Stimulus Proposal: $10,000 In Credit Card Interest Relief During Coronavirus Pandemic

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The U.S. economy is continuing to roil from the coronavirus pandemic. While the official April unemployment rate of 14.7 percent marked the highest level since the Great Depression, it also understated the true economic devastation being inflicted across America. With Congress deadlocked on when to pass the next relief bill, let alone what provisions it should include, now is an opportune time to consider creative solutions to help Americans weather the extended Covid-19 crisis. One novel proposal by two law professors would provide government subsidies for consumer credit card interest payments.

The brainchild of Norman Silber, a senior research scholar at Yale Law School and professor at Hofstra University’s Maurice A. Deane School of Law, and Jeff Sovern, professor at St. John’s University School of Law, the proposal would have the federal government subsidize interest payments on consumer credit card charges while also capping interest rates and allowing consumers to fully defer minimum payments. These steps would help stem the impending credit crunch that has already started to hit many Americans and maintain an accessible lending mechanism readily available to 75 percent of Americans.

In order to fully appreciate the potential impact of Silber and Sovern’s proposal, it is crucial to contextualize it in the missteps of the CARES Act and the early warning signs emerging of financial institutions scaling back available credit to consumers.

CARES Act Did Not Provide Sufficient Relief

The CARES Act passed by Congress provided direct cash infusion to many Americans as well as additional financial support through enhanced unemployment benefits. While these measures could temporarily mitigate financial insecurity, the execution has hardly been smooth sailing. Plus, the impact of a one-time stimulus check is limited, and the financial struggle has only increased for many Americans.

While 130 million Americans have received stimulus checks, many more are still waiting for their payment or received checks for a lower amount than anticipated with little short-term recourse. State unemployment offices have been deluged with calls and millions have struggled to claim benefits. Meanwhile, the U.S. Secret Service recently uncovered an organized crime ring exploiting the pandemic and “committing large-scale fraud against multiple state unemployment insurance programs, with potential [state budget] losses in the hundreds of millions of dollars.”

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More glaringly, many who received funds are finding that a one-time stimulus check is not sufficient to get them through the crisis. A recent Bankrate survey found that 55% of respondents anticipated that economic impact payments would sustain them for less than three months. Another survey, conducted by SimplyWise in mid-April underscored the predicament many Americans are in; 63% responded that they would need another stimulus check within three months. “What the first set of congressional responses have shown is that we have a very poor foundation of a safety net for the middle class and below to build on,” said Michael Graetz, a professor at Columbia Law School and co-author of The Wolf at the Door: The Menace of Economic Insecurity and How to Fight It.

55% of Americans say a stimulus check would sustain them for less than three months

Bankrate

Coronavirus Crisis Is Squeezing Consumers

As the United States heads into the third month of the coronavirus crisis, consumers are being squeezed by compounding forces. Thirty percent have reported that their income has declined since the start of the pandemic.

Household debt has reached $14.3 trillion the first quarter of 2020

Federal Reserve Bank of New York

This decline in income coincides with a peak in overall household debt, which rose by 1.1 percent to $14.3 trillion during the first quarter of 2020, according to the latest Household Debt and Credit Report by the Federal Reserve Bank of New York. This is $1.6 trillion higher than the previous peak in 2008, but doesn’t fully account for coronvirus effects given that the data only goes through March 31. “It is critical to note that the latest report reflects a time when many of the economic effects of the Covid-19 pandemic were only starting to be felt," said Andrew Haughwout, a senior vice president at the New York Fed.

Simultaneously, overall consumer spending has declined precipitously as Americans increase their savings rate given uncertainty and as shelter-in-place restrictions have led to the cancellation of both one-off events and routine activities. This is a harbinger for the economy given that consumer spending drives growth and is to key not only to recovery in the short term, but also to balanced longer term growth.

Research by JP Morgan Chase Institute found that average weekly household credit card spending dropped by 40 percent year-over-year. “The magnitude of the spending drop is enormous; it is eight times larger than the spending drop typically observed among UI recipients in the first month after job loss,” according to JP Morgan’s findings.

The Credit Crunch Has Already Started

The Fed’s survey did show a decline in credit card debt in the first quarter of 2020; however, it is worth noting that credit card debt had peaked in the fourth quarter of 2019 at $930 billion, which was well above levels seen in 2008. In fact, credit card debt, like other forms of non-household debt, had been increasing even before the economic hit from Covid-19 as consumers, reassured by a strong economy and low unemployment, spent and borrowed aggressively.

While credit card debt declined in the first quarter of 2020, it had grown significantly and is ... [+] higher than 2008 levels.

Federal Reserve Bank of New York

Now, in the midst of the pandemic, many Americans are resorting to credit card debt to bridge income gaps. A recent survey by Creditcards.com found that 28 million have added to their balance as a direct result of coronavirus. “As so many people have lost their jobs, it's become a lot harder to make ends meet. And we see a lot of people turning to their credit cards as a result," said Ted Rossman, an industry analyst at creditcard.com in an interview with WSFA News. “I think it shows just how many people are using [their] cards to buy groceries and other necessities," he added.

