The Rate Your State Can't Touch

It's Monday, April sixth, and welcome to HigherIQ. If you have a credit card, you're probably paying somewhere between twenty and twenty eight percent interest on any balance you carry. If you've ever wondered why that number is so high, or why your state's consumer protection laws don't seem to apply, the answer involves a 1978 Supreme Court case that almost nobody noticed, a governor in South Dakota who saw an opportunity, and a race to the bottom that gutted usury protections in forty four states within five years. For most of American history, states set limits on how much interest a lender could charge. These were called usury laws, and they go back centuries. The theological roots run deep: Thomas Aquinas argued in the thirteenth century that charging interest on money was like selling the same thing twice. State legislatures inherited that instinct. Through the mid-twentieth century, most states capped credit card interest rates somewhere between nine and twelve percent. The system worked because inflation was low and banks were local. Your bank operated under your state's rules. Then two things happened at the same time. In the late 1970s, inflation spiked. The Federal Reserve pushed interest rates above fifteen percent. Banks that were lending credit card money at twelve percent were losing money on every dollar they lent. The business model was broken. Citibank, which was based in New York where the usury cap was set at twelve percent, was hemorrhaging cash on its credit card portfolio. The bank needed relief, and New York's legislature wouldn't budge. The second thing was a Supreme Court case. In 1978, a small bank in Minneapolis called Marquette National sued the First National Bank of Omaha for marketing credit cards to Minnesota residents at Nebraska's higher interest rate. Minnesota capped rates at twelve percent. Nebraska allowed eighteen. Marquette argued that Omaha's bank was violating Minnesota law. The Supreme Court disagreed, unanimously. Justice Brennan wrote that under the National Banking Act of 1863, a nationally chartered bank is governed by the laws of the state where it's located, not the state where its customers live. A bank in Nebraska could charge Nebraska rates to customers in Minnesota, and Minnesota couldn't do anything about it. Justice Thurgood Marshall, during oral arguments, cut to the heart of it. He asked Marquette's lawyer: your customers can get a card at twelve percent from you, and the Omaha bank is offering cards and signing up your customers? The lawyer agreed. Marshall's conclusion: "You don't have a legal problem. You have a marketing problem." The case attracted almost no public attention. Elizabeth Warren, years before she became a senator, later called it "the single biggest policy change in the whole consumer credit area, through an obscure Supreme Court decision interpreting some ambiguous language." Chicago labor lawyer Thomas Geoghegan went further, calling it, in terms of changing American lives, "the biggest case of our lifetimes." The implications took two years to become clear. In early 1980, South Dakota's governor, Bill Janklow, was dealing with a struggling agricultural economy and looking for ways to diversify. South Dakota's own bankers, frustrated by inflation eating their loan margins, had already pushed the state legislature to eliminate its usury cap in January 1980. The bill passed by a wide margin. Weeks later, a Citibank executive named Charlie Long flew to Pierre, South Dakota, to meet with Janklow. Long had never been to South Dakota. He didn't know anyone there. He didn't even know about the usury repeal. He was there because Citibank needed to move its credit card operations out of New York, and it needed a state legislature to formally invite the bank in. Janklow immediately saw the opportunity. On the last day of the legislative session, at the governor's urging, a bill inviting Citibank to establish a subsidiary in South Dakota was introduced, passed, and signed into law. The whole thing happened in a matter of days. In June 1981, Citibank opened its credit card operations in Sioux Falls. The bank could now charge whatever interest rate the market would bear and export that rate to every cardholder in America, regardless of what their home state's laws said. Citibank's CEO, Walter Wriston, and Governor Janklow celebrated "Citibank Day" in Sioux Falls. Twenty five years later, Citibank's next CEO came back for the anniversary and said, with what one historian described as reverent awe: "Think of that. Saved Citibank." Delaware passed virtually identical legislation within a year. Then the dominoes fell. States realized that if they didn't drop their usury caps, they'd lose banking jobs to the states that had. By 1983, forty four states had either loosened or eliminated their usury laws entirely. The race wasn't to protect consumers. It was to attract employers. Sioux Falls alone now employs roughly twelve thousand people in credit card and financial services operations. The state's economic development plan worked. The cost was borne by every American carrying a balance. Before Marquette, thirty eight percent of American households had a credit card. The decision and the deregulation that followed made credit dramatically more available, which was genuinely beneficial for millions of people who had previously been shut out. But the tradeoff was that the price of credit was now set by the state with the loosest rules, not the state where the borrower lived. The average credit card APR today is above twenty two percent. If you carry a ten thousand dollar balance at that rate and make minimum payments, you'll pay more in interest than the original balance before you're done. And if you fall behind, default rates can spike to twenty eight, thirty two percent, or higher, because there is no effective ceiling. Brennan acknowledged, in the final paragraph of his opinion, that the ruling would make it difficult for states to enforce their usury laws. But he said the fix was Congress's job, not the Court's. That was in 1978. Congress has never acted. So if this comes up in conversation, here's how to think about it. In 1978, the Supreme Court ruled that a bank can charge the interest rate of the state where it's headquartered, not the state where you live. South Dakota eliminated its interest rate cap in 1980 and invited Citibank to move there. Delaware followed. Forty four states dropped their usury laws within three years, not to protect consumers, but to compete for banking jobs. The credit card in your wallet almost certainly routes through South Dakota or Delaware. Your state's consumer protection laws don't apply to it. The Court said Congress should fix this. That was forty eight years ago. Stay informed, stay curious, and we'll see you tomorrow.