Credit Cards Don’t Kill Credit Ratings, People Do
Credit card companies are getting a lot of grief in the blogosphere (not to mention Congress) lately. Most of these critiques are just a bunch of shaggy dog stories, but the very smart Rortybomb has an extremely numerate post in which he points out that when the interest rate on your plastic goes from 8% to 28% because you’re two days late on a payment, it’s highly unlikely that this is a pure reflection of a change in your probability of default. His analysis indicates that the way this price (i.e., interest rate) change is determined is not by the change in creditworthiness that is indicated by the new piece of information, but instead by the price sensitivity that is indicated by this new piece of information:
One model is that the credit card companies are lying to you – they think of you less as an individual to have a dynamic risk factor dynamically assigned to you, and instead as part of a portfolio to have a specific rate of return extracted from. So they have statisticians and psychologists not to create a credit risk, but instead to figure out who is likely to pay what when, and use that to keep their returns very high. Quants to study how much they can squeeze from someone – not too much, but not too little. So it is less about the awesome part of markets, the price information and the convergence and feedback, and something more feudal.
And then:
Update: So after discussing with some people, I think the big problem, as was a problem with subprime mortgages, in invoking the market is that the inital rate is competitive, but the refinancing later is not. Companies bid up and down your initial rate plus rewards package. However once you are locked in, and get a balance going, nobody is bidding against your rate.
His conclusion is that credit card companies are, morally speaking, “scumbags”.
In my experience, and very broadly speaking, he is correct about the logic by which price changes (including interest rates, fees and other contract terms) are determined. The credit card company is making decisions with the intent of maximizing their shareholder value, consistent with the law. (See *1 for more details about method.)
In other words, this is a normal consumer market in which the guy selling you something is not looking out for you, but is trying to make money for himself. This is just like a car company, search engine provider or private university. Why is the guy who sells you a credit contract responsible if you are later unhappy about the decisions that you made?
In the specific example that Rortybomb cites, a reasonably prudent person should be aware that he or she has just signed a contract that gives the counterparty the right to increase the interest rate on a debt contract from 8% to 28%, or to the so-called penalty rate, if you miss a payment. If you have a credit card, go to your cardholder agreement and search for “penalty rate”. In any normal such agreement, you will almost certainly find a specification of the penalty rate, and the conditions under which this rate may be invoked. Expecting that your counterparty will not act to serve their own interests under a contract is the attitude of a child. If you didn’t want this deal, you shouldn’t have signed the contract.
Now, fraud is generally forbidden in these markets, and is for credit cards as well. There can get to be a gray area – what amount and type of disclosure is required and so on. Second, there is normally some kind of (speaking non-technically, and without a specific legal meaning to the term) implied warranty. Even if my purchase agreement with GM doesn’t say “this car will not explode in a ball of flame if you tap the accelerator twice and then hit the brakes”, they are subject to legal action if this occurs.
What we are really debating is where to draw the line on these two questions. That is, to what degree does the issuer have to emphasize risks, what degree of complexity should be allowed in the contract and so forth?
The Center for American Progress is typical of current sophisticated liberal thought in emphasizing this:
Credit cards are convenient, but difficult to use responsibly. Credit cardholder agreements are written in language that is above the level at which about 50 percent of U.S. adults read, and information within them is poorly organized. Moreover, issuers appear to “price” the cost of using credit cards by taking advantage of cardholders’ behavior biases. For example, credit card issuers take advantage of the fact that cardholders underestimate the probability of paying late or going over the credit limit, and punish this behavior with fees and increases in the penalty rate.
The right information at the right moment can help cardholders make better decisions. A text-messaging system by itself would not prevent issuers from continuing to price credit cards however they like, but it would orient cardholders toward the best outcomes, such as paying on time and not going over their credit limit. This approach recognizes that most individuals don’t behave like homo economicus—the “economic man” of economic textbooks who maximizes every financial decision and has perfect information to do so. Most cardholders could benefit from a “nudge” toward a more beneficial choice.
But why is it the credit card company’s job to “nudge” you to “more beneficial choices”?
It is an unfortunate reality that there are many people who are not equipped to get along in a capitalist system. They lack some combination of (rarely) the basic intelligence and (much more frequently) the emotional maturity and self-discipline required to make their way in a world in which others are not looking out for them. Much of the rationale for traditional notions of child-raising, education and social organization is to prepare people to live in such a world. That is, to produce actual adults. To the extent that we can count on people to act responsibly, we can have a less regulated economy that will tend to produce greater freedom and growth. But the problem of how to deal with the semi-incompetent is a real problem that will never go away entirely.
One practical effect of proposed credit card legislation would be to make it illegal for party A to voluntarily engage in a credit contract with party B that has some specific elements that might be abused by an irresponsible person. Why should this freedom of contract be restricted for responsible people? Because the guy who lives down the street might use the same contract to drive himself into personal bankruptcy with Cheetos, beer and big-screen TVs?
Maybe, actually. If (i) the abuse problem were severe enough, (ii) the productive uses of such credit extremely rare and (iii) there were no other practical remedies, this could be a theoretically poor, but practically-workable, compromise. But I don’t think any of these assumptions holds. First, the vast majority of people who use credit cards don’t default, and second, they continue to voluntarily use this source of credit.
Further and most importantly, I think there is a different and better approach. I don’t think our basic strategy should be to forbid contracts that are only suitable for actual grown-ups, but instead to provide safe havens for the less competent. This could, in theory, include things like requirements for a “simple card” alternative and so on. I’ve tried to describe such an overall approach to financial regulation as “walls, not brakes”. It would not eliminate the problem of some sympathetic people getting over their heads in credit card debt, but should reduce it, while not giving up on the dynamism enabled by freedom of contract.
*1 In my experience, the way this is determined is by running structured experiments in which, by illustrative example, 50,000 randomly-chosen late payers are given a large interest rate bump and a matched control group is not. The experiment is run long enough to measure the true life-cycle profitability of each group. The superior rate approach is deemed the “champion”, and future tests pit other potential “challenger” rate, fee or other changes against it. Segmentation of test results is used to fine-grain this to identify sub-groups for whom different approaches work better. While individual scores are developed by individual, it is a lot more complicated than simple data mining to develop propensity scores (for reasons of identification of causality that are complex and beyond the scope of this post).
