The Skirmish over Credit Cards

The Senate may be voting this week on a bill to tighten regulation of credit card issuers – or not, since you can never tell with the Senate. Despite an agreement between the ranking members of the Senate Banking Committee, there is a series of amendments from both sides to go through; Real Time Economics has a summary of the issues that were open as of earlier this week.

I wrote a post on The Hearing earlier describing the debate as one between two economic perspectives: classical economics (credit card issuers should be able to offer any terms they want; if people accept them, that by definition means it increases their utility) and behavioral economics (people suffer from cognitive fallacies, like thinking that they will never pay any of those fees threatened in the credit card agreement, so regulations should help people make better decisions and protect them from bad decisions).

Looking back over that post, it was far too balanced. There is a plausible theoretical argument that tighter restrictions have the effect of limiting the supply of credit to marginal customers, but that’s not what’s going on here. First of all, there isn’t much demand for credit these days. Second, it’s really about whether credit card issuers will be able to use increased interest rates and fees to partially offset their increased default rates. And of course, this isn’t going to be decided by economics, but by power. The more relevant question is the one that Simon was asked on MSNBC: “Do the banks own the Senate?”

As we’ve written before, there is a complex relationship of co-dependency between the government and the banking sector. The administration has placed its bets on the banking sector in its current form, with its current leaders, and has provided it large amounts of financial support; and many members of Congress have even more direct allegiances to the banking sector via the mechanism of campaign finance. At the same time, banks are largely hated today, and credit card companies perhaps more than any other part of the banking industry. (They are largely the same companies – Bank of America, Citigroup, and JPMorgan Chase all have huge credit card businesses – but people feel differently about their credit cards and their checking accounts.) So this bill, and President Obama’s lobbying for it, is a way to strike a blow for the beleaguered consumer while not doing too much damage to banks’ profitmaking ability. As Felix Salmon pointed out, the Federal Reserve already defined new credit card regulations that go into effect in July 2010. 

From the banks’ perspective, this may look like a slippery slope to more regulation, and so they are trotting out all the usual arguments that Salmon describes in his post. But when push comes to shove, I doubt they will call in all their favors fighting this battle. The big fight will be over the new regulatory structure in the fall, and in the meantime it doesn’t hurt to let the administration have a victory.

By James Kwak

29 responses to “The Skirmish over Credit Cards

  1. You need some bit of regulation, especially if you consider the general awareness levels of people who apply and get credit these days.

    It is not enough to say that free market can take care of itself. If you allow college students to hold three or four credit cards, then inevitably a lot of them will fall in the debt trap and suffer like they do today.

    Classical economic theory that is grounded on assumptions of no external influence or ceterus paribus is simply too simplistic to be of any use in the real world.

  2. As you point out, “there isn’t much demand for credit these days”. So isn’t this entire issue a tempest in a teapot?

    Am I the only person who thinks this is something like 1729th on the list of things with which Congress should be concerning itself right now? Admittedly, it makes for great political theater… But in terms of actual impact on society, is this bill really going to make any detectable difference?

    The only relevant point in the one you and Prof. Johnson suggest: If Congress is so controlled by the banks that it can not get even this trivial bill passed, what hope is there for real reform?

    I suppose this might be the first step along the “slippery slope” to actually breaking up the banks that are too big to fail, which would be great. But far more likely, I think, the bill will pass after much hand-wringing and debate… And then our dear Representatives and Senators can hang their hat on it and say they “passed banking reform”, while relegating more substantial proposals to the back burner permanently.

  3. While I was working for MasterCard International back in the 1990s, we commissioned a survey that asked card holders, among other questions, “on average, how many months during the last year did you carry a balance over to the next monthly statement?” The average cardholder answered somewhere between 0 and 1. The actual national average was somewhere between 11 and 12. How did this happen? They convinced themselves in hindsight that the other 10 to 11 months that they carried over a balance either never happened, or “didn’t count.”

