Whether its restricting credit card late fees, overdraft fees, or nonsufficient fund (NSF) fees, the principles remain the same: price controls lead to shortages.
Subcommittee on Financial Institutions and Monetary Policy
Chair Barr, Ranking Member Foster, and members of the Subcommittee, thank you for the opportunity to testify at today’s hearing. My name is Nicholas Anthony and I am a policy analyst at the Cato Institute’s Center for Monetary and Financial Alternatives. The views I express in this testimony are my own and should not be construed as representing any official position of the Cato Institute.
Whether it’s when we are turning in a library book that fell behind the couch or paying off a credit card balance after hitting a rough patch, paying fees is never fun. But that alone is not enough to justify the government implementing price controls throughout the economy.
Credit Card Late Fees, Overdraft Fees, and NSF Fees
Over the last 13 months, the Consumer Financial Protection Bureau (CFPB) has proposed price controls for credit card late fees, overdraft fees, and nonsufficient fund (NSF) fees.1 These proposals have been central to President Joe Biden’s reelection campaign as part of his “war on junk fees”—or, more accurately, his war on prices.2 That is why today’s conversation centers on how using financial regulation for political gains can negatively impact consumer credit and community development.
Yet, today’s conversation is not a novel one. It has long been understood that price controls lead to negative, albeit unintended, consequences. For example, Paul A. Samuelson—the first American to win the Nobel Prize in Economics—warned Congress in 1969 that setting price controls on interest rates (e.g., interest rate caps) would “result in drying up legitimate funds to the poor who need it most and will send them into the hands of the illegal loan sharks.”3 Thanks to Samuelson and many others, it is now commonly understood that price controls are a bad policy tool. And its because of that understanding that the CFPB’s proposals have been met with a chorus of objections from economists, industry groups, the private sector, members of Congress, and others.4
Still, the CFPB remains committed to restricting these services in what will likely secure short term political gains at the long-term expense of both the financially vulnerable and well-off.
Principles Matter
Whether its restricting credit card late fees, overdraft fees, or nonsufficient fund (NSF) fees, the principles remain the same. First, price controls set below the market clearing price will result in shortages. In other words, price controls reduce access to services because they reduce the incentive to supply those services. Second, statements that prices should equal costs are detached from economic reality. I will explain each consideration in turn.
The Economics of Price Controls
If the CFPB’s price controls are enacted, there is no denying that they will initially result in lower fees for consumers. The problem lies in what happens next as the price controls result in either shortages or higher costs elsewhere.
Consider a simple illustration of supply and demand (Figure 1). In a free market (Option A), the appropriate price (P*) can be determined at the intersection of the two lines. Introducing a binding price control (PPC) to this scenario would be to set the maximum price below what would clear the market (Option B). The lower price results in a greater quantity demanded (QD) from consumers, but it also results in a lower quantity supplied (QS) from businesses. In other words, the price control results in a shortage (QD > QS).
In practice, that means people will lose access to the service entirely as it becomes no longer economically viable for businesses to offer them. Yet, that’s not the only consequence. Price controls could also result in businesses increasing fees for other services as they attempt to recoup losses. So, options like free or low‐cost checking accounts, travel rewards, and the like could become a thing of the past.
Many providers have already warned the CFPB of this reality. In a comment letter responding to the CFPB’s proposal to restrict credit card late fees, Securityplus Federal Credit Union wrote:
As a small credit union, this proposal will impose a disproportionate burden and require us to raise other fees for all members, reduce dividends, consider eliminating our credit card products altogether, or even explore a merger with a larger institution that is better able to forgo fee revenue and shoulder compliance costs.5 (Emphasis added)
In another letter to the CFPB, MC Federal Credit Union wrote:
Scale is another element the CFPB needs to understand. We offer a credit card program to 2,654 members. The costs to provide this product are not leveraged by the numbers. So understand that your proposed action will have consequences you may not have intended but will become reality. What would those consequences look like? We could suspend [or] terminate the privilege to use the card forcing them to go to a higher cost (interest rate) option. We could tighten our approvals and force low income or underserved communities to other costly and unregulated options. We could decide to get out of the card business altogether. Who will win then?6 (Emphasis Added)
Who will win if consumers only have limited access to financial services? Who will win if consumers are fully priced out of the market? Who will win if consumers are denied accounts because financial service providers do not have the tools to mitigate risks? It won’t be consumers.
