FTC Staff Comment to Governor Garrey Caruthers Concerning New Mexico H.B. 275 and S.B. 171 to Impose Interest Rate Ceilings on Credit Cards and S.B. 203 to Impose Ceilings on All Credit Transactions

Federal Trade Commission
Offi('t' ne tht' Rt·gional Dirt·ctor
8303 Elmhrook Drive
Dallas. Tnas 75247
(21·lj 7fi7·7050
COl4fVlISSION
APPROVED,·	'j
The 	Honorable 	Garrey 	Carruthers
Governor 	of 	New Mexico
State 	Capitol 	Building
Santa 	Fe, 	New Mexico 	87503
Dear 	Governor 	Carruthers:
March 	18, 	1987
.
we 	are 	pleased 	to 	submit 	this 	letter 	in 	response 	to 	your
staff's 	request 	for 	comments 	on 	House 	Bill 	275 	and 	Senate 	Bill 	171,
which 	impose 	interest 	rate 	ceilings 	on 	credit 	card 	transactiops,
and 	on 	Senate 	Bill 	203, 	~hich 	imposes 	an 	interest 	rate 	ceiling 	on
all 	credit 	transactions. 	- 	-
As 	you 	are 	aware, 	the 	Commission 	does 	not 	tegulate 	maximum
prices 	for 	credit. 	However, 	the 	Commission 	is 	directl¥ 	and
actively 	involved 	in 	other 	consumer 	cred~t regulations 	and 	in
regulations 	governing 	pricing 	generally. 	Our 	experience 	and 	the
economic 	literature 	on 	maximum 	pricing 	regulatio~s both 	indicate
that 	ceilings 	on 	interest 	rates 	are 	accompanied 	by 	substantial 	harm
1
2
3
'These 	comments 	represent 	the 	views 	of 	the 	Dallas 	Regional
tOffice 	and 	the 	Bureaus 	of 	Consumer 	Protection, 	Competition,
and 	Economics 	of 	the 	Federal 	Trade 	Commission 	and 	do 	not
necessarily 	represent 	the 	views 	of 	the 	Commission 	or 	any
individual 	Commissioner. 	The 	Commission 	has, 	however, 	voted
to 	authorize 	their 	submission.
See, 	e.g., 	Truth 	in 	Lending 	Act, 	15 	U.S.C. 	S 1601 	(1982) ~
Equal 	Credit 	Opportunity 	Act, 	15 	U.S.C. 	S 	1691 	(1982 	and
Supp. 	III 	1985)~ 	Fair 	Credit 	Reporting 	Act, 	15 	U.S.C. 	§ 	1681
(1982 	and 	Supp. 	III 	1985).
See, 	e.g., 	Federal 	Trade 	Commission 	Act 	§ 	5, 	15 	U.S.C. 	§ 	5
(1982)~ 	Robinson 	Patman 	Act, 	15 	U.S.C. 	§§ 	13-13(b), 	21~ 	(1976
and 	Supp. 	III 	1985). 	;

to 	many 	consumers. 4 An 	effort 	to 	restrict 	interest 	rates 	will
cause 	lenders 	to 	alter 	c:her 	loan 	terms, 	including 	collateral
requirements, 	minimum 	monthly 	payments, 	administrative 	or 	user
fees, 	duration 	of 	the 	loan, 	and 	criteria 	for 	creditworthiness.
These 	offsetting 	changes 	are 	likely 	to 	affect 	many 	consumers
adversely. 	We 	therefore 	recommend 	against 	the 	enactment 	of 	any 	of
these 	bills.
INTEREST 	RATES 	ABSENT 	INTEREST 	RATE 	CEILINGS
In 	the 	absence 	of 	a 	rate 	ceiling, 	the 	interest 	rate 	that 	a
creditor 	can 	charge 	for 	a 	loan 	of 	a 	given 	size 	and 	duration 	is
determined 	by 	competition 	among 	creditors. 	This 	competition 	can
be 	actual 	-- 	where 	a 	would-be 	borrower 	has 	several 	sources 	of
credit 	-- 	or 	it 	can 	be 	from 	potential 	entrants 	into 	the 	business
of 	extending 	credit. 	.-
Data 	on 	the 	rates 	of 	return 	earned 	by 	various 	categories 	of
creditors 	suggests 	that 	crsditors 	earn 	only 	a 	competitive 	return
on 	their 	invested 	capital. 	In 	other 	words, 	the 	interest 	earned
on 	loans 	covers 	the 	creditor's 	costs, 	including 	losses 	on 	bad
loans) 	and 	normal 	profits. 	This 	conforms 	to 	economic 	theory 	and
exper ience, 	as 	any 	credi tor 	who 	at.tempts 	to 	earn 	supranormal
profits 	by 	charging 	higher 	than 	competitive 	interest 	rates 	would
lose 	business 	to 	either 	existing 	creditors 	or 	new 	entrants .
