Credit Card Fees and Why It's Hard Protecting People from Themselves

It's a dirty little secret that banks make a lot of money on their worst credits. Bad credits tend to be desperate or cognitively challenged, making them good customers. But there is competition for these saps, and banks are profit maximizing, so they set prices such that the spread, loss, and volume is optimized. Thus, one can expect any regulation that caps prices to lower volume and profits.

Congress and the President are hot to get some good PR by limiting the ability of credit card companies to add fees and whatnot. Minor stuff in the scheme of things. Here in Minnesota, there is a proposed 30% corporate surcharge on all revenue from interest rates over 15%. That sounds like a nightmare to administer, and I don't know if that means they follow the profits of all payments from individuals to their various companies around the globe, just apply it to Minnesota based companies, or how they plan to determine earnings on a single line of business within a large diverse financial organization (it's a surcharge on earnings, not revenue). Hey, it's popular, worry about details later. But all this will do is lower the amount of credit extended to these people, and probably raise their overall lending costs. If you think their spending is like buying cigarettes, that's a good thing. I'm actually quite shocked by the amount of debt most poor people have, and think they would be wise to borrow less.

In sum, it does not amount to much, but protecting people from themselves is never easy. There are alternatives, and if credit card debt becomes overly regulated, then pay-day loans, or rent-to-own, will gain market share, and it's not clear the poor win. The bottom line is that it is hard to protect someone from their own poor judgment, and it just gets harder the further away one gets from the person. Credit is fungible, coming in various conditions and services. Unfortunately, regulations to protect consumers tends to merely overwhelm them with information. For instance, even in 2006 during the height of the mortgages lending bubble, a mortgage document would take about 15 different initials on various pages of 10 point font documentation that borrowers did not read. Anything that aims on informing desperate or stupid people on how much they are paying should focus more on prioritization of information disclosure, not the absolute amount. Investment professionals would benefit from greater disclosure about financial balance sheets, because there are relatively few analysts but they have the ability and willingness to check this out. Your average borrower's eyes glaze over when faced with page after page of disclosures. Know your audience, legislators.

Comments

[dcb]

I read the title, the answer is no it isn't. You don't give them credit in the first place. One of the reasons we are in this crisis (as you point out) people with bad credit make good profit streams. Unfortunatety this creates systemic risk and we all suffer. The truth is that most people just want to go to work, pay their bills, raise their kids, and have a bit of fun in life.

In an ideal world it would be buyer beware, don't take out credit you can't afford etc. Of course the cards are marketed to those people, and when you are struggling to pay the rent or pay the bills you will charge it. So, there is a bit of a dichotomy there.

So while it may not e the greatest thing to admit one of the things government has to do is protect people from their own stupidity. We elect people we hope will to that, or at least give us more handouts :-)

2009 May 15 03:51 AM

[tedstr]

So the first step is to have the ruling class, and that includes many of the SA readers, stop with the attitude that this is all about stupid people making stupid mistakes. Then you don't have to deal with the government's diffeculty in a task like that.

It's all about how you frame it.

Killing the usury laws made this problem. Loose credit and preditory lending made this problem. Not the unfortunate who were perhaps not as gifted as you.

Instead of letting competitive capitalism run wild, how about let's get back to a better moral standard and let both business and government leaders show some leadership by reinstating those laws and take the systemic risk back down where it should be.

2009 May 15 07:34 AM

[BigJake]

It is impossible to protect the stupid from stupidity. Why? Because stupid people don't know they are stupid. They think they already know it all and do not need to be burdened with the need to acquire more knowledge.

2009 May 15 09:34 AM

[Larrysyr]

There are a lot of reasons people make bad financial decisions. Usually, the people I see just don't know any better and end up over their heads with fees, high interest rates, and unsustainable payment streams.

We can't protect people from their own bad decisions, but it seems morally repugnant for the profit incentives to be skewed toward taking advantage of people's ignorance or desperation.

Perhaps applicants for credit should prove a minimal level of financial literacy. Perhaps lenders should actually have incentives to seek out credit-worthy borrowers. I'm not sure usury laws work that well, as the desparate simply go to the next available line of credit, the local leg-breaking loan shark.

2009 May 15 10:12 AM

[Borbastic]

Right. Lets control interest rates so that risky punters can't get credit. Then lets have the govt mandate loans to deadbeats to solve that problem. Sound familiar?


