Payment Protection Plans

We have not talked a lot about payment protection plans, those great deals where the bank agrees to pay your credit card balance in the event of disability or death in exchange for premiums. They are great for the banks. In an article in the American Banker, Victoria Finkle and Jeff Horwitz reports that the banks only return to the consumer 21 cents of every dollar paid in premiums and earn profit margins of 50% or more on the plans. Finkle and Horwitz report that the FDIC and CFPB are looking into the plans, with a regulatory probe of Discover Financial Services already underway. The article is worth a read, especially for the surprisingly candid assessments of industry insiders.

These plans are another example of "gotcha capitalism"--a business model dependent on sustained miscalculations or mistakes by the other party to the transaction. For everyone but the consumer at death's door, the premiums are way too high to justify the expense.

UPDATE (2/8): More on the CFPB probe of Discovery from Donal Griffin and Carter Dougherty over at Bloomberg.

American Banker: Chase Has Halted Credit Card Collection Suits

Yesterday, the American Banker reported that Chase has stopped filing lawsuits to collect consumer debtors. Moreover, they did it quietly and quickly. With concerns over sloppy procedures in debt collection, akin to the robo-signing problems in the mortgage industry, this news was quite interesting.

H/t to our reader who pointed me to the story.

What is the Relationship Between Credit Cards and Mortgage Delinquency?

Previously I mentioned this new paper on homeowners in bankruptcy in the American Bankruptcy Law Journal. The central goal of the paper was to investigate what makes homeowners more or less likely to have mortgage troubles as they head into bankruptcy. One of the notable findings is that, across all the models, credit access had a significant effect on keeping mortgages current and avoiding foreclosure initiation (specifics listed pp. 302-304). But why?

Change.org Petition Plays Part in BoA Debit Fee Reversal

In early October of 2011, Bank of America announced that it would begin charging its customers an additional $5 users fee for using its debit cards. In my financial literacy class the weekend after the announcement, some students were resigned to it, some furious, but we all vowed to switch banks if we banked at BofA. Yet we all also knew what would happen next, if history was any indication. Other banks would follow suit and eventually we’d all get charged the fee, which would just go up even more over time. It turns out, at least for now, the ending is happier. People mobilized around recent college grad Molly Katchpole’s online petition requesting a reversal of the fees.The petition was brilliant in its simplicity, stating simply this:

Greetings,
I'm writing to express my deep concern over Bank of America's decision to charge customers $5 a month to use their debit cards when making purchases.

The American people bailed out Bank of America during a financial crisis the banks helped create. You paid zero dollars in federal income tax last year. And now your banks profiting, raking in $2 billion in profits last quarter alone. How can you justify squeezing another $60 a year from your debit card customers? This is despicable.

Consumer Credit Levels Reach Their Lowest Point in over a Year

According to a recent Reuters story, consumers are reluctant to hold debt due to the U.S. Credit rating downgrade and debt problems in Europe. The economy is shaky so people are apparently less willing to carry tons of debt. Consumer credit fell $9.50 billion in August after rising $11.92 billion in July, the report said, which is well below economists’ expectations of a $7.75 billion increase.

Revolving credit, which mostly measures credit card use, dropped $2.27 billion in August after falling $3.56 billion in July. Non-revolving credit, which includes mostly auto loans, fell $7.23 billion, the largest decline since August 2008, after rising $15.48 billion in July.
"Consumers are extraordinarily sensitive to economic conditions and as things started to look a bit more sour, they stopped using their credit card," said Steve Blitz, a senior economist with ITG Investment Research in New York. While this story paints this as a bad thing for the economy as a whole, it speaks well of consumers’ efforts to protect themselves in this economy.

 

Bully for BofA: New Debit Card Fees!

Bully for you, Bank of America.  Bank of America's starting charging monthly fees for debit card usage to some customers. This is being taken as an "I told you so" by opponents of the Durbin Amendment, who argued that it would only result in higher costs for consumers. Actually, the BoA move is exactly what we might expect:  consumers are having to pay for their rewards. That's how it should be. They might be paying too much, but that's another matter.  So what does Bank of America's move tell us?

Credit Card Securitization and Skin-in-the-Game

I have a new paper on credit card securitization and what it teaches us about the likely effectiveness of the Dodd-Frank Act's skin-in-the-game risk retention requirements. Credit card securitization has long required 4%-7% credit risk retention (cf. 5% under Dodd-Frank).  

I argue that when combined with other features of credit card securitization it was actually counterproductive at aligning issuer/securitizer and investor incentives and likely contributed to rate-jacking. Instead, credit card securitization didn't go off the rails like mortgage securitization because of the existence of implied recourse, effectively 100% skin-in-the-game. This suggests that skin-in-the-game cannot be relied upon as a one-size-fits-all cure. Its effectiveness will instead depend on the other securitization features with which it is combined.  