The “reasons why” such a strategy of raising interest rates dramatically for most people who pay late might work (e.g., it actually indicates a higher default risk; it indicates somebody is more absent-minded, and will be slower to notice and respond to a rate change; it’s a predictor of future low profitability, and the very high interest rate is way to encourage them to go elsewhere, etc.) are complex, overlapping and subject to interpretation. Nobody ever fully understands why any consumer or group of consumers makes a specific decision. (This is a huge practical distinction between the professionalized, wholesale and commoditized bond market that Rortybomb references, and a typical consumer market like this one.) However, the test result – that strategy X makes the issuer more money – is the reliable result.
And while there is often some element of consumer lock-in in various ongoing purchase decisions (this is why razors tend to be surprisingly cheap, and blades surprisingly expensive), it’s not quite true to say that “refinancing later is not [competitive]”. The of the explosion in credit provision to high-balance revolvers was largely predicated on the invention of the balance-transfer with teaser rate business model 15 – 20 years ago; that is, on poaching exactly such (potentially) high-profit customers sitting in the portfolios of incumbent issuers.
Well, why are you responsible if he isn’t happy? Yet that’s precisely the position the CC companies put themselves in – hrm, I’m not happy with the terms of the contract we “negotiated” at the outset, here are the new ones. You don’t like it? Tough titties.
I’m not sure it is, but surely their participation in a free market system has to be predicated on their honest behavior? What we have now is a system where consumer credit rating is touted as a system that rewards honest and responsible credit use with preferential interest rates, but is actually a system that operates on some other, opaque basis – potentially affecting not just your ability to access credit, but your capacity to be employed, rent an apartment, own an iPhone, get health insurance, and myriad other non-credit-related things.
What we have now is a system where many Americans have to treat their credit card companies like vengeful tiki gods – “I did everything you asked, I paid down my debt every month, I’m a responsible creditor – and you still jacked my rate and lowered my limit! What else do I have to do?!“ – because the behavior credit card companies say they want to reward is actually the behavior that apparently costs them money.
Remember how making it dramatically harder for individuals to enter personal bankruptcy was supposed to make credit cheaper for the rest of us? Does anybody remember that actually happening? I don’t.
— Chet · May 28, 04:22 PM · #
“But why is it the credit card company’s job to ‘nudge’ you to ‘more beneficial choices’”
Because we are in debt to them? If their business is, as they claim, the issuance of credit and not the usury that their model and practices actually suggest, then their primary interest is in the repayment of said debt (with appropriate interest), not in its continued existence as a source of mere revenue.
— forestwalker · May 28, 04:31 PM · #
Chet:
You say:
But my point is that this is not true. Assuming you have a credit crad, go look at your cardholder agreement. I’m highly confident you’ll find a section called “penalty rate” that specifies the maxmimum penalty rate and the conditions under which your issuer can invoke it.
— Jim Manzi · May 28, 04:34 PM · #
forestwalker:
You say:
State Farm “claims” in the sense you are using here that they’re a “good neighbor” – should I be pissed at them when they don’t bring me cake my first week in my new house? Come on, you have a contract with a credit card issuer that specifies rights for each party. They’re job, as with any profit-making venture, is to make profits legally.
— Jim Manzi · May 28, 04:39 PM · #
I am. In particular I’m looking at the part where they can unilaterally alter the terms of the contract at any time. I’m not given to understand that this is unique to my credit card, so now I’m kind of wondering how you managed to miss it, Manzi.
— Chet · May 28, 04:54 PM · #
But usury is against the law.
— Chet · May 28, 04:57 PM · #
I think you’re missing the forest for the trees, Jim.
In the small frame, yes. You signed the docs, your rate exploded. You either didn’t read, didn’t understand what you read, or didn’t think it was going to happen to you. In other words, you are an asshole and you pay.
But isn’t “didn’t read/didn’t understand/didn’t think” more or less a recap of the CDOs et al that brought pyramid scheme to a screeching halt? “But these were complex instruments and they had misinterpreted the risk model…” Blah blah blah.
Fuck that shit.
Didn’t read, didn’t understand, didn’t think it was going to happen to them.
No keep in mind, nearly ever proposed consumer credit reform I’ve read about will hurt me, or at least would have hurt me when I used credit to build my little empire. I wouldn’t have been able to buy my first home without what is now referred to as an toxic mortgage. I wouldn’t have been able to finance my business without the fast and loose credit we had over the last decade by necessity that includes the punitive terms attached to failing to meet my obligations as a borrower.
If you’re a work-a-day guy and you leave a five-figure balance on a note that can go from 8 points to 28 points, you are playing with fire. Does that take an IQ of 152 to understand? Maybe, but I don’t think so. Sit down with a calculator and do the math. It’s 7th grade stuff, or at least it used to be. But that’s a rant for a different day.
— Tony Comstock · May 28, 05:01 PM · #
“State Farm ‘claims’ in the sense you are using here that they’re a ‘good neighbor’ – should I be pissed at them when they don’t bring me cake my first week in my new house?”
That’s just silly. Misrepresenting the nature of your business and the nature of the contractual relationship you are inviting customers to enter into (if that’s what these companies are in fact doing) is not at all the same thing as an over-the-top advertising slogan.
“They’re job…is to make profits legally.”
Legal standards are not static (as the recent change in bankruptcy law these same companies so strongly lobbied for demonstrates), hence the current debate in Congress. If you want to defend the legal status quo you need to do so on social/moral/pragmatic grounds. From a defensibility under the current legal regime (within the narrow scope of ethics) does not follow an implication that the current legal regime must or should stand.
— forestwalker · May 28, 05:20 PM · #
“If you want to defend the legal status quo you need to do so on social/moral/pragmatic grounds. From a defensibility under the current legal regime (within the narrow scope of ethics) does not follow an implication that the current legal regime must or should stand.”
