The High Cost of Cheap Credit
Politics often relies on the suspension of arithmetic. The recent proposal to cap credit card interest rates at 10%—a policy that has found strange bedfellows in both the MAGA camp and the progressive left—is a perfect case study in how moral intentions crash against the hard rocks of balance sheet logic.
On the surface, the proposition is seductive. Americans are drowning in revolving debt, paying upwards of 25% or 30% APR to faceless institutions that seem to print money. Capping that rate at 10% sounds like a valiant strike against usury, a way to keep money in the pockets of the working class. It frames the issue as a battle between the virtuous struggling family and the greedy banker.
But in the world of capital allocation, there are no villains and heroes; there are only risk and return. If you legislate the return below the cost of the risk, the capital simply vanishes. This proposal, if enacted, will not lower the cost of borrowing for the poor. It will eliminate their ability to borrow entirely.
The Mechanics of Risk Pricing
To understand why a cap is destructive, we must first strip away the emotional baggage of debt and look at the mechanic of lending. A credit card is an unsecured loan. Unlike a mortgage, where the bank can seize the house, or an auto loan, where they can repossess the car, a credit card issuer has no collateral. If a borrower defaults, the money is gone. This makes it one of the riskiest asset classes for a lender.
Interest rates are not arbitrary numbers pulled from thin air to maximize suffering. They are calculated aggregates of three specific components:
- The Cost of Funds: The interest rate the bank pays to acquire the money it lends out (tied to the Federal Reserve’s rates).
- Operational Costs: The cost of processing transactions, maintaining fraud detection, and customer service.
- The Risk Premium: The statistical probability that the borrower will not pay the money back.
When you see an APR of 28%, it is easy to assume the bank is pocketing a 28% profit. This is false. A significant portion of that rate is essentially an insurance premium paid by the collective pool of borrowers to cover the losses generated by those who default. In the subprime sector, charge-off rates (loans written off as uncollectible) can easily reach double digits.
Here is the math that the populists ignore: If the cost of funds is 5%, and operational costs are 3%, the bank is already at an 8% hurdle before accounting for a single cent of risk. If you cap the revenue at 10%, that leaves a 2% margin to cover all potential defaults and generate a profit.
If the statistical probability of default for a subprime borrower is 12%—which is not uncommon in lower credit tiers—lending to them at 10% guarantees a mathematical loss. Legislation cannot force a private entity to burn capital. Therefore, the bank will not lend at 10%. They will simply close the account.
The Great De-Risking
If this cap goes into effect, we will witness an immediate and brutal “flight to quality.” This is standard behavior in any market where prices are artificially suppressed. When you cannot price for risk, you eliminate the risk.
Banks will immediately run their algorithms across their entire portfolio of cardholders. Anyone whose risk profile exceeds the break-even point of a 10% yield will be purged. This does not mean the billionaires will lose their Centurion cards. The wealthy, who typically pay off their balances in full every month and present near-zero default risk, will be unaffected. In fact, banks compete for these customers because they generate revenue through interchange fees (the fee merchants pay per swipe), not interest.
The axe will fall on the very people the policy purports to save: the “marginal” borrowers. These are households with credit scores below 660, people who carry balances because they use credit cards as a bridge for cash flow gaps—fixing a car to get to work or buying groceries before a paycheck clears.
Under a 20% or 30% regime, banks are willing to extend credit to these risky profiles because the high interest rate compensates for the high likelihood of default. Under a 10% regime, these customers are toxic assets. Millions of Americans would wake up to find their credit lines slashed to zero or their accounts closed entirely. The liquidity that smoothed their consumption shocks would evaporate overnight.
The Displacement of Desperation
When legal, regulated markets are closed, demand does not disappear; it moves to the shadows. This is the iron law of prohibition, whether applied to alcohol, narcotics, or credit.
If a family needs $500 to repair a radiator in January, and they can no longer put it on a Visa card, they do not simply decide not to fix the radiator. They find the money elsewhere. If the regulated banking sector is forced out of the market by price controls, that demand will shift to alternative lenders.
