Sunday, January 17, 2010

Government can say anything

My brother is a perfect example of the principle, use it or lose it. He used to be a smart guy, but lately he has taken a short cut in his thought processes, so short that he has stopped thinking entirely. So there we are, debating the recent credit card legislation, and he laments that the law is ineffective because there is a six month window allowing credit card companies to change rates before they are locked down. He goes on to say that this all could have been avoided if only Congress had been smarter and eliminated this loophole. I tell him it doesn't matter, that the entire idea of government trying to impose price controls on credit is foolish. And then he says it...I shudder..."government can do anything." Technically he's right, government can impose whatever legislation they want, what they can't do is change the laws of economics. God made man and those, and both are inviolable.

Credit is like any other product, it has a cost. That cost is reflected in borrower's default rates and consequently, those borrowers with higher default rates cost more. Hence, credit card companies charge those customers a higher rate of interest. Now it shouldn't take a rocket scientist to figure out that if you force credit card companies to charge a lower interest rate to people with a higher risk of default, the credit card companies will go broke. There's a reason those customers were charged more, they cost more. The question for my brother is this: what is the consequence of Government dictating the lower rate of interest (also known as price controls)? Will the cost change? No. Well, if the cost doesn't change, something else must.

Here's what will happen, riskier customers will no longer be able to get credit (also known as a shortage) because what can be charged is less than what it costs. It doesn't matter whether Congress dictates this immediately or six months from now. Congress' political magic tricks can never have any effect on reality.


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