What I meant, said better. With the rules being re-written everywhere else, it seems odd to focus “you knew the rules when you decided to get in the game” in this one instance. What comes after too big to fail? Too big to succeed!
— Tony Comstock · May 28, 05:40 PM · #
Chet:
There are two possibilities here:
1. You are one of the 99.99% of the people who have signed a cardholders agreement that says your issuer can change these terms with X days notice, during which time, you can terminate your agreement (in practice, of course, there are statutory and judicial limits placed on this right), or
2. You actually signed an agreement that allows your counterparty to change terms unilaterally without notice (hard to imagine).
In either event, why did you sign such an agreement?
— Jim Manzi · May 28, 05:52 PM · #
Empirically, how many people actually get trapped by rate increases? It looks like offers to transfer balances are all over the place — has anyone done work on how many people (1) pay a few days late, (2) are not actually a bad credit risk, but (3) are unable to avoid the rate increase (at least after the first month) by changing cards?
Put another way, Rortybomb argues that if he pays a few days late, the risk to his credit card company isn’t actually increased that much. That’s true, but if he actually still is a good credit risk, he can presumably leave. If he’s a bad credit risk, then the rate might be appropriate. Hitting him with the rate is the cheapest way of sorting that stuff out, and requiring a more expensive method will show up in cardholder costs someplace. (Rortybomb discusses this in his recent Tony Soprano post, and is excellent as usual).
— J Mann · May 28, 05:55 PM · #
forestwalker:
It’s about as silly as claiming that “because they’re in the business of providing credit” it should be illegal for a credit card issuer to have a defined penalty rate with a defined late payment trigger in their credit contract with you. In any event, silliness is pretty subjective, so I doubt we’ll make much progress on this.
— Jim Manzi · May 28, 05:59 PM · #
Hey thanks! I feel bumped-up one now.
One thing that really jumps up at me, but is a bit dorky to explain why it’s so odd, is that a ‘simple card’ has a fee with it, but when you add an embedded option to revolve that transactional debt (cc = simple card + revolver) it goes from a negative expected value to the cc company to a positive or zero one! The embedded option has a negative expected value to the consumer. You have to pay more to get less services with the simple card. And I do think that’s fantastic – I hope debit cards and transaction cards get emphasized more in the future. Did you see interfluidity’s call for a national simple card? That’s probably not what you have in mind :)
I have done some credit risk work at the high-end, so I’m very sympathetic to the notion that jumps in prices really do reflect underlining information; I like hearing more like *1 about how these rates get implemented. The system has seemed to converge to an optimal profit model of buying out-of-the-money puts on consumers. Which I find disturbing in the implications – ideally we don’t want a financial company’s profits to be primarily from people’s finances collapsing. That’s going to happen in part by the nature of the business, but suddenly there’s an incentive to de-stabilize people’s finances with the rates and terms.
But why is it the credit card company’s job to “nudge” you to “more beneficial choices”?
It isn’t. Quite the opposite – it is their job to optimally confuse and indebt people, and I think they are doing a fantastic job. Provided the government can enforce a ‘nudging’ mechanism (a big if!), why shouldn’t they? Especially with the informational stuff, wouldn’t they have an obligation to? If the business’s large profits is predicated on people being confused about their actions and consequences, then it strikes me as non-controversial as putting a warning on cigarettes.
— Rortybomb · May 28, 06:03 PM · #
J Mann:
Yes, this is a real effect. It’s what I tried to nod toward in the third of my illustrative examples of why this might be profitable in the *1 methodology note at the end of the post.
— Jim Manzi · May 28, 06:04 PM · #
JM, RE: Rortybomb and Marty
Watch that Good Fellas clip and then tell me we’re not running a bust out scheme on ourselves.
— Tony Comstock · May 28, 06:08 PM · #
Rortybomb:
You can think of the card as the ante the cc company has to pay to get into the business of making high-margin revolving credit available. This is, in analogy, how almost all retail financial services work (ask any senior retail LOB banker about what fraction of their economic profits come from overdraft fees – NSFs – and “cold money” deposits!), and by analogy, retail in general.
I take the point about the role of government. But I think it’s more accurate to say that the government’s job is to promote the general welfare. We’re not going to resolve the debate about the proper scope of free markets versus regulation here, but I think it’s fair to say that just becauase you and I might agree that the world would be better place if this specific list of people could not make this list of deals with these people (assuming no knock-on effects), that a law to forbid this is not necessarily therefore a good idea. That is, there do tend to be a lot of unpredictable knock-on effects. As a general priniciple, which I believe has a lot of empirical support but is far from a scientific finding, it is my view that we should have a strong presumption in favor of letting other people be free to make decisions, even though we think these decisons are unwise. On the other hand, arguing against almost any reasonable form of disclosure is pretty hard to do.
— Jim Manzi · May 28, 06:20 PM · #
In a dramatic failure of the free market system, I observed that all credit card contracts had these terms, and since nobody was offering me what I wanted, I chose from the available options.
But now your position seems to have changed – now you recognize that the credit card companies are in the unique position to change the terms of the contract as they see fit, but now you’re defending it. I guess that’s a step up from using fictional credit contracts as evidence. Somehow I was supposed to know from the outset how the CC company would use their unilateral power, and how the laws that were in force when I signed the contract (which I thought would protect me) would be changed – mostly by the CC companies themselves – at some undetermined point in the future.
Why is it that I seem to be the only one in this arrangement who is actually bound by what he signed at the beginning? Oh, right, that must be the “free” market I’ve heard so much about, the one where competition produces vendors falling all over themselves to attract my business.
Funny how it never seems to work like that.
— Chet · May 28, 06:28 PM · #
Rortybomb, I see the disconnect, but I wonder about it from the opposite side.
Why should a simple card cost me money? My visa card is raking 2% of my purchases from the vendor as transaction fees and coughing back 1% to me. Is it really impossible to make a profit from that without also hoping that I may one day revolve my credit?
I guess that Manzi’s model explains it if the transaction card is actually a loss leader to the credit card companies. In that model, the transaction card + credit account costs me less than the transaction card by itself for the same reason that a toaster + a free checking account costs me less than a toaster by itself, but that doesn’t mean that the value of the option of depositing money in the bank is negative to me.
