest rates is a bad idea that would undermine bank earnings and add to consumers' problems in obtaining loans, Federal Reserve bank economists said.
The Senate on Wednesday passed a ceiling of 14 percent on the rates credit-card issuers may charge their customers as part of the banking bill before Congress. Such rates average nearly 19 percent.
Although the proposal faces a minefield of congressional procedures before it could become law, fears of its eventual approval sparked a fall in bank stocks and credit-card asset-backed issues. It was cited as a factor behind Friday's 120-point drop in the Dow Jones industrial average.
To reassure the markets, Vice President Dan Quayle indicated yesterday that President Bush would veto such a measure.
Federal Reserve Chairman Alan Greenspan said in a letter to Congress on Friday that a cap would have "a number of possible serious adverse effects on the economy and financial institutions."
"Lenders undoubtedly would cut back sharply on the availability of credit cards," Greenspan said in the letter, which was made public.
Across the Fed system, economists echoed this view in interviews with Knight-Ridder Financial News. Consumer spending is vital to the recovery, and clamping down on credit lines would in turn squeeze that spending.
Randall Pozdena, director of the financial research unit of the San Francisco Fed Bank, called the proposal "ill-conceived . . . a bad idea. There is really no economic logic" to such types of rate cap.
Pozdena, who recently conducted a study on credit-card interest rates, said such a cap would reduce consumer credit and increase banks' risk. "It's almost as if you are expecting your insurance policy to vary with interest rates," he said.
Robert Clair, senior economist at the Dallas Fed, saw any cap as "bad for the economy, both for the banks and for consumers. . . . We could just as easily say Congress should mandate a price reduction on cars to make them more available to the public."
The Fed sources stressed that measures in the past that tried to put ceilings on interest rates or impose usury fees were abandoned for good reason. They interfered with the market and caused more overall cost than benefit.
Herbert Baer, senior economist at the Chicago Fed, said the many user fees that were in place in the late 1970s were removed. "This is really sort of rolling back the clock," he said of the cap proposal.
An economist from an East Coast Fed bank who requested anonymity, said: "Generally, the arbitrary setting of rates by the legislative body is not a good idea. . . . The preferable way is to let competition take its course."
Baer and other economists defended the charges that banks make for credit-card debt, since the debt is high-risk and largely unsecured.
"Some of the credit that is being extended through credit cards is not economic for banks to extend at a lower rate," Baer said.
He said that, as well as losing profit directly from new lower rates, banks would be faced with a potential unwinding of securitization deals, in which banks have backed up part of these loans at fixed interest rates to improve their capital standards.
Pozdena said that while credit-card rates had tended not to fall with market trends, neither had they followed rising rates.
xTC And he noted that as recourse against default, credit-card issuers can only take someone to court, which costs money itself, or inform credit-rating agencies about their customer.
The stickiness of credit-card rates in coming lower in line with other interest rates nonetheless irks consumer groups, and pressure mounted for Congress to take action.