Should We Cap Interest Rates?

A new article in Harper's Magazine (subscriber only, but here is an interview where he gives the main points) by Thomas Geoghegan offers an interesting solution to the problem of financial collapse: cap interest rates.

His argument is provocative: by deregulating interest rates, we encouraged the massive growth of the financial sector, for the simple reason that capital can obtain much higher rates of return through lending consumers money at high interest rates than it can get in, say, manufacturing. Securitization separated the lender from the owner of the debt, which created an incentive for lenders to engage in misleading practices and really sell the idea of debt to consumers. The average working family got killed by higher and higher interest rates.

He's right about so much of this that I find it frustrating that he arrives at the conclusion of capping interest rates.

Yes, the growth of the financial sector was because of higher profit rates; yes, securitization separates lender from owner of debt, creating some bad incentives; and yes, the average household is getting killed by high interest rates. But to cap interest rates would simply mean that much of the lending to consumers would simply dry up or be driven underground at much higher interest rates. (The classic deal with a loan shark is "a point a week", or 52% yearly interest.)

High adjustable-rate interest is simply the market's response to inflation. Eliminate the inflation, and you will eliminate high interest rates. Indeed, the sooner the market correctly prices the asset-backed securities that are based on debt, the better, because that will be the day when this scheme is finally buried once and for all.

To get the government involved in this process would be a mistake. Government-based pricing does not tend to produce good outcomes, it tends to produce shortages and surpluses.