FTC Staff Comment Before the Oklahoma Attorney General Concerning Proposed Revisions to the Oklahoma State Constitution to Eliminate Interest Rate Ceilings

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UNITED STATES OF AMERICA
FEDERAL TRADE COMMISSION
DALLAS REGIONAL OFFICE
V8900g9
COMMISSION 	AUTHORIZED
1
September 	8, 	1989
The 	Honorable 	Robert 	H. 	Henry
Attorney General
State 	of 	Oklahoma
112 	State Capitol 	Building
Oklahoma City, 	Oklahoma 	73105
Dear Mr. 	Attorney General:
The 	Federal 	Trade Commission 	staff 	is 	pleased 	to 	respond 	to
your 	invitation 	to 	comment 	on 	the 	Oklahoma 	Constitution 	Revision
Commission's 	proposed 	revisions 	to 	the 	Oklahoma 	State
Constitution. 	In 	this 	letter, 	we 	focus 	on 	the 	Constitution
Commission's 	proposal 	to 	amend Article 	XIV, 	§ 	2 	of 	the
Constitution, 	which, 	if 	enacted, 	would eliminate
constitutionally-mandated 	interest 	rate 	ceilings 	in Oklahoma. 	In
general, 	we 	believe 	that 	deregulation 	of 	interest 	rate 	charges 	in
Oklahoma 	would 	promote 	the 	availability of 	consumer 	credit 	and
would 	be 	beneficial 	to 	consumers.
I. 	Interest 	and 	Experience 	of 	the 	Staff 	of 	the 	Federal 	Trade
Commission
The 	Federal 	Trade 	Commission 	is 	charged with 	promoting
competition and 	protecting consumers 	from 	unfair 	and 	deceptive
commercial 	practices. 2 In 	fulfilling 	this 	mandate, 	the 	staff 	of
the 	Federal 	Trade 	Commission often submits 	comments, 	upon
request, 	to 	federal, 	state, 	and 	local 	governmental 	bodies 	to 	help
assess 	the 	competitive 	and consumer welfare 	implications 	of
pending 	policy 	issues. 	In enforcing 	the 	Federal 	Trade 	Commission
Act, 	the 	Commission 	staff 	has 	gained 	considerable 	experience 	in
analyzing 	the 	impact 	of 	various 	private 	and 	government 	restraints
These 	comments 	are 	the 	views 	of 	the 	staff 	of 	the 	Dallas
Regional 	Office 	and 	the 	Bureau 	of 	Economics 	of 	the 	Federal 	Trade
Commission. 	They are 	not 	necessarily 	the 	views 	of 	the 	Commission
or 	any 	individual 	Commiss·ioner.
2 ~ 	15 	U.S.C. 	§ 	41 	~ ~.

The 	Honorable Robert 	H. 	Henry 	Page 	2
on 	competition and 	the 	costs 	and 	benefits 	to 	consumers 	of 	these
restraints. 	More 	specifically, 	by enforcing 	the 	Truth 	in 	Lending
Act,3 	the 	Equal 	Credit 	Opportunity Act,4 and 	the 	Fair Credit
Reporting Act,S 	the 	Commission 	staff 	has 	gained 	substantial
experience 	in 	the 	area of 	consumer 	credit. 	In 	addition, 	the
Commission's 	staff 	has 	submitted comments 	to 	various 	state 	bodies
on 	proposed 	legislation relating 	to 	interest 	rate 	ceilings. 6
II. 	Interest 	Rate 	Ceilings 	in Oklahoma
Currently, 	Article XIV, 	S 	2 	of 	the Oklahoma 	Constitution
establishes 	a 	maximum 	interest 	rate 	of 	10 	percent 	in Oklahoma
unless 	the 	Legislature 	sets 	a 	different 	rate. 	Pursuant 	to 	S 	2,
the 	Oklahoma 	Legislature 	has 	set 	a 	variety of 	interest 	rate
ceilings 	in 	Oklahoma, 	depending 	upon 	the 	amount 	or 	type 	of 	credit
extended. 7
The 	proposed 	amendment 	to 	Article 	XIV, 	§ 	2 	would 	eliminate
the 	constitutionally-imposed 	interest 	rate 	ceiling 	in 	Oklahoma.
