Prices and signals

I’m sure most of my readers don’t need this explained to them, but obviously some legislators do.

Price is a signal.

And some people don’t seem to realize that interest rates are a price too - the price of credit. They aren’t an arbitrary number picked out of the sky, they reflect the risk calculations of the lender.

Someone with good credit and a 40% downpayment can get a very low mortgage rate. Because that loan is very low risk for the lender. The borrower has skin in the game, and moreover the house is an asset that can be repossessed if the borrower defaults.

Credit cards, on the other hand, are the riskiest bet for any lender. Completely unsecured. If you run up $60,000 on a Visa card and skip the country, there’s not much they can do. And you may be surprised to learn just how many people default on credit card debts! So credit card interest rates are high.

That’s how it works. Low risk loans, low interest. High risk loans, high interest.

But some people struggle with this.

This proposal is insane - and most of the people cheering it on won’t benefit from it.

Government interventions, like restricting credit card firms to only charging 10% interest does not mean “lower credit card bills for everyone”. It means a lot more people not getting credit cards at all. People who are too much of a risk will just be denied (And those who still qualify for cards, will get hit with other charges instead, as a way of recouping losses). If you think credit card companies are sharp operators - you’d be right. They can figure out an angle, but it won’t be one you like.

We saw the result of such attempts to override market price signals in the tragic California fires. Legislators had tried to cap what insurance companies could charge for coverage. But again - price is a signal. The pooled risk for houses in a fire zone is extremely high! Unlike other house insurance issues, like burglarly, wildfire is a correlated risk (this means it won’t just affect one property, it will affect dozens or hundreds, at the same time). So coverage prices reflected that. When laws were passed trying to cap the prices, insurance companies didn’t say “ok, here’s your lower policy premium”, they said “hell no”. They could not afford to offer policies at a price that did not reflect the true risk. Some just stopped offering policies in California all together. Which hurts those consumers who would have been willing to pay a market rate, but can’t find a provider.