— J Mann · May 28, 06:37 PM · #
That is, there do tend to be a lot of unpredictable knock-on effects. As a general priniciple, which I believe has a lot of empirical support but is far from a scientific finding, it is my view that we should have a strong presumption in favor of letting other people be free to make decisions
I agree entirely. I tend to be of the opinion that ‘nudge’ type informational action, at a bird’s-level view, don’t hurt actions. If someone knows what they are doing with a cc, they’ve simply read something they already know. If not, then their actions are brought more in line with what an informed actors would do. I think bad information can shred markets. Now if these measure work, there will be knock-on effects. But almost by definition, these effects are sub-optimal if actors could be acting on better information. People with bad information, or perhaps bad self-control, aren’t just random particles – but if there are means to get them better information about the contracts they are signing, we should expect a general welfare increase.
(Now what qualifies as information, and how, is very political, and I tend to think the ‘Nudge’ thing is a neoliberal band-aid on a gushing wound, but I’m keeping this high-level.)
— Rortybomb · May 28, 06:39 PM · #
“In a dramatic failure of the free market system, I observed that all credit card contracts had these terms, and since nobody was offering me what I wanted, I chose from the available options.”
This is just so much horseshit.
I might go along with the proposition that it is impossible to navigate the modern world without a credit card, and in that respect you have to choose what is offered. Automakers don’t make a car that’s exactly suited to my needs either, so I have the best option instead of what I really want.
So fine, you don’t get exactly the CC you want, I don’t get exactly the car I want. The ready made car is a significantly better value than the bespoke option. You want custom unsecured financing? Then go a bank and make a pitch and then sit down with a calculator and do the math.
But the only way the rate switch term effect you, Chet, is if you carry a balance that you can’t wipe. That’s not a failure of the free market, that’s your failure, and yours alone. You signed a variable rate note, the rate varied. What did you think was going to happen?
— Tony Comstock · May 28, 06:40 PM · #
Chet:
I’m not recognizing any such thing. If you signed an agreement that says the other party has right X, then complaing that right X is “changing the contract” just doesn’t hold water.
You are describing the limit case of X = “can make any change I want at will with no notice period or out clause and without any of the normal constraints of contract law”. I don’t believe that you have a contract with such a term in it. Most cardholder agreements have a term which allows the issuer to change terms with all of these constraints: a notice period, out clause, and the various limitations embedded in the body of contract law that governs such credit contracts. You agreed to this.
It’s funny, I went to lease a car for a lease with a term of 17 months, 4 days and 2 hours and nobody would make that deal. Is that a failure of the market? It just means that nobody’s figured out how to make money with arbitrary lease terms (without me being willing to pay an extraordinary price).
If you don’t want a credit card with such a term in your contract, and there is no such card available on the market, don’t get a credit card.
— Jim Manzi · May 28, 06:42 PM · #
J Mann: Why should a simple card cost me money?…Is it really impossible to make a profit from that without also hoping that I may one day revolve my credit?
I believe that’s actually the case. Let’s assume your AmEx transaction card has a limit of $5K. You spend all of it each month and pay it off. They’ve made a month long loan to you. If the lending-rate is like 3% (LIBOR), they make 1%, so the net is -2%. If they have the cash on hand, could just loan the money to the bond market and make that 3% instead of 1%. And that’s before fixed costs of mailing you your bill and hiring someone to take your phone call.
— Rortybomb · May 28, 06:48 PM · #
All of this is just a good argument for making the law much more balanced toward consumers. Manzi, you’re right that card companies are making profits within the law.
The problem is, they’re also largely writing that law.
The agreements behind every card in the market demand that the terms of any loan are subject to change at the whim of the lender. The only other recourse consumers have is to close the account, which has a strong negative impact on their credit rating. This would all be fine if credit ratings were only used to issue unsecured debt, but as pointed out above, they impact nearly every aspect of a person’s life.
— Term · May 28, 07:21 PM · #
“Let’s assume your AmEx transaction card has a limit of $5K. You spend all of it each month and pay it off. They’ve made a month long loan to you. If the lending-rate is like 3% (LIBOR), they make 1%, so the net is -2%. “
You’re forgetting the bite the CC companies take on the merchant side of each transaction.
— Tony Comstock · May 28, 07:23 PM · #
But that’s what “right X” is – the right to change the contract! Calling something what it is – instead of changing it to “X” – always holds water. Maybe you don’t understand yet – we’re literally talking about the right, specified in the contract, of credit card companies to make changes to the contract that aren’t specified at the time you sign the contract.
I’m not talking about pre-programmed penalty terms; I’m talking about changes to the contract you have no way to predict at the time you sign up and begin using your credit.
In any other circumstance, saying “I won’t do long-term business with you without knowing what I’m committing to down the road” is considered legitimate – even obligatory – behavior under capitalism. But in this specific instance, for some reason, you find it an unreasonable expectation that cardholders should be able to insist on the contractual terms they originally signed up for.
Why is that, exactly, Manzi?
— Chet · May 28, 07:24 PM · #
Rortybomb, I assume AmEx’s cost of borrowing is 3% when annualized, right, not 3% per month. If it’s 3% per month, I would be happy to buy AmEx corporate bonds at 2% monthly. (I’ll grant that they might still be losing money on me, though).
— J Mann · May 28, 07:26 PM · #
But usury is against the law.
It was, but was effectively legalized in the 1970s, directly contributing to the culture of endless debt that has caused this calamity.
They’re job, as with any profit-making venture, is to make profits legally.
Hence changing the law to render unethical practices illegal.
— Freddie · May 28, 07:29 PM · #
And those are supposed to make it ok? A “notice period” doesn’t protect my rights when what we’re talking about is two weeks notice, or so, to pay a 2 grand balance or something. I mean I ran up that balance – hypothetically – in the first place because two grand is more than I can raise in two weeks. I’m locked in, and now the CC company is using that to get what they want. And even if I could pay it – I take the ding to my credit, and now I can’t get the job I was qualified for, or rent an apartment, or any number of other things. The credit card companies – indeed, all lenders – will essentially respond to my contractual rights by colluding against me.