    I am, at this point, no longer even entirely convinced that credit cards should be legal at all. If we’re going to continue issuing people unsecured open-ended lines of credit with no disclosure of finance costs at the point of sale, then yes, by all holy gods, we MUST have very strict and inescapable consumer protections … unless the point of issuing people credit cards is not to lend them money, but to keep them in open-ended debt slavery, in which case the system is functioning as intended.

  4. I heard a caller to a radio show say that her father went to prison for loan sharking, for charging loan rates lower than what the credit card companies can charge.

    ‘Nuff said.

  5. The banks would argue that the purpose of the fees and rates is to offset defaults, and it probably is to some extent.

    But debt slaves are a good source of income and good sources of income can be bundled into good securities. People who don’t carry balances, not so much.

  6. Let’s assume the banks aren’t bluffing and are correct to predict that under the new credit card regulations many marginal customers will be denied access to this form of credit. It still does not seem that the balancing of costs and benefits weighs against the regulations. Perhaps we shouldn’t be too bent out of shape by that prospect.

    The interests of those that lose access to credit cards because their profiles are so risky (and you wonder, really, if they are all that much worse off to be denied a significant chance of inescapable indebtedness) should be compared to the benefits accrued to those that get to keep their now more consumer-friendly cards.

    The banks can benefit from the regulations too, in that they are discouraged from pursuing the riskiest kinds of loans – unsecured debt to the uncreditworthy. Do the banks and/or our economy really need more exceptionally risky loans?

    On the other hand, the banks want something which seems fairly sensible. They are looking for maximum flexibility to change credit terms since, in these volatile and uncertain economic times, the credit ratings of millions of their customers are likely to change dramatically. Furthermore, the set of rates and fees that the models deem necessary in order to make a profit from a particular profile (which could describe millions of people) could also change significantly with potential dramatic shifts in the economy.

    If banks face the possibility that easy terms, that were rationally offered to creditworthy customers, would be fixed in stone while the chance of default of those same customers skyrockets, they would have little reasonable choice but to be proactively risk-averse and raise rates and fees for the general credit-card using population to insure against further deterioration in the economy. Competitive pressures wouldn’t do much about this since all the banks models would likely yield similar strategies.

    So, if the banks actually do all this – cut off the bottom fraction of debtors entirely, and raise the rates and fees of (now legally “friendlier”) cards for the rest of their customers, will we be better off?

  7. Is loan demand down? Well, if you look at the charts that say, “Net Percentage of Domestic Respondents Reporting Stronger Demand” for certain classes of loans, the graph shows a downward slope (the respondents being banks). But what does that mean? How do the banks measure demand? Do they do surveys? Do they send out mailers? Or do they count how many people apply for loans? Perhaps in this case “demand” means loan applications. But what if the banks have raised their rates or tightened their requirements? These rates and requirements are generally known among their potential loan applicants, who will be unlikely to waste their time applying for a loan they know they cannot get. OTOH, they might be quite willing to apply for a loan under the previous conditions. Apples and oranges.

    To paraphrase Victor Mollo, famed contract bridge writer, perhaps the demand for easy credit exceeds the supply — as always. ;) Well, maybe not always. :(

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  10. 1) When did debt become the primary focus of our fiscal policy? Seems there is A LOT of attention and money going into the ensure our ability to become more laden with debt.

    2) When Paulson formulated TARP last fall, it was pitched, in part, as a way to ensure affordable credit (so I thought.) Since receiving billions of US tax dollars, banks are apparently changing existing agreements with consumers to increase the percentage rate on existing credit card debt.

    Seems a little unfair – but in all honesty, allowing credit to flow like a swift-flowing river was one of the key factors in the crash, so perhaps the tightening of credit and the higher cost of credit is a way to persuade people to live within their means?

    3) If consumers would buy what they could afford, the banks wouldn’t have anything to hold over them.

    4) Has anyone seen this frightening story in the NY Times? http://www.nytimes.com/2009/05/17/magazine/17foreclosure-t.html?pagewanted=1&_r=1#

    A Times reporter talks about how he landed into a very deep pit of debt. Astonishing how easy it can be to put the blinders on and move forward, despite the lack of funds to cover the progress….