Although 	this 	proposal 	would 	not 	automatically 	repeal 	the
3
4
5
15 	U.S.C. 	§§ 	1601-1677e 	(1982 	& Supp. 	III 	1985).
15 	U.S.C. 	S§ 	1691-1991f 	(1982 	& Supp. 	III 	1985).
15 	U.S.C. 	§§ 	1681-1861t 	(1982 	& Supp. 	III 	1985).
6
7
~ 	letter of 	March 	18, 	1987, 	from 	Jim Moseley,
Director, 	Dallas 	Regional 	Office, 	Federal 	Trade 	Commission, 	to
The 	Honorable Garrey Carruthers, 	Governor of 	New Mexico; 	letter
of 	April 	20, 	1987, 	from 	Janet 	M. 	Grady, 	Director, 	San 	Francisco
Regional 	Office, 	Federal 	Trade 	Commission, 	to The 	Honorable 	Ross
Johnson, 	Vice 	Chairman of 	the 	Committee on Finance 	and 	Insurance,
California 	State 	Assembly; 	letter of 	May 	15, 	1987, 	from 	John M.
Peterson, 	Director, 	Chicago 	Regional 	Office, 	Federal 	Trade
Commission, 	to 	The 	Honorable Greg 	Zito, 	Illinois 	State 	Senate,
and 	The 	Honorable Monroe 	L. 	Flinn, 	Illinois 	State 	House 	of
Representatives; 	letter of 	May 	29, 	1987, 	from 	Edward Manno
Shumsky, 	Regional 	Director, 	New York 	Regional 	Office, 	Federal
Trade 	Commission, 	to 	The 	Honorable 	Herman 	D. 	Farrell, 	Chairman 	of
the 	Committee 	on 	Banks, 	New York 	State Assembly.
The 	interest 	rate 	ceiling 	for 	credit 	cards 	in 	Oklahoma
is 	21%. 	14A Okla. 	Stat. 	S 2-207(3). 	The 	interest 	rate 	ceiling
for 	loans 	up 	to 	$750 	is 	30%; 	for 	loans 	from 	$751 	to 	$2500, 	the
ceiling 	is 	21%; 	and 	for 	loans 	over 	$2500, 	the 	ceiling 	is 	15%.
14A Okla. 	Stat. 	§ 	3-508A(2)(a)(i)-(iii).

The 	Honorable Robert 	H. 	Henry 	Page 	3
8
9
10
11
interest 	rate 	ceilings 	set 	by 	the 	Legislature, 	it 	is 	a 	good 	step
toward 	deregulating 	interest 	rates 	in Oklahoma.
