Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



Nasty Credit Card Policies Are Bad for Business

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

It's always refreshing when the bad guys lose and the good prevail. In the credit card business, that's exactly what happened when the Credit Card Accountability, Responsibility, and Disclosure Act became effective in July 2010. Gone was the ability of credit card issuers to raise consumers' rates willy-nilly, tacking on fees without prior notice, along with numerous other slippery practices to wrangle more money out of unwitting cardholders. Card issuers lobbied hard against this law, claiming that such restrictions would hurt their bottom lines. As it turns out, they were wrong: According to a new study, it was their bad behavior, not regulation, that dinged profits.

A free-for-all for banks and credit card companies
In the year before the law took effect, credit card issuers went on a tear, raising fees, interest rates, and customers' ire. Consumers had their accounts closed without notice, and many saw their credit limits lowered. The banks and card companies claimed that they had to do these things to fill their coffers before the changes became law and began eating into their profits.

JPMorgan Chase (NYSE: JPM  ) and Discover Financial Services, for example, raised the minimum payment percentage for some customers, as well as the rate on balance transfers. In some cases, Chase also charged customers $10 per month to maintain their lifetime low interest rate, as well as informing them that they had to bump up their monthly payments. Bank of America (NYSE: BAC  ) also raised various fees and, along with Citigroup (NYSE: C  ) , lowered monthly limits and pushed up interest rates. Citi, in fact, had the dubious distinction of enacting the largest interest-rate increases of the top-tier card issuers. Capital One (NYSE: COF  ) raised rates on low-risk customers by more than 6% in some cases, with little prior notice. Wells Fargo (NYSE: WFC  ) joined its peers in the fall of 2009, raising interest rates by 3%, though it did remove fees for customers who exceeded their credit limits.

Why did these banks and card issuers do it? They claimed, at the time, that these changes were necessary because of the state of the economy and high unemployment, which increased the chances that customers would stop paying their credit card bills. Supposedly, raising fees and interest rates was making up for the idea that extending credit was becoming more risky.

Credit practices caused the very problems banks sought to avoid
What happened was the exact opposite of what the banks said they wanted to prevent, as people defaulted in droves. As it turns out, ratcheting up rates and minimum payments in an economic downturn isn't a great business plan.

A recent New York Fed report indicates that household debt has fallen over the past four years -- particularly credit card debt. Indeed, the news looks good when you consider that Americans are holding a mere $679 billion now versus a 2008 level of $866 billion on their cards, but there is more here than meets the eye.

In 2010, the year after all the hijinks on the part of credit issuers, the industry was forced to write off a huge amount of debt as uncollectable, representing a 300% increase from four years prior. Interestingly, charge-offs were up appreciably in 2009 as well, at the very same time as banks were raising rates and minimum payments. In fact, of the $93 billion decrease in credit card debt for that year, fully 90% was written off by the credit card industry. When a company boosts a customer's minimum payment to $900 per month from $373, as Chase did with one retired cardholder, problems should be expected.

Credit card issuers' behavior was directly linked to losses
The report from the Center for Responsible Lending pointed out how deceptive credit practices directly affected banks' bottom lines for the years 2006 to 2010. Among their findings was that banks tended to engage in several of these activities at once, and that the biggest offenders were among the top 10 credit card issuers. Issuers with the most consumer-friendly and easily understood credit rules tended to be smaller regional banks and credit unions.

The study compared pre-recession losses with those experienced by issuers during 2009 to 2010 and found that the loss rate was markedly higher for institutions with dicey credit card practices than for banks that had more transparent rules. In fact, when the CRL compared the bank with the least onerous practices with the institution with the worst profile, the loss rate more than doubled for the latter.

The bottom line
The study found that the very practices that banks insisted would protect their profit margins in the short term actually worsened the losses they sustained over time by triggering higher defaults. In fact, many of the banks' actions were not truly associated with risk management, such as deliberately applying payments to customers' accounts in a way that triggered higher fees and interest rates.

What does this mean for investors? For one thing, it supports the position that financial regulation protects not only consumers, but financial institutions as well. It would be hard to argue, given all the evidence, that banks and credit card issuers had read the market correctly when many decided to engage in shady credit practices. Apparently, legislative guidance is necessary to avoid such mistakes in the future, and the CARD Act will be of assistance in that regard.

This scenario also shows that customer-friendly policies can be good for business, and serious investors will do well to explore this factor when performing due diligence on financial stocks in the future.

Careful research applies to any type of investing, and when it comes to vetting stocks to add to your retirement portfolio, it's important to have access to expert information. Let The Motley Fool show you the "3 Stocks That Will Help You Retire Rich," as well as some excellent tips about saving for those golden years. This special report is free, but for a limited time -- so get it now.

Fool contributor Amanda Alix owns no shares in the companies mentioned above. The Motley Fool owns shares of Citigroup, JPMorgan Chase, Wells Fargo, and Bank of America. Motley Fool newsletter services have recommended buying shares of Wells Fargo. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1905236, ~/Articles/ArticleHandler.aspx, 5/30/2016 8:39:48 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated 2 days ago Sponsored by:
DOW 17,873.22 44.93 0.25%
S&P 500 2,099.06 8.96 0.43%
NASD 4,933.51 31.74 0.65%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

5/27/2016 4:01 PM
BAC $14.88 Up +0.18 +1.22%
Bank of America CAPS Rating: ****
C $46.58 Up +0.47 +1.02%
Citigroup Inc CAPS Rating: ***
COF $73.83 Up +1.27 +1.75%
Capital One Financ… CAPS Rating: ****
JPM $65.43 Up +0.40 +0.62%
JPMorgan Chase & C… CAPS Rating: ****
WFC $50.85 Up +0.30 +0.59%
Wells Fargo CAPS Rating: *****