PBS: Secret history of the credit card
pbs.org
pbs.org
Honestly, even though I bought a house in summer 2007 (which is now worth somewhat less than I paid), I've been made vastly better off by the free and easy credit that others took part in and that I for the most part did not. Sure, the economic turmoil/headwinds now are less pleasant than 2004-2006/early 2007, but that's far from saying "I got screwed by this obviously unsustainable great ride ending."
The entire U.S. financial industry and the entire U.S. auto industry have, for all intents and purposes, been vaporized out of existence. To me, that seems a pretty high price to pay for "artificially high good times." Enough so that regulations that would have kept the good times from being quite so good in exchange for the down times not being disastrous, are more than a fair exchange.
Do you disagree?
The US financial industry, I'd agree with you IF I thought we could effectively modulate without introducing deadweight losses for no net gain. (Historically, I don't think we have a good track record at this, in this or any other country.)
What do I mean by that? The minute you introduce legislation to try to modulate something, a substantial result of that is to take smart people and apply them to figuring out how to comply with and/or work within/around the new regulations. So instead of building something people want or that makes the world better/more efficient, they're instead working on regulatory compliance.
Then the most powerful institutions bid up the prices of the services of those people who are the very best at working around the regulation, or at lobbying for their activities to be exempted, and the cycle continues. If we could come up with a means to instanteously generate perfect regulation, I would indeed agree with your proposal. I'm not holding my breath for it...
But apart from 'information' requirements like those imposed on tobacco in many places (advertising bans, warning labels, mass propoganda campaigns) I don't think any more information would help. If you go that path, you may as well regulate.
What would happen if all regulations beyond basic information availability requirements were lifted? If you could sell people whatever they would buy? We know what happens in lower risk, higher value credit.
The effect of large scale defaults is a flavour of everyone else is screwed.
What other form of loans/credit can you purchase and then have the interest rate changed without your knowledge and without informing you because of a missed or late payment on a different loan?
What other form of loan can increase your interest rate (cost) based on an increase in the balances on accounts with completely different companies?
I've meet well educated Md's and people with Master's degrees who've gotten screwed by credit card companies. It's not a matter of education, IMHO. It's a matter of deceptive business practices that people don't really get wise to until they've gotten burned badly. Have you ever tried to read through a credit card agreement? I'm a well educated man, and I can't make heads or tails of those agreements.
I'm sorry, but even an industry needed regulation, its the credit card industry.
If they want to change those in any other way then they have to contact you and you have the option to stop using the card and pay off the balance at the old rate.
The agreements are not that complicated - people simply don't read. I see it happen all the time with website UI's - the instructions are right there and people never read them.
You don't need to read the full agreement - everything you need to know about the rates is on the back of the application - in a format set by congress. How much more regulation do you need?
Edit: apparently there is more regulation coming: http://www.ft.com/cms/s/0/d70973f2-ca0f-11dd-93e5-000077b076...
Why shouldn't a lender be a able to offer a contract that allows them to increase their fees when the borrower shows themselves to be a less than ideal credit risk at some point in the future? The borrower signed the terms; if they didn't like them, they could have not signed them, or they can pay off and close the account now. Those are the two (non-bankruptcy) avenues for them to get out of the contract that they now don't like having signed.
Student loans are normally fixed interest rate loans and they only charge penalty's when your late in paying them.
The problem with increasing rates when people get into trouble is it tends to force more people over the cliff. Let's say you owe 20k at 10% and make 50k/year. You get hospitalized for 5k and your old and new rate becomes 33%. You have gone from a 2k /year to 5k/year when you need to borrow 5k more. If the company lending you 5k wants to charge you 33% interest that's fine you can focus on paying them back first and get free of debt but when everyone starts raising your rates while your in trouble it's almost impossible to get out of the hole.
PS: Not to mention demonstrating a lack of good credit is an ill defined concept. Loss of a job reduces credit worthiness even if you make all your payments.
Private student loans are variable interest rate loans, many at the whim of the providing company. (I'd agree that private student loans are much closer to evil than revolving credit, and that more education is due on both topics to consumers of both types of debt. But I'm still not in favor of restricting the availability of a financial product that might not be in any given consumer's best interest, so long as it is in the best interest of some consumer.) Govt-backed student loans are as you describe.
As to the over the edge "problem", that's a problem of the consumer's making+, and a creditor acting in their own best interest probably OUGHT to tighten credit for borrowers that it identifies, even on an acturial basis using information unrelated to the direct consumer<->creditor interaction, as being a higher risk.
+ - Debtors who are not in over their head generally don't face these problems.
Edit: Ok, running the numbers it would not be that bad but I would become far more focused on having zero debt.