  11. The fact that Congress can’t pass credit card legislation is a symptom of the larger cancer that controls our federal government. Large corporations, especially the banking/financial corporations, control Congress. Someone once told me that they heard a credit card exec. laugh at the the credit card terms/agreement paperwork, saying that the fine print boils down to – we can do whatever we want with fees, interest, etc. and the person using the credit card can’t do anything about it.

    The worst thing is that just when people can least afford to get hit with exhorbitant fees and loan-shark interest rates is exactly the time when the credit card banks/businesses stick it to them. Usually the reason they are falling behind is loss of a job, serious illness, divorce, etc. and the last thing they need are more problems. So what do the credit card companies do? They double the interest rate from 14% to 29% and hit them with $29 – $35 late/overlimit fees.

    I can just imagine the debate that goes on behind closed doors in Congress, “Well heaven forbid we regulate credit cards. That could lead to regulation of credit default swaps and CDO’s, regulation of how the credit ratings agencies rate these products, regulation of how the SEC audits investment firms (Bernie Madoff, Stanford Group), regulation of the conflict of interest relationships between governmental regulatory agencies and banks/financial corporations (Goldman Sachs, Chase, BOFA, Citi etc.)”

    So why should it matter whether credit card protections pass Congress? The US has bigger problems, right? Well philisophically speaking – a country is measured not by how it protects it’s strongest citizens, but by how it protects it’s weakest. IMO we need to protect the weakest first, those preyed upon by credit card business, and then Congress should work it’s way up the financial services ladder. If Congress can’t even solve the predatory practices of credit cards, can they really pass effective legislation to regulate more complicated financial transactions? And if Congress can’t regulate complex financial transactions – won’t we continue to have global economic crisis after global economic crisis? Congress needs to start somewhere and regulating predatory credit card practices is a good warm-up for the larger work ahead.

  12. Excellent post. I agree entirely with your observations and sentiments.

  13. As I have said hundreds of times: Competition in the marketplace is essential to Capitalism working to create better products and services at better value.  

    If there was truly significant competition in the credit card market, then the creation of better products would be ongoing and apparent – things like “plain language” statements, competitive rates, & simple to understand terms would already have come into existance. What has happened in this market, like many others in the parade of commerce consolidation is essentially complicit collusion.

    Until TPTB grasp this simple, yet essential notion, and we move away from the “laissez-faire,” dog-eat-dog economic system and move towards a more decentralized Capitalism (where government’s primary economic role is to ensure competition in the markets), we are going to face these same kinds of issues and problems over and over.

  14. As I have said hundreds of times: Competition in the marketplace is essential to Capitalism working to create better products and services at better value.  

    If there was truly significant competition in the credit card market, then the creation of better products would be ongoing and apparent – things like “plain language” statements, competitive rates, & simple to understand terms would already have come into existance. What has happened in this market, like many others in the parade of commerce consolidation is essentially complicit collusion.

    Until TPTB grasp this simple, yet essential notion, and we move away from the “laissez-faire,” dog-eat-dog economic system and move towards a more decentralized Capitalism (where government’s primary economic role is to ensure competition in the markets), we are going to face these same kinds of issues and problems over and over.
    BTW I love your blog!

  15. Hoi Polloi

    A compelling read re credit cards and sub prime mortagages.

    http://www.nytimes.com/2009/05/17/magazine/17foreclosure-t.html?ref=business

    Here’s a guy, an economic reporter for the Times who wrote several early-warning articles and still got personally fully dragged into the credit card and subprime frenzy.

    What draw my attention is the last sentence:

    “I was actually beginning to feel sorry for Chase. It seemed to be so flooded with defaulting borrowers that it didn’t have time to foreclose on my house. Eight months after my last payment to the bank, I am still waiting for the ax to fall.”

    I wonder what the big picture is here?

  16. Do the banks own the Senate? Illinois Senator Dick Durbin thinks they do and he should know.

    We shall see shortly another example with credit card reform.