Which I guess is fine, or whatever, except it’s apparently not fine because Americans have used their democratic franchise to say “um, no, we’re going to change that.” Free market – of ideas – at work, seems to me.
— Chet · May 28, 07:29 PM · #
“In any other circumstance, saying “I won’t do long-term business with you without knowing what I’m committing to down the road” is considered legitimate – even obligatory – behavior under capitalism. But in this specific instance, for some reason, you find it an unreasonable expectation that cardholders should be able to insist on the contractual terms they originally signed up for.”
This is horseshit.
Credit is rented money. Rent the money from a CC company and you are month to month; no guarantee that the landlord won’t raise the rates. Don’t like it? Get a lease. You want fixed terms, get fixed financing. Good luck finding unsecured money at 8 points fixed. If you don’t like either of these options, don’t rent money. Nothing about carrying a credit card forces you to carry a balance.
— Tony Comstock · May 28, 07:31 PM · #
What we’re talking about isn’t really like buying a car – where you have an impressive array of options, from a wide variety of manufacturers, and while the exact car you want may not exist, there’s surely something that is pretty close, because market pressures have incentivised carmakers to chase new market segments, and new trends in consumer demand.
This is a lot more like buying gasoline – there’s basically one price, no matter where you buy it, one set of terms under which you buy it, market forces that raise the price are reflected instantly, but market forces that reduce the price are reflected much later, if at all, and the entire industry has a closed and opaque mechanism to collude in presenting you exactly the same choice regardless of where you take your business.
Buying a car is the free market working. Buying gas, or “buying” a credit card, is the free market failing. What is it about conservatives where they can’t see the difference?
— Chet · May 28, 07:35 PM · #
I don’t rent month to month, though; I rent year by year, and the landlord can put no restriction on my ability to move my crap out of this place and into another. And the landlord can’t simply put a flag in the database that says “don’t rent to this guy, because he opted out when I tried to raise the rent.” And my potential employers or insurers aren’t looking in such a database and saying “gosh, if he’s willing to move to a new apartment rather than have his rent jacked, he’s probably not willing to work long hours for low pay, or work illegal unpaid overtime.”
Except the part where they cancel it, and ding my credit, if I don’t. Remember we were talking about CC companies punishing ostensibly “good” behavior? Not carrying a balance prompts them to collude against me; “don’t give this guy a credit card; he’ll never carry a balance and we won’t make any money.”
Look, I’m not saying I’m going to dynamite the CC buildings. I’m just saying, pardon me if I exercise representative government to have a few laws made. The CC companies get to do the same. What’s unfair about it, except for the CC companies having better lobbyists?
— Chet · May 28, 07:41 PM · #
Chet, my understanding is that when the credit card company changes terms, you can say no without paying the balance immediately. If you say no, you get to keep paying the balance under the old terms, but the credit card company doesn’t have to loan you any more money.
— J Mann · May 28, 07:41 PM · #
Further to Chet: Can the credit card companies really ding your credit?
1) They don’t write the credit score formulas, the credit rating agencies do.
2) The credit card companies only report two things: current balance and payment history, and can get sued if they report those things wrong. AFAIK, nothing in your credit report tells other credit card companies whether you carry a balance month to month, only what your balance is today and whether you pay on time.
3) Generally, not using much of your credit increases your score, because it lowers your debt to available credit ratio.
— J Mann · May 28, 07:44 PM · #
Rortybomb,
You omit that the credit card companies all assess a fee (I believe around 3%?) on all purchases at the point of sale, which I would imagine they probably receive immediately. (In fact, Amex came under fire from merchants some years ago for charging a higher such fee than its competitors.) On a balance of $5K, that would be about $150. As a result, even if the card company had only customers that paid on time, I think they would probably at least break even, if not make a slight profit. No doubt they make more money off of those who incur a penalty rate but pay their bills on time, but still.
Perhaps the best evidence is simply the presence of companies that do not charge such a fee, which seem to be doing fine.
— JeffB · May 28, 07:45 PM · #
Rortybomb, I assume AmEx’s cost of borrowing is 3% when annualized, right, not 3% per month.
Ha! Correct. Whoops. Don’t tell anyone I made a freshman mistake.
The interchange is something akin to a 12% return, which I have to imagine covers the cost of capital. And indeed the industry would downplay the profits from there to better emphasis high fees and interchange.
I have no idea. A lot of people are telling me it is a razor thin margin.
— Rortybomb · May 28, 07:45 PM · #
JeffB – You omit that the credit card companies all assess a fee (I believe around 3%?) on all purchases at the point of sale
That’s the one percent I mentioned. To be clear, an interchange fee of around 1.86% is charged at the time of purchase and collected by the bank. In there is the actually technology of charging the credit, the series of tubes your information goes through, an “assessment fee” that goes to the brand name of the credit card (Visa, Mastercard), and the rewards that are kicked back to you in your rewards programs. So they probably net a third of that as profit.
It strikes me that the interchange fee increasing as a percent over the past decade while the technology costs have plummeted is de facto price fixing, for whatever that is worth.
— Rortybomb · May 28, 07:51 PM · #
Canceling a card with no balance decreases your debt to available credit ratio dramatically.
— Chet · May 28, 07:53 PM · #
“Except the part where they cancel it, and ding my credit, if I don’t. Remember we were talking about CC companies punishing ostensibly “good” behavior? Not carrying a balance prompts them to collude against me; “don’t give this guy a credit card; he’ll never carry a balance and we won’t make any money.”
Horseshit again. I haven’t ever carried a balance longer than 4 months; and then only a half dozen times in 20 years. I get CC offers every week. I’ve cancelled 10 times as many accounts as I have open. My credit score is 800+
— Tony Comstock · May 28, 07:55 PM · #
Cancelling cards on which you have no balance generally:
1) lowers your credit score (if it does anything), by
2) increasing your debt to available credit ration, because
3) it leaves your debt unchanged but reduces your total available credit (assuming you have any debt at all).
