Innovation, Regulation, and Credit Cards

Fresh Air had an excellent interview with Georgetown law professor Adam Levitin, who blogs here. It’s only 21 minutes and I recommend it if you are interested in credit cards or in financial regulation in general.

Credit cards are an interesting if perhaps extreme case of the interplay between “innovation” and regulation in the financial industry. A long time ago, someone invented the credit card. This was a real, beneficial innovation, because it allowed people to make medium-sized purchases on credit. (You could already buy a house on credit, if you put 30% down.) Let’s say that without credit, it would take you nine months to save enough money to buy a refrigerator. Now you could buy the refrigerator and then save the money; it might take you ten months with the interest, but you get to use the refrigerator for that whole time. (A refrigerator could also save you money, because it might allow you to go shopping less often, buy in bulk, and eat at home more.) All good so far.

Someone also invented the charge card (like the old American Express card), which gave you the convenience of not having to carry around cash, and the ability to make long-distance purchases immediately, rather than having to mail a check and wait for it to clear. Also a good thing. All credit cards have this feature in addition to the credit feature.

Since then, however, Levitin argues that all the innovation in the credit card industry has been in pricing – specifically, making prices less transparent, so issuers can “compete” over interest rates while they really make money on fees (late fees, cash advance fees, foreign transaction fees, etc.) and billing practices (like double-cycle billing). The actual product you get – the ability to take out a modest unsecured loan on an instant’s notice – is the same as it always was.

From my personal perspective, credit cards are a lot better than twenty years ago, but that’s because I pay no annual fee and I get rewards (cash back). This is pure reallocation of money, since all that has happened is that the interchange fees charged to merchants are now going to fund my rewards, and those interchange fees get passed on to consumers as higher prices. More generally, Levitin says, the innovation has gone into more and more complex combinations of different price terms (teaser rate, long-term rate, ability to change rates, late fee, reward program, etc.) that simply make it harder for consumers to understand what they are paying.

If innovation doesn’t give us new products, does it at least give us the same product at a lower price? Not so much. Here is a graph of credit card interest rate spreads (interest rate minus Fed funds rate) since the end of 1994:

cards

Data are from the Federal Reserve; credit card rates are from Table G.19, credit card rates on accounts assessed interest; Fed funds rates are from Table H.15. Since credit card rates are only available quarterly, I used a 3-month trailing average of both series. That spike at the end is not particularly ominous, at least not yet; the Fed funds rate has collapsed over the last two years, and credit card rates haven’t had time to catch up.

Given this situation, Levitin argues that the usual approaches to regulation are ineffective. Disclosure alone is insufficient when consumers lack the ability to estimate the total cost of credit based on complex interest rate and fee schedules. (I would add that disclosure also doesn’t work when people have biased estimates of their own future behavior – as in, “I’m not going to miss any payments.”) Prohibiting specific practices, as in the recent credit card bill, only motivates card issuers to find new things to charge money for.

Instead, he says, regulation should constrain the number of things issuers can charge money for – like the interest rate, the annual fee, and the transaction fee – and then let them compete on price. The basic product will be the same, since it’s never changed. And there will be no caps on prices or fees, so even risky borrowers will be able to get credit at some price. The main difference is that people will have a clear understanding of what the price actually is.

Update: Earl Killian has an interesting comment below arguing that there should be minimum minimum payments – that is, card companies should be prevented from setting the minimum payment so low that you will only run up more and more debt. The idea is that if you insist on reasonable amortization schedules, then consumers will better understand the cost of credit, and won’t carry their balances for as long. This is one of those proposals that the libertarians will hate and (some of) the utilitarians will like. 

By James Kwak

52 responses to “Innovation, Regulation, and Credit Cards

  1. the average credit card interest might not be a good measure — to show whether credit had got cheaper you would have to adjust for risk. i’d guess that the credit card companies were making riskier loans like everyone else, and that existing loans have been getting riskier still.