We will see a surge in the usage of payday loans, title loans, and pawn shops. In many states, the effective APR on a payday loan can exceed 400%. By capping credit card rates at 10%, the government effectively pushes vulnerable borrowers from a 25% APR product into a 400% APR product. It is a catastrophic degradation of their financial health, driven by the desire to protect them.
Furthermore, this creates a vacuum for unregulated, illegal lending. The “loan shark” is not a relic of 1920s cinema; it is a function of market failure. When legitimate institutions cannot serve a high-risk demographic due to regulatory caps, illegitimate actors step in. They do not report to credit bureaus, and their collection methods involve physical intimidation rather than sternly worded letters.
The Death of Rewards and the Fee Explosion
There is a secondary consequence that will hit the middle class: the end of the rewards economy. The 2% cash back, the airline miles, and the travel points that American consumers have grown addicted to are funded by a mix of interchange fees and interest income. The profitability of the credit card portfolio relies on a cross-subsidy model. The interest paid by revolvers (those carrying balances) helps subsidize the perks enjoyed by transactors (those who pay in full).
If interest revenue is capped at 10%, the profitability of the entire ecosystem collapses. Issuers will have to claw back revenue elsewhere. We can expect the immediate elimination of rewards programs for all but the highest-tier cards. The “free” credit card will become a thing of the past. Annual fees will return with a vengeance. We will likely see the introduction of monthly maintenance fees, inactivity fees, and higher transaction fees passed on to merchants (who will then raise prices on goods).
Essentially, the credit card will revert to what it was in the 1970s: a transactional tool for the affluent, requiring an annual fee, with no perks attached. The democratization of credit—which, despite its flaws, allowed working-class families access to the same payment networks as the wealthy—will be reversed.
The Temporary Trap
The specific proposal calls for a “temporary” cap. In economic terms, temporary measures often inflict permanent damage because they introduce uncertainty. Capital is a coward; it flees from uncertainty.
If banks believe that the government has the political will to cap prices whenever inflation bites or whenever an election looms, they will permanently adjust their risk models. They will view the US consumer credit market as a regulated utility rather than a free market. This means permanently tighter lending standards and permanently lower innovation.
Even if the cap is lifted after a year, the damage to credit scores will be lasting. When a bank closes a credit card account, the borrower’s “credit utilization ratio” spikes (because their total available credit drops), which tanks their credit score. A policy intended to help people creates a wave of artificial defaults and credit score destruction that will take years to repair, making it harder for them to rent apartments, buy cars, or get jobs.
The Reality of Inflation
We must also look at this through the lens of the current macroeconomic environment. We are living in a period where inflation has been sticky and the risk-free rate (Treasuries) is higher than it has been in decades. When the government borrows money at 4% or 5%, asking private banks to lend unsecured money to risky borrowers at 10% is asking them to accept a risk premium that is historically microscopic.
During the era of zero-interest-rate policy (ZIRP), money was free, and yield-chasing allowed for looser lending standards. That era is over. The cost of capital is real again. A 10% cap in a ZIRP world is restrictive; a 10% cap in a 5% federal funds rate world is a blockade.
Conclusion: The Value of Honest Pricing
It is easy to look at a 25% interest rate and call it gouging. It feels morally wrong. But price is a signal. A high interest rate is a signal of high risk. It tells the borrower that the market views their financial position as precarious. It acts, however imperfectly, as a brake on over-leverage.
By artificially suppressing that signal, we distort reality. But we cannot distort the consequences. If we ban the pricing of risk, we do not eliminate the risk; we simply eliminate the access. The proponents of this cap believe they are fighting for the little guy against the titans of Wall Street. In reality, they are pulling the ladder up just as the little guy is trying to climb it.
The most expensive credit is not the one with a 25% interest rate. It is the one that you cannot get when you desperately need it. That is the future this policy guarantees.