III. 	Interest 	Rate 	Ceilings 	Injure 	Consumers
The 	economic 	literature on consumer credit 	indicates 	that
interest 	rate 	ceilings 	may 	substantially 	harm many consumers. 8
Lenders" 	like 	all 	others 	in 	the 	marketplace, 	must 	earn 	a
competitive 	rate 	of 	return. 	Therefore, 	when 	an 	imposed 	interest
rate 	ceiling 	is 	lower 	than 	the 	competitive market 	rate, 	lenders
must 	make 	adjustments 	by either 	increasing other charges,
reducing 	the volume 	of 	credit 	available 	to 	higher-risk 	borrowers,
or 	doing 	both. 9 Credit 	card 	issuers 	can respond 	to 	interest 	rate
ceilings 	by moving 	their 	credit 	card operations 	to 	states 	that
have 	higher 	or 	no 	interest 	rate 	ceilings 10 and 	under 	federal 	law
a 	national 	bank may 	charge 	its 	out-of-state customers 	an 	interest
rate 	allowed 	by 	its 	home 	state, 	even when 	that 	rate 	is 	greater
than 	the 	interest 	rate permitted by 	the 	state 	of 	the 	bank's
nonresident 	customers. 1
~, 	e....Jl,..a.., 	Villegas, 	"The 	Impact 	of 	Usury Ceilings 	on
Consumer 	Credit," 	56 	S. 	Econ. 	J. 	126 	(1989); 	Canner 	& Fergus,
"The 	Economic 	Effects 	of 	Proposed Ceilings 	on Credit Card
Interest 	Rates," 	Fed. 	Reserve 	Bull., 	Jan. 	1987, 	at 	1; 	Nathan,
"Economic 	Analysis 	of 	Usury 	Laws," 	10 	J. 	Bank Res. 	200 	(1980);
Ostas, 	"Effects 	of 	Usury Ceilings 	in 	the 	Mortgage Market," 	31 	J.
Fin. 	821 	(1976). 	~ ~ 	Barth, 	"The 	Effect 	of 	Government
Regulations 	on 	Personal 	Loan Markets: 	A Tobit 	Estimation of 	a
Microeconomic 	Model," 	37 	J. 	Fin. 	1233 	(1982).
Villegas, 	"An Analysis 	of 	the 	Impact 	of 	Interest 	Rate
Ceilings," 	37 	J. 	Fin. 	941 	(1982). 	A recent 	article 	concluded:
"[T]he 	analysis 	points 	to 	the 	likelihood 	that 	usury 	ceilings
divert 	funds 	away 	from 	high-risk 	borrowers 	in 	states 	with 	usury
ceilings 	to 	borrowers 	in other 	states 	or 	to 	other capital
markets." 	Villegas, 	"The 	Impact 	of 	Usury Ceilings 	on 	Consumer
Credit," 	supra 	note 	8, 	at 	140.
~ DeMuth, 	"The Case 	Against 	Credit 	Card 	Interest 	Rate
Regulation," 	3 	Yale 	J. 	on 	Regulation 	201 	(1986). 	Such banks 	will
then 	be 	able 	to 	charge 	Oklahoma 	consumers 	rates 	above 	the
interest 	rate 	ceiling 	in Oklahoma.
National 	Bank Act, 	12 	U.S.C. 	S 	85 	(1982); 	Marquette
Nat'l. 	Bank of 	Minneapolis 	v. 	First 	of 	Omaha 	Servo 	Corp., 	439
U.S. 	299, 	313-18 	(1978).

The 	Honorable Robert 	H. 	Henry 	Page 	4
12
The 	projected 	return 	on 	a 	loan 	depends 	on 	the 	likelihood 	of
timely 	repayment, 	among other 	things. 	Accordingly, 	bank 	lenders
often offer credit on different 	terms 	reflecting borrowers'
differing 	levels 	of 	creditworthiness. 	A borrower with
substantial 	assets 	(particularly 	in 	relation 	to 	outstanding
indebtedness) 	and a 	solid 	history of 	timely 	repayment 	of 	loans
often may borrow at 	a 	lower 	rate 	of 	interest 	than 	a 	consumer with
few 	assets 	or a 	marginal 	credit 	history. 	However, 	if 	interest
rate 	ceilings 	are 	established, 	they may 	inhibit 	the 	ability 	of
lenders 	to 	charge 	sufficient 	interest. 	-Thus, 	those 	consumers 	who
may 	be 	viewed 	as 	higher 	credit 	risks, 	often 	the 	young 	or 	those 	on
lower 	or 	fixed 	incomes, 	may be 	denied credit. 12
Credit 	card 	issuers 	and 	some 	other 	lenders, 	however, 	are
willing 	to 	extend credit 	to 	a 	general 	pool 	that 	includes 	higher
risk 	borrowers. 	They do 	so 	by 	offering credit 	on 	terms
reflecting 	the 	likelihood of 	timely 	repayment 	by pool 	members, 	on
average. 	However, 	if, 	as 	a 	result 	of 	interest 	rate 	ceilings,
such 	lenders 	are 	unable 	to 	charge 	sufficient 	interest 	to
compensate 	for 	this 	average 	risk, 	they may 	alter 	other 	terms 	of
the 	credit 	arrangement 	to 	cover 	their 	costs. 	Hence, 	credit 	card
issuers 	and 	other 	lenders 	may 	charge 	higher 	annual 	and 	service
fees, 	require 	larger minimum 	payments, 	increase 	collateral
requirements, 	shorten 	loan 	durations, 	reduce 	services, 	and 	the
like.