  2. bobgreenfest

    What a credit card has basically done is take taxes out of the equation for the purchaser. Think about it James? It takes $2 of your hard earned money to buy a $1 item after you pay federal, state, city, FICA, etc. taxes to the government. With a credit card, you get $1 of purchasing power for every $1 you spend – what a bargain! For more insight into this and other matters please see http://www.bobgreenfest.wordpress.com. @BobGreenfest

  3. The underlying assumption here is that people are stupid, and that over time people will continue to get credit cards that lead them into bankruptcy without adapting. Therefore, we are in need of a regulator, who will ensure that credit card terms are “fair” to all consumers.

    Nobody has a right to a credit card, let alone one with so-called fair terms. When a govt steps in to mandate terms, there are always unintended consequences. Increasing the credit card companies costs may make it harder for poorer people to get credit cards, and push them into more costlier forms of debt like payday lenders.

  4. Why not ban rewards as well?- these after all introduce another layer of opacity in the market. It seems you have merchants and those who carry balances/pay fees subsidizing a large universe of convenience users. Even without rewards there are lots of convenience, and I’m not sure how it makes sense for me to spend $100 at a retailer to get a $1 reward, when if there were no rewards, the fee to the merchant would be less and the price lower ie I spend $99 for the same item with no reward. I grant that my assumption the full saving is passed on is debatable. Still, I can’t think of a reason, if you were designing a payment system from scratch, that you would include a reward component.

  5. Wait a second. Many lifelong smokers spend more to buy cigarettes by the pack and not the carton so they can have the option to quit without wasting cigarettes. Why shouldn’t we believe that credit cards are the same, that issuers are responding to a genuine demand for a product that doesn’t cost much if you follow all the rules, even if many consumers ultimately don’t? A complicated fee structure alone is hardly evidence of a need for regulation.

  6. James specifically said that there would be no caps so risky borrowers would see high interest rates, so they can still have a credit card it will just obviously cost them more (not only cost them more after their check is processed extra slow so they’re one day late and their rate jumps 10%)… I don’t see the real objection here except a knee-jerk “government is bad” reaction.

    The story Levitin is telling seems to be a case of big companies finding a market imperfection (people don’t act like rational agents when calculating the full cost of fees and weird billing practices) and innovating to exploit the imperfection rather than introduce innovative products or reduce costs. “Free” market perhaps but not efficient market by any stretch of the imagination. By reducing the number of back-door fees it will make people more able to do the future cost calculation and force the companies to compete on a transparent price rather than on new ways to hide sneaky legalese and gotcha terms. The winners will be those who have lower costs (e.g. actually charge customers at the rate their risk merits) or come up with real innovations. Companies who compete only on being the best at exploiting non-rationality will lose. I for one am fine with that.

  7. David Nowakowski

    The Congress is passing new laws right now to make this industry more transparent.

    http://www.nytimes.com/2009/05/20/opinion/20weds4.html?scp=20&sq=credit%20cards&st=cse

    Some weeks back, Gibson et al recommended a standard form for credit card disclosures. As Elizabeth Warren and others have argued, just as we have an FDA we ought to have a financial services watchdog.

    http://www.nytimes.com/2009/05/24/opinion/24gibson.html

  8. it doesn’t benefit the cardholder, and it doesn’t benefit the merchant. it benefits the credit card company. if the credit card company offers you a reward, it encourages you to put more of your purchases on the credit card.

  9. if the fee structure were complicated but transparent, you might have a point.

    however, even then, there is a problem. one of the key things to learn from this crisis is that we do need state regulation (ie limiting) of credit.

    if large amounts of credit are extended — on any terms — to people unlikely to have the ability to pay the money back, there is a good chance — whether because of fraud, miscalculation, or bad macroeconomic conditions — that losses will be much higher than anticipated.

    if it were isolated to the individual lender and the borrower, there would be no problem. however, this has macroeconomic effects — it can take down the economy — with or without a bank crisis.