Not that the last 3 months suggests the idea is without risk but it's not enough money that I really care. However, if I had less in the way of assets an my rate where to spike I would quickly start caring.
That's not true.
Many commercial bond and loans include covenants that cause changes (loan gets called, interest rate changes, etc) when certain things (sales revenue, money in bank, etc) happen.
Some even tie their interest rate to external factors, like LIBOR.
And, biz credit lines do get pulled.
> Loss of a job reduces credit worthiness even if you make all your payments.
It's unclear if you find that wrong or not. Job loss may well affect future ability to repay even if you're current now.
Same reason as the Mortgage Industry. The credit card issuers have been irresponsible to the point that the entire system is in danger of failing. They have lent so much money to so many people who can't afford to pay it back that it appears likely that there is going to be a huge cost to society, including those who have behaved responsibly.
In other words, we do not only have to protect consumers from their inherent irrationality. We have to protect society from the inherent irrationality of the financial industry as well. If this is not true, please explain to me how we would not be better off right now if there were regulations in place that could have prevented financial companies from taking on the amount of risk that resulted in the vaporization of Wall Street.
Money is not purchased when it is loaned. It is rented, and lots of rented goods have rate changes.
And, yes, money is rented via credit cards, but every purchase that I make with a credit card is in effect subject to a variable cost, because the interest rate that I'm being charged varies. So, I might buy a $1000 computer, thinking that I'll pay it off in on year at %10.
If my interest rate suddenly goes up to %29, I'm now paying closer to $1300 for the computer that I was planning on paying $1100 for.
And, furthermore, I have little recourse when my interest rates go up. I say that it's only because of the obscurity of the terms that people put up with this. If the same thing happened to people's car payments or rent payments, they'd be up in arms.
For the issues you've listed (interest rate changes, etc.), all of this information really is included in the agreement you're given when you sign up for the card. And the bank or CC company is supposed to mail out the updates to the terms levels whenever changes are made. You have a choice on whether to agree to those changes or to cancel your card.
What usually happens instead, however, is that people just look at the glossy marketing brochure or whatever gimmick is used to promote the card (airline miles! cash back!). And of course, assume that nothing bad's going to happen.
There's a lot to be said about not signing your name on anything that you don't fully understand. It's the same with any legal agreement: employment contracts, software EULAs, etc.
[Full disclosure: I used to work at Discover.]
Personally I try to hit the high points of standardized contracts but at some point you have to operate on trust. If some entity wants to screw you over, it can be done over subtle things.
But the problem here isn't information. People have that, one way or another. The problem is bad choices, starting with the choice to make an uninformed decision. My girlfriend once worked at a bank. They had a credit cards brochure with a comparison table. 4 or 5 cards had gimmicks: miniature cards, points, miles, gold card (virtually no actual benefit), personalised card, internet purchase insurance (for those that reckon themselves rational). 1 card was the right choice. Lower fees, lower rates, lower penalties. It was grey & ugly & had no fun stuff. No one ever picked the right choice.
Those too sophisticated (old) to be swayed by something as dumb as a miniature card or fun points would be swayed by something with a little more mature like exclusivity (gold) or miles. Those making a rational choice pick the extended no interest period or some obscure feature like online purchase insurance or travel insurance or something else they think saves them money.
Now these were all the good cards you get at a bank: 16%-19% interest rates. The low interest card was around 11%. Absolutely economical compared to what you get a furniture store.
The crucial info wasn't in the small print. It was in a big glossy table. There was a clear right choice for anyone that hasn't had a card & never paid interest or late fees in the last 5 years. It was the least popular option.
*prime interest at that point was 7.5%.
There is no problem making a decent credit card with no frills. People won't take it.
I personally chose an Amex card with better rewards, but higher interest, since I pay it off in full every month.
You, or your girlfriend, don't know what's best for a particular customer's usage pattern.
But we do know that this was the correct choice for the majority. We also know that the majority didn't take it. So we know that the majority made a mistake.
It doesn't take much of a lapse to void the benefits.
Housing, stocks, commodities, pokemon cards, electronics.
It's not a matter of education, IMHO.
You're right, it's a matter of discipline. We can tell people to not play the lottery as your expectancy will never be positive, but they'll still be there, scratching the foil off with car keys.
Note that the deceptive business practices don't help with enforcing discipline.
The amount of liability you have + paperwork in the event of fraud is exponential compared to credit cards.
http://www.consumer-action.org/english/articles/understandin...
(Edit: I have read the linked article. The debit card system is somewhat different in Germany, where debit cards are much more widespread that credit cards. In fact credit cards are still somewhat of a rarity while everyone seems to have a debit card.)