— J Mann · May 28, 07:58 PM · #
“To be clear, an interchange fee of around 1.86% is charged at the time of purchase and collected by the bank.”
You find me a place where I can cut my CC charges to 1.86% and I will blow you by the light of the full moon at every equinox.
— Tony Comstock · May 28, 07:58 PM · #
I’m afraid your argument doesn’t hold water Chet. If gasoline companies are colluding to keep the price high, then why let the price come down at all? The reason there is one price no matter where you buy it is precisely because there is competition. If Exxon is charging a buck fifty a litre and Texaco a dollar forty-five, everyone would go to Texaco. The difference in prices occurs because when the price of oil goes up today it means the price of gas will go up tomorrow, so producers reduce the supply of gasoline already produced to sell at the higher price, but since everyone else is doing that supply falls immediately until the new equilibrium price equals the future equilibrium price. Why doesn’t it work the other way around? Stockpiles are depleted and firms don’t have inventory. When oil falls they would like to sell more today at the higher prices which would make the current price reflect the cheaper future price, but they are already running at full capacity so they can’t increase supply. It’s not because they’re trying to screw you.
With respect to credit cards, there isn’t a man alive that doesn’t know this is the worst debt to hold. Yet still people run up their balances and ruin their credit rating. I ran a balance for years when I was a student, and I paid a great deal of interest, but I wasn’t being screwed by Visa, I needed to borrow against my future income and that need was sufficient to justify paying a high premium for it. I’d much rather have access to credit even at a high rate then have the government cap the rate and make it so I can’t access credit at all.
— Kailer · May 28, 08:02 PM · #
Tony: You find me a place where I can cut my CC charges to 1.86% and I will [be grateful].
I’m going off what I hear and what I see in the sidebar here ; confusing and varied, but they tend to range in the 1.5%-2% category. What do they look like in practice? Are there are charges that aren’t interchange?
— Rortybomb · May 28, 08:39 PM · #
With respect to credit cards, there isn’t a man alive that doesn’t know this is the worst debt to hold.
I don’t know this. All I know is that there are some things money can’t buy, and for everything else there’s Mastercard.
To econo-math up Chet’s complaint, it is not easy for a consumer to pick an optimal level of credit card debt when the level of debt and interest rate changed can be changed in a way that’s arbitrary to the credit risk of the consumer (you charge at Wal-mart, for instance). There’s a lot of talk about financial instruments, but taking a corporate revolver for instance, the level and the rate changes are far, far more regimented.
— Rortybomb · May 28, 08:48 PM · #
Rortybomb:
True, but as per Tony C’s point, you can go rent money with more certain terms, it’s just a ton more expensive. The uncertainty in the rate is part of the deal that supports the economics of the issuer.
— Jim Manzi · May 28, 08:58 PM · #
You find me a place where I can cut my CC charges to 1.86% and I will blow you by the light of the full moon at every equinox.
The card swipe rate is normally much lower than the manual number entry rate because of the increased difficulty of fraud.
— Bo · May 28, 09:12 PM · #
“I’m going off what I hear and what I see in the sidebar here ; confusing and varied, but they tend to range in the 1.5%-2% category. What do they look like in practice? Are there are charges that aren’t interchange?”
I only know what I see as a merchant, and once everything is factored in it’s more like 4%, but that’s getting sliced up between gateway providers, processors, issuing banks, Visa (or whatever the brand of the card is) and probably a few more I’m not even aware of; so maybe we’re both right, answering the question the way we see it.
Bullshit on “It’s not easy for consumers to pick an optimal level of credit card debt.” This is the same sort of nonsense that has people thinking they should pay their bills as late as possible to “keep earning interest”.
Nonsense. Pay your bill as soon as possible. Nevermind a 20 point jack in interest rates, a single $25 late fee will wipe out 20 years of living on the margin.
Same for the “optimal level of CC debt”. The optimal consumer CC debt level is zero with no less than 90 days cash on hand. If you’re carrying a balance switch to eating rice and beans washed down with tap water.
— Tony Comstock · May 28, 09:17 PM · #
Tony, frankly, after our last incomprehensible exchange I determined that you were clinically insane, and so I really don’t take your word on anything.
— Chet · May 29, 12:44 AM · #
Because at some point, people notice, Congress starts sniffing around the oil companies, and they lower the price a nickel a gallon to ease the political pressure. Seems pretty obvious to me – like when Hurricane Katrina hit, and took out one oil refinery, and the next day gas was a dollar more expensive in Missouri. Sure, capacity was reduced – but only in the markets served by that New Orleans refinery. I didn’t live in one of those markets, and while I’m sure gas is fungible, the demand and supply for gasoline in Missouri did not change in the least.
It’s price-fixing.
But that’s exactly the opposite of what competition looks like. I would expect to see a chain of service stations where you paid an extra dime for their specific, brand-name formulations, plus they came out and pumped it for you; and then a chain of super-low-cost WalGas stations, entirely self-service, with not even an attendant or a place to buy snacks.
Instead, all gas stations are completely identical, with the same three tiers of gasoline, and the same prices everywhere you go in town. That’s not competition, that’s anti-competition. Price fixing. I dunno, again, seems obvious to me, but conservatives can seem to see when markets are working and when they’re not. Some curious kind of blindness.
Unless Exxon provided a nickel’s worth of better service or gasoline. You’re telling me it’s impossible for a gas station to provide anything but plain gasoline? Seriously?
— Chet · May 29, 12:54 AM · #
This doesn’t address the abusive practices by credit card companies: excessive fees, delaying acknowledging checks to force late payments, changing interest rates on existing loans without notice, using irrelevant credit score issues for raising interest rates on clients who are otherwise in good standing (i.e., client has problem with another institution, so credit card punishes him with rate hike).
There is also the issue of credit card companies giving thousands of dollars of credits to college freshmen, people without jobs, or excessive credit lines to people. At one point, I had a credit limit that was 2/3 my annual income because my 2 credit card companies increased my limits without my permission. I could have been $20k in debt with a $30k annual salary, and I still got more credit offers.
