Is there really a credit card crisis?

Like many Americans I get a great deal from the companies that provide me with my credit cards. I generally pay my balances in full every month like roughly half of all credit-consumers do. I don’t pay anything when I use my card and in fact some of the companies give me rewards for using my card—they pay me! I get some free float since there are generally a couple of weeks between when I charge something and when I have to pay for it. I also get—for free again—the peace of mind of knowing that I have a credit line to tap into if I need to or if I just happen to forget about paying my bill. People like me therefore rightfully worry that the government could only muck up this excellent deal.

Other Americans intentionally take advantage of the financing feature of cards and some just forget to pay their bills. The credit card companies charge these people all sorts of fees. They do that for a couple of reasons. Some of the fees are designed to discourage people from engaging in behavior that imposes risk of non-payment on the credit card companies, or to compensate themselves for the lending service they provide to consumers. I suspect other fees are there because they provide a source of income and they know that some people will pay for them. Just like car companies make their money on frills, credit card companies make some of their money from people who keep paying their card bill late or do other things. From one perspective you could say that the card companies are taking advantage of people who are willing to pay more, but from another perspective you could say that those people are helping to defray the cost of cards for those millions of people who pay their cards in full every month.

I suppose the people who end up paying some of these fees could complain that they didn’t know they were going to be charged for it. That argument is tough to swallow. There are many products where companies can engage in opportunistic behavior like the used car dealer who sells you a lemon knowing that you probably don’t have any recourse and you’ll never be a customer again anyway. That isn’t the case with cards. People get bills once a month so people who are screwed once or twice on their monthly statements will know to start looking for another card. And therein lies the big problem with the argument for government intervention in this industry. There are lots and lots of cards to choose from and these companies are all looking for you business. It is easy to switch—many allow you to switch your balances. Now, someone might argue that competition isn’t enough if they all engage in bad behavior. But basic economics teaches us that if all these companies are coming up with the same pricing schedules those are probably the ones that are dictated by cost and other competitive considerations. Otherwise one of them could offer consumers a better deal and get a lot of business. That kind of discipline in one of the benefits of greedy capitalists—they like to take business away from other greedy capitalists.

A Lose-Lose Proposition

The Obama Administration and Congress obviously don’t buy these arguments since they are seeking to impose a variety of restrictions on pricing for the credit card companies. Some of these proposals seem superficially fine because they require more disclosure and transparency. But they all make it more costly and harder for credit card companies to do business. There’s no free lunch here and the proposals will do a combination of several things. First, they will make it more expensive for people like me to use cards. If credit card companies lose sources of revenue they will have to adjust prices to make up for that or reduce the supply of credit card services. The people who currently finance some of their charges will pay more too, just in the form of different fees. They will pay more in annual fees and less in late fees perhaps. Second, it will reduce credit card profitability. If the credit card issuers were raking in obscene profits they wouldn’t be so bad. But they aren’t. As card profitability falls card companies are going to issue fewer cards and most importantly extend less credit.

My view of the legislation is that it is largely a lose-lose proposition for everyone concerned.

• Consumers aren’t going to pay less for using cards. They will just pay differently.
• Consumers will have less access to cards and credit.
• Banks will make less profit at a time when jeopardizing bank profits is a very bad thing.

I don’t dispute that some card issuers engage in bad behavior and frankly there have been times when I’ve been furious. But there is a lot of market discipline for this. As many consumers know, if you threaten to switch cards the issuers often back off. The proponents of legislation can point to anecdotes of bad behavior. There is, however, no systematic evidence that there is a credit card crisis. First, there’s no evidence that the “prices” that people pay for credit cards adjusting for risk are too high. Second, there’s no evidence that the “profits” that credit card issuers earn after taking risk into account are too high on average over time. Has anyone noticed by the way that the credit card issuers are being royally whacked as a result of credit defaults?

Perhaps it will make people in the Administration and Congress, and a frustrated public, feel better that they have stuck it to the credit card issuers. The price for that temporary satisfaction is that the legislation will harm consumers, the economy, and our precarious banking system.