Friday, August 20, 2010

Where Credit is Due

Part of the financial summit this week was devoted to new credit card disclosures. And since it is now Friday and we are heading off to the weekend, when we will probably be using our credit cards more, I thought that the subject of credit card reform would be an appropriate one for the final post of the week.

In his paper, Behaviorally Informed Financial Services Regulation, Michael Barr and his co-authors propose disclosures which will "encourage good credit card behavior." As with mortgages, Barr believes that with credit card usage borrowers cannot be trusted to make their own decisions because, "behavioral economics suggests that consumers underestimate how much they will borrow and overestimate their ability to pay their bills in a timely manner." According to Barr's paper, nearly 60% of credit card holders fail to pay the full balance due on their credit cards every month. "Credit card debt is a good predictor of bankruptcy." Further, Barr states that creditors actually work to keep consumers from paying off their debt by forcing them to pay high fees for as long as possible until they finally they declare bankruptcy.

What Barr proposes is a new system of disclosures with an opt-out plan for credit cards. In this disclosure, the consumer would be required to make the payment to pay off their credit card balance in a short amount of time. They would also be offered an alternative plan with longer payments if the minimum payment were too burdensome, but they would have to opt-out of the higher payment to get the lower one. The authors of this paper believe that most consumers would choose to pay the higher default payment which would lead to lower costs and fees. Barr says that this might have consequences because "some consumers may follow the opt-out payment plan when it is unaffordable for them, consequently reducing necessary current consumption, such as medical care or sufficient food, or incurring other costly forms of debt."

So let's get this straight--to protect consumers from making only their low minimum payments on their credit cards, the now Assistant Secretary of the Treasury over Financial Institutions wants the credit card companies to create default payments high enough to pay off the cards in a relatively short period of time even if it means that the consumer may end up making those payment rather than paying for medical care or food. Well at least this might help with the obesity problem.

Late fees should also be regulated under this proposal. While Barr and his co-authors admit that the credit card issuers do need to charge late fees to motivate consumers to pay on time, they maintain that the issuers should not be allowed to benefit from consumers' poor choices. Rather, the majority of these fees would be put into a fund for "financial education and assistance to troubled borrowers." The credit card issuers would be allowed only to keep enough to cover the actual cost of collecting the late payments.

Nobody likes paying their credit card bill; I am the first to admit it. But credit cards are voluntarily entered into agreements for unsecured debt. We are not forced into agreements with credit card companies, and higher fees and charges is the price that we pay (literally) for the use of a small plastic card with no intrinsic value which allows us to make purchases we don't have the money to cover. And I think Barr's premise denies the basic truth that while a lot of Americans do certainly default on their cards, many others use credit to balance cash flow and pay their bills in a timely manner.

All of this just simply comes back to choice. The more regulation that is in place, and the less profitable that the cards are for the creditor, and the less available credit is going to be for the consumer. And raising the payments artificially high is not going to produce better behavior among consumers; rather it will increase defaults, which will in turn increase creditor's costs, which will in turn reduce access to credit. In a credit society such as ours, this will further slow the economy, which will lead to fewer consumer purchases, which leads to more job losses. Lack of access to credit fuels a vicious cycle with unemployment at the end.

Just something to think about the next time we are on-line paying our credit card bill.

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