I agree Congress should avoid micromanaging, but responsible credit is not something the market will provide on its own without serious damage to individuals and the economy at large. The housing bubble proves that financial institutions will risk long-term failure for short-term profits, and such failures can take down the entire world economy.
— AxelDC · May 29, 02:07 PM · #
“Why should this freedom of contract be restricted for responsible people? Because the guy who lives down the street might use the same contract to drive himself into personal bankruptcy with Cheetos, beer and big-screen TVs?”
Ya know, I’d like to believe in that old idea that “people are better capable of spending their money than the government is,” but there are too many guys down the street with Cheeto stains, beer breath, and a personal bankruptcy.
— Herb · May 29, 02:14 PM · #
Interesting that throughout this discussion there is no mention of the factor that underlies the debt-addled state of America’s macroeconomy and individual financial profiles—where are these companies coming up with all this money available for people to “rent”? They must have huge stockpiles of liquid assets somewhere in order to extend all this money to college students, the unemployed, and millions of others who are in no position to service large debts responsibly.
Oh wait….
Unless the state-sanctioned legal privilege that gives the financial industry license to manifest super cheap credit basically from thin air, there will always be a money cartel that will use their privileges to amass tremendous economic power and political sway.
— Jord · May 29, 04:19 PM · #
This is a very simplistic argument. I have both degrees and a significant amount of experience with finance and legal contracts and can barely make my way through one of those agreements myself, both because they are complicated with a lot of heavy legal language and because they are completely mind numbing.
This is not a situation where a corporation or other commercial entity is facing up against a bank and, if they have any sense, hiring an actual competent experienced attorney to review and negotiate the documents based on the specific situation, past operations, facts surrounding and future expectations of the borrower.
You seem to be saying, “lets be real here” by stating its as simple as the personal borrower simply just looking up the penalty and other provision buried in many pages of small type, and acting accordingly.
But “lets be real” on all fronts then. The consumer is sold one of these revolving credit instruments, with a hard sell on the ease and benefits (including sometimes a free cooler), and little to no encouragement to read the contract or have a professional look at it for them and consider it in their personal context. The great benefits are highlighted, but the costs and obligations are not equally stressed. In fact, like those ridiculous lease commercials for cars, the obligations are only stressed to the extent the law requires it, in those cases its apparently flashing some small unreadable type onto the screan for milliseconds at the end and maybe having a speedtalker jumble through a comressed garble of legal exclusions (for the record I have stopped my TIVo on those before and I could not even read them clearly – and I have a HDTV).
Additionally, there is little to no ability for you to negotiate these, because the process is set up so you cant. If you tried to ask the front line bank and card company people about changing one of these terms because it did not quite work in your personal situation (something that would occur in a commercial deal) they would put up a wall of “no can do” or be confused to the point of uselessness.
So even if people could understand the dense legal terms, its not like they can negotiate them. And even if people could understand enough to compare and shop them, all your options seem to conveniently have basically the same harsh terms (I’m not sure if its similar to the convenient competitive pricing at my local gas pumps or because they all make them as harsh as they can to the limit of the law).
Additionally, like “implied warranties” which I am glad that you mentioned, many intelligent industry attorneys carefully craft the contract terms to maximize the benefit to the institution within both the reality of the market (including behavioral studies) and the framework of the law. Most consumer warranties actually take away your legal rights to sue under state warranty law for the implied warranties you mention. I believe the Federal warranty laws were intended to promote warranty competition. With a few exceptions, the reality is that its more of a tool for the party with the benefit of many lawyers to craft careful language in their contracts to enable them to promote the benefits while at the same time severly reducing their true obligations to fulfill. So instead of creating a market for warranties or giving better protection that the otherwise applicable legal framework, it instead creates loopholes to avoid legal and arguably ethical obligations to stand behind your products. Sound a bit familiar.
So crafting an argument on freedom of contract is too simple, unless you want to give everyone a free government lawyer to negotiate the deal for them (that last part is a joke).
— Thomas · May 29, 04:21 PM · #
Acquiring information, familiarizing yourself with terms, has costs. There is substantial risk of misinterpretation or simple inability to understand.
There are some efficiencies to be had in reasonable and limited regulation of terms for credit cards and mortgages.
There’s a lot to be said for “assumption of the risk” and freedom of contract, but taken to the full extreme we would permit a lot of things that we’re just better off restricting at the consumer level— such as $10k penalty clauses for withdrawing from your cel-phone contract (not regulated against per se to my knowledge, but no court would uphold the provision), or “predatory” mortgages designed in a manner so as to be nearly impossible to pay off (paying interest on the entire original principle until it’s all paid off, say).
Many people are improvident. This will always be the case. It’s not government’s job to entirely protect them from the consequences, but it’s a bit much to just throw up our hands and refuse to make any regulations in consideration of improvidence. One example of this is national unemployment insurance— many intelligent people would fail to get unemployment insurance on their own due to oversight, poor planning, what have you. As long as the program is run efficiently, it’s a pretty reasonable thing for gov’t to step in and save us all the cost of figuring it out and obtaining it ourselves. Moreover there are externalities—- without unemployment insurance, at 12% unemployment there is likely to be a lot more social instability. Your failure to plan and purchase unemployment insurance affects ME when you turn to crime, etc. Again, that doesn’t NECESSARILY mean a particular unemployment insurance plan is a good idea, but it does mean that it CAN be a good idea.
For comparison look at securities law. We regulate the heck out of public securities offerings because in the era when we didn’t, there were constant swindles in which investment opportunities in mines and railroads that didn’t exist were touted. When we’ve relaxed securities laws, fraud has promptly reappeared as a problem. As irksome as the securities laws are, they do appear to be beneficial at least when applied to securities offerings to the public (as opposed to knowledgeable institutional investors who have the ability and the financial wherewithal to truly make their own fully informed decision).
The conservative point that every regulation limits the market a bit more and causes some harms is absolutely correct—- but that’s no reason not to apply a cost/benefit analysis to each regulatory proposal, and to at least favor regulation when the C/B argument in its favor is compelling.
