THE FUROR about the proposal to cap interest rates on credit cards is an instructive parable of what ails the economy and those who regulate it. Interest rates have come down, finally, to an 18-year low. Ordinary savings accounts are paying 5 percent. Mortgages can be had for under 9 percent. But credit cards still charge an average of 18.9 percent.
So Sen. Alfonse D'Amato, R-N.Y., up for re-election, had the idea to cap credit card rates at four points above the interest rate that the IRS charges to delinquent taxpayers. Very nice symbolism there. This would have limited credit card interest to 14 percent.The rest of the Senate thought so too, and passed D'Amato's amendment 74-19. When it looked as if the House would soon follow, a panicky stock market considered the likely effect on bank earnings, setting off a 120-point plunge.
Almost immediately, right-thinking legislators, editorialists and financial statesmen agreed that the Senate move had been ill-considered. Consumers are about the only people willing to pay very high interest rates to banks, which desperately need the income. Even House Banking Committee Chairman Henry Gonzalez, long derided by bankers as a populist relic, decided that this was no time for a quaint throwback to the era of regulation, such as a usury ceiling setting maximum legal interest rates.
Consider for a moment why bank credit card interest rates have remained so high. For one thing, credit card interest used to be tax-deductible. Congress ordered that deductibility phased out when it passed the 1986 tax reform act. However, consumers had been conditioned to accept high interest rates on consumer borrowing -- after all, it was a tax deduction -- and kept right on reaching for the plastic.
In an era of bad investment decisions and declining earnings in real estate and Third World debt, bankers came to rely on credit cards as a cash cow. They kept marketing them to people who, in more normal times, would have been seen as credit risks.
Meanwhile, in a deregulated era, other players, such as Sears-Roebuck, got into the credit card business. American Express began proliferating different kinds of credit cards. College freshmen with neither personal incomes nor credit histories found "pre-approved" credit cards offered in their registration packets.
The result, predictably, was an epidemic of late payment, default and consumer bankruptcy. But if you're a bank earning an average of 18.9 percent, you can afford a few defaults. And if you're plagued by defaults, you can't very well afford to lower interest rates. Yet to keep the earnings flowing, you have to keep marketing the cards to more and more high-risk customers. Some people might call this a kind of trap.
The banks and their competitors, joined by retailers, kept churning out the cards. (Any self-respecting consumer has a walletful.) Each of these cards, of course, represents debt -- the very same high debt and refusal to save that is bemoaned by the very same right-thinking legislators, editorialists and financial statesmen who want healthy banks with high-interest income.
If you noticed a paradox here, and a similarity between the credit card story and the Third World debt story and the real estate bust story, you are right. In each case, banks found their earnings depressed, so they kept turning to ever riskier investments in the hope of higher yields. But as those investments turned sour, interest rates had to remain high even on sound investments to make up the loss.
There is another parallel. Each of these excesses is the product of the frenzy of deregulation.
Between the mid '40s and the early '70s, which just happened to be the golden age of America's economic growth, banks were very tightly regulated and supervised. They were limited in what they could market, how they could compete, the interest rates they could charge borrowers and the interest rates they could pay depositors. Regulators also limited who could engage in banking. And -- oddly enough -- real interest costs were low, there were almost no bank collapses and the real economy thrived. Consumers got less into hock.
Today, in one of the rings of the legislative circus, Congress is deadlocked on the issue of how to restructure the nation's banks. When the exercise began, most legislators seemed to think the cure for the excesses of deregulation was more deregulation. Then several key subcommittee chairmen began expressing serious doubts.
It now appears that Congress will replenish the FDIC fund, tighten bank supervision and perhaps allow nationwide bank branching -- but wisely refuse banks the new entrepreneurial powers that seemed so certain a year ago.
Under the circumstances, this is wise. Congress needs to rethink the whole business of banking and bank regulation, and begin again -- possibly with a new administration of a very different philosophy. When Congress finally does get serious about rebuilding the edifice of banking and bank supervision, it might even wish to include such musty and useful concepts as usury.
Robert Kuttner writes on economic matters.