Last week I explained why policymakers should avoid passing legislation that would threaten the accuracy and predictability of credit reporting and credit scoring in response to the COVID-19 crisis. However, these substantial revisions of the Fair Credit Reporting Act were just one of many recently proposed financial services policy changes that could have far-reaching consequences. During this crisis it’s important that any federal response be targeted, temporary, provide immediate relief, and adhere to free market principles.
So even with the ink barely dry on a $2 trillion stimulus package, it’s no surprise that lawmakers are already discussing what to include in “Phase 4” of the federal government’s response. Lawmakers would be wise to exclude from “Phase 4” legislation controversial provisions that wouldn’t pass the Congress on their own merits. Specifically, NTU has strong opposition to the following provisions being included into the next package:
Extending the Qualified Mortgage Patch
We’ve written at length about the risks Fannie Mae and Freddie Mac pose to taxpayers and the entire economy, and why housing finance reform should be a front-burner issue for Congress to tackle. Yet, despite being more than a decade removed since taxpayers bailed out the GSEs, Congress has failed to enact any significant reforms to the broken system. In the absence of congressional action, regulators have taken a few important steps to rightsize the government’s role in the mortgage market.
One of more significant changes to the federal government’s role was the decision by the Consumer Financial Protection Bureau to end the Qualified Mortgage “patch” rule by January 2021. The QM patch is a provision brought about by the Dodd-Frank law that allows GSEs to sidestep stricter mortgage underwriting requirements and underwrite mortgages that exceed a 43 percent debt-to-income ratio. Replacing the patch with carefully considered, transparent, and quantifiable data-driven standards that private sector lenders can understand and incorporate in their own procedures will ensure the GSEs play by the same set of rules and compete on a more even playing field.
Developing those standards and procedures may require a phase-in period after the new rule takes effect in January 2021, but delaying the rule entirely would be counterproductive and would introduce less certainty than establishing a timetable with definitive implementation points that begins next year. Language in H.R. 6379 that directs the CFPB to extend the GSE QM Patch until January 1, 2022 may be well-intended, but many participants in the mortgage lending sector have developed sensible guidelines for gradually transitioning away from the QM patch while preventing unintended impacts (such as shifting more loans into that taxpayer-backed Federal Housing Administration portfolio). Punting a decision on this patch put the government on the hook for an additional $260 billion of mortgages in 2018; extending the patch for another year beyond 2021 could likely lead to hundreds of billions in more guarantees taxpayers will underwrite.
Unfortunately, much of the admirable work that has been done to create a smooth transition away from the QM patch could come to naught if certain Members of Congress get their way. Seeking to delay phase-out of the QM patch seems on the part of some inside and outside of Congress seems understandable but is unnecessary, given the flexibility CFPB has to create a gradual implementation period for a replacement. Furthermore, a detailed, mature body of guidance can be developed from the extensive recommendations that private sector lenders have been able to furnish CFPB.
Unfortunately, when it comes to other financial services policies, there seem to be far less constructive motives to use the Coronavirus as a vehicle for imposing a litany of bad ideas that have little to do with the crisis at hand.
Nationwide Interest Rate Cap on Short-term Loans
Some groups are also calling for Congress to include legislative language contained in the Veterans and Consumers Fair Credit Act, which places a price ceiling on all consumer loans. This troubling legislation is modeled after the 2015 update to the Military Lending Act, and mandates a nationwide 36 percent interest rate cap on consumer credit.
Specifically, the legislation states that no consumer loan can be made if the Annual Percentage Rate (APR) of a loan exceeds 36 percent. However, using APR as the rationale to cap interest rates is entirely arbitrary and economically flawed. The APR is simply the rate of interest a borrower will pay over the course of a year due to compounding, but short-term consumer loans are rarely outstanding for an entire year. These loans act typically act as a cash advance that are paid back in full at the borrower’s next pay period. So while the loans may indeed carry a high APR, the vast majority of loans are repaid in a matter of weeks or months, not extended for an entire year.