  10. from the article:

    “Unfortunately, the powerful pro-gun forces in the Senate managed to contaminate the bill with an amendment to allow licensed owners to carry loaded firearms into national parks.”

  11. Agoraphobic Kleptomaniac

    “the fee to the merchant would be less and the price lower ie I spend $99 for the same item with no reward. I grant that my assumption the full saving is passed on is debatable.”
    I believe retailer fees were around before the glut of reward cards showed up. I don’t think the two are related at all.

    “Still, I can’t think of a reason, if you were designing a payment system from scratch, that you would include a reward component.”
    I disagree. I see it as a dividend sharing perk. If i’m a good enough customer to get the good reward card, then why not get some of the profits the credit card company makes off of those who abuse their credit cards? I see your point though, in a perfect world, Retailers wouldn’t get charged a fee, and a lack of rewards for me would result in lower interest rates for everyone, but somehow, i don’t think the credit cards would do that. We’d just end up with rewards-less cards, retailer fees, and interest rates would creep up again…

  12. The underlying assumption might be more accurately described as positing that people are irrational and at an informational disadvantage with the credit card companies. This point can hardly be argued.

    So instead you counter that argument with the argument that no one has a right to a credit card, a claim which James never tried to claim.

    This kind of regulation would not increase credit cost; it would make the costs easy to understand. It might even reduce costs, as it seems likely that each company has an entire department whose sole purpose is to confuse the customer.

  13. D. Christopher Leonard

    I don’t think you even have to argue that people are irrational in addition to the fact that there a significant ‘asymetries’ in information between card companies and card holders. Rather, accepting that for the card holders the costs in time and energy discovering all the ins and outs of obtuse statements is real. And of course, that is not the sole area in life that people must confront decisions that involve obtaining information about complex matters. They are multiple and constant. In the face of this people are rationally ignorant, making the calculation that the transaction costs are too great to become as informed as a specialist in the issue. Physicians when treating other physicians, for example, usually assume little knowledge on the part of the patient – even though the patient possess a significant corpus of technical and craft knowledge. In fact, they typically have fairly narrow competencies – hence treating them like an ordinary patient.
    The problem with straight caveat emptor arguments then, is that they don’t acknowledge that no one can be a specialist about everything.

  14. Brooks Gracie

    You said: ” When a govt steps in to mandate terms, there are always unintended consequences.”

    Well, then spell out the consequences. There are also unintended consequences when the government fails to act–including the sort of fee and rate hike “innovations” that have led to the current mess by lack of regulation, and which allowed Wall Street banks to take on excessive risk.

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  16. I’m finding it amusing lately when the card companies call and beg me to use my cards.

    I just tell them I don’t use it and can’t close it because it will hurt my credit rating if I do.

    Ironic, huh?

    LEt them innovate themselves into oblivion for all I care.

  17. Well, there are two interesting things here:

    1. As Mr. Kwak mentioned – credit card use has actually changed the entire retail pricing landscape. The money moved around from the credit card-using consumser, to the merchant, to the card company, and back to the consumer as “rewards” shows up as a small hidden but ubiquitous tax of a few percent on all our purchases – but a tax from which one only gets relief when one uses credit cards. Payment by cash, check, or non-rewards card forgoes the tax – and therefore credit card use is further encouraged.

    2. There really is a large idea in the regulation philosophy / program described here. It helps to clarify and simplify information and therefore aid consumer choice, but it isn’t merely a Thaler / Sunstein “nudge” because it’s more than about presentation.

    What it is really doing by limiting the terms on which competition can be founded is focusing a company’s improvements on actual results – that is – telling firms that their innovations must be truly productive instead of merely gimmicks of market manipulation through confusing the customer. A credit card firm, for instance, would be encouraged to innovate by making their internal systems more efficient and reducing costs but not by creative obscuration of the true price of the service they provide.

