A:

A true financial horror story began on Halloween in 1978. On that date, the Supreme Court began hearing Marquette National Bank vs. First of Omaha Corp. The case appeared to be a simple conflict over which state laws govern the relationship between debtor or creditor - the state where the creditor is based, the state where the debtor lives or the state that decides to grant the loan.

Marquette was a Minnesotacredit card issuer that followed the state cap of 12%, but charged annual fees as a tradeoff. An out-of-state issuer, First of Omaha, followed the looser laws of its state and offered cards charging 18% with no annual fees. The lack of annual fees attracted more customers and cut into Marquette's business. The Supreme Court ruled that the relevant laws are those of the state in which the lending decision was made. This meant a bank could open a credit division in a state with friendly usury laws and run all of its lending operations through that division in order to avoid tougher usury laws in either its own state or that of the debtor.

Initially, the drive to find friendly states was fueled by high inflation. Many credit card companies were capped below a 15% interest rate by state laws at a time when the inflation rate was as high as 20%. This meant many of the credit card companies were better off not lending at all, if they could not raise rates to keep up with inflation. The solution was offered by down-and-out states like South Dakota and Delaware.

When Citibank ran up against New York usury laws and it became clear that the state would not budge, Citibank cut a deal with South Dakota. South Dakota was in the economic doldrums and eagerly agreed to alter its usury laws to bring Citibank's credit arm and its thousands of jobs into the state. Other states have changed their laws to attract credit companies into relocating and the trend has continued - to the great advantage of credit card companies. Although inflation has dropped sharply since the stagflation period in the 1970s, many of the relocated credit card companies have kept their interest rates very high simply because they can.

(For more on this topic, read Cut Credit Card Bills by Negotiating a Lower APR and Understanding Credit Card Interest.)

This question was answered by Andrew Beattie.

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