— James Wilson · May 29, 04:36 PM · #
Oh, the dynamited Credit towers are coming, alright, and I’ll be setting up the gallows in the lobby after I prep some molotovs for the Dies Irae. Hard to know which bank/creditor should be the worthy target, since they merge and swap beds more than the characters in “Gossip Girl.” If I hear any more punishment of the victims for their own ignorance raison d’etre, it could happen even sooner.
Restructuring, bail-outs – sign of maturity huh? Sounds more like Linus’ security blanket to me, funded by us “irresponsible” taxpayers for your shareholders’ portfolio. Nice rotten stump in the redwood of Mircoecon. You gonna tell me I shit where I eat? Boo-fuckin’-hoo, fuck you, pay me.
I got the siren song for frequent flier miles if I signed up for AmEx as a college freshman. They played right off my romantic yearning for travel overseas. Too bad they didn’t tell me that I was “too incompetent” at a US News Top 20 college to know better. Nothing worse than having a family that can’t afford a usurous tuition, backed by rapacious loan terms have to force the kid to look to the creditor Rich Uncle for such dreams, but not help pick up the pieces into responsible behavior. In fact, will send out more cc offers to put to my temple. THIS is why I flunked Econ Freshman year – fundamental, visceral disgreement with the Free [Wheelin’/Basin’] Market. Boo-fuckin’-hoo, fuck you, pay me.
The fact that most of the nation’s debt is owned by foreign governments should bring us all on the same page of impotent rage. Boo-fuckin’-hoo, fuck you, pay me.
That’s why most collections callers are safe in Dubai – life is much cheaper there for them than the sub-$10/hr domestic call ctr. drones here. They treat a collection call like any other telemarketer – thrill of the hunt for the Profit from which they see barely a blown-nose Kleenex in their paycheck. If I see toll-free or other area codes come up, I get the air horn or free jazz recording ready for the receiver.
Why is it that when you are not informed of “over the limit” penalties until too late, after making steady payment on monthly minimums w/in the billing date cycle, it takes forever and a day to get out of the improperly-brainwashed “adult” assumption that what’s an available balance should stay that way, and not be taken beyond the pale by that “low” %ge rate?
Good faith payments notwithstanding, payment protection plans suspended w/ cause, though paid for to accommodate unforseen illness and unemployment? You know, “grown-up” stuff? Russian roulette Usury, by any other name…
Capitalism, now more than ever, is operating like the casino facing liquidation under RICO, because “The House Always Wins.” Seems to sum up a couple of centuries’ “grown-up” logic…or, there’s always the rats fleeing the sinking ship of fools. I like that one better.
Outsourced debt, outsourcing dirt cheap labor pools, seems about par for the course, which is where you’ll find most of the decision-makers anyway.
What self-respecting being can accept being punished by the assumptions and risk assessment pools which that are about as effective as any other consumer-predictive tools in a volatile world ecnonomy? Oh wait, I have 5 balance transfer offers for every 10 unsecured…Boo-fuckin’-hoo, fuck you, pay me.
See you on the other end of a democratic Socialism long-overdue – hey, my bank is know owned by a Canadian one. I’m already there, dude, w/o a hair of hipster irony. Wonder how my interest rates play out in “loonies?” Suits of the world unite, you have nothing to lose but your imprinted coke cutter!
— Tyler Durdin · May 29, 04:38 PM · #
Can we please stop using college students as the default example of consumers who should categorically be denied credit? I’m a college sophomore with two part-time jobs, annual disposable income around $5,000, and a credit limit of $750. I use my credit card for all purchases, for the convenience more than anything (I hate carrying cash, and I’m afraid of the $35 overdraft fees on debit). I like that I can pay for textbooks at the beginning of each term (by far my biggest fixed expense) without worrying about the timing of my biweekly paycheck. I also like that I can track my spending online, and that I only have one bill to pay. The numbers themselves aren’t huge, but for someone with few expenses (not counting college itself, of which I pay around 80% with loans and work, and my parents make up the difference), they’re significant.
The card itself is a real piece of crap with no rewards program and an APR close to 20% (lacking a credit history, it was the only one I qualified for). I really don’t care about the interest, as I pay my balance in full every month, but I’d been hoping to trade up to a card with a decent rewards program once my credit history looked more solid.
As far as I can tell, the new reforms will make that impossible, since I’m not yet 21 and conventional wisdom holds that college students (a) are either children or incompetents, needing desperately to be protected from themselves, or (b) should just rely on daddy’s credit for a little bit longer, as if childhood in this country hasn’t already been extended long enough.
I told my (Swedish) parents about this, and they said, “So when exactly are American children supposed to grow up?” I really wonder the same sometimes.
— Liz Lemon · May 29, 05:45 PM · #
Why is the guy who sells you a credit contract responsible if you are later unhappy about the decisions that you made?
I think you mean the decisions he made, deliberately concealed in pages of fine print legalese that <1% of customers can understand, and then convinced you to “agree” to.
If that’s freedom of contract, I’ll try the other thing.
Seriously, what part of “their business model is built around designing contracts that their customers will misunderstand” are you not getting here? Do you really intend to defend that as an ethical business practice?
It’s their job to make money within the law. And it’s Congress’s job to make the law and therefore decide where its boundaries are – to promote the general welfare. If Congress decides that deliberately misleading contract terms do not promote the general welfare, is that really an argument you want to have?
— cbyler · May 29, 08:28 PM · #
Wow, a product of Scandanavian socialist democracy (democratic monarchy) is the voice of reason and counterpuch to a good ol’ Apple Pie in loco parentis? Without home field advantage? That’s a thick skin who doesn’t add “foreign student” to the whingeing bars to responsible underclassmen worship of Mammon.
I’ll take debit ovedraft protection and paper currency any time over the Wild West of CC APR gallows that still seem to beckon from the Manifest Destiny of a future overeducated, underemployed work force. Europe, c’mon board anytime, pardner! I’ll take over your the reins of an astronomical VAT-underwritten social safety net model any time. Takes a true non-native American to parrot back our Gilded Age redux!
Hee-haw, bring on the Aquavit.
— Tyler Durdin · Jun 1, 08:57 PM · #