    So, what would you call this attempt at consumer protection that keeps institutions concerned with actual productivity by forbidding value-less complication of presentation? “Competitive Channeling”? “Productive Focusing”? I’m sure someone out there can do better.

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  19. TonyForesta

    Fraud = Willful deceit, trickery… This issue (again) is not innovation or regulation. The core issue is legality. Credit card companies resort to various forms of trickery and willful deceit to ROB and THEIVE from consumers. Attempting to prettify these crimes or painting lipstick on the pig that is the fact that credit card companies intentionally ROB and STEEL from consumers for profit. And this element of ROBBING and STEELING only involves the “willful deceit” and “trickery”, and does not consider the grotesque usury fee’s being charged by credit card companies, (often without disclosure). Loansharks in Brooklyn charge similar fee’s, but at least the customer knows they are dealing with a criminal.

    The banks operate as unrestrained crime syndicates and like any crime family or mafia buy, purchase, bribe, or coerce politicians, judges, and regulatory agencies to shield, cloak, turn a blind to, and/or ultimately support and advance their criminal enterprises.

    If banks and the predatorclass cronies who own or profit from the finance sector were FORCED to abide by the laws, (if there were ICElike raids on bankers who break the law with SWAT team brutally whisking them off to Homeland Security detention centers) – we would not be in this crisis, and America’s poor and middle class would have a fair opportunity to succeed in America. Now Amerika is nation of the predatorclass, by the predatorclass, and for the predatorclass exclusively. Socalled financial innovations like the credit card and the alphabet soup of irredeemable debt products and PONZI schemes benefit the predatorclass singularly and exclusively, and intentionally and purposefully abuse, deceive, and disadvantage the poor and middle class.

  20. “Let’s say that without credit, it would take you nine months to save enough money to buy a refrigerator. Now you could buy the refrigerator and then save the money; it might take you ten months with the interest, but you get to use the refrigerator for that whole time. (A refrigerator could also save you money, because it might allow you to go shopping less often, buy in bulk, and eat at home more.) All good so far.”

    WRONG!!! The consumer is GAMBLING that the market for refrigerators will remain supply constrained (the refrigerator will the be the same price or higher in the 9 months), that the consumer’s work hours will NOT be cut, and the consumer’s hourly pay rate will NOT be cut.

    This all feeds into the fed’s attitude for the lower and middle class of spend now with debt and work later. When you do NOT get a raise, you can work longer (more hours per week and/or retire later). This is the fed’s preferred solution to help spoil the rich UNTIL the refrigerator market becomes demand constrained and the worker starts to lose income.

    This is EXACTLY what is wrong with the fed! They are trying to use a GLOBALLY oversupplied labor market to produce negative real earnings growth for the lower and middle class and to produce more DEBT for the lower and middle class to prevent price deflation from cheap labor and productivity. This all leads to wealth/income inequality and asset prices (stock prices and housing prices) being higher than they should be based on income.

    ABOLISH the fed. Get rid of the debt. SOLVE 80% to 90% of the world’s problems!!!

  21. RIGHT! And, besides the fed and the gov’t “looking the other way”, the spoiled and the rich and the bankers NEED AN OVERSUPPLIED LABOR MARKET so that WAGES DO NOT RISE!!!

  22. Will the credit card companies next call be to the fed (especially alan greenspan) so that they can get your earnings negative in real terms so you have to boorow or even negative in nominal terms?

  23. If you feel you cannot trust yourself with your credit cards you might be better off cutting up your cards and living purely on ready cash, living within your means takes discipline initially but is both rewarding and beneficial to your health.