On May 15 07:34 AM tedstr wrote:

> So the first step is to have the ruling class, and that includes
> many of the SA readers, stop with the attitude that this is all about
> stupid people making stupid mistakes. Then you don't have to deal
> with the government's diffeculty in a task like that.
>
> It's all about how you frame it.
>
> Killing the usury laws made this problem. Loose credit and preditory
> lending made this problem. Not the unfortunate who were perhaps
> not as gifted as you.
>
> Instead of letting competitive capitalism run wild, how about let's
> get back to a better moral standard and let both business and government
> leaders show some leadership by reinstating those laws and take the
> systemic risk back down where it should be.

2009 May 15 10:21 AM

[MinAkkar20]

Many lower-income people are faced with paying minimum payments for the rest of their lives on 20% rates. I receive offers of credit every day in the mail, but don't use them. Unfortunately, many do and despite the notion it is for necessities, frequently it is for perceived necessities.

If someone needs to be saved from their own "stupidity" I suggest it's done by someone who is less "stupid" than them. Our Congress doesn't fit that description.

2009 May 15 11:40 AM

[nyoneway]

This article is focused on the economics side of things, however, the real debate on hand revolves around simplying the fee structure for the layman. I've been caught off-guard that my BAC credit card which held a balance (from a transfer) suddenly shot up from 2.9% to 29.9% because an authorized user in the family was inadvertently late in one of her other credit cards. Luckily in my case, I've noticed the increase (no warning) and quickly settle the balance and have never used that card again.

These types of pratice needs to be stopped.

2009 May 15 12:11 PM

[Alan Young]

People don't get stuck with high rates just because they're stupid or irresponsible.

In the business world, if you take out a loan at 8%, you plan to pay 8%, and the lender can't come back and say, "now it's 24%." But if you borrow with a credit card, that's exactly what can happen.

I can make a perfectly responsible decision to maintain a certain debt load at a certain interest rate, and then be ruined when the bank suddenly demands 2 or 3 times as much interest on that same balance. Of course I wouldn't borrow at such a high rate, but that's not the question here.

Why are banks allowed to demand of credit card customers a privilege which would be a non-starter with any other kind of loan?

2009 May 15 12:48 PM

[FloridaBoy2]

On May 15 12:11 PM nyoneway wrote:

> This article is focused on the economics side of things, however,
> the real debate on hand revolves around simplying the fee structure
> for the layman. I've been caught off-guard that my BAC credit card
> which held a balance (from a transfer) suddenly shot up from 2.9%
> to 29.9% because an authorized user in the family was inadvertently
> late in one of her other credit cards. Luckily in my case, I've noticed
> the increase (no warning) and quickly settle the balance and have
> never used that card again.
>
> These types of pratice needs to be stopped.

Yes they do need to be stopped and that linkage you describe is a prime exapmle. Many people do use credit responsibly but get caught in these traps when they can least afford it.

Here is a link to a PBS program about credit cards. It is worth viewing.

www.pbs.org/wgbh/pages.../

2009 May 15 07:31 PM

[Moon Kil Woong]

The simple fact is between maybe those who don't manage credit correctly is vicious financial institutions that also don't manage risk or credit correctly and have decided that making people who aren't at fault for their mortgage and derivative mess can pay for all their mistakes through increasingly high fees, service charges, and interest rates. This is not about usery as much as it is about banks taking advantage of a captured client base which hppens to be 95% of the US population (everyone who uses credit cards).

They aren't just ripping off stupid people. They're most likely trying to rip you, your children, your wife, and your parents off too. After all they need to raise bilions to cover the tide of red ink they, the banks, made due to poor lending habits not the consumer. Trust me, if you want to punish the consumer you can be happy that the consumer is already feeling the pain and happily, the US savings rate has finally turned positive. This is all about out of control financial institutions and their dubious practices.

2009 May 15 11:13 PM

[tedstr]

Allowing one evil to save from another is not a solution. Usury is Usury and it has been around since the moneychangers. There is a reason we outlaw exhorbidant interest rates because they impoverish.

Loan sharking is illegal too though by today's standards Chase and BOFA and the rest would be yesterdays loan sharks.

2009 May 16 09:31 AM