Interest rates are incredibly important for lenders, as it allows them to price in all their fixed and unforeseen
costs. Factors such as the lender’s costs and risks and consumer demand for credit all affect how expensive or inexpensive credit will be. Any short-term interest rate includes a number of important factors, such as the risk of lending to potentially credit-unworthy borrowers, chance of default, and fixed costs of operating a business.
As NTU wrote in a February letter to the Financial Services Committee about the VCFCA, “More than 12 million Americans rely on short-term loans each year, with 7 of 10 borrowers using the loans for basic expenses such as rent and utilities. It is highly likely that if enacted, H.R. 5050 could make it substantially harder for Americans to access short-term, small dollar loans. Without this access, potential borrowers may either have to miss a payment or default, or seek an illicit, unregulated market for a loan.”
Plain and simple: government-imposed price controls do not work. As we’ve seen in virtually every example in history, price controls worsen the very problems they are supposed to solve. Whether placed on gasoline, interchange fees, or prescription drugs, setting price controls at below-market rates leads to shortages, squeezes the cost bubble toward some other portion of the economy, and imposes a deadweight cost on society. These laws of economics will certainly apply to the short-term lending industry if a price control were to come into effect.
Government Price Controls on Credit Card Interchange Fees
Slipped into the landmark Dodd-Frank financial reform bill at the 11th hour, the “Durbin amendment” requires the Federal Reserve to limit the fees banks can charge retailers for processing debit card transactions.
As a result of the price control, many financial institutions suffered a significant drop in revenue. To offset the revenue decline from interchange fees, banks increased other fees and reduced services, including higher overdraft and ATM fees, fewer accounts with free checking, and increased minimum balances. In addition, proponents of the Durbin amendment said capping these interchange fees would be a boon for limited-income Americans because businesses would lower prices on goods. Unfortunately, evidence seems to disagree. In fact, a Federal Reserve Bank of Richmond report noted 98.8 percent of retailers either raised prices or kept them the same after the legislation passed.
The Durbin amendment didn’t touch credit cards, however, and some groups in Washington are calling for it to be extended to credit card transactions as a way to help restaurants, bars, and other brick and mortar retailers hit by the COVID-19 crisis.
This of course is problematic. As NTU has stated from the beginning of the crisis, any action must be temporary, targeted, and provide immediate relief. First, since many in the industry are experiencing immediate financial stress, it could take upwards of a year in order for the Federal Reserve to draft the regulation, conduct a cost-benefit analysis, have an open comment period, and then actually implement the interchange cap. If this measure actually provided the relief that its proponents claim, it wouldn’t materialize until at least a year from now, when the worst of the crisis is projected to be long over.
Second, due to stay at home orders, most businesses are unfortunately closed down with little to no customer traffic. Since there’s a sharp reduction in consumer activity, most businesses would only see little if any benefit. Retail interests seeking a Durbin-style amendment for credit transactions should be directing their energy instead toward more productive, effective relief measures, such as property tax reductions, less burdensome employer mandates, and forbearance with difficult tax administration tasks such as reporting and remitting sales and use tax.
Third, if history is any example, price controls on interchange transaction fees could have disastrous consequences on consumers. If enacted, credit card users will likely have their cash back rewards altered, credit limit reduced, and other negative effects. Nearly half of all open credit accounts are considered prime or subprime (177 million accounts), and the vast majority of these users have at least one credit card. To that end, a study found 74 percent of cardholders with an income between $20,000 and $30,000 own a rewards credit card. For these individuals, extra cash-back or “points” at the grocery store or the gas station can go a long way. Most importantly, 94 percent of cardholders earning less than $30,000 believe their credit card rewards program is valuable to them.
As Congress and the administration continue to respond to the imminent public health threat they must balance the conflicting needs of emergency responsiveness, fiscal responsibility, and economic vitality. It’s more important than ever for Congress to remember free market principles and prioritize actions that limit government spending. Unfortunately, the policies outlined above toss aside free market principles and leave taxpayers on the hook for more exposure.