  17. A smart bank is going to use risk based lending on credit cards. This way rates are in line with the risk of default.

    The problem is banks stopped being smart when the got addicted to debt slavery. They started giving away debt at horribly low (bad) rates to ever increase the number of debt slaves. Well now the cows have come home and they have decided they need to go back to being wise lenders. As my grandmother always said, you made your bed now go lay down in it.

  18. Charles R. Williams

    I love my credit card company. Capital One offered a cash advance of $30,000 for a year with no interest and no balance transfer fee. I paid off my 5% car loan. They must think I am fool enough to default. They are the fools.

    Obviously, other people are too stupid to manage their own lives. The Democrats have to do it for them – geniuses like Barney Frank and Chris Dodd.

    If we are truly concerned about the foolish use of credit and debt slavery, we should think about all the 18 year-olds who are racking up tens of thousands in debt collecting worthless educational credentials. This is debt that is essentially immune from the bankruptcy process, comes with unconscionable penalties for people who can’t pay it back on time and will be collected with the full assistance of government agencies.

    Of course this kind of debt slavery props up the bloated higher education sector of the economy – a key constituency of the Democratic Party.

  19. Of course banks own the Senate. It’s the only thing they didn’t pay too much for. A real bargain. If they could mark that asset to market, their balance sheets would look fantastic.

  20. “classical economics (credit card issuers should be able to offer any terms they want; if people accept them, that by definition means it increases their utility)” — If this is the argument, then the banks ought to compete to offer LOWER interest rates and better terms to people with good credit, instead of raising rates to 29.99% for everyone regardless of credit scores. This simply discourages people who manage credit wisely from using it, while it exploits those who were trapped in days of easier terms into carrying large balances. This is the type of abuse that cries out for regulation, and the banks brought it on themselves.

  21. Let’s not pretend that capitalism is working regarding Credit Cards, Mortgage Loans, Health Insurance policies etc. The basis of effective capitalism has a few components. Competition is one, the ability to delay gratification is another, and fully understanding what you are purchasing is the third. Unfortunately in the digital age, everyone applies for credit cards, mortgages, home equity loans, insurance policies etc. through the internet or with some fly by night corporation that just got to town, like Countrywide or IndyMac. This was supposed to cut costs, cut out middle men etc. But instead, the corner banker, the town insurance agent etc. have been left out of the loop. So the very people that for decades were able to explain to potential customers what they were doing, and whether it was good or bad because their profit motive was longevity in the business not making a quick score has been lost. Instead we get either internet applications, or mortgage companies springing up in the old KFC building, basically using former KFC employees to pump mortgages, or card etc. with the profit motive being making a million dollars before this whole thing collapses.

    I don’t think any regulations, even the best structured, overseen by the best people can completely solve these issues. In a lot of ways this country lost it’s sole over the last few decades. We don’t build lives in single communities, families don’t live near each other, and nobody trusts anybody. At the fundamental level that was always the best regulation, a trusted relationship with a banker or financial advisor, or insurance agent, or CPA over years and years, helping you makes these decisions and knowing they were advising you in your best interest. Instead, we apply for the 0% transfer balance credit card from XYZ bank of some state with lax banking laws and suddenly a year later all that interest comes due in a balloon payment, and debt slavery has begun.

  22. Ah capitalism….

    “Socialism is for the rich, capitalism is for the poor”.

  23. Irrational behavior for rational reasons.

    Exhibits…
    - Banks, Credit Cards etc want to loan money out at the best rate of returns. The debtors that have jobs and earn income but are just squeaking by make the best prospects.
    - Title, Mortgage and Home Servers want to increase sales of properties to increase profits.
    - Real Estate Brokers etc want to increase commissions by increasing the cost of the properties they are selling.
    - Brokers make fat commissions bundling this debt and selling it as triple-A bonds
    - Rating companies make fat fees by saying that debt is worth the triple-A rating
    - Politicians (yes…both Democratic and Republican…there is no exemptions here) get contributions from all of the above. They tell the voters how great this is and the system works just great.
    - The consumers are sold on the Madison Ave marketing and advertisement put out by all players listed above.