. Consumers 	may 	pay 	higher 	finance 	charges 	on 	credit 	card
'balances 	than 	for 	other 	typ~s of 	credit. 	However, 	this 	type 	of
credit 	has 	certain 	features 	for 	which 	consumers 	are 	apparently
wiliing 	to 	pay. 	These 	features 	include 	the 	availability 	of 	a
pre-approved 	line 	of 	credit, 	the 	lack 	of 	collateral 	requirements,
the 	acceptance 	of 	a 	credit 	card 	by 	large 	numbers 	of 	merchants 	in
various 	locations, 	and 	the 	record 	of 	purchases 	created 	by 	using
the 	card. 	Further, 	profitability 	data 	indicates 	that 	disparity
4
5
See, 	e.g., 	Canner 	& Fergus, 	The 	Economic 	Effects 	of 	Proposed
Ceilings 	on 	Credit 	Card 	Interest 	Rates, 	Fed 	Reserve 	Bull.
Jan. 	1987, 	at 	1; 	Ostas, 	Effects 	of 	Usury 	Ceilings 	in 	the
Mortgage 	Market, 	31 	J. 	of 	Fin. 	821 	(1976). 	See 	also 	Barth,
The 	Effect 	of 	Government 	Regulations 	on 	Personal 	Loan
Markets: 	A Tobit 	Estimation 	of 	a 	Microeconomic 	Model, 	37 	J.
of 	Fin. 	1233 	(1982). 	On 	a 	similar 	s~bject, maximum 	rent
regulations, 	see 	Bethell, 	No 	Growt~-No 	Vacancies, 	Regulation,
Jan.-Feb. 	1979, 	at 	48; 	Rent 	Control 	and 	the 	Decline 	of 	the
Cities, 	Regulation, 	Jan.-Feb. 	1981, 	at 	13.
Canner 	& Fergus, 	supra, 	note 	4, 	at 	1-2.
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~etween 	finance 	charges 	associated 	with 	credit 	cards 	and 	the
interest 	rates 	charged 	for 	other 	types 	of 	credit 	does 	not 	6esult
in 	directly 	corresponding 	higher 	profits 	for 	card 	issuers.
THE 	EFFECT 	OF 	INTEREST 	RATE 	CEILINGS
When 	an 	interest 	rate 	ceiling 	is 	established 	at 	less 	than 	the
competitive 	market 	rate 	for 	some 	borrowers, 	lende5s 	will 	reduce
the 	volume 	of 	c:edit 	extended 	to 	those 	borrowers. 	The 	reason
for 	this 	is 	clear. 	Lenders 	themselves 	face 	costs 	of 	borrowing
money 	from 	investors 	as 	well 	as 	costs 	of 	administering 	their
loans. 	If 	legislation 	forces 	prices 	(interest 	rates) 	below 	the
level 	of 	costs, 	lenders 	must 	either 	go 	out 	of 	business 	or 	stop
making 	the 	loans 	that 	do 	not 	provide 	at 	least 	a 	normal 	rate 	of
return.
Because 	t~e 	ul~imate return 	from 	making 	a 	loan 	includes 	the
losses 	from 	loan 	defaults 	as 	well 	as 	the 	positive 	income 	from
interest 	payments 	and 	administrative 	fees, 	lenders 	are 	able 	to
offer 	different 	rates 	to 	different 	types 	of 	borrowers. 	A
borrower 	with 	a 	long 	history 	of 	timely 	repayments 	and 	a 	large
pool:of 	assets 	to 	guarantee 	repayment 	can 	usually 	obtain 	lower
rates 	because 	the 	expected 	costs-of 	such 	a 	loan 	are 	lower.
Unfortunately, 	not 	all 	borrowers 	have 	such 	sterling
characteristics, 	yet 	lenders 	are 	usually 	willing 	to 	make 	loans 	to
a 	gener al 	pool 	t,ha t 	inc ludes 	higher 	risk 	bor rower s 	if 	the 	lender s
are 	able 	to 	charge 	a 	suitable 	overall 	interest 	rate.
. 	If 	government 	forces 	a 	reduction 	in 	allowable 	interest
rates, 	however, 	lenders 	will 	no 	longer 	be 	able 	to 	make 	loans 	to
higher 	risk 	borrowers 	with 	the 	same 	freedom 	as 	they 	did 	before
the 	regulations. 	Lenders 	will 	compensate 	for 	the 	lower 	interest
payments 	with 	other 	charges, 	such 	as 	higher 	annual 	fees, 	more
restrictive 	loan 	terms, 	or 	denial 	of 	credit 	to 	borrowers 	who 	are
relatively 	high 	credit 	risks.