Unfortunately, just as households particularly hard hit by the pandemic need access to credit, banks are cutting back on it. According to The Wall Street Journal, many financial institutions “are tightening lending requirements for new loans—including approving fewer consumers with low credit scores, asking for more income documentation and lowering spending limits on new credit cards.” A Lending Tree consumer survey found that 25 percent - or close to 50 million Americans - had their credit limit reduced or their account closed in the past 30 days. While the move makes financial sense for card issuers, who know that consumer delinquencies and defaults lag the unemployment rate, it comes at the most inopportune time for struggling Americans.

With uncertainty about whether a second round of stimulus checks will materialize or if the augmented federal unemployment benefits will be extended beyond July, credit cards could offer a vital lifeline to assist Americans in weathering the economic storm.

Credit Card Interest Relief During the Pandemic Act (CIRPA) Proposal

Sadly, the coronavirus pandemic isn’t the first catastrophe to fuel consumer credit challenges. In a paper, Thriving on Adversity: Disclosing Corporate Mistreatment of Consumers Caught in Hurricanes Katrina and Rita and Exploring the Consumer Movement's Response to Crisis and Catastrophe, which was published in the Loyola Consumer Law Review, Norman Silber, the proposal’s lead author, outlined the progressive obstacles that consumers faced in the wake of Hurricane Katrina: Americans let credit balances grow and could only afford to make minimum payments; high interest rates caused the amount owed to increase rapidly, which reduced the amount of available credit; credit scores started to drop, reducing credit lines and access to affordable borrowing; delinquencies and bankruptcies began to rise causing a strain on the national economy. “There were huge problems created as consumers, who were out of work and had extra expenses, all of a sudden couldn’t make installment payments,” Silber told me via phone. “Banks and credit card companies who were supposedly generous by postponing payments and interest, just deferred the problem and eventually starting charging consumers additional fees and getting tough with them.”

Applying the lessons learned from Katrina against the backdrop of the Covid-19 crisis, Silber and Sovern developed a proposal, called the “Credit Card Interest Relief During the Pandemic Act” or CIRPA, to allow consumers and small businesses financed through credit card borrowing to have the credit they need to get past this crisis.

Here are the basic tenets of CIRPA:

Allow banks to charge the government directly for 70 percent of interest charges on consumer credit cards; with the remaining 30 percent being charged to consumers, who could defer their portion until after the crisis is over;
Cap the interest rates on credit card charges that are being subsidized by the government;
Cap the benefit for each consumer at a certain amount - Silber and Sovern suggest $10,000;
Condition payment by the government on banks agreeing to defer monthly credit card payments due from consumer cardholders for the length of the coronavirus catastrophe and forgiving prior minimum payment defaults;
Provide for lenient consumer repayment terms thereafter; and
Prohibit lenders who participate in the program from increasing interest rates, reducing consumer borrowing limits, or raising interest rates after the pandemic is over on charges that were incurred during the crisis.

An Example To Bring CIRPA To Life

To bring the CIRPA proposal to life, assume Karen has a $6,000 balance on her credit card with a 25 percent nominal interest rate (the balance may sound high, but according to NerdWallet, the average household has revolving credit card debt has an estimated balance of $7,104 as of December 2019). When her statement comes, she would normally owe $125 in interest.

Under CIRPA, the nominal interest rate would be capped based on negotiations between the government and banks. Normally, credit cards are considered unsecured loans because there is no collateral if a consumer defaults (a mortgage is a good counterexample of a secured loan because if a consumer defaults, the bank can foreclose on the property). Unsecured loans, therefore, tend to have high interest rates; credit card interest rates range from 9 to 29 percent. However, given that with CIRPA the majority of the interest charge is backed by the government, the risk borne by the credit card companies is substantially lower and a lower interest rate would be justifiable.

Let’s assume that the negotiated interest rate cap is 12 percent under CIRPA. In this case, the interest charge on Karen’s credit card would be $60. The government would pay 70 percent, or $42. Karen would be responsible for the remaining 30 percent, or $18, which she could defer. Ordinarily, credit cards have a minimum payment of at least 1 percent of the balance, but CIRPA would allow Karen to defer this $60 minimum payment too.

After six months, assuming Karen had $500 in new purchases each month, CIRPA would mean that she could defer a total of $455 in minimum payments and would only owe $131 in interest charges rather than $929. The lower interest charges are a function of a lower interest rate, 12 percent, as well as the government interest subsidy of 70 percent.

Both Karen and the bank benefit from this arrangement. Karen has reduced interest obligations and can preserve cash flow without immediate bills while the bank reduces the likelihood of default and is receiving regular payments from the government in excess of minimum amounts due.

As Silber and Sovern told me, “The overall impact is to defer payments due from Karen during the crisis; to eliminate the bank’s ability or incentive to cut Karen’s credit line; to increase her borrowable amount; and to provide her with 70% off of her carrying charges for the debt she incurred during the crisis.”

Why CIRPA Would Help Millions Of Americans

There are four key dimensions to consider when evaluating CIRPA: speed, cost, security, and effectiveness.