    Things have to change. Things must change. But, how it changes will have unattended consequences going forward.

  24. I read something online earlier this week, but can’t remember where! Yes, I hate when that happens. The point of the article was whether or not the banks are double dipping. It went on to postulate that if the banks are getting help from the government, more literally the taxpayers indirectly, then proceed straightaway to ratchet up interest rates, fees and penalties directly on tax payers, the answer is beyond an emphatic yes or better yet YEAH!!! if you’re a bank. Just imagine the Frat House that is today’s banking sector having the usual beer bash. Yeah, that kind of YEAH.

    If we take as fact, “there isn’t much demand for credit these days” the next most logical step would be to ask how profit centered credit providers would make up for defaulting accounts. This is important because if there is not the usual influx of new accounts AND there is an increase in defaults the only solution left to credit issuers is to monetize everyone you already have on the hook and by any means necessary or NOT. What is Wall Street behaving like if not a drunken Frat House!

    Miss a payment on one account and suddenly all the rest of your creditors are raising interest rates demonstrates a pick a fight with one of us and you’ve picked a fight with all of us attitude. Only they’re going to get back at you, each and all of them, by screwing you to the wall.

    The precursors for this type of corporate behavior have been around for some time. Ever since I can remember there were 20th. Century Insurance envelopes in my home as my parents were pretty much lifetime policy holders. My lifetime anyway. Seriously, they went literal decades without car accidents and when I was in my early thirties my dad had an accident and then my 17 year old brother (the youngest) less than a year a part. Maybe a year later my brother had another accident. 20th. Century cancelled my parents. I was livid. My parents had gone my lifetime with no accidents, while insuring a plethora of luxury and non-luxury automobiles in addition to mom, dad and four sons. What really got me was when I got my own cars I went with another provider and told my dad he should consider changing because 20th. Century was relatively high. He declined because they’d been with them so long he didn’t see the need in changing. 20th. Century of course, no loyalty whatsoever didn’t mind.

    I have a question too. As I understand it, some loans are insured against default. In these instances, lenders have an incentive to let the account go into default which would trigger the policy payout instead of working with a delinquent account holder. If that is so, if AIG held most of these insurance policies (theoretically), had we let AIG fail, would not the banks have been on a more even footing with borrowers and so a lot more willing to compromise?

    On PBS recently there was some discussion as to why lenders weren’t just adjusting loans to keep existing homeowners in their homes. If they can’t afford a 700K home but they can a 550K or so loan, why do the banks prefer empty homes. If the truth is that the key to honest negotiations with the banks was the demise of AIG, then Wall Street owns all of Congress. Congress not only gave them tax payer money to gamble with but they set the deck and made sure the tax payers got no cards and the banks got all the cards.

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  26. Limit credit cards to those who truly can afford them. There are three heads of the dragon with this financial mess. Extremely high taxes, Usurious credit cards and Mortgages. Make the first two reasonable and folks will be able to afford their home.

  27. What great advice! Eliminate high taxes? Limit Credit Cards? Limit Interest Charges?

    First, the government needs to live within its means to limit the need for taxes. Now if you have to spend money on military, bail out every single financial institution, pay retirement/entitlements and other government services. If revenues are going down; now there is a devils bargain that needs to paid. The question is do you pay it or do your children, grandchildren and great-grandchildren get stuck with the bill?

    Second, anybody who earns income qualifies for a credit card. Now has the credit card companies gone overboard about the amount of credit — that’s true. However, I bet if you survey these folks that got into trouble I would bet a whole lot of them had a life reversal because of lost of job or medical emergency or plain poor financial management of their affairs. So, I don’t know who to feel sorry for the creditor or debtor?

    Finally, financial companies I guess own the government so I can’t imagine it will change. Theoretically, if it did I would imagine the credit card rules would change as well — probably to a secure debt scheme. It will be like the good old/bad days when credit was really difficult to obtain. Credit cards is what has built this consumer based economy. Changes will create whole new economic reality.

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