FTC Staff Comment to the Hon. Ross Johnson Concerning California A.B. 2 to Set Minimum and Maximum Interest Rates on Credit Cards and A.B. 325 to Set Maximum Rates on Retail Store Credit Card Accounts

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'!he Ha'lOraole Roes Johnson
Vice Chainnan
Assembly canmittee on Finance arx1 ~
state capitel
sacramento, 	california 	95814
APR 	Z0 1987
Roe: 	Assembly Bills 2 arrl 325
Dear Assemblyman Jetmson:
we are pleased to have the c::pp:Jrtunity to provide our ccmnents on Assembly
Bill 2, 	Which wcW.d set min:i.Imlrn arrl IMXirrurn interest rates that may be iJrposed on
bank credit card ao:::amts, 	arrl A. B. 	325, W'hid1 would set maximum interest rates
that my be ilrq;;osed on retail store cred.it 	card acco.mts. 1
we ~ against the enactlrent of either of these bills. 	().rr
experierce 2 am the e::oncrnic literature on maximum pric~ regulations 3 both
Wicate that restrictions on interest rates are accornpanied by substantial ham.
to many consumers. 	Any effort to restrict interest rates will usually cause
creditors to alter other credit t.enns, 	in::11.rl.i.r'g minimum Jronthly payrrent..s,
administrative or user fees, 	grace periods, 	an:i criteria for creditworthiness.
To the ertent that creditors cannot maintain their profit rrargins by alterin:3'
these terms, 	they will simply reduce the total anamt of credit exterded, 	thus
deny~ credit to marginal consuners who otherwise would be able to obtain it.
1 	'lhese ccrrrnents represent the views of the san Francisco Regional Office
an:! the alreaus of Consurrer Protection, 	Cr:l!T'petition, 	am Econcrnics of the Federal
Trade cammission, 	arrl do not necessarily represent the vier.ors of the Cc::mnission
itself. 	'!he camtission has, 	hcuever, voted to authorize us to suhnit 	these
ccmnents to you.
:2 	'n1e Federal Trade Ccmnission has been actively involved in consumer
cre:lit 	regulations ard in regulations governin.3 pricin:J generally. 	See, 	e, g. ,
Truth in l.en:lin::j Act, 	15 U.S.C. 	§ 1601 	(1982) i Equal credit ~ty Act, 	15
U.S.C. 	§ 1691 	(1982 and SUpp. 	III 1985); Fair Credit Reporting Act, 	15 U.S.C. 	§
1681 	(1982 and SUpp. 	III 	198~); Robinson-Patman Act, 	15 U.S.C. 	§§ 13-13 (b) , 	21a
(1976 and SUpp. 	III 1985).
3 	see, 	e.g., 	canner & Fergus, 	The EConctn.ic Effects of Prg:x:?sed. Ceilings on
Credit card Interest Rates, 	Fed. 	Reserve Bull., Jan. 	1987, 	at 1; Nathan, 	EconOn1c
Analysis of Usury Laws, 	10 J. 	of Bank Research 200 	(1980); 	Ostas, 	Effects Qf
Usury ceili.rgs in the Mortgage Market, 	31 J. 	of P'in. 	821 	(1976). 	see also Barth,
lbe Effect of Goverrgnent Regulations on Personal Loan Markets; 	b Tobit Fstimation
of a Microeconomic MOdel, 	37 J. 	of Fin. 	1233 	(1982). 	On a similar subject,
~ rent regulations, 	see Bethell, 	No Grc,...1:h-No Vacancies, 	Regulation, Jan.-
Feb. 	1979, 	at 48; Bent Control arrl the Decline of the Cities, 	Regulation, Jan.-
Feb. 	1981, 	at 13.

