I have always considered myself in-the-know when it comes to credit and pride myself on what my little three-digit number is, but I just learned some very, very interesting things about credit cards that I am anxious to share.
First and foremost, today, we are going to take a look at credit card interest rates and how they became the monsters that they are today.
I don’t know if this stuff is new to all of you, but it was to me. Though it is hard to imagine in today’s world where the average American family has $8,000 worth of credit card debt at average interest rates that tower over 20%, there was once a day when credit card companies were real banks and were regulated like banks.
Let me take you back to the early 1970s for a picture of the credit card industry that is unimaginable today. See, back then, your bank and the bank that issued your credit cards made money from loaning money out at a higher interest rate than it paid on deposits.
Just like today, right? Well, not exactly.
Back then, there were state laws in place called Usury Laws that, in order to protect consumers, capped the interest rates that people could be charged on loans from banks. There was a limit for the rate for a new car loan, a limit for the rate for a used car loan, a limit for the rate for a mortgage, and yes, a limit for the rate for credit card loans.
Though we tend to forget today, that credit card balance is a loan. Credit cards were a small business back then and the credit card powerhouses of today were just banks that offered credit cards as one form of a loan.
So, what in the world happened? Well, in the late 1970s and early 1980s interest rates were skyrocketing. Credit card issuers, like CitiBank, were being forced to pay nearly 20% on its deposits to keep competitive with the market, but the New York State Usury Laws capped credit card interest at 12%.
Do the math and you’ll see that CitiBank was going to run out of money and run itself out of business with high interest rates on deposits and low interest rate caps on loans. With conditions like this, capitalism did what it is supposed to do and created an opportunity.
With Usury Laws capping loan interest rates in all 50 states, what if you were the one state that turned things upside down by eliminating the caps on interest rates, allowing banks to charge higher interest rates on loans?
Bill Janklow was elected governor of South Dakota and immediately asked that question. He, in a matter of mere weeks, pushed through legislation that revoked all Usury Laws in the state of South Dakota. So, long story short, CitiBank moves its credit card division to South Dakota and begins charging a rate higher than the going interest rate being paid on deposits in South Dakota. Shortly thereafter, other banks moved their credit card divisions to South Dakota, and then, seeing South Dakota’s new-found success, a few other states dropped their Usury Laws.
As bad as this was for consumers in these states who were once protected by Usury Laws, the final nail in the coffin on Usury Laws that capped loan interest rates came in the early 1980s with a court decision called the Marquette Decision that allowed all U.S. banks to export the non-capped rates of their home state to all other 50 states, thus, in essence, rendering all the Usury Laws in all the states null and void as long as a bank’s credit card headquarters was in a state without credit card Usury Laws.
So, in essence, following the Marquette Decision, there were no more caps on what banks could charge their customers for loans through credit cards.
Needless to say, that as interest rates on deposits deflated and came down over the years, the banks never adjusted their credit card loan rates back down and today, while you get a 40-year low of 0.25% on a savings account from a bank, that same bank will charge you over 20% on the credit card you have with them.
With the Usury Laws null and void, it is perfectly legal for the bank to do this.
The mass of income that this has generated over time as Americans became less and less responsible with their credit and personal finances turned those banks like CitiBank into credit card companies with credit card interest being their main money-maker.
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