Today (April 12, 2006) is the 25-year anniversary of Citibank’s move to South Dakota. Why should you care? Well, if you’re paying excessively high interest rates on your credit cards, you can thank South Dakota and its sweetheart deal with Citibank.
Believe it or not, 25 years ago Citibank was bleeding red ink all over the place. The problem, you see, was that they could only charge 12% interest in New York where they were headquartered. New York’s usury law prohibited interest rates in excess of 12%. This was at a time when the prime rate stood at a mind-boggling 20%. That was during the era of “stagflation” — high inflation coupled with stagnant economic growth. And Citibank, among other financial institutions, was getting crushed. Imagine being able to borrow money on your credit card at 12%, then turn around and deposit it in a money market account tied to the prime rate, thereby pocketing an automatic profit! Those days are long gone, but at the time things looked pretty grim for the major credit card banks.
In 1978, the Supreme Court ruled that a bank could “export” interest rates to states other than its own, without respect to the interest rate regulations for the destination state. Bill Jankow, then Governor of South Dakota, met with Citibank’s VP to discuss Citibank moving its credit card operation to Sioux Falls. In 1980, Jankow succeeded in getting legislation passed in South Dakota that eliminated that state’s existing usury law, thus effectively allowing unlimited interest rates. He also got another bill passed that allowed out-of-state banks to create subsidiaries in South Dakota. This allowed Citibank to charge any interest rate it felt the market would bear, without respect to New York usury laws or those of any other state.
The result of this sweetheart deal between South Dakota and Citibank is that states no longer have any control over interest rates charged by out-of-state banks. This has caused a lot of financial pain for consumers caught on the treadmill of endless minimum payments (that never seem to reduce the principal debt balance). Of course, excessively high interest rates are not paid by cardholders with perfect payment histories. As of today, the nationwide average for standard credit cards with variable rates stands at 13.99%. (Source: Bankrate.com) This may still be too high, but it’s not in the category of “outrageous.”
However, everything changes if you fall behind. Miss one or two payments due to financial difficulty, and rates can jump to 28%, 32%, or higher — even if you later catch up and get current again with your payments. And that’s because there is no effective ceiling on what credit card banks can charge. Once a customer starts to slip, the banks no longer have to worry about the customer switching to a competitor, so they can literally charge whatever they want to.
Just to put it in perspective, here’s the common definition of usury: “the lending of money at unconscionable or exorbitant rates of interest.”
Now, let’s take a look at a $10,000 credit card balance at 32% interest. If you pay $266.67 per month — a typical minimum payment level, it will take 40 years to pay off the debt, at a cost of more than $118,000 in interest! If that doesn’t meet the definition of usury, what does? Is it any wonder people have filed bankrupcy at record pace in recent years? Or that scams have flourished that falsely promise a way out of this trap?
Something is clearly wrong here, especially when one bank can raise your interest rate when you fall behind on payments with a completely different company. (That’s the infamous “universal default” clause we’ve heard so much about lately.) So where will it stop? The genie is out of the bottle, and we’re stuck with this situation on a permanent basis. Thank you, Supreme Court, South Dakota, and Citibank!