The Nature of Costs
The second factor to consider is the idea that fees should equal costs. This idea is fundamentally misplaced. Proponents of price controls have referred to various fees as “disproportionate,” “excessive,” or “exploitative” as reasons for restricting prices.7 Yet prices exceeding costs in a competitive market are a sign that businesses have created value for society. In contrast, prices at or below cost in a competitive market are a sign that a business is wasting resources that could be used elsewhere.
Unfortunately, however, this misunderstanding is embedded deeply within existing policies. For example, the CFPB has based its proposal to restrict credit card late fees on the requirements in Regulation Z.8 In short, the regulation states that credit card fees must only be used to recoup costs:
A card issuer may impose a fee for violating the terms or other requirements of an account if the card issuer has determined that the dollar amount of the fee represents a reasonable proportion of the total costs incurred by the card issuer as a result of that type of violation. A card issuer must reevaluate this determination at least once every twelve months.9 (Emphasis Added)
This language overlooks that fees are fundamentally a price of a service and that prices do not serve to solely recoup costs.10 Rather, costs only set the minimum level for whether a product is economically viable to offer. Prices, however, can reflect much more. For example, the language in Regulation Z seems to overlook that fees can include a punitive element to deter bad actions. Prohibiting credit card issuers from deterring bad behavior exposes them to greater risk and strips them of the tools to mitigate that risk—seemingly running counter to other regulators attempting to promote stability in financial services.11
Yet, making matters worse, it seems the CFPB’s proposal to restrict credit card late fees does not even seek to allow providers to recoup costs. In addition to restricting prices at a fraction of their current level, the CFPB also called for eliminating the inflation adjustments to these thresholds. How the CFPB squares this issue is far from clear. It’s almost as if the CFPB is denying that inflation increases the cost of doing business. Furthermore, from a more general perspective, if inflation is defined as an increase in the general level of prices and fees are prices, then it stands to reason that fees should be able to increase just the same.
Instead, it seems that the CFPB is attempting to use the absence of an inflation adjustment to effectively ban fees over the long term. At a rate of 5 percent (i.e., the rate when the proposal was made), the $8.00 price ceiling proposed by the CFPB will be nearly cut in half in real terms in just ten years (Figure 2). Even a more modest rate of inflation at 2% would lead to around a quarter reduction during that time.
Fees in Context
In addition to understanding some of the fundamental problems with this “War on Prices,” it is also important to understand what a fee is in context and what these services provide.
When explaining why the CFPB was going after credit card late fees, CFPB Director Rohit Chopra said, “Markets work best when companies compete on price and service, rather than relying on back‐end fees that obscure the true cost.”12 Director Chopra is partly correct, but this statement is ultimately misleading insofar as it suggests fees are not a price for a service.
Financial institutions are providing a service when they allow customers to overdraft accounts or go without paying their bills on time. Furthermore, these fees allow financial institutions and customers to settle differences without having to end relationships or involve the police. For example, to go without paying a credit card bill is to break a previous agreement to pay on time. A late fee effectively is a way to pay for the service of extending the billing without notice and make amends for violating the contract.
This concept should not be shocking. From the Internal Revenue Service (IRS) to the United States Postal Service (USPS), the government regularly charges people late fees for similar purposes (Table 1).
Still, some proponents of price controls object that fees are an unfair source of revenue. It is important to consider this question from both a historical perspective and consumer perspective.
First, consider the historical perspective. Now is a strange time to target overdraft fee revenue given that it has been steadily dropping for years. For example, researchers at Curinos found that overdraft fee revenue fell by 68 percent between 2008 and 2023 (Figure 3).13 Likewise, researchers at Bankrate found that overdraft fees fell by 11 percent between 2022 and 2023.14 In fact, even the CFPB has recognized this trend. In a May 2023 report, the CFPB found that revenue from overdraft and nonsufficient fund fees “for the fourth quarter of 2022 alone was approximately $1.5 billion lower than in the fourth quarter of 2019.”15
Reflecting on these trends, Michelle Clark Neely of the Federal Reserve Bank of St. Louis wrote, “Competition—from other banks and nonbank providers such as fintech firms—arguably has affected overdraft practices more than anything else.”16 For example, many banks have changed their overdraft practices extensively to either eliminate or reduce fees (Table 2). Furthermore, the increasing availability of mobile banking has made these cheaper options more accessible than ever. So these proposed restrictions seem to be unwarranted, to say the least.