  24. Professor Levitin offers a good idea, it just needs an added dimension. Today, credit card lenders can unilaterally change conditions of their agreement with consumers. Talk about being able to play whack-a-mole. In the commercial world, most agreements are written to require two-party consent, so it is not unfounded to force credit card lenders to stick to the terms they agree to at the time when consumer buy their credit product. Without such a condition, even Professor Levitin’s idea can be abused. To the consumer, sure the pricing was good when she bought the credit card, but now the conditions have changed and I am locked into this particular card with no easy exit. Certainly without Professor Levitin’s suggestion, such a restriction on changing terms should be instituted.

  25. donna: “I’m finding it amusing lately when the card companies call and beg me to use my cards.

    I just tell them I don’t use it and can’t close it because it will hurt my credit rating if I do.”

    It may hurt your credit rating if you do not. They are canceling cards now for non-use. If they cancel your card, that will lower your available credit, and that will lower your credit score. I now put something on each of my cards at least every other month. I hope that’s enough.

  26. Earl Killian

    Congress should pass legislation mandating higher minimum payments on credit cards. The goal should be to maintain the convenience of being able to make small purchases on credit, while protecting the consumer from a debt trap, and reducing the severity of recessions.

    The minimum payment set by credit card companies varies, but it is typically 1%-2% of the balance plus interest, with a minimum payment of $10-$25. Imagine a credit card with a balance of $4,000. If the holder stops making any new charges, and pays the minimum payment calculated with the 1% and $10 parameters, it takes almost 20 years to pay off the debt, and the interest payments at 16% will total $4,673 . Very few items purchased with credit cards have a lifetime this long; it is unwise to continue paying for an item long after it has been discarded. With only $40 of additional purchases per month, the balance never declines. If the bank uses the 2% and $10 parameters, then it takes almost 13 years to repay $4,000, assuming there are no new purchases, and $80 of additional purchases each month maintains the $4,000 balance indefinitely.

    I suggest that Congress pass legislation mandating a minimum minimum payment calculation that targets a 24-month payoff. This would be appropriate for most purchases. If the consumer wishes to purchase items with longer lifetimes and pay them off over their lifetime, then she should seek a non-recourse loan specific to the item. Such a secured loan will typically have a lower interest rate than the credit card company charges. For example, auto loans at my credit union are currently 5% to 6.5% depending upon the term (3-7 years).

    To target a 24-month payoff, the appropriate calculation is no longer a simple percentage of the balance (my $4000 example would require a 22% minimum payment, putting most of the payment burden up front). Rather the minimum payment would be calculated as new purchases are made using standard fixed-payment loan formulas that incorporate the current interest rate. The interest rate for new purchases would be locked in at the time of purchase; changes in rates would only affect purchases made after the card holder is notified. Each month the minimum payment would be the sum of the fixed payments for unpaid purchases. Any additional payment beyond the minimum would go towards paying off the purchases made with the highest interest rate, and for the oldest debts at the same rate.

    Under my proposal, if someone makes a purchase of $4000 at 16%, then the minimum payment from this purchase is $195.85. When the purchase is paid off in 24 months, the purchaser has paid only $700 of interest. This is much more consumer-friendly. It would also help provide greater macro-economic stability by lessening positive feedback; consumers would enter recessions with less debt, and so need to cut-back less (i.e. they could make more new purchases than otherwise). During booms, they would fewer new purchases, because the monthly payment would be limiting. Both add to macro-economic stability.

  27. How about “babysitting?”

  28. TonyForesta

    Interesting proposal Earl Killian. Though I would prefer congress mandating a cap on credit card interests rates at some fair point above the banks rate. Everyone would know the rate on both side of the counter, and banks could compete of fee’s or service (remember service?) In the end it would deinsenitivise consumers to over extend, because banks would be less willing to push credit cards. I know people with 10 credits, which is insane.

    I have one ATM card. If I can’t afford something, I don’t buy it. I pay cash for airfare, or use have a friend or relative buy the tickets and pay them in cash. Those evil rental car companies are tricky, but there are ways around any obstacle when those obstacles arize. It’s humbling yes, but I survive.