These distortions 	resulting 	from 	interest 	rate 	ceilings 	will
affect 	consumers 	unequally. 	For 	example, 	among 	credit 	card
users, 	only 	the 	"borrowers," 	the 	estimated 	53 	percent 	of
consumers 	who 	sometimes 	or 	usually 	do 	not 	payoff 	their 	account
balances 	in 	full 	every month, 	will 	enjoy 	the 	benefits 	of 	lower
finance 	charges 	on 	their outstanding balances. 13 "Convenience
users," 	the 	estimated 	47 	percent 	of 	all 	credit 	card 	users 	and 	76
percent 	of 	all 	elderly users 	who 	payoff 	their 	account 	balances
In 	a 	recent 	study, 	Villegas 	found 	that 	"low-income
households 	in 	states 	with 	usury ceilings 	had 	significantly 	lower
levels 	of 	consumer credit 	than 	low-income 	households 	in 	states
without 	usury 	ceilings." 	His 	study 	reached 	a 	similar conclusion
with 	respect 	to 	middle-income 	households, 	although 	the 	reduction
in 	credit was 	not 	so 	large 	as 	for 	low-income 	households.
Finally, 	he 	found 	that 	"usury ceilings 	have 	no 	significant 	impact
on 	the 	quantity of 	credit 	obtained by 	high-income 	households."
Villegas, 	"The 	impact 	of 	Usury Ceilings 	on Consumer Credit,"
supra 	note 	8, 	at 	140.
13 Canner 	& Fergus, 	supra 	note 	8, 	at 	6, 	Table 	3.

The 	Honorable 	Robert 	H. 	Henry 	Page 	5
in 	full 	every month 	and 	thereby 	avoid 	finance 	charges,14 	will
gain 	no 	benefit. 	In 	fact, 	the 	convenience 	users 	are 	likely 	to 	be
worse 	off 	if 	changes 	in 	other credit 	terms, 	such 	as 	higher 	annual
and 	service 	fees, 	are 	imposed.
Retail 	card 	issuers 	may 	also 	seek to 	offset 	reductions 	in
interest 	revenues 	by 	increasing merchandise 	prices 	to 	all
consumers, 	thus 	shifting some 	of 	the 	costs 	of 	credit 	transactions
to 	those 	who 	pay cash, 	including those 	unable 	to 	qualify 	for
credit. 	Similarly, 	bank card 	issuers 	may attempt 	to 	increase 	the
fees 	charged 	to 	merchants 	for 	processing bank card 	sales. 	This
may 	shift 	some 	of 	the 	costs 	of 	credit 	transactions 	to 	the
merchants 	themselves, 	who 	may, 	in 	turn, 	pass 	these 	costs 	to
consumers.
Finally, 	if 	unable 	to 	adjust 	interest 	charges 	to 	reflect 	the
average 	creditworthiness 	of 	pool 	members, 	credit 	card 	issuers,
like 	other types 	of 	lenders, 	may eliminate 	less 	creditworthy
borrowers 	from 	the 	pool 	altogether, 	in effect 	adjusting 	the 	pool,
and 	hence 	the 	risk 	of 	default, 	to 	reflect 	permitted 	interest
charges. IS 	This 	might 	reduce 	the 	credit 	available 	to 	less
wealthy 	individuals 	for 	the 	purchase 	of 	clothing, 	furniture, 	and
other 	basic 	items.
