By James Kwak
I wasn’t sure if I was going to write about the Whitehouse Amendment, which would allow states to regulate the interest rates charged to their residents. According to a 1978 Supreme Court decision, financial institutions are governed by the law of the state that they reside in, not the laws of the states they do business in; the result was the current situation, where the big credit card issuers are based in South Dakota, because Citibank basically wrote South Dakota’s consumer credit laws. In its essence, the amendment says this: “The interest applicable to any consumer credit transaction [not a mortgage], including any fees, points, or time-price differential associated with such a transaction, may not exceed the maximum permitted by any law of the State in which the consumer resides.”
Obviously I’m in favor of it, as the current system just allows the worst kind of regulatory arbitrage. (Note that administration officials like to oppose strict legislative measures, like a hard leverage cap, on the grounds that these things need to be negotiated internationally so that banks won’t just set up shop in the most lightly-regulated jurisdiction — yet that’s exactly what happens with credit cards.) But I wasn’t sure what there was to add, since Mike Konczal and Bob Lawless have already weighed in.
Then I read the ABA’s argument against the amendment, that gave me all the motivation I needed.
Here is one of its arguments, broken up into four paragraphs:
“The state rate cap may be based on an all-inclusive APR that is different from the Truth in Lending Act (Regulation Z) definition of APR. For example, the interest rate calculation under the bill could include application fees, late payment fees, and annual or periodic fees. This means the rate calculated under a state rate cap could be higher than the Regulation Z APR, making it more likely a lender will reach the state rate cap, particularly for small dollar loans with short terms.”
Um . . . that’s the point. Right now banks are allowed to pretend that application fees, late payment fees, annual fees, and periodic fees are not part of the cost of credit. That’s a bad thing. And if the federal agencies aren’t going to fix it, then states should be allowed to. “Making it more likely a lender will reach the state cap” is a good thing if what makes it more likely is the elimination of a misleading loophole.
“Determining the state rate cap for open-end credit and overdrafts would be particularly problematic, as it would have to be determined retroactively (the ‘historic’ APR) in order to take into account fees such as periodic fees and late payment fees. Banks would have to either significantly limit or eliminate all such fees so that the APR would be under the state rate cap, or simply not offer those products.”
Again, that’s a feature, not a bug. If the only way banks can offer a product is by hiding its true cost outside the APR, then the product shouldn’t exist. State legislatures should have the power to determine what the maximum cost of credit should be. Here the ABA’s complaint is that banks won’t be able to evade that limit through dodgy accounting.
“Overdrafts are ‘credit’ according to bank regulators, but currently the fees are not considered ‘finance charges,’ and therefore exempt from Regulation Z. State laws would be permitted to limit the ‘interest’ on overdrafts by treating them as open-end loans subject to a retroactive ‘effective’ or ‘historic’ APR calculation and limiting the amount that may be charged.”
If overdrafts are credit, then the cost of credit should be disclosed and regulated, one way or another. Reading the first sentence above, the only reasonable inference to be drawn is that the fees should not be exempt from Regulation Z.
“Affordable small dollar loans such as those intended as alternatives to payday loans, (such as the 36 percent loans suggested under FDIC’s affordable loan pilot) may not be permitted under state laws. By definition, loans that are small dollar amounts, have fixed costs that are part of the finance charges and reflected in the APR, and have short terms will have higher APRs likely to exceed any state interest rate cap.”
I like this positioning of “affordable small dollar loans such as those intended as alternatives to payday loans.” If those things would be banned by state law, so would payday loans. The Truth in Lending Act already applies to non-bank lenders, even if the Greenspan Federal Reserve neglected to enforce it.
The ABA’s argument boils down to this: Right now, federal regulations allow us to hide the true cost of credit. State laws might not let us hide it anymore. We can’t let that happen.
The other main argument that I see against this amendment is that it increases the cost of regulatory compliance for banks. Again, that’s a good thing, relative to where we are now. Sure, the optimal outcome would be a single federal regulatory system that was good and well enforced. But we’ve just lived through an episode that has proven that you can’t count on the federal regulatory agencies to do their job.
Besides, the costs will be lower than industry advocates claim. First, the vast majority of banks only operate in one state, or at most a couple (since the vast majority of banks are very small). Second, the insurance industry has dealt with this issue since forever, and while the insurance industry has it problems, it generally works. (And many of those insurance regulations are process regulations, such as the amount of time you have to respond to a notification, which are considerably harder to comply with than rate regulations.) Third, the programming to ensure that you aren’t violating a state interest rate regulation based on the customer’s state is trivial (although, given most large enterprise IT environments, it could take months), especially compared to the programming the banks do to decide which mailing to send you.
Of course I think there is a role for the federal government when it comes to regulation. Imagine what the country would be like if we didn’t have the federal government to set a minimum floor when it comes to civil rights, or clean water, or guns. (Um, strike that last example.) But just as in the civil rights arena, I think Washington should set a minimum floor of constraints (for example, no employment discrimination on the basis of race or gender) that states can go beyond if they so choose (no discrimination on the basis of sexual orientation).
As always, it will be interesting to see if the nominally pro-states’ rights Republican Party will go along with an amendment that is all about states’ rights.
Update: If there was any doubt, that’s the American Bankers Association, not the American Bar Association.