The US Has An Alarming Consumer Debt Problem

In the US, total consumer loans from commercial banks is more than a trillion dollars, mostly in the form of credit card debt. Over 80% of Americans have at least one credit card, and on average has a balance of more than $6,000 outstanding. What you might not know is that the proliferation of credit card debt in the US can largely be traced back to a single law change in 1978. A Supreme Court case, Marquette National Bank vs First of Omaha Service Corp, whose decision radically reshaped how Americans spend money. That ruling is responsible for banks dramatically increasing the interest rates they charge, the aggressive marketing tactics used to lure you in, and a slew of other side effects. With the flick of a switch, credit cards became a huge business. The measly $4 billion industry of the 70s has grown more than 300 times in size in just 50 years. But it's not just that banks lent more money to people and charged them higher fees. The decision fundamentally shifted the relationship we have with personal debt, without us even realising it was happening. So let me take you down the rabbit hole I fell into this week, to explore how the credit card industry turned into a trillion dollar nightmare. Credit card debt continues to reach record highs. One trillion dollars. Collectively, Americans owe more on credit cards than ever before. There are many households that are using credit cards as an extension of their income. A lot of people are close to the edge. These deep dive videos are not possible without our fantastic channel sponsors, today of which is MyHeritage. They're the number one global service for family history research, and I decided to partner with them because I love exploring history, but I realised I knew very little about my own family origins. They have over 20 billion historical records that you can easily search through to learn more about your relatives from earlier generations. But MyHeritage will also look for matches for you once you start adding some people to your family tree. It's really easy to manually add family members, and they also have some great features for making this process even easier. They have a feature called Smart Matches, where they'll connect your tree to other family trees on the site, and Instant Discoveries feature allows you to add entire branches of up to 50 people with a single click. This is a photo of my great-great-grandfather taken in the late 1800s that I found through their Discoveries feature. They even have some great AI tools for repairing and enhancing old photos. Join their 90 million users and discover your family origins with a 14-day free trial, the link is also down in the description below. 1978 was a critical turning point for the credit card disaster we see today, but they've been around for much longer than that. The concept of the credit card has origins dating back to the 1910s, where you had companies like Western Union issuing metal charge plates to their most credit-worthy customers. Western Union called the product Metal Money, and it gave a limited number of their top customers the ability to defer payments on purchases they made. We take this for granted 100 years later, but at the time it was a very novel idea. In fact, it wasn't until the 1950s that the modern credit card was introduced. The Diners Club card was one of the first. Customers could use the card to spend money, and then pay the balance at the end of the month. It started with just 200 cardholders with access to 27 restaurants in New York, but within a year the Diners Club card had about 42,000 customers. The next big leap came in 1958, with American Express issuing the first plastic credit card. It was cheaper and easier to make, and far more durable than what was available at the time. Also in 1958, Bank of America issued its first plastic card in California, Bank AmeriCard, which was the first revolving credit card. Revolving credit meaning customers could carry a balance into the next month, and simply pay interest on what they owed. By 1959, California had over 2 million credit cards, and was accepted by 20,000 merchants. If you're wondering why the colours of the card look so familiar, Bank AmeriCard would later become Visa, today's largest payment processing corporation. The second largest payments company, MasterCard, introduced their MasterCharge card in 1966 to compete with Bank of America. Despite making considerable innovations in the consumer debt market, credit cards were still very niche. Just 16% of American households had a revolving credit card in 1970, and total credit card debt was just $4 billion. The problem for banks issuing these cards was that most of them operated under very strict state banking regulations. The biggest limiting factor was interest rates. Many states had tight caps on the rates banks could charge, which stopped them from offering credit cards to people with poor credit quality. For a bank to be able to extend credit to someone with a higher chance of missing payments, they need to be able to charge a higher interest rate. So most people continued to use cash or checks to make their purchases, spending money they already had. By the mid-70s, total US credit card debt was still just $10 billion. But the banks could see the juicy profit potential of a world with widespread credit card use. And that's where we get the 1978 landmark Supreme Court case of Marquette National Bank vs First of Omaha. The case that ignited the credit card boom, opening the floodgates for millions of new customers, forever transforming the finance industry, and most importantly, radically shifting how we spend money. The court case came from a dispute between Marquette National Bank of Minneapolis and the First of Omaha Service Corporation, the credit card division of the Nebraska-based bank. At the time, different US states had varying restrictions on what kinds of credit card products banks could issue their customers. Many states had what are called usury laws, which are regulations that limit how much interest can be charged on a loan. Minnesota had some of the stricter usury laws, which capped interest rates at 12%. But Nebraska didn't have a cap on interest rates. So when First of Omaha Bank began charging higher interest rates to their Minnesota customers, Marquette National Bank sued them. They claimed that the bank was violating Minnesota's usury laws by charging interest rates above the 12% cap. The case went to federal court, as it asked a question about the interpretation of the National Bank Act, a piece of federal legislation. Section 85 of the act stated, Any association may charge on any loan interest at the rate allowed by the laws of the state, where the bank is located. So the legal question at the heart of the court case was whether a bank could export the interest rate laws of the state they were headquartered in to customers who resided in other US states. Marquette tried to argue that Minnesota's 12% interest rate cap should apply to Minnesota residents regardless of where a bank was