In 1978 the United States Supreme Court fired the shot heard ‘round the consumer finance world. In a now overlooked case involving a dispute between a bank in Nebraska and one in Minnesota, the Supreme Court ruled that for a credit card agreement between an individual living (or traveling) in one state and a bank located in the other, the interest rates terms of the contract would be governed by the law of the state in which the bank is located, not the consumer.
The effect of the Supreme Court’s ruling (known since as the Marquette case) was to allow consumers residing in states with low ceilings on permissible interest rates, such as Minnesota, to obtain credit cards from national banks located in states with higher interest rate ceilings, such as Nebraska.
The Court’s unanimous decision (written by liberal lion William Brennan) has transformed the financial lives of American families and the economy. By allowing interest rates to be set by market competition and consumer choice rather than political mandates, general purpose credit cards—once a privilege of the rich—now became available to almost everyone. Annual fees, which had been imposed by card issuers to make up for their inability to charge a market interest rate, quickly disappeared.
But while a boon for consumers, the Court’s decision created a dilemma for banks. The United States is unique in the world for its “dual banking” system, in which states issue charters for banks and credit unions, not just the federal government. In fact, 79% of U.S. banks hold state, not national charters, including the overwhelming number of community banks that serve small towns and rural areas across the country.
The problem was that the Supreme Court’s decision applied only to national banks but not state banks. State-chartered banks quickly realized that this created a huge competitive disadvantage that eventually would destroy the dual banking system. The problem became especially acute during the late 1970s and early 1980s when inflation soared into the high double-digits thereby crashing against interest rate ceilings (known as “usury” laws) in many states.
Congress responded quickly by enacting the Depository Institutions Deregulation and Monetary Control Act of 1980 (known as “DIDA” or “DIDMCA”). The law’s intent was simple and clear—to provide “parity” for state banks to compete with national banks to contract under the same rules as national banks, thereby state-chartered banks could “export” the interest rates of their states on the same terms as national banks. DIDA also extended to state banks another privilege previously reserved to national banks—the right to even exceed a state’s applicable usury ceilings by charging the prime rate plus 1%. But Congress also left an exception—states could “opt-out” of the DIDA parity regime.
For decades, few states opted-out under DIDA. Two years ago, however, Colorado exercised that power and just recently Oregon followed suit. The Colorado case is currently pending before a rare en banc review panel by the 10th Circuit Court of Appeals (along with the Center for Individual Freedom I submitted an amicus brief in the case). But exercising this long-dormant clause in the law has raised a pressing issue—what does it mean for a state to “opt-out” of DIDA?
Colorado believes it can prohibit consumers located in their state from accessing products offered by state-chartered banks in other states. But that has it backward. By opting-out, Colorado denies its state-chartered banks the privilege of exceeding state usury laws under the “prime rate plus 1%” clause that was important in the high-inflation 1970s. But nothing about the law or history even hints at giving Colorado the power to disadvantage state banks relative to national banks located in other states.
A panel of the 10th Circuit previously backed Colorado’s theory by holding that a loan somehow is “made” in both the consumer’s and the lender’s “location” simultaneously. But as the Supreme Court noted in Marquette, expanding the location of where a loan is “made” to multiple locations is unworkable—if an issuing bank is located in Delaware, a student resides in Texas, has a summer job in New Mexico where she applies for a credit card, uses the card to buy gasoline in Oklahoma, and then attends college in Colorado, is the loan “made” in all of those states? If the card’s interest rate is legal in Texas and Oklahoma but not in Colorado, does the card only work in some states but not others?
For the Supreme Court the answer was easy—it has always been understood that if a Minnesota consumer traveled to Nebraska to open a credit card account, the loan would be “made” in the bank’s location. Problem solved. In fact, today consumers residing in state’s with very low usury ceilings still routinely cross state lines to obtain credit products available in neighboring states. Entering into the same contract by mail or, today, via the internet doesn’t change that.
Moreover, if Colorado’s interpretation stands, it could prove the death knell for the dual banking system, which is why Congress enacted DIDA in the first place. Many fintech companies are also partnered with state-chartered banks and credit unions, providing a needed lifeline of personal loans that aren’t otherwise available. Many store-brand private label credit cards are issued by state banks who are willing to underwrite many consumers with weaker or unproven credit that massive card issuing behemoths won’t touch. The most vibrant and successful state banks could all simply convert to national charters.
When consumers cannot access desired products through the banking system they turn to non-bank lenders instead. It is well-established that usury ceilings invariably hurt those who they are intended to help by restricting access to credit. Recent research even demonstrates that usury ceilings have a regressive effect—not only do they reduce access to credit for higher-risk borrowers they actually increase credit availability for lower-risk borrowers. Even before this most recent step, economists found that Coloradans already had less access to credit than consumers elsewhere. If Colorado prevails in the 10th Circuit, this shortage will be exacerbated.
This dismal result for Colorado’s consumers is neither necessary nor mandated by DIDA. The 10th Circuit’s en banc opinion will be a bellweather for future cases to come. It should act decisively to clean this up.