Assemblyman Ross Jdmson
c;n:rtit Terms l\bsept Interest Rate ceilirgs
In the abserx:e of a statutory ceilin;J, 	the maxiJmJm interest rete that can be
chal:ged is deteJ:Inined by carpetition ~ lerrlers. 	'l11is canpetition can l::e
actual--..mere a WOJld-ce bo~ has 5eVerdl saJrCeS of credit-or it can l:::e
fran potential entrants into the tusiness of exterrli.n;1 credit. 	Arrj lerrler who
atteJrpts to earn above-nonnal profits by charging higher than coupetitive
interest rates would lose business to either existirq creditors or new entrants.
P1:qx)nents of interest rate ceilin;1s assert that because the credit card
market has been slow to resp::>rrl to recent reductions in the o:st of money, 	as
reflected by fallin;J interest rates in other areas of ccmnercial 1~, credit
card interest rates are too high ani creditors are ~ t.mreaSOnable profits.
'!hey also argue that COI"\S1.lITet' cannot shop for better credit terms because all
creditors offer the same te.nrs. 	'!he facts silnply do not SUI=POrt these
assertions. 	'!he cost of rroney c:onstitutes a much 1~ proportion of total costs
for credit card q:;erations than for other major types of bank len:li.rq.4 	'!bus,
one would not expect credit card rates to go down 	(or up) 	as fast as general
interest rates. 	While short-run frictions 	in the market, 	such as entry lags arrl
i.n;:erfect c:xm.st.nTer information, 	may initially have lessened establiShed
creditors' 	.incentives to react swiftly to the fall.i.n;J cost of rrorey, 	the market
is t"Dtl respon:::l.i.n:;J to ce::ttpatitive pressures by offerin;; a variety of rore
desirable credit card plans. 	In a<Xiition, 	there has been a 	rapid develq:Jl"el1t of
ntiM 5O..lrCeS of revolvin:J crEdit-in the form of lines of credit secure1 by
residential equi."'=i arrl overdraft cra:lit 	lines on d1eck.:i.rt; acca.xnts-..mich provide
carpetition to traditional credit cards.
'D:lose who argue that interest rates shcW.d be rest;.n,ined in order to
eliminate the a~Uy unreasonable profits earned by credit card plans ignore
the data i.njicati.ng that, 	over tima, 	creditors have earned only a o::ir1petitive
retun1 on their invest.Ed capital. 5 	'!he annual net before-tax earnin;]s of bank
card plans averagoo L 9 percent of balances outstarx.ti.rx;J fran 1972 1:hrc\lgh 1985. 6
CNer the same period, 	average net returns on other major types of ccmrercial bank
lerxi.in;I .....-ere significantly higher: 	2.3 percent on real estate lrortgages, 	2.4
percent on consun-er installment debt, 	an:1 2.8 percent on ccrrmercial ard other
loans. 7 	Sb.xlies of retail store credit card plans irrlicate that on average-not
considerin; profits on associated nerd1arrl.ise sales-these plans consistently
4 	canner & Fergus, 	~ note 3, 	at 1-2.
5 	In other words, 	the interest earned on cred.it 	card a<:X;'O.U1ts has covered
the creditor's costs, 	incl1.rli.ng losses on credit defaults, 	am. normal profits.
6 	canner & Fergus, 	mmrn note 3, 	at 1-2 	(cit.in3 Federal Reserve Bank data').
7 	lQ.
2

Assemblyman ~ Jchnson
have cperated at a loss. 9 	Of ~, 	returns on all types of loans fluctuate
CNer time. 	Profits for 1994 an:i 1985 on bank credit cani balarces were 3.4 am
4.0 percent, 	respectively. 9 	Although these profits were high relative to other
types of bank. credit, 	they were earned folla./irg a pericrl between 1979 arrl 1981
v.ne.re profits on bank credit cards were severely squeezed ard considerably lC1.rJ'er
than profits for other bank credit instnments. 10 	'lhus, vierwed aver the
perspective of a number of years, 	profits on bank am retail store. credit cams
have rot been particularly high, 	nor are recently higher profits likely to
persist given the cullpetitive i.npetus cited above.