Speed: CIRPA has the advantage of utilizing existing lending relationships between consumers and credit card issuers. Instead of waiting for direct deposits, prepaid cards, or paper checks, consumers who have credit card would have access to relief immediately. For the subset of Americans who do not have credit cards, CIRPA could mail them checks to cover benefits leaving them no worse off from a timing perspective than waiting for a stimulus check in the mail.

Cost: Last year American consumers spent approximately $122 billion in credit card interest. If CIRPA were implemented for six months, it would cost at most $61 billion; most likely substantially less as not all consumers would opt-in to the program. In comparison, the first round of stimulus checks sent to Americans will cost $293 billion, according to the Congressional Budget Office. Moreover, because the program would operate though existing lending channels, administrative costs would be relatively low. Some may balk at having the federal government subsidize banks and double digit interest rates; however, these need to weighed against the consumer benefits this subsidization would enable.

Security: The CARES Act stimulus program has led to an uptick in scams, with thieves using personal identifiable information to redirect stimulus checks into their own bank accounts. Moreover, the IRS Get My Payments portal has embarrassingly lax security that has allowed landlords to spy on tenants’ check status, for example. CIRPA would not provide the same opportunity for scammers to get cash and would be able to leverage existing Customer Identification Programs (CIP) that credit card issuers have.

Effectiveness: Given the high-interest rates on credit cards, CIRPA would help tremendously by reducing the compounding of interest charges, which quickly force consumers deeper into debt. It also “allows the resources of consumers to go further and reduces their anxiety and stress,” about paying for essentials, according to Silber and Sovern. CIRPA would empower consumers to determine how much of the government subsidy they need to utilize. Those who do not need the aid could simply pay off their entire balance while those who are already struggling could opt-in and revolve to temporarily cover expenses. The goal is to provide enough coverage to provide genuine relief to Americans in financial trouble while not encouraging consumers to run up unnecessary charges.

Having consumers responsible for 30 percent of the interest charges and making them responsible for the eventual repayment of the entire principal balance ensures they have skin in the game and prevents moral hazard. “Deductibles and copays work in every other context and there is no reason they will not work here,” Silber and Sovern argue. Perhaps most importantly, CIRPA allows “consumers to preserve their credit scores, keep their existing lines of credit, borrow at dramatically lower cost and on lenient credit terms.”

CIRPA would help to stabilize the secondary market for credit card debt by preventing consumer defaults, delinquencies, and collection costs. It would also facilitate consumer spending, which would help catalyze the economy and stem the precipitous decline highlighted in the JP Morgan Chase Institute findings.

Potential Objections to CIRPA

In interviews with several experts, the most common criticism of CIRPA was that it was a sub-optimal policy response compared to direct stimulus payments. “I’m going to show my libertarian streak and say it would be much better just to give families the money,” said Luke Shaefer, a professor at the University of Michigan. Others were worried about the eventual reckoning when CIRPA ends and consumers are faced with repaying their bill, unlike a stimulus check which has no repayment.

These points are valid, but also confound a standalone program with one that could complement existing initiatives, like stimulus checks. CIRPA “is not a substitute for relief checks,” Silber and Sovern acknowledged. “We think its critical that relief checks keep flowing.” Instead, CIRPA could amplify relief for consumers for whom direct payments are not sufficient.

A similar line of argument was raised by Michael Graetz, the Columbia Law professor, who made a comparison to the home mortgage crisis during the financial meltdown of 2008. “When you look carefully at the efforts of federal government to address the crisis, one thing that became clear is that the reduction in interest rates, which was the primary government tool, didn’t stop foreclosures, it only helped a little,” he told me. “The only thing that helped was a reduction in principal to the market value of the house.”

However, as Gaetz points out, the notion of a homeowner bailout was political dynamite. It led to Rick Santelli’s infamous rant on the floor of the Chicago Mercantile exchange, which has been credited with spawning the Tea Party Movement. “Paying down principal was very bad politics, but it would have been better policy than paying down interest,” Graetz said. While CIRPA doesn’t pay down the principal balance on consumer’s cards, the capped interest rate and government interest subsidy go further than a simple reduction in interest rate, which should make the proposal more effective.

It is important not to overlook Graetz’s underlying point about the need to balance policy goals with political feasibility. Even if CIRPA isn’t the optimal policy response, it would be more political palatable than other proposals currently being discussed, like a recurring $2,000 monthly check, which couldn’t even make it into the Democratic HEROES Act messaging bill or the devil’s bargain proposed by right-leaning scholars to offer a stimulus check loan in exchange for delayed Social Security benefits. “We have one set of legislators who are very focused on helping individuals and another focused on helping businesses,” Sovern noted. “CIRPA helps both groups” and should be amenable on both sides of the political aisle.

Bundling CIRPA with some form of additional stimulus payment as well as other interventions may be the best compromise solution to stem the financial struggle millions of Americans are experiencing. With top policymakers, including Federal Reserve Chair Jerome Powell, warning that the economy is likely to weaken before it starts to turnaround, acting soon is imperative. As Silber and Sovern conclude, “if getting money to consumers effectively is the goal, allowing consumers to use the credit cards they already have is the best way to do it.”