Will New Credit Card Regulation Lengthen the Recession?

While the markets are focused on the next bull market of the coming years, the groundwork that sustained economic growth in the past decades is being dismantled by new regulations and increased risk aversion on the part of investors.

This is not surprising, as the era-changing events of last year will have a long-lasting impact on the way business is done in this country and elsewhere for many years to come, a fact which appears to be disregarded by the markets so far.

At this difficult moment, nobody wants to deepen or lengthen the crisis. Both private savers and the regulators assume to be doing what is best for the economy, and in many cases what is being done is right from a long-term perspective. That these actions will bear their fruit in the long term, and that their results have little relevance to the short-term development of the crisis, are the main causes of the misunderstandings which plague analysts and officials at the moment.

The impact of the latest regulation on credit cards, the so-called credit card bill of rights, should be seen in the same light. While authorities are trying to curb abusive and reckless practices that led us to where we are in the first place, the timing of their actions is more in line with panic than prudence.

At this stage, no one should expect the American consumer to be saved from bankruptcy through tighter standards imposed by the government on the banking industry, since no one can save the consumer from the massive debt load, and the huge burden of mistaken financial decisions of the past decade.

But politicians have to be seen to be doing something, and the weakest victim of their efforts is the banking industry, for reasons well-known to everyone at this stage.

As with most issues these days, the divisions on the bill are powerful and deep. But a careful examination of the details shows that it is neither as radical nor as weak as it is made to be by those on the edges of the aisle. The bill was approved last week, but it will not go into effect until February next year, which means that its full impact will be felt only around summer-autumn of next year.

In addition, it will mostly help new borrowers, and those who are already paying the maximum interest on their cards will keep doing so. They are, in essence, still beholden to the willingness of their lenders to renegotiate the terms of their credit card balances.

Since the bill makes it harder for banks to charge higher rates for less creditworthy consumers, it is argued that they will respond by shrinking their balance sheets even further, leading to greater troubles for the US consumer. Critics argue that the contraction in credit that will be caused by the legislation contradicts the letter and spirit of government actions aimed at jump starting the economy.

But no one seems to ask the pertinent question on the impossibility of jump starting an economy that is likely to suffer from double-digit unemployment for quite a while to come.

Eventually, when the issue is consumer’s solvency, terms of consumer credit lose much of their significance. It is irrational to expect that banks can keep lending to the jobless in America on the same terms and conditions as they did during the past decade, with or without legislation.

Consequently, the impact of this bill is mostly about cosmetics: it is the rubber-stamping of a process that was already underway.

Ultimately, the legislation is another example of the right thing being done at the wrong time, and the right time would have been years ago, when bank credit was multiplying through meiosis. Since the beginning of this crisis in the summer of 2008, we have seen a patchwork of solutions improvised in response to shocks and turmoil in the markets, without any consideration given to timing.

Such haphazard efforts at managing the symptoms of the crisis have since proven to be incapable of resolving the deep and complicated root issues such as the profligate consumer culture, and the lack of financial discipline at all levels of the American economy. The credit card bill, restrictions on the salaries and bonuses of high-level corporate officials, and the numerous other attempts at restraining the freedom of Corporate America should all be regarded in the same light.

These changes are unpleasant for the banking industry, ill-timed for the economy, and confusing for economists, but are unavoidable in this period of soul-searching and self-incrimination following the massive turmoil of the past two years. The short and medium benefit provided by them will be minuscule due to a lack of vision on the part of authorities.

Yet their potential harm to the recovery effort is also insignificant, as the dismantling of the economic culture of the past decades is bound to do its harm through deleveraging anyway, regardless of the feeble actions of government.

Comments

[russ:]

I agree that it would have been better to do the reforms years earlier, but that was not possible until the Democratic numbers were increased in the Congress. It takes a special type of mental qymnastics to propose that reform of arbitary and punitive practices somehow causes large scale economic problems. The whole column is superfical, silly and far fetched.

May 28 08:30 AM

[Graham and ...:]

"The right time would have been years ago." Certainly true. But "better late than never."

May 28 10:44 AM

[Konrad:]

This move is indeed a little late. The average household is already 8,000 or so in debt and I dread to even mention the average credit card debt of college students coming out to the market. With bankruptcy as a valid exit I won't be at all surprised to watch many such individuals take that route soon.

The predatory behavior of credit companies needed to be curbed in order to restore a semblance of conscionable practice to that particular industry. It takes a fool to look at a group of customers who had a hard time making more than minimum payments and then increasing the APR's hoping to squeeze some more dollar out of a rock.

Ironically many are racing to beat the clock and have already begun increasing their interest rates now, before the legislation takes effect. With what I see as more Americans drawing on their credit lines in the coming months this will have a negative effect on their ability to pay those credit card bills.

Free Market resolution is those companies that over reach will be faced with an increased percentage of defaults on credit loans they've issued and watch their own value go down the tubes.

May 28 12:59 PM

[wtp:]

By all means, let's not constrain the credit companies from being free to attach any remaining grams of their customers' flesh, nor the CEOs from continuing uninterrupted their history of laughable and unwarranted overcompensation. The credit card "bill of rights" is still a cynical sop, failing to address the problem of usurious rates at the most obvious and opportune time. As for more party-on executive compensation as the goods-producing class gasps its last -- you're joking, right? Takes more than a whiff of green-shoot smoke to actually forget some of the basic issues here.

May 28 04:16 PM

[ain't no fo...:]

Four years ago, over a two month period, I paid off a 4 year car loan (all 48 payments on time). I paid off (early) a $1500 revolver (the NO Payments for 2 years type of card) on some furniture I had bought. I paid off a $2000 balance on my only credit card and called the credit card company to ask them to lower my credit limit from $37,000 to $5,000 (I had never had a balance on the card over about 3,500, but it kept creeping up because evidently the card company liked me so much that they thought I should be a lifetime mark).

Ahh, life was grand and I was DEBT free for the first time in years - did not owe a penny to anybody. My income remained the same. I couldn't wait to use one of my once-a-year-free credit reports to see how much my credit score had improved. Naively, I thought that my responsibility would mean good things.

So I did. And guess what? My score went DOWN!!!!!!!!!!!!!!!!!!!! By about 50 points!!!!!!!! I tried to get a reason from the credit reporting agency, but they refused. That's when I knew, beyond any doubt, just how screwed up our credit and debt industry and mentality was in this country.

May 28 10:35 PM

[CJJ:]

Please refrain from all the bit**ing and moaning about credit cards and credit scores. People act like other people actually care about their sob stories...Be happy you are out of debt.

The articles idea that this is a good thing at the wrong time. There's a reason the Constitution hasn't been updated more than a few times in 300+ years...there is a reason there are bubbles and will continue to be so. People don't make tough choices when things are good. You don't stop playing blackjack when you are on a roll.
That also doesn't mean you don't do the right thing just because its a little later than you should have.

You don't stick to stupidity just because you've been sticking to it for a long time.

May 28 11:45 PM

[BrentB:]

These changes are fiddling on the edges - not getting at the real problem with credit cards. And the growing problem - from the point of view of merchants. Banks keep on introducing new cars with even more premiums on the cars - some as much as 5% cash back. Air miles, cash back - consumers think this is all free. Well, the merchant is jacking up his prices for all consumer to pay the credit card fees for these premium cards. A few get some money back, the bank gets even more - the average person pays. Some areas - Australia for example - have capped the merchant fees at 0.3%. Goodbye all those premium cards. Hello lower prices for everyone. Time for all countries to get with it and limit the banks' take on all purchases.

May 30 10:23 PM