'!be allegation that there oontinues to be carplete unifonnity in the credit
terns offera:! to oon.suzrers is also without foun:iation. 	~le SCIre bank am
retail store credit card plans continue to offer interest rates of between 18 ani
21 percent, 	a recent survey con:iucte::l by a san FranCisco-base1 COflSUlreL- l:JLUUl:J
f~ that six california institutions a:rrl ten out-of-state institutions ncrw
offer bank credit card plans with fixed arrl variable interest rates of between
10.5 an:i 15 percent. 11 	M:>reover, 	the surv~ disclosed that the lower-rate credit
card plans offer variety in other i:rrq;:ortant terms, 	sum as annual fees arrl grace
perioda. 12
ConsuIrers rray .in:1eed pay higher finance charges on credit card balances t.'"lar.
for other types of credit. 	'1his type of credit, 	hCMeVer, 	has certain features
for whid1 consumers are ~ly wUlin; to pay. 	These in:::looe the
availability of a pre-aWroved line of credit, 	the lack of collateral
~ts, the ao::eptance of a credit card by large numbers of merchants in
variClJS locations, 	the ability to payoff the am:unt C1wroOO within the grace pericrl
in order to avoid i.ncurrirg any finance cl1arges, 	arrl the record of pLLrchases
created by using the card. 	All these features are costly for an issuin; creditor
to provide, 	which explains why the relatively high interest rate doe:; not
nea:-ssarily imply the existence of "excessive" profits to the creditor.
1be Effect Of Interest Rate ceilings
When an interest rate ceilin.; is established by statute at less tllan the
~titive market rate for sarwa b:l~, 	len:lers will reduce the volurre of
e 	canner & Fergus, 	mmrg rote 3, 	at 2 	(citing two national sm:veys of
retailers conducta:i on behalf of the National Retail Mero1ants AssoCiation in
1968 and 1985 and a study of retailers in New York made in 1973).
9 	canner &. Fergus, 	~ note 3, 	at 2.
10 	Isj.
11 	consurrer Action's National Credit card survey 	(1987).
12 	Annual 	fees ran;ed. fran no charge to $22.50, 	am grace pericx:1s of
differ~ l~ were offered by ten of the sixteen institutions.
3

Assemblyman Ross JctU"lson
credit exterXSed to those bo~.13 	!he reason for this is clear. 	Lerrlers
themselves face cx:sts or borrcwi.n; noney fran investors as well as costs of
administerirq their loans. 	If the pt'q:lOSed leqislation forces prices 	(~,
interest rates) 	below the level of costs, 	lerrlers will either go cut of bJsiness
or stop rnaJd.rg the loans that do not provide at least a nonnal rate of re~.14
secause the ultiJnate return fran exterrl:in3' credit is a 	function of the
losses fran crerlit defaults as well as the i.nccme fran interest payrrents a.rrl
administrative fees, 	creditors might consider offeri.n:} different rates to
different types of bo~. 	A borrower with a 	lorq hlstol:)' of timely
repayments an:i a large pool of assets to guarantee repaymant can usually obtain
lower rates because the expected costs of ext:.erd.i..n;J creclit 	to strl1 a l:orrcwer are
lower. 	For exawple, 	American Express recently has announced a rew credit card,
the "Cptima," witil an initial interest rate of 13.5 percent. 15 	'!he card will be
narketed only to current American Express card holders with good re~yn-ent
records. 	Not all borrowers have such attractive characteristics, 	yet creditors
usually are willin;J to exten::1 credit to a general p:ol that inclu:1es higher risk
borrowers if they are able to charge a higher interest rate.
