How the CARD Act Killed Credit Access

The Credit Card Accountability Responsibility and Disclosure Act of 2009 gave us several important protections, such as requiring more transparency regarding credit card fees and the like.

But like a drunken sailor who stumbles back to the saloon for another 15 shots of tequila, the government just couldn't stop there. By restricting when and how credit card companies could manipulate rates and the application of payments, lenders had to adjust their risk-management strategies. We all think that sounds good on the surface, but like anyone following the Fake John Locke on Lost, once you follow his pitch, you're led to your doom. What we ended up with was an act of government nanny-statism masquerading as consumer protection.

What was last is now first
Before the CARD Act, banks generally applied payments to balances with lower interest rates first, maximizing revenue from the riskiest customers who might have multiple tiers of interest rates. Now, credit cards must apply payments to higher interest-rate balances first, effectively lowering interest rates on the riskiest borrowers.

Because of this increased risk, banks responded by offering fewer low-interest promotional rates, and they raised rates on people with multiple interest-rate balances to squeeze as much out of them as possible before the law went into effect.

Even worse, you'd think that since the government insisted on playing Mary Poppins, it should have given the credit card companies the medicine along with the sugar. Nope. The legislation did not cap interest rates for consumers, nor did it prevent rate increases! All it did was require a 45-day notice for changes. So the riskiest borrowers saw their rates jack up immediately, before the law could take effect.

Changing the rules
Amid all these new rules, the risk-management folks got together, ran their sophisticated algorithms and talked Geek, and then decided the safest thing to do was to simply drop the riskiest borrowers. American Express (NYSE: AXP) went so far as to pay customers $300 to go away. Or they lowered people's credit limits, even if they were great customers with great credit scores. That's what happened to me.

How much has this all affected consumer credit access? The Federal Reserve puts out a monthly report on consumer credit. Look at the decreases in revolving credit at the end of last year.

Just when consumers needed access to credit, the government inadvertently starts restricting it. Nice job, Washington!

What it means for investors
While Americans were having their credit cut, banks happily unloaded the deadweight. For March, American Express announced that it posted the lowest card delinquency rate among the six biggest issuers. Last quarter, U.S. card income exploded to $428 million compared with a loss last year. Citigroup's (NYSE: C) first-quarter credit-loss provision fell by 22%. Meanwhile, JPMorgan Chase (NYSE: JPM) announced that it would no longer offer cards to 15% of customers who have them and would cut off or reduce some credit lines. The company lost more than $300 million in the quarter because of its credit portfolio.

Meanwhile, Discover Financial Services (NYSE: DFS) posted a $103 million loss this past quarter, compared with a similarly sized profit the year before. Fools looking to profit from this situation must examine each issuer's loan-loss provisions and charge-off rates to see who is faring the best.

Others might be better off looking at Visa (NYSE: V) or MasterCard (NYSE: MA). As processors, they are a de facto oligarchy, and I think infrastructure plays are inherently less risky than the products they support. That being said, Congress just voted to reduce debit card fees, so the situation is obviously fluid.

Bottom line: Be careful owning these stocks until the full impact of the CARD Act and pending Consumer Financial Protection Agency regulation is clear. As a cardholder, however, all I can suggest is cutting up your card and sending it to Congress.