IV. 	Free Markets 	Efficiently Allocate 	Credit
In 	the 	absence 	of 	government 	restrictions, 	competition 	among
lenders 	will. result 	in a 	variety of 	credit 	offerings 	tending 	to
fulfill 	the 	credit 	requirements 	of 	different 	consumers. 	For
example, 	a 	consumer who 	frequently 	defers 	payment 	may 	select 	a
credit 	plan 	having 	relatively 	substantial 	initial 	costs 	but 	lower
interest 	charges. 	In contrast, 	a 	consumer who 	enjoys 	the
convenience 	of 	credit 	purchasing 	but 	seldom defers 	payment 	may
opt 	for 	a 	plan 	having 	lower 	initial 	costs 	but 	higher 	interest
charges. 	Unrestricted 	credit 	markets, 	unlike 	regulated 	credit
markets, 	can efficiently 	serve 	such divergent 	consumer 	interests.
A free 	market 	will 	provide 	these 	services 	without 	excessive
costs. 	Competition among 	lenders 	results 	in 	total 	costs 	to
consumers 	that 	generally 	reflect 	no 	more 	than 	creditors' 	costs,
14 .li1.
15 Villegas' 	empirical 	findings 	support 	this 	conclusion.
~ 	"The 	Impact 	of 	Usu:;"7 Ceilings 	on Consumer Credit," 	supra 	note
8 .

The 	Honorable 	Robert 	H. 	Henry 	Page 	6
including 	losses 	attributable 	to 	bad 	debt, 	and 	normal 	profits. 16
Firms 	that 	seek to 	earn higher 	than 	competitive profits 	will 	lose
business 	to 	other creditors.
Studies 	provide 	evidence 	that 	over 	time 	creditors 	have
earned 	no 	more 	than 	a 	competitive 	return on 	their 	invested
capital. 17 The 	annual 	net 	earnings 	(before 	taxes) 	of 	bank card
plans 	averaged only 	1.9 	percent 	of 	balances 	outstanding 	from 	1972
through 	1985. 	Over 	the 	same 	period, 	net 	returns 	on other major
types 	of 	commercial 	bank 	lending 	ave~aged 2.3 	percent 	on 	real
estate mortgages, 	2.4 	percent 	on consumer 	installment 	debt, 	and
2.8 	percent 	on commercial 	and 	other 	10ans. 18 Retail 	store 	credit
card 	plans 	stand 	on a 	somewhat 	different 	footing; 	studies 	show
that 	these 	have, 	on 	average, 	consistently operated 	at 	a 	loss,
apart 	from 	consideration 	of 	profit 	on 	goods 	sold. 19
To 	the 	extent 	that 	consumers 	bear 	higher charges 	for 	credit
card use 	than 	for 	some 	other 	forms 	of 	credit, 	this 	appears 	to
reflect 	the 	differing 	nature 	of 	credit card use. 	For 	example,
the 	higher 	cost 	of 	this 	credit 	reflects 	the 	pre approved 	and
unsecured 	availability of 	credit 	for 	purchases 	from 	a 	host 	of
merchants 	rather 	than 	greater 	returns 	to 	credit 	card 	issuers.
Although 	general 	interest 	rates 	have 	fallen 	substantially 	in
recent 	years, 	it 	is 	not 	surprising 	that 	credit 	card 	interest
rates 	have 	not 	fallen 	as 	fast 	as 	general 	interest 	rates. 	The
total 	costs 	of 	lending 	include 	the 	cost 	of 	money 	as 	well 	as 	other
costs, 	such 	as 	operating costs, 	overhead, 	and bad 	debt. 	These
other costs 	constitute a 	higher 	proportion of 	total 	costs 	for
credit 	card 	operations 	than 	for 	other major 	types 	of 	bank
lending. 20 	Thus, 	one 	would 	not 	necessarily expect 	credit 	card
,interest 	rates 	to 	go 	down 	as 	fast 	or 	as 	far 	as 	general 	interest
rates.