If government forces a reduction in allowable inte.rest rates, 	hcwever,
creditors will no lon:;er be able to offer credit to higher risk l::o~ ·,.;i~'1
the same freedan as they did 1:efore. 16 	One probable result will be to cut off
credit to less attractive bot'rC1WerS, 	incl~ YOUI'X:l" people with little credit
history, 	people with lC1ft1 incorre, 	or people \¥ho have had t.reuble repayirq a 	loan
13 	Villegas, 	'n1e Ilrpaet Of Usury ceili.n;s on RevolvirJ;J Credit 	(1986)
(unp.lblished manuscript available fran Arizona State University Econanics
Depart:Irent); Villegas, 	M 	Analysis of the Irrpact of IDterest Rate ceilings, 	37 J.
of Fin. 	941 	(19S2).
14 	A1ternatively, 	sore california-based creditors lMY choose to transfer
their credit canl plan operations to related finns 	in states with higher or no
interest rate ceilin;;s, 	enabl.in; them to evade the interest rate ceil~ in
california. 	tJrrler the National Bank Act, 	12 U.S.C. 	§§ 1 et seq. 	(1982 ard SUW.
III 1985), 	a national bank ma¥ charge its oot-of-state cust.cmers an interest rate
allC1HE!d by its am h~ state, 	even when that rate is greater than the interest
rate permittOO by the state of the bank's nonresident custcrners. 	12 U.S.C. 	§ 85
(1982); MgrgUette Nat'l Bank of MinneaPOlis v. 	First of omaha 5ery., 	439 U.S.
299, 	313-318 	(1978).
15 	Charge of the Plastic Brigade, 	Time, 	Mar. 	23, 	1987, 	at 52.
16 	Of course, 	a.rt:-of-state creditors still will be free to charge rates
higher than the ceilirq rate 	(see supra note 14) 	arrl thus cx:W.d offer credit to .
these higher risk~. 	In practics, 	ho..leVer, 	the oot-of-state creditors
t.en:l to solicit busiJ1ess through rnailin;rs arrl rarely accept unsolicited
applications. 	This may explain why, 	as di5O.lSSed infra at ~ 17, 	lower i.ncx::m3
families in states with relatively low interest rate ceili.n:;Js generally hold
fewer cre:lit 	cards.
4

\ 	.
Assemblyman Ross Johnson
in the past. 	In fact, 	empirical stlrlies in states that have iIrp:lsed credit card
interest rate oeil~ shat.i exactly this effect .17
In ackiition, 	even the credit available to the nost qualified borrowers may
be exterrled on less attractive terms, 	incl~ higher annual fees, 	lC1Ner credit
limits, 	higher nonthly payments, 	Shorter or no grace pericds, 	or It'Ot'e time-
ccnsum:i.n;J am costly credi~rthi.ness checks. 	To increase ~, bank card
issuers may at:teIrpt to increase the merchant disco.mt fee-the fee d1arged
rnerdlants for process:i.N1 credit card sales. 18 	Merchants lMy in turn pass these
costs on to COnstll'terS. 	Similarly, 	retail store crerlit 	card issuers my increase
marcl'wrlise prices in an att.enpt to offset the reduction in finance charge
revenue. 19 	SUCh IrerChan:lise price increases would hann not only credit card
users l:ut also la,.,-i..ncc:.lne OO~ who typically pay cash for me.rch.a.n:iise.