Of course, that's not what happens. So the harm limited to self argument does not apply.
How do you assess that except on a case-by-case basis?
My guess is that at one or more levels of this industry, there is an effective cartel: if you want to offer a credit card that's better for merchants, or consumers, or just run more efficiently, you're unlikely to be able to buy your way in. It does seem ludicrous that 1% to 3% of your purchases (or, from the merchant's side, revenue) goes somewhere into Visaland instantly; this seems like a massive privatized tax in return for administering an electronic payments system which might not be that difficult to replace today.
* Charges no fees of any kind
* Charges a rate that is determined by a publicized equation where the only variables are the amount borrowed, time (in, say, days), and the rate.
"You know -- 'transparency card,' 'rock solid card' -- whatever it may be. I don't believe that that would succeed."
> If an elderly but distinguished expert says that something will be successful he is almost certainly right, but if he says that it won't, he is very probably wrong.
Look at prosper.com. Regulatory costs are astronomical. Between state and federal auditors and Sarbanes-Oxley and CRA, etc, you'll have your hands full.
Also, why would investor capital flow to you? You'd make a lower return with no upside of lower defaults, etc.
But yes go ahead. Start a low rate credit card company. I might sign up for your card!
FYI, Discover's been around since 1985 (introduced during '86 Superbowl), suit was filed in 2004 (along with a similar one by AmEx) and finally settled in October for $2.75 billion.
Only if you're public in the US.
If you're not holding deposits/selling insurance, it's unclear why you'd have financial audits by govt organizations.
You'd have to deal with the restrictions on offering credit though.
Interesting. What he is really saying is 'what's fair got to do with it? Free markets dissolve the concept.
"If there was a demand for a credit card product that never changed its terms and rates and stuck with the customer no matter what, I'd be running around telling people 'Let's market this wonderful fairness card,'" he said.
"You know -- 'transparency card,' 'rock solid card' -- whatever it may be. I don't believe that that would succeed."
Some would say that free markets implement the concept of fairness. Of course, there are no free markets in the world today, to a first approximation, since all the prices and outcomes are distorted by external agencies, so whether free markets are fair is a bit academic.
The free market comes to a result based on a series of self interested decisions. At the core are the buy/sell decisions. I price in a way that maximises my profit, you buy in a way that maximises your utility.
Fair (I admit an ambiguous term) represents something external to this.
Huh? People who are "riskier" paying higher rates and fees IS fair. Would you lend your (presumably hypothetical) deadbeat, drug-addled uncle your entire $100,000 retirement nest egg at the same rate and terms that you'd lend the US government?
Why the hell not?! He's family, and these big mean credit card companies are profit-seeking arms-length lenders, and you would expect them to act morally better (by your standard, not mine) than you would to family? (I would neither expect, nor as an investor, wish for them to do that.)
The problem with credit card companies is that they loan the initial money at one price, and then adjust the price dependent on changing credit scores, insurance claims or whims.
And, a large percentage of a credit card companies, profit isn't in the initial interest rate. The profit is made in late fees, over limit fees and credit rate increases. So, they have a vested interest in the customer defaulting, being late in their payments or in going over their limit. And, when those fees are assessed, the customer generally has little recourse.
I agree that people to whom no one will lend more money are at a great disadvantage. I don't see any way to fix that, as preventing CC companies from offering variable APR offers in the future will likely make things worse for marginal customers; it will just make the companies completely unwilling to extend them credit. Embargoing consumers who are already suffering doesn't help them in the short term.
As stated in the original article, the second-worst kind of credit card user from the issuer's POV is the one who immediately pays down their balance each month, without ever incurring interest or late-payment fees.
This is possible only because of the altogether too-cozy relationship between the credit rating agencies and card issuers. I think any regulation of the lending industry should start with the credit rating agencies, and move on to the banks only after they've established effective oversight and consumer protection in that space.
(Incidentally, my disgust with the normal lending practices in the credit card market is the reason that the only one I will carry is a small-limit emergency card issued by my local credit union. Since they're a member-owned not-for-profit institution, I have far more trust in their desire to serve my financial needs, rather than trying to screw me over for a buck.)
In order to attract prudent capital to a riskier investment, the projected rate of return must be higher than that of any available safe, or safer, investment. IOW, to lend to "high risk" customers, the credit card company has to charge some form of higher fees or rates. If they don't elect to offer lower rates to the "low risk" customers than those that they have to charge the high-risk customers, then someone else will come along and cherry-pick the low-risk customers.