16 Canner 	& Fergus, 	supra 	note 	8, 	at 	1-2.
17
18
19
In 	other words, 	total 	costs 	to 	consumers 	have 	equalled
creditors' 	costs, 	including 	losses 	attributable 	to 	bad debt, 	and
normal 	profits.
Canner 	& Fergus, 	supra 	note 	8, 	at 	1-2 	(citing 	Federal
Reserve 	data).
~. 	at 	2 	(citing 	two 	national 	surveys 	of 	retailers
conducted on behalf 	of 	the 	National 	Retail 	Merchants 	Association
in 	1968 	and 	1985 	and 	a 	1973 	study of 	retailers 	in New 	York).
20 ~. 	at 	1-2.

The 	Honorable 	Robert H. 	Henry 	Page 	7
Competitive 	pressures 	appear 	now 	to 	have 	forced 	credit 	card
issuers 	and 	other 	lenders 	to 	offer credit on a 	variety of
attractive 	terms. 	For example, 	a 	1988 	survey of 	18 	financial
institutions 	found 	that 	bank credit 	card 	plans 	had 	fixed 	and
variable 	interest 	rates 	between 	10.9 	percent 	and 	16 	percent.
Moreover, 	the 	survey disclosed 	that 	the 	lower-rate 	credit 	card
plans 	offer variety 	in other 	important 	terms, 	such 	as 	annual 	fees
and 	grace 	periods. 	Annual 	fees 	ranged 	from 	no 	charge 	to 	$35.00,
and 	grace 	periods 	of 	differing 	lengths 	were 	offered by 	14 	of 	the
18 	institutions. 21 In addition, 	new 	sources 	of 	revolving 	credit
are 	rapidly 	developing, 	such 	as 	overdraft 	credit 	lines 	on
checking 	accounts 	and 	so-called 	"mall 	cards," 	which 	provide
credit 	at 	all 	retail 	outlets 	in a 	given 	shopping center. 	These
newer 	credit 	offerings, 	in 	turn, 	increase 	the 	pressure 	on
conventional 	lenders 	to 	compete 	for 	consumer 	allegiance 	on 	the
basis 	of 	price 	and 	other terms. 	Consumer credit 	markets
currently 	seem 	to 	be 	operating competitively, 	and 	there 	appears
to 	be 	no 	need 	for 	further 	interest 	rate 	regulation.
v. 	Conclusion
Government 	imposition 	of 	interest 	rate 	ceilings 	may 	injure
consumers 	by 	inflating other costs 	of 	credit 	and 	reducing 	the
amount 	of 	credit 	available. 	Consequently, 	the 	Oklahoma
Constitution Revision Commission's 	proposal 	to 	amend Article 	XIV,
§ 	2 	of 	the 	Oklahoma 	Constitution to 	eliminate 	the
constitutionally-mandated 	interest 	rate 	ceilings 	in 	Oklahoma
would 	be 	a 	good 	step toward 	removing 	regulations 	that 	harm
consumers.
We 	are 	pleased 	to 	have 	this 	opportunity 	to 	present 	our
views. 	Please 	do 	not 	hesitate 	to 	contact 	us 	if 	you 	have 	any
questions 	or would 	like 	further 	information.
Sincerely,
./
, I
,-/~-// 	. /7/_n.
~ /'2/1-'. I 	.•/(
/ 	Thomas 	B. 	Carter
Director
Dallas 	Regional 	Office
21 Consumer Action's 	National 	Credit Card 	Survey 	(1988).