headquartered. Tried and failed. A state district court in Minnesota first ruled in favor of Marquette. But when appealed to the Minnesota Supreme Court, the decision was reversed, holding that under the National Bank Act, they were allowed to charge interest rates based on the laws where they were headquartered. Finally, in 1978, the US Supreme Court took the case. Being the highest court in the US, the decision would definitively establish whether banks could override or bypass the state interest rate caps. And it did. The court ruled unanimously in favor of First of Omaha. Now national banks all across the US could move their headquarters to a state with lenient usury laws and essentially export those laws, charging interest rates to residents all across the US. Two US states in particular quickly became the go-to destinations. South Dakota and Delaware. In 1980, South Dakota became the first state to completely eliminate usury laws. So Citibank, which had been limited by New York banking regulations, was one of the first to move its credit card division to South Dakota. Delaware followed in South Dakota's footsteps, passing the Financial Center Development Act in 1981, which permitted out-of-state banks to establish a subsidiary in Delaware and benefit from no interest rate caps. Suddenly, the landscape for the credit card industry opened up, and it could become a major part of banking revenue. By the mid-1980s, many banks had relocated their credit card divisions to lenient states. From just $18 billion in 1978, the industry ballooned to $100 billion within a few years. The removal of interest rate caps meant that banks could now issue credit cards to a much wider range of customers. The more likely a customer is to default on a loan, the higher the interest rate needs to be in order to compensate the bank for that risk. So higher interest rates on credit cards meant lower-income and less credit-worthy households were now potential customers. And it also opened the door for some of the more predatory lending practices we see today. Banks charging excess hidden fees, particularly on the riskiest customers who they knew they could profit from. Late fees, over-limit fees, and annual fees became more common. These fees contributed to higher outstanding balances on credit cards, meaning higher interest payments, and for many people, starting a debt spiral that was difficult to escape. Another side effect of the court ruling was predatory marketing. All of a sudden, you had a bunch of banks all across the US fishing in a vast ocean of new customers. This increased competition led to lots of aggressive marketing tactics. By the late 80s and early 90s, it was common for households to receive several pre-approved credit card offers in the mail each month. No need to fill out any detailed paperwork, just sign up and the bank would extend you a significant line of credit. By 1998, 68% of households had at least one credit card, with 37% of all households carrying an outstanding balance. By the early 2000s, credit card debt had skyrocketed to $300 billion. But this isn't just a story about growing debt. It's also a story about how that 1978 court case has impacted consumer behavior. Credit cards, when they were first invented, were seen as a luxury item, used in rare circumstances where it was appropriate. Today, credit cards, for many people, are an everyday financial weapon. A study by the Federal Reserve Bank of San Francisco found that in 2022, 31% of all purchases were made using credit cards, a vast juxtaposition from the 70s where most people purchased things with cash. Credit cards are quite the double-edged sword. On one hand, they allow customers to make large purchases easily without needing to have cash on hand or sitting in a checking account. They also often offer rewards, so by simply using it for regular month-to-month purchases, a responsible cardholder can essentially collect cash back on their expenses, partially or fully funding holidays or other discretionary purchases. On the other hand, many people who start out as responsible cardholders quickly devolve into someone who is living beyond their means and using debt as a way to do it, spending more than they earn, constantly running a balance, and exposing themselves to exorbitant fees and payments. In 2009, credit card delinquency rates reached an alarming level. 12.5% of Bank of America's customers were in default. Today, the total credit card debt in the US is $1.2 trillion. 82% of US adults owned a credit card as of 2022, with 73% of Americans getting one before the age of 25. And the average cardholder carries $6,400 in credit card debt. In 2024, credit card delinquencies are rising again. A shocking 9.1% of balancers became delinquent in the last year, according to the New York Fed, which I think illustrates just how many people are using credit cards and other personal debt to cope with the cost of living crisis. While not all of this can be attributed to the Marquette Supreme Court ruling, it has definitely played a major role. The reason credit cards average an interest rate of 22.8% and how banks are aggressively marketing them at you is traced back to 1978. States like Delaware continue to be the go-to headquarters for banks because of their lax banking regulations. I didn't actually plan on this, but as I was making this video, it just so happened that usury laws became a focus point in the upcoming US election. During a campaign speech this week, Donald Trump floated the idea of a temporary cap on credit card interest rates, suggesting a federal limit of 10%, which would be even stricter than the 12% Minnesota limit imposed at the start of all of this. Because of that 1978 Supreme Court ruling, if Donald Trump wanted to do this, he would need to pass it as legislation, so it would have to pass through both the House of Representatives and the Senate in Congress. Interest rate caps aren't particularly popular among economists. While the intention is to reduce the cost of debt for households, the expected result would be the restricting of access to short-term credit to lower income families and could also result in higher fees. Citing a study in the Journal of Public Choice, the New York Fed argued that rate caps in the past have led to financial well-being declining. I personally tend to lean on the side of consumer choice, and interest rate caps tend to limit access and can have a number of other unintended consequences. But there should be much better financial education embedded in society to protect people from falling into debt spirals. Credit cards are a tool, just like many other financial products. If you use them responsibly, it works great. If you don't, it can ruin your life. But hey, what do I know, I'm just a guy making videos on the internet. Hit the subscribe button if you want YouTube to remind you that I exist every once in a while, and maybe check out another one of my videos here. A reminder to check out MyHeritage via the link below, sign up for a 14-day free trial and enjoy all of the amazing features they have to offer.