Thursday, March 28, AD 2024 6:30am

Regulation & Credit Card Companies

My wife was going through the mail yesterday and noticed that the contract terms for two of our credit cards were changing.

On the first card there was a large credit-limit increase (unrequested), and on the second, the interest rate for carrying a balance was being adjusted upward to 18%. Neither of these changes were of much consequence: we don’t carry a balance, and, as I said, the credit-limit increase (timed for the holidays, no doubt) was not requested.

I am generally not in favor of increased regulation for private contractual arrangements. Paternalism from politicians is nearly always distasteful and/or ill-advised, and the accompanying over and under-inclusiveness problems make government regulation of private contractual arrangements difficult to do well. Additionally, one person’s license to make irresponsible decisions is another’s much-needed access to credit.

But the credit card industry needs more regulation. An 18% interest rate is unconscionable, and the variety of programs by which credit card companies ensnare unsophisticated borrowers disproportionately impacts the most vulnerable consumers. In her book, The Two-Income Trap, bankruptcy expert and Harvard law professor, Elizabeth Warren, recounts being hired as a consultant by Citibank to recommend ways to cut its losses from cardholders in financial trouble. She made a proposal essentially arguing that Citi should stop lending to borrowers who were already in obvious financial trouble. As she recounts it, the ranking executive present at the meeting replied “We appreciate your presentation. We really do. But we have no interest in cutting back on our lending to these people. They are the ones who provide most of our profits.” Warren is a bit of a polemicist, and she has been known to strain statistics to the breaking point.

Nevertheless, it seems to me that the credit card industry, as presently constructed, is morally bankrupt (not just morally in Citi’s case). It systematically tries to identify and exploit the most vulnerable and unsophisticated members of society by offering temporary financial relief in exchange for an unreasonably large long-term commitment. I plan to explore in a future post the type of regulatory safeguards that I think should be in place, but I am curious in the meantime about people’s thoughts. Are many of the credit card industry’s practices immoral? Does the industry need more regulation? If so, what should that regulation look like?

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Donald R. McClarey
Admin
Monday, November 24, AD 2008 12:58pm

I have small love for the credit card companies, as my hundreds of bankruptcy clients can attest, but you can either have easy credit with little regulation, or you can have tight credit with lots of regulation. Credit card debt is a classic unsecured debt. Those type of debts are going to have high interest rates unless the government subsidizes the loans. Who knows? Perhaps the government will be doing that in a few months. The Federal government is doing precisely the wrong thing with the bailouts, and I imagine this philosophy will spread with the government taking on additional obligations that the taxpayers will never be able to pay. Far better to let debtors, both individual and corporate take bankruptcy.

Zak
Zak
Monday, November 24, AD 2008 2:55pm

I am relatively open to regulation, and I hold no love for credit card companies, but capping their interest rates just drives people to pay day lenders and loan sharks, with worse outcomes than bankruptcy.

Donald R. McClarey
Admin
Monday, November 24, AD 2008 3:19pm

Pay day lender loans often have rates, in Illinois, that work out to about 345% per annum or worse.

Donald R. McClarey
Admin
Monday, November 24, AD 2008 7:48pm

“but it seems to me that it would be relatively easy to cap the interest rate at something like the the prime rate plus 6-8 percent.”

It’s certainly very easy to do John Henry by government fiat, but it would also place credit cards out of the hands of most people who believe that they need credit. Today the prime rate is 4.00. Limit credit card rates to 10.00 or 12.00 and only people with pristine credit ratings will be able to have credit cards. Banks are in business to make money and they are not going to give unsecured loans to people with less than stellar credit histories without the ability to charge interest rates commensurate with the risk. I believe adults should be able to decide for themselves whether an interest rate on a credit card is too high. Careful buyers with good credit ratings can get low interest credit cards. For the rest, let them make the decision as to what is in their economic interest rather than have the government take that decision from them. The vast majority of credit card debt is repaid so I would submit that only a small minority of credit card holders are unable or unwilling to live up to the terms of their agreements. I prefer a society with easy credit and high interest rates on unsecured debt to government regulation which artificially lowers interest rates and dries up credit.

Darwin/Brendan
Monday, November 24, AD 2008 8:16pm

On average, a person who is willing to borrow at an 18% APR for a significant period of time is not in a good position to repay it.

Generally speaking, an interest rate will reflect convenience (both convenience of the borrower and potential inconvenience for the lender) as part of the interest rate. One of the things about credit cards is that they allow you to take out a significant loan (up to a certain amount) at any time, and pay it back whenever you want, so long as you’re making a pretty minimal payment. That naturally increases the interest rate — both because the lender doesn’t know when they’ll get their money back, and because the borrower can take out money based on circumstances that he knows about but the lender doesn’t.

So for instance, if I lost my job, and then we had a major medical expense, I could run up a few thousand dollars on my credit card without any clear idea of how I’d pay it, using it as a way to get a 5k loan without collateral or any fixed pay-off period and wait till I had work again — but if the lender had to evaluate me at that moment they would certainly not offer to give me 5k given that I had no income.

In other words, it give the borrower the edge in terms of information.

Now, I agree that credit card companies are often, to some extent, predatory in their approach. They know that if they have good enough ways of calculating who really needs money but will eventually pay it all of, they can successfully land long term borrowers who will net them a lot of interest.

However, that the CC companies even make much money in the first place suggests that much of the time they do indeed get paid off — which means that most borrowers aren’t simply postponing the inevitable. (While nearly everyone who declares bankruptcy doubtless has lots of CC debt, most people with CC debt never declare bankruptcy.)

I suppose a lot depends on what you mean by “significant period”. We’ve had a pair of nearly year long periods in our marriage when a combination of unexpected expenses and low income resulted in carrying a balance — though for a slightly lower interest rate.

The trick is, I was fairly confident in my ability to earn and save my way out of those situations — but a government regulator is not really in a good position to determine if a given borrower is.

Darwin/Brendan
Monday, November 24, AD 2008 10:30pm

And similarly, I’m not necessarily totally against regulation of such companies per se — but it strikes me that most of the regulation ideas which are developed specifically by those wanting to “protect the poor from predatory lending” aren’t unhelpful. Maybe in part because those with that specific aim often attempt too much.

I could potentially see things which are fairly circumscribed working well — designed more to change the weighting of the game rather than “protect” people. For instance, one might allow rate changes at most once a year and limit the amount a rate could be increased as a “penalty rate”. (Though one would need to understand this would result in higher rates over all and weigh the two possibilities.)

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