Credit Confusion
As I write this, the Congress is preparing to pass a bill that would place restrictions on the ability of people to get credit. Personally, I have mixed feelings about the bill. On the one hand, when you make it harder for (mainly poor) people to get credit cards, you encourage them to turn to less savory means of obtaining credit. On the other hand, it’s at least arguable that some of the common irrationalities demonstrated by behavioral economics are present in the credit card market (whether the bill will actually address these problems is another story). And then there’s this.
But I don’t really want to argue about the credit card bill. Rather, I wanted to note an odd premise that both the pro and anti credit bill folks seem to be relying on in making their respective cases.
Let’s start with the pros. Here’s Ezra Klein, writing in the Washington Post:
The credit card industry, in recent years, has developed something of a tiered model. Good customers are treated extremely well. There are rewards programs, favorable terms, and high limits. But those who don’t prove as assiduous about their bills, or slip up amidst their payments, fall into a second tier that’s as punishing and deceptive as the first tier is serene and straightforward. Hidden fees, unexpected rate increases, universal default, and all the rest. The result is that low income credit card holders effectively subsidize high income credit card holders.
For the case against the bill, we have to turn to that notoriously right-wing rag, the New York Times:
Congress is moving to limit the penalties on riskier borrowers, who have become a prime source of billions of dollars in fee revenue for the industry. And to make up for lost income, the card companies are going after those people with sterling credit.
Banks are expected to look at reviving annual fees, curtailing cash-back and other rewards programs and charging interest immediately on a purchase instead of allowing a grace period of weeks, according to bank officials and trade groups.
“It will be a different business,” said Edward L. Yingling, the chief executive of the American Bankers Association, which has been lobbying Congress for more lenient legislation on behalf of the nation’s biggest banks. “Those that manage their credit well will in some degree subsidize those that have credit problems.”
As Bryan Caplan notes, the argument made by the credit industry folks doesn’t make much economic sense: “When you make lending to high-risk people less attractive, the result is not worse terms for low-risk people who have been profitable all along. The result is that high-risk people get less credit. They used to be able to get credit despite their credit-unworthiness by paying extra; if the law forbids this, why lend to them?”
Caplan is right, but by the same logic Klein’s claim that high risk borrowers are subsidizing low risk ones seems rather dubious. If people who always paid their credit cards on time were a drain on credit card companies’ profits, you would expect them to try to deny credit to such people, or at least offer it to them on less favorable terms. You certainly wouldn’t expect those companies to go out of their way to attract these very customers by offering them “rewards programs, favorable terms, and high limits.” The idea that if everyone who paid their credit cards on time were denied credit those who didn’t pay on time would get more favorable terms doesn’t make much more sense than saying car insurance companies would benefit if they only insured people who got in accidents, because then they could increase people’s rates.
The idea that lenders benefit when people don’t pay them back on time is one that is attractive to a lot of people (see here for a related discussion). Partially this may rest on an implicit zero sum fallacy; paying late is clearly not to the benefit of the borrower, so people assume that it must be to the benefit of the lender. Mainly, though, I think it’s an example of the seen and unseen. The benefits that credit card companies get from having people use their cards wisely (e.g. intercharge fees) tend to be invisible to consumers, whereas the money they pay in late fees and interest is highly salient.
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Incidentally, the argument here is similar to the argument I gave on why the CRA didn’t cause the housing crisis.
A lot of the weird things that were happening in four or five states had dramatic nation-wide impact, as Dan Walters and others in the media are starting to dig out:
http://www.sacbee.com/walters/story/1867849.html?mi_rss=Dan%20Walters
The loose credit was unbelievably loose.
With the release of more and more data, it is very feasible that Sailer and the thus far anon. sociologists and data crunchers he is working with are going to be increasingly vindicated:
http://vdare.com/sailer/090517_foreclosures.htm
A major fundamental problem is loose credit and the reworking of incentives and regulatory pressure to lend, lend, lend, lend – until the bill of false assumption that prices can only increase and that notes will be repaid comes due and the whole house of cards comes crashing down.
Also worth a look:
http://pewhispanic.org/files/reports/109.pdf
Some truly crazy things were happening from 04-07.
I completely agree in the sense that the two tiers are not subsidizing each other.
I think Mr Klein fails to understand that the growth strategy for the industry was the same for both low-income and high income individuals.
The goal of both tiers of service was to drive spending, for the following two reasons:
1) Increasing the revenue due to interchange fees (which is approximately 3% on each transaction, I think).
2) As CC spending grows to the point where customers fail to pay their bills — we all the know what happens next — late fees and interest rates apply.
But in this case, we’re talking about 17% or more in interest. In comparison to the 3% interchange fee, it would ridiculous to assume that banks are not interested in maximizing the number of customers falling behind on payments (especially those with higher limitis).
The only difference in the tiers was that to drive spending, one has to lull/push customers with the right incentives. For low-income earners, just having the luxury of a credit card suffices. For high income earners, coaxing spending requires benefits. It seems unfair, but at the end of the day, both customers are being manipulated into increasing spending.
The best part about this bill is the lifting of the ban on firearms in national parks!