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  30. If you travel for either business or pleasure, you will find there are organisations you deal with that will ONLY take credit cards.

    Hotels/motels and car rentals spring to mind.

    I had to travel overseas at short notice a few years back due to a death in the family. I didn’t have a current credit card, because my replacement card had literally been lost in the mail and I hadn’t bothered to chase up because I live on ready cash/debit cards as suggested.

    It was INCREDIBLY awkward until I actually arrived at my destination and could borrow one of my mother’s cards for the duration on a “pay the bill in full when it comes” basis.

    I now always keep one card current, even though I never use it outside of holidays.

  31. I hear where you’re coming from, but this would be too complex IMHO.

    A mandated 5% minimum payment on the overall outstanding balance (I.E. $200 on your $4,000 example) would have a similar effect.

  32. Consumer advocates have been going on about minimum payments for years and years and years, to no avail. Yes, minimum payment schemes are designed to keep the consumer in debt and paying interest for ever. Only now that the income stream is threatened is change coming to the industry, because now it is more to the industry’s advantage than the consumers (the banks really need the money back).

    All you need is cash.

  33. It’s a strong hint that the whole credit scoring system is badly flawed when credit scores decline because of frugal, responsible behavior and credit-worthiness (as defined by FICO) is enhanced by taking on debt. This seems like an under-discussed aspect of the credit crisis.

    My personal experience has been a slightly declining credit score in the last few years, even as my income soared from slightly above median into the millions, allowing me to pay off all my debt (including mortgage) and to cancel bad deal credit cards in favor of the great card deals available to us rich folks. By any rational underwriting standard, I am a bullet-proof risk. Yet FICO liked me better as just another debt-laden average guy juggling to make ends meet. Does this make sense?

  34. Another thought:

    Doesn’t it smack of illegal pricing collusion for card issuers to allegedly “price risk” for borrowers by using a FICO system where an individual who cancels a card because it costs too much is likely to be punished by other issuers via a higher rate? In essence, the card issuers have set up a system based on tacit agreement to punish those customers who seek competition for the lowest price. This seems like it might be actionable.

  35. There seems to be some discussion of whether consumers are rationally calculating the costs and benefits of their credit cards, with the underlying assumption being that if they are, then there is no basis for protecting consumers, and if they aren’t, then there is such a basis.

    So I wanted to share something relevant to this discussion.

    As far as I am aware, consumer finance-providing institutions don’t actually believe that consumers acccurately calculate the total costs of the packages that they buy, at least in many situations. When I was a management consultant, our clients in retail banking commonly distinguished between parts of the fee structure to which consumers reacted (e.g. ATM fees, annual fees) and parts to which they didn’t (e.g. travellers’ cheque issuing fees), and it was already de rigeur strategy for retail banks to shift their fees from the type that consumers were sensitive to, to those which they were not. (This was 9-10 years ago, and I suspect that it is no coincidence that at that time the headline and highly noticeable fees had already been disappearing for some time.)

    There are other examples where companies introduce fee structures that consumers don’t understand- mobile telephoney, at least in the UK- is one. The combination of different call rates at different times of the day, fixed and variable costs and handset subsidies makes the various packages very difficult to understand. (In fact, harking back to my management consultancy work, I recall that one of my colleagues did a little mini-research project in which she created various use profiles for herself and then identified which packages on the market were really the best value, and then travelled to a number of reputable phone retailers and, posing as a prospective buyer, asked them which package was the lowest cost (based on the profiles she had created). Few, if any, gave the right package, although in retrospect I am not sure if she was able to control for varying commissions offered to the dealers.)

    Anyway, this libertarian “caveat emptor”-type argument seems to hinge on the claim that consumers really do know what they’re doing. What does it say that even companies think they don’t?

  36. I am part of the “new economy” in that I don’t have any credit cards, and pay as I go. There are lot of us out there now. We need to get back to the beginning of the phenomina which got started in the 60′s and has continued to the present. I think that most people don’t know how to manage credit. The best thing is to save and wait until you can afford, except for cars and homes. Otherwise, the bank oligarchs are “waiting” for us to fall into their traps.