Finally, 	any benefits of laNer interest rates will not flow equally to all
consumers. 	Rather, 	only the estimated 53 percent of COI"ISl.llller who scmeti.nes or
usually do not payoff their a.co::m1t balances in full every II'Onth-the
''borraNerSlI---'i\l'ill enjoy the benefits of lower finance dlarges on their
ootstardi.nq balances. 20 	"Convenierce users" -the estimate:i 47 percent of all
credit card users arrl 76 percent of all elderly users who payoff their acccu.l1t
balances in full 	every rronth arrl thereby avoid finance charges 21 -will gain no
benefit. 	In fact, 	such convenien:::e users are likely to be ~rse off because of
the d1an.;es in other credit t.e.nns discussed above. 	Moreover, 	oo:=ause of recent
tax law c.ha.rx;es that eliminate the deductibility of credit card interest charges,
it is li.kely that the number of convenience users soon will 	increase to Irore than
17 	One study fourrl that the proportion of D:lI'\SUlTer'S hol~ credit cards in
Arkansas, 	a 	state with an unusually lo-v statutory rate lilnit, 	'WaS substantially
Sl'Mller than that in other states with higher interest rate ceili.n;s. 	canner &
Fexgus, 	supra note 3, 	at 10 table 5. 	A nultivariate analysis of the study data
(.1.&.:., 	one that atterrpted to hold other factors constant) 	disclose1 that "tight
ceili..rqs on credit card interest rates are rore likely to result in reduced
availability of b3nk credit card ao::oonts for lCMer- an::1 l~-m.iddle 	iN:nne
families than for higher ina:rne families." 	lQ. 	at 10. 	TI1e terrlency of interest
rate ceil.i..n;s to harm lC1N'er L~ groups rore than other groups was also fcurrl
in a New York state study reported in 1975. 	,Ig. 	at 10-11 arrl table 6.
18 	One stu.1y reported that bank credit earn issuers' 	retailer merchant
discount fees were higher in Arkansas, 	which has a 1& interest rate ceil.irq,
than in neighbori.n;; states with higher interest rate ceilin;Is. 	canner & FetgUS,
~ note 3, 	at 11-12.
19 	One study ~ that retail prices for major aWliances were an average
of 5 percent higher in Arkansas than in neighboring states with higher interest-
rate ceilirqs. 	canner & Fergus, 	supra note J, 	at II.
20 	canner & ~, 	~ rote 3, 	at 6 table 3.
21 	,Ig.
5

half of all o:msuIterS. 	Thus, 	the prc:posed laws Irely prcduoe fewer '''winners'' than
"losers."
The Effect Of Interest Bate Floors
A. B. 	2 WOlld set the m.inina..nn annualized i.nterest rate on bank c:redi.t card
plans at 12 percent. 	current law does not establish an interest rate floor. 	As
noted above, 	sette creditors a.rrrently d1.arge an annualized interest rate of only
10.5 percent on altstan::1i.r:g balances. 	Presumably such creditors J:eJ.ieve they can
make an adequate rate of return by chargiNJ 10.5 pe.rc:ent. 	A.B.:2 would ootlaw
such lCM interest rates to the direct detriment of califonria consurrers. 	'!he
interest rate floor walid also harm canpetition by artificially protect~ sare
finns 	fran their rore efficient c:anpetitors. 	We knew of fX) econcrnic or consumer
welfare justifications for any interest rate floor.
Conclusion
Interest rates should be determined by the market forces tilat result fran
CC!t'lpatition am:)I'~ lerders to obtain credit custauers. 	sett~ an interest rate
ceil1n;J IeMer' than the rrarket rate is li}r.ely to result in ~tervailin:J
restrictions on the terms of credit, 	a reduction :in the number of california
c:x:msuroors who quality for credit, 	arxi a ~ion in the aggregate ana.mt of
credit available to them. 	In J,:articular, many 10W'-i.nc:c:roo consumers who are Irost
in need of credit to bJy clot:h.in; anj other :recessities will be less able to do
so if interest rate ceilin3's are.inposed. 	ArroN; C011Sl.lJ'OOrS who continue to be
able to obtain credit, 	many will fira that the advantages of lONer interest rates
will be offset by higher m.inimum rrcnthly payments, 	increased creditworthiness
starrlards, 	reduced aItO.Ints of available credit, 	ani higher annual fees.
For all of the above Ili!QSOns, 	we respectfully urge you to reject A.B. 	2 ard
A.B. 	325. 	we have referre:l to a rn.nnber of stu::Ues anj other materials, 	arrl ~d
be ham" :to ~ly ~ies of them if you so desire. 	Please let us ~ if we may
be of any further assistance.
Sincerely,
anet M. Grady
Regional Director
6