Things Jack Layton doesn't understand (a public service message)

For those of you who weren't paying attention or don't live in Canada, we are having an election in a little over a month after the government fell on a no confidence vote on the budget. Try as I may to be politically disengaged due to not being particularly compelled by any of the current stable of party leaders, occasionally a news item forces me to sit up and take notice. In this case, a campaign platform by Jack Layton, leader of the NDP, revealed an embarrassingly poor grasp of economics so while I encourage everyone to vote, I also encourage rational, policy-based decisions which it would appear are not part of his platform.

Things Jack Layton doesn't understand volume one: basic tenants of economics

In an effort to score some points from the populist vote, Jack Layton recently unveiled a way to combat the increasing debt load of Canadian families: legislate a cap on credit card rates of prime plus 5%. Currently, that would be an 8% maximum rate. Good idea?

No. Interest rates on a variety of products, from mortgages to lines of credit and credit cards are determined by a variety of factors, including among other things, whether the debt is secured (like it would be in the case of a mortgage by the property), what the borrowing history and credit score of the borrower is, and the propensity for fraud in the product. In the case of credit cards, which are unsecured, and have a significant loss to fraud, not to mention that the most credit worthy borrowers tend to be the ones that pay off their balances in full every month so that the banks don't make any money on them, the rates are based on the risk level and costs associated with providing credit cards along with a margin for profit. The average rate in Canada is generally in the neighborhood of 20%, in some cases higher or lower based on a number of factors.

If credit card rates were capped at 8%, a few things would happen in quick succession. Low credit borrowers would lose access to credit cards entirely, or have to pay a large annual fee for the privilege so that financial institutions could recoup costs and meet their required rates of return. A few high credit borrowers might still qualify, however very likely the rewards such as air miles and cash back that have typically encouraged people to get credit cards would be gone due to cost cuts. This would mean those who need credit most would lose access to credit cards and in some cases fall victim to payday lenders who charge even more interest that starts accumulating right away rather than after a 30 day grace period as in the case of credit cards. The very people the NDP wants to help would be harmed.

Rather than simply criticize I would like to offer Jack Layton an economically sensible alternative: develop legislation that encourages financial literacy in at risk groups and teaches about lower cost credit solutions that already exist, such as lines of credit, that often offer a lower rate than he was proposing for credit cards. Additionally, encourage stronger financial management skills that boost savings rates and lower reliance on borrowing to finance living costs. Until such rational platform changes occur, I will have no choice but to confront the crazy.