  37. Mr. Killian, I like your idea very very much. It’s ingenious, easy to apply, understandable to the “average Joe”, beneficial to the country in down times, and could save the people out there whose very nature is inclined to be a debtor all of their lives. In fact, it’s so ingenious that I PREDICT THIS IDEA HAS ABSOLUTELY NO CHANCE OF EVER BECOMING LAW AND EVEN LESSER CHANCE OF COMING UP FOR A VOTE. Because as we all know, the latest stunt of Congressmen who don’t want to enact good laws, is to make certain they’re never ON RECORD as having voted against those good laws. How to avoid being ON RECORD as having voted against a good law??? Make certain it NEVER comes up for a vote (put it last on the agenda pile). If voters or journalists ask why it wasn’t voted on, just shrug your shoulders and say “Well, we had a lot on our plate this legislative term, and I guess it got shoved to the bottom of the pile.” Then go eat a nice steak dinner with the Bank company which owns the credit card business, and ask him what bag of goodies he’s going to give you this year.

  38. @Bayard: No credit cards? That’s communism!

  39. Joe, have often considered this after a conversation I had with a former client who worked with senior management at one of the Big Three credit reporting bureaus. This manager revealed that after initially wanting to compete with FICO, they decided it was more profitable to position their services, paid for my lenders, as collaborative with FICO. They also routinely refer to their means of collecting and analyzing credit data as a Trade Secret, as does FICO, so that they will not have to bear scrutiny for their scoring. As you suggest, this manager told me that they effectively punish consumers for smart credit management decisions such as canceling higher rated cards in favor of other cards or no cards. In my opinion, they do not measure credit-worthiness as much as they measure profitability potential for lenders, as demonstrated by this factor. How else to explain the onslaught of credit card offers in 2003-2007 specifically targeted to poor FICO score consumers? More profit potential, as identified by FICO, is my take.

  40. i don’t get it. it wouldn’t work.

    if people had two credit cards they can get around minimum payments by paying them off with each other. or they would additional purchases on their credit card to conserve cash to pay their higher minimum balance.

  41. q: “i don’t get it. it wouldn’t work.

    “if people had two credit cards they can get around minimum payments by paying them off with each other. or they would additional purchases on their credit card to conserve cash to pay their higher minimum balance.”

    Yes, people can get around it, and people already do what you say. That does not mean that the proposal would not work.

    A lot of people simply make the minimum payment, unless things are such that they feel that they can pay more. If the minimum goes up, most of them will continue to do the same thing. Others may charge more in order to have the cash to make higher payments, and either continue in that vein or take measures to reduce their balances.

    People will adapt to higher minimum payments. And a good bit of that adaptation will be better financial discipline. The fact that some people will increase their debt load, and that some of them will do so indefinitely, does not mean that “it will not work”.

  42. My strong belief is that nobody who carries a balance on a card that they continue to use could possibly understand the costs involved. How can it make sense to buy food with a credit card and immediately incur 18%+ additional extra cost, unless you don’t understand that is what you are doing. I can understand carrying a balance after buying something you want today–the refrigerator example–if you immediately stop using that card. If next month you buy a tank of gas with that same card, you’re adding 18% cost to the price of that gas and ensuring that you won’t actually pay for that gas for 10-15 years. I know relatively intelligent people who carry balances on their cards which they continue to use. When I’ve had this discussion with them, they inevitably didn’t realize what they were actually doing.

    So, traditional transparency won’t work. Just as you won’t improve eating habits by posting a standardized label on carrot cake saying that a portion has 1100 calories unless you’ve also trained your eater to realize that most of us can’t afford to eat even 2000 calories daily.

