Consumer Credit / Credit Cards
Re: Tell Congress to Fix Credit Cards

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By Patzer
December 14, 2005

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[The following is in response to an article by Selena Maranjian (TMF Selena)]

Nobody's saying the credit cards aren't usually honoring the terms of their agreements. The problem is that certain terms in those agreements are so unreasonable that as a matter of public policy they should be forbidden.

Hear, hear!

Just because I can read the terms and conditions, and understand them, and jump through the appropriate hoops to avoid getting hurt, does not mean that the terms and conditions are reasonable per se. Competition is a fine thing, but sometimes the competitive market produces a socially undesirable result. This is when regulation is needed.

A less controversial case in point: The Do Not Call list. This is regulation. It is the government interfering with the action of the free market. And it is totally necessary, because the action of the free market produced a socially undesirable result. The pre-Do Not Call list telemarketing industry was acting rationally in response to the market. Calls were cheap. Machines to place automated calls were cheap. Labor was expensive, but the cheap machines meant you didn't have to actually use human labor unless a human picked up on the other end. The cheap machines let the telemarketers keep trying the same list of numbers again and again without using any of their human labor until they got a human answer. The low cost of people hanging up on them let them call many, many uninterested people in order to achieve one sale. It made perfect economic sense, and required regulation to eliminate to socially undesirable practice of making my phone ring with unwanted calls.

Granted, regulation is usually inefficient. It frequently imposes costs for functions of no value. It is frequently written to address some tangent to the real problem instead of the actual problem. And it tends to become public policy when private industry is being unreasonable. Even though I can use credit cards without hurting myself, I believe that many current CC industry practices have become so unreasonable as to invite regulation. Perhaps the proposals on the table are unwise, or will produce results worse than the unregulated market has produced. But think about what the unregulated market has produced: I can get any card I want, but I can't know for sure what my terms and conditions will be a year from now, or even three months from now. The CC companies can afford to make my terms and conditions change so much that I don't have the time to understand all the changes. They haven't got to that point yet, but they are clearly headed in that direction. And guess what? If I get disgusted with one card issuer's revised terms and conditions, I find that all the other issuers are doing something similar and changing just as often!

Just for giggles, let me take a look at the proposals on the table:

1. "Congress should cap interest rates on credit cards at no more than the prime interest rate plus 10%.

I like the idea of a cap. There should be some interest rate above which lending is illegal. A natural corollary of this concept is that if it is too risky to lend to a specific borrower at the usury limit, the lender should not be required to extend credit. If these concepts were implemented in a reasonable manner, people wouldn't be able to foolishly spend themselves into bankruptcy. On the down side, there would be people who are unable to get credit for medical needs. This is the poster child example that prompts the concept of credit as a "right". I tend to think that allowing unlimited interest rates creates too many problems, and that unaffordable medical needs should be addressed in a different context than extending credit to people who can't afford to pay back the loans.

Having said I like the idea, the actual proposal of prime + 10% is dumb. Prime is a number created by the financial industry. Create a limit of prime + X, and prime will become a very high number. The most favored borrowers will get loans significantly below prime, and prime will essentially be a meaningless number. Instead of indexing to the prime rate, either an absolutely fixed rate or cap indexed to the consumer price index would be a better idea.

2. "The first page of every month's bill should state how long it will take and how much it will cost -- interest included -- to pay off the balance at the minimum payment."

I think this is a dumb idea. The kind of people who need to be shocked simply won't read this information, or, if they do read it, they won't care until they're already in a deep hole. Let's not create a regulation that doesn't accomplish anything.

3. "The number and types of fees should be restricted to make it easier for consumers to compare cards."

This is another dumb idea. It's not the number of fees, or the type of fees; it's the total amount that is triggered by failure to pay on time. I further believe this idea is as futile as CAFE was for the automotive industry. No matter how you write the regulations, in 5 years or less the CC industry will figure out how to drive through all the loopholes.

4. "Card companies shouldn't be allowed to add new terms and pile on increases after the consumer has signed on. Card companies that raise the interest rate should not be allowed to apply the higher rate to existing balances -- that is, money already borrowed at a lower rate."

I agree with this one. Money borrowed at 6% should stay at 6%. Money borrowed at prime + 10% should stay at prime + 10% and fluctuate with prime. If a customer's risk profile increases, let the CC issuers assign a higher interest rate to new borrowing. And let them continue to apply payments to the lowest interest balance first. The CC companies can still phase in higher interest rates for increased risk, but customers don't get socked with a double digit increase in interest rates on existing debt.

The more important aspect of this is that it ought to force CC issuers to be more careful about extending credit to risky borrowers. Better underwriting and lower credit limits for sub-prime borrowers means the people who dig holes won't be able to dig them as deep. With luck, this results in lower uncollectibles and comes back to all of us as lower costs of borrowing.

5. "Card companies should be prohibited from increasing the periodic interest rate because a cardholder missed a payment to a different creditor or because his or her credit score changed."

On its face, this one sounds reasonable. It is needed to limit the damage done to a borrower from identity theft, a false report of a late payment, or simply a dispute with a third party about a whether a bill is owed. In my mind, the harm from interest rates rising in response to false information outweighs the right of the CC issuer to reassess risk.

However, if proposal #4 is adopted, #5 is probably unnecessary. If any increases to interest rate are only for new borrowing, the consumer should have sufficient time to correct erroneous information and negotiate a better future rate with the CC issuer.

6. "Credit card companies should be required to evaluate each consumer's ability to repay before issuing a credit card. Cards that encourage unrealistically high balances keep consumers on a debt treadmill."

Another dumb regulation. Adopt #1 and #4, and the CC issuers will do this. Write regulations to require this, and you just create more meaningless bureaucracy.

7. "Practices that trigger unnecessary fees, such as setting short grace periods and failing to count a payment from the date of the postmark, should be banned. Consumers should be guaranteed 30 days to pay and shouldn't have to pay a late fee if the envelope is postmarked on time."

A laudable goal, but I don't think you can write regulations that will accomplish this. I suspect that any regulations requiring grace periods to be such and such a length are likely to make grace periods a thing of the past. I certainly don't want that result. And postmark date is an anachronism in the age of online bill payments.

I have a card with a 30-day grace period and a card with a 20-day grace period. I accept the shorter grace period because it comes with better cash back. I'd rather not have regulations messing with this aspect of what the free market has produced.

In summary, I think that some additional regulation of the credit card industry would be a rational public response to how the industry has behaved over the past decade. However, I'm not terribly impressed with the regulatory agenda as set forth in the article. There are some good ideas there, but there are more bad ideas.


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