Said only slightly differently, why would anyone choose invest at arms-length in something riskier if there were a safer alternative available with an equal rate of return? They wouldn't, and any attempt to compel them to do so via regulation is unlikely to produce a result that you'd be happy with. It will either dry up credit for everyone, dry up credit for only the riskier potential patrons, or result in #1, followed by the demand for changes to the bankruptcy laws to enable creditors to safely lend at the mandated terms to all comers. I doubt that any of those will be a net benefit to society, except possibly the second, which would still result in extreme short-term pain to lower economic status individuals, who are disproportionately represented in the "high risk" cohorts of the market.
That has nothing to do with fair. At least not a definition of the term outside of the rules of the market. If you define fair as 'legal' or 'in keeping with free market economics' then sure, it's fair.
In a free market of lenders and borrowers, "fair" is whatever each party agrees to enter into acting in their own best interest. If the lender thinks the terms are "unfair" to them, they don't lend. If the borrower thinks the terms are "unfair" to them, they do not borrow. Therefore, if a lender lends to a borrower, both parties have agreed that the deal is "fair".
If a borrower finds that no one will lend to them on terms the borrower likes and then freely decides to loosen their standards and borrow anyway, I don't see any unfairness at work, rather that the borrower has updated their own concept of what a "fair deal" is, in order to borrow the money they want.
He is talking about statistically risky groups. Someone who has had >X accidents (regardless of fault) is statistically riskier to insure to drive. As are males between certain ages. I'm sure you could find all sorts of links between ethnic affiliation, schooling history, level of education that identify individuals as statistically riskier to loan to.
These all pass his (& your) fairness test. IE, you make more money (or lose less) by not lending to them, or lending at higher rates. It passes the market test. For the individual who gets told that Mongolians from Sweden pay an extra 3% if they where shiny shoes, it may seem unfair.
Your use of "fair" (whatever each party agrees to enter into acting in their own best interest) is the same as saying 'what's fair got to do with anything.' By your definition, price gouging is fair. Monopolies are fair (unless you want to mark your definition of fair to conventional free market wisdom pretty pedantically). There is no such thing as unfair or obusive practices.
Fair is unnecessary to describe the ethical world you are referring to. Coercive/noncoercive will suffice.
In this case you agree with me on all but semantics: 'what's fair got to do with it? Free markets dissolve the concept.
> For the individual who gets told that Mongolians from Sweden pay an extra 3% if they [wear] shiny shoes, it may seem unfair.
It may seem unfair to that person, but if it's wrong (meaning not borne out by the facts/stats), then another insurance or credit card company will almost surely come along and offer Swedish Mongolian shiny-shoe wearers deals at par, or even at a discount, to what the 3% surcharge company offers. In other words, if a company significantly overprices a given risk, that's just bad business or bad judgement, but it's not unfair. Similarly, if they underprice the risk, that's also not unfair, just bad business/judgement. Wherever significant price deviations are present and leaving money on the table, a competitor will come in to address the consumer need. And if they don't, then that's just the market price, which to me is the fair price.
So I think I agree with your assesment that in my mind fair is a synonym, or at least an extremely close analog, to non-coercive.
What you call price "gouging" (such as increasing the price of food, water, or gasoline in a time of shortage), I call an efficient market allocating scarce resources to those in the greatest need (as demonstrated by being willing to pay the highest price). If you mandate that the price of gasoline be $1.00 in the weeks following Katrina, how much gasoline do you think will get sold? Almost none would be my prediction. Instead, you'd find massive hoarding and gas stations closing rather than selling gas at a loss. How does that help anyone?
Instead, if you let the price float to $5, $6, then those who need gas will buy it; those that don't will have no incentive (in fact a disincentive) to hoard it, and those who might be just driving around aimlessly for amusement will temporarily stop doing that, conserving that very limited resource. Seems VASTLY more efficient to me, and seems perfectly fair as well.
Similarly, if you arrive at a monopoly through market forces, I think that's perfectly fine. If you are AWARDED a monopoly by the state, then that monopoly must be a tightly regulated monopoly by that same state. But I don't see any reason why Google shouldn't be allowed to reap the rewards of conquering search if they eventually do so. Or why Virgin Galactic couldn't operate a de-facto monopoly on space tourism, or any other example of where a market-derived monopoly is inherently unfair. To me, the state taking away an earned monopoly is what would be unfair.
I have really enjoyed our discussion, though I suspect we're at the point of understanding pretty well what each other is saying and probably unlikely for you to agree that $5-$6 gas is "fair" post Katrina, and for me to think it is, and agree to disagree after a thought-provoking discussion.
So this is an oligopoly, and behaves accordingly. Of course it charges sellers extra, charges high interest rates, and all that other shit; they don't allow more entrants into their market.
He did this by truly understanding his target customer and their risk/expense threshold.