Second, there is the consumer perspective to be considered. The issue can be distilled by focusing on who is affected and why they use these services.
Past surveys have found that it is generally uncommon for households to incur overdraft or nonsufficient fund fees. For example, the Financial Health Network reported that only 17 percent of households incurred overdraft or nonsufficient fund fees in 2022.17 However, the Financial Health Network also found that it is more common for households earning $30,000 or less to incur overdrafts than more financially secure households.18 This finding should make sense intuitively given that an overdraft results from spending beyond one’s means. In other words, it occurs when someone runs out of money.
Core consumers of overdrafts appear to be even more uncommon. In 2017, the CFPB reported that only 9 percent of people had more than 10 overdrafts in a year.19 In 2023, the Financial Health Network reported that only 1.53 percent of people had more than 10 overdrafts in a year.20 So for most people, overdrafts appear to be a rare occurrence.
With this insight into who incurs these fees, we can now look deeper into why they do so.
When asked how these fees came up, respondents often told the Financial Health Network that they incurred the fees by mistake (i.e., due to a miscalculation or lack of attention).21 However, of those that overdraft frequently, 35 percent said they did so intentionally.22 A survey by Curinos adds additional insight where 81 percent of “frequent overdraft users indicated that they would have preferred to incur a fee on their most recent overdraft transaction rather than have the purchase or payment declined.”23
Taken together, these results suggest that very few people are incurring these fees. Those that do are primarily concentrated in lower-income households and many of which recognize the fees, but value the service that incurring them provides. Coupled with an ever-improving marketplace, it is unclear what justifies having the government come in to restrict the market.
Recommendations
It’s a free and open marketplace that makes products and services more affordable, not ever‐tightening restrictions. To that end, here are three steps Congress should take to create a free market that benefits everyone.24
First, the Bank Secrecy Act should be reformed. While it may sound outside the present conversation, the Bank Secrecy Act adds additional costs every time a financial account is opened and every time a customer makes a transaction. In 2022, it was estimated that U.S. financial institutions spent $46 billion in compliance.25 Those are costs that get passed on to consumers and raise the barrier to entry for competitors. An immediate starting point would be to adjust the currency transaction report (CTR) threshold for inflation.26 Originally set at $10,000 in 1972, the threshold should now be over $75,000. Every year this threshold is not adjusted, the number of reports and the associated compliance costs increase.
Second, barriers to competition within financial services should be removed, not erected. Restricting the prices providers may charge makes it harder for new competition to enter the market and for smaller competitors to stay in the market. To that end, Congress should review the barriers financial institutions must contend with to do business. In addition to the Bank Secrecy Act mentioned above, financial institutions must contend with the maze of money transmitter licenses, the opaque process for obtaining a master account at the Federal Reserve, the challenges of serving industries that hold different state and federal statuses (e.g., the cannabis industry), and much more.
Third, the CFPB should be required to explain how it squares its goal of creating a more inclusive financial services environment with its own admission that its proposals would price consumers out of the market. For example, Rodgin Cohen, Stephen Meyer, and Jennifer Sutton pointed out the issue when stating, “The CFPB’s conclusion that subprime consumers are not harmed when they are effectively priced out of the credit market seems inconsistent with the CFPB’s efforts to expand access to credit to underserved segments of the population.”27 At a minimum, the CFPB should be required to explain its seemingly conflicting stance before pushing forward with its proposals.
Conclusion
The idea of bringing down prices when inflation is still on everyone’s mind is likely to play well in headlines for President Biden’s re‐election campaign. However, this initiative will do nothing to help people if these services are regulated out of existence.
Whether it’s restricting credit card late fees, overdraft fees, NSF fees, or any other fee, the CFPB’s price controls are likely to succeed in only one thing: limiting the supply of financial services. If these proposals are enacted, the sudden price change may score political points in the short term, but consumers will suffer from the absence of services in the long term.
Thank you for the opportunity to provide this information, and I welcome any questions that you may have.