6
7
The 	annual 	net 	earninss 	of 	bank 	card 	plans 	before 	taxes
averaged 	1.9 	percent 	of 	balances 	outstanding 	from 	1972
through 	1985. 	Over 	the 	same 	period, 	average 	net 	returns 	on
other 	major 	types 	of 	commercial 	bank 	lending 	were
significantly 	higher: 	2.3% 	on 	real 	estate 	mortgages, 	2.4% 	on
consumer 	installment 	debt, 	and 	2.8% 	on 	commercial 	and 	other
loans. 	Canner 	and 	Fergus, 	supra, 	note 	4, 	at 	1-2, 	citing
Federal 	Reserve 	Bank 	Data. 	Returns 	on 	all 	types 	of 	loans
fluctuate 	over 	time. 	Profits 	for 	1984 	and 	1985 	on 	credit
card 	balances 	were 	3.4 	and 	4.0%, 	respectively: 	high 	for 	the
period 	but 	considerably 	less 	than 	highs 	for 	commercial 	and
other 	credit, 	which 	reached 	more 	than 	5% 	in 	1981. 	Id.
Villegas, 	An 	Analysis 	of 	the 	Impact 	of 	Interest 	Rate
Ceilings, 	37 	J. 	of 	Fin. 	941 	(1982).
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,.
Consequently, 	one 	probable 	result 	of 	restricting 	interest
rates 	on 	loans 	will 	be 	to 	cut 	off 	credit 	to 	less 	attractive
borrowers. 	Those 	borrowers 	will 	include 	young 	people 	with 	little·
credit 	history, 	people 	with 	few 	assets 	to 	use 	as 	collateral, 	or
people 	who 	have 	had 	trouble 	repaying 	a 	loan 	in 	the 	past.
In 	addition, 	credit 	available 	even 	to 	the 	most 	qualified
borrowers 	may 	be 	extended 	on 	less 	attractive 	terms, 	such 	as
shorter 	repayment 	periods, 	lower 	lines 	of 	available 	credit,
higher 	(or 	higher 	minimum) 	monthly 	payments, 	or 	more 	time-
consuming 	and 	costly 	creditworthiness 	checks. 	In 	the 	case 	of
credit 	cards, 	retail 	card 	issuers 	may 	increase 	merchandise 	prices
in 	an 	attempt 	to 	offset 	the 	reduction 	in 	finance 	charge
revenue. 	Bank 	card 	issuers 	may 	attempt 	to 	increase 	the 	merchant
discount 	fea 	-- 	the 	fee 	charged 	merchants 	for 	processing 	credit
card 	sales.
CONCLUSION
Interest 	rates 	are 	determined 	by 	the 	market 	forces 	that
result ,from 	competition 	among 	lenders 	to 	loan 	money 	to
consumers. 	Setting 	an 	interest 	rate 	ceiling 	lower 	than 	the
market 	rate 	is 	likely 	to 	result 	in 	countervailing 	restrictions 	on
the 	terms 	of 	credit, 	a 	reduction 	in 	the 	number 	of 	New Mexico
consumers 	who 	qualify 	for 	credit, 	and 	a 	reduction 	in 	the 	.
aggregate 	amount 	of 	credit 	available 	for 	New 	Mexico 	consumers 	as
a 	group. 	In 	particular, 	many 	consumers 	who 	are 	most 	in 	need 	of
,credit 	t~ buy 	clothing, 	furniture, 	cars, 	and 	homes 	will 	be 	less
able, to 	do 	so 	if 	binding 	interest 	rate 	ceilings 	are 	imposed.
Among 	consumers 	who 	continue 	to 	be 	able 	to 	obtain 	credit, 	many
will 	find 	that 	the 	advantages 	of 	lower 	interest 	rates 	will 	be
offset 	because 	lenders 	will 	seek 	to 	reduce 	their 	costs 	or
increase 	their 	non-interest 	revenue 	by 	requiring 	higher 	minimum
monthly 	payments, 	reducing 	amounts 	of 	credit 	available,
increasing 	down 	payment 	or 	collateral 	requirements, 	raising 	fees,
and 	shortening 	repayment 	schedules.
t 	Thank 	you 	for 	considering 	our 	comments. 	We 	would 	be 	happy
to 	supply 	copies 	of 	the 	various 	studies 	mentioned 	in 	this 	letter
if 	you 	so 	desire, 	or 	to 	provide 	any 	other 	assistance.
Sinje,lYj? 	/
;; 	/f{~;,,:,-;
~m M~se;e; 	~~	.., Regional 	Director
Dallas 	Regional 	Office
,,
8 	Canner 	and 	Fergus, 	supra, 	note 	4, 	at 	8.
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