    If you’ve ever known somebody who’s never dieted, you know that this individual often has no idea of what a normal calorie or fat allowance should look like. In order to be effective, labels must be combined with training.

    When did you last see a public service announcement describing the actual cost of 18% or 28% interest on routine purchases made with a revolving charge? You see two types of communication–that aimed at the relatively sophisticated consumer who probably never engages in self-destructive financial behavior, and angry ranting aimed at less knowledgeable consumers who don’t understand the basics.

  43. no offense, but if people just make the minimum payment without thinking about the consequences, they aren’t thinking. if that is the case the government can make whatever rules it wants and someone will find a way to take advantage of them.

  44. There are many issues here; however, if there is to be new regulation, then one simple rule will make it easier for busy consumers to avoid late fees and interest: Require all businesses to submit their demands for payment on the same date – or at least the same date for last names beginning with a particular letter, or some such. I use my credit cards as charge cards, paying off the balance each month. However, about once every two years I miss a payment – either on a credit card or a PG&E bill or some such. I suspect I’m not alone in having this problem. My demands for payment dribble in over the month, creating an unneeded distribution of a task (bill payment) across the month and making it easy to loose track of a payment. If they all arrived on the same day, I would pay all of them at the same time and none would be missed. Of course, that would deny the card companies a source of income, so I would expect that they would resist such a rule.

  45. let me clarify.

    i can see how reasonable and reasonably cautious people can get ripped off by credit card terms that are not transparent or that involve large rate changes.

    i can see a role for government in enforcing transparency certainly and for ensuring (to some extent, because it’s not totally possible) that the terms are not set up to hit someone very hard while they are going through unanticipatable difficulties.

    but i don’t see a role for government in encouraging people to pay back debt or to get out of debt. it is reasonable for people and businesses to carry debt over a long period of time. people can make that choice, and i don’t think the government needs to have a stance on that one way or another.

  46. Bayard, I’m 35 and I never got a credit card. I had many opportunities when I was at University (I was getting 1 offer very other day in the old “snail mail”). I also could have gotten one after I got in the real work a day world. I know Ross Perot talked about the evils of debt when he ran for president. I lived in China for some time and saving money is something Chinese seem to understand quite easily. We can see this also in the way their government owns a lot of U.S. Treasuries now. I can’t say that I live a dream life now, but it’s a nice feeling to get up in the morning knowing you don’t owe $1 to anyone. It’s a really great “peace of mind”. The only problem where you really need to get a credit card is buying a car or house. But just get ONE credit card (if you have a female in your life, tell her to get her own credit card, with only her name on it, TELL HER YOU’RE A STRONG BELIEVER IN EQUALITY OF THE SEXES). ALWAYS pay the balance at the end of the month. Federal Credit Unions are a good place to get a credit card account. I guess easier said than done.

  47. Relating to what I just said above, I should say, when I said you need a credit card to buy a car or house, I didn’t mean to use it specifically for that, I mean because you need the credit card to build up your credit rating.

  48. What Fair Isaac does is pretty lunatic in some cases. While hardly rich, my experience has been very similar. I currently have “worse” credit that I did as a penniless 18-year-old college student, because I have zero debt and don’t use my cards. That my income is top-decile and that I have a year or two of after-tax salary in cash equivalents doesn’t interest, I guess.

    The major piece of regulation I want to see is turning credit reporting and scoring into regulated utilities. Right now, I want to fire my primary card provider for incompetence, but dare not, lest my FICO dip even lower.

    Sad.

  49. The real product innovation has been in the payment system with the introduction of the debt card and the pre-pay card. I now have three options — pre-pay, pay now (debit) or pay in the future (credit).

  50. What made me laugh (a bit cynically) is that business school students everywhere study an HBS case: Capital One–and its all about credit card innovation–and in fact, the case is used to demonstrate how innovation and experimentation with customers is good. It will be interesting to see the next revision of this case–as these CapOne guys could very well be characterized as part of the evil empire.

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