If you're interested in going into the sausauge factory of credit card securitization, there's plenty of gore and detail here for you. If you're interested in the connections between credit card securitization and rate-jacking, there's something here for you. And if you're interested in whether Dodd-Frank's risk retention requirements will be effective, there's something here for you too.  

The (overly long) abstract is below the break:

A Plea to Financial Reporters

Why do financial reporters insist on reporting interest rates on complex consumer financial products as if they were meaningful in isolation? To wit, an otherwise good New York Times story reports an increase in credit card interest rates over last year. That figures doubly meaningless. First, interest rates are but one component among many of the cost ofusng a credit card. This is akin to reporting that because A increased, therefore the sum of A+B+C+D+E increased. Unless we know that other factors held constant (fees of various sorts, etc) it doesn't mean much to know what happened to interest rates. And second, interest rates only matter for revolvers (including sloppy payees). That's the majority of card accounts, but it means interest rates just are so important as to be reported in isolation as significant. So tomy financial reporter friends, please stop repeating this logic fallacy.

More on the Durbin Amendment Rulemaking

I have an op-ed on the Durbin Amendment rulemaking in the American Banker.  

The Politics of the Durbin Rulemaking

It goes without saying that I think the Fed did a real jerk move on the Durbin Amendment rulemaking. But the more interesting issue is why? 

The Fed didn't have any new data to work with after the proposed rulemaking in December. Sure, it had lots and lots of comments, and there was some a crazy amount of lobbying. But it's hard to see what that lobbying would have accomplished in the January-June window that it hadn't in the July-December window. 

Instead, I think that the volte-face was the result of bigger picture Federal Reserve Board politics. For the Fed, interchange is the regulatory issue that they have with merchants. The Fed doesn't have to handl-vandl with merchants on other regulations. But the same can't be said about the banks. The Fed has an on-going regulatory relationship with the banks that it has to manage.  And interchange just isn't a very important issue for the Fed. It's not a regulatory duty that they wanted in the least. So the Durbin Amendment rulemaking offered Bernanke (and the other Governors) a low-cost way a chance to throw the banks a bone and build up some goodwill before the gloves come off on the real fight about capital adequacy levels. 

If that's correct, I think it's a bad calculation by Bernanke et al.  The banks are going to fight on capital as ferociously as they can and $4B annually of goodwill payments aren't going to change that. And given the way the Fed did the rulemaking, I think there are a good grounds for a litigation challenge that would defeat Chevron deference. If that happens, there'll be a lot of egg on the Fed's face. 

The Fed Bails Out the Banks...Again

[Updated 6.30.11]

If anyone doubted who set the marching tune for the Federal Reserve Board, it was sure clear today. The Fed announced its final rule under the Durbin Interchange Amendment, and it was quite the handout to the big banks.  

The Durbin Amendment instructed the Fed to pass rules that clarified its instruction that debit interchange fees must be reasonable and proportional to the incremental cost of authorizing, clearing, and settling an individual debit card transaction.  The Fed came out with a proposed rule last December that solicited comments on two alternative safe harbors.  One was for a flat fee of 7 cents per transaction, the other for 12 cents per transaction. The Fed also solicited comments on whether debit cards should have to be routable on 2 unaffiliated networks or on 2 unaffiliated PIN and 2 unaffiliated signature debit networks (4 networks total). 

Well, today the Fed came out with the final rule, and what a surprise.  

Still Not Working Abroad

I've previously posted about my frustrations at being stranded abroad without a functioning credit card -- particularly at train stations -- and the refusal of American credit cards to adopt a technology that has been in my building laundry room for years.

So I was quite excited to read in this morning's Times that Chase has begun to offer "chip and pin" cards. As Katie has previously noted, I use a Chase British Airways Visa. So I called them up all excited, hoping to get a card before my summer family vacation, only to be told that only private banking clients were getting chip and pin cards.

The customer service agent seemed entirely perplexed when I said "your loss." The inability to get somebody to supply a product that consumers demand is almost enough to undermine my faith in the invisible hand.

Dodd-Frank Gotterdämerung: The Durbin Amendment Rollback

As early as this Tuesday we might find out who runs this country.  Is it Wall Street and the financial economy or the real economy of consumer citizens and retailers?  We will know the answer to this question based on what happens when the Senate votes on a bill to unwind a Dodd-Frank Act provision that would prevent banks from charging anticompetitive debit card swipe fees.

This provision, known as the Durbin Amendment is a bellwether for the state of political power and thus financial regulatory reform in the United States. Banks are working furiously to roll back the Durbin Amendment, and their success or failure at doing so is a measure of the political power of financial institutions. If the banks win, it will not just be the traditional story of the banks' routing the consumer groups. If the banks win, it will show that the financial services sector is more powerful than the largest retailers in the US.  (Heck, the US Chamber of Commerce is on the banks side on this, which might say something about the Chamber's funding. It's certainly not from all the small businesses over which they weep crocodile tears.) 

The Three Consumer Banking Systems

For the past couple of years we've heard a lot about shadow banking versus traditional banking. But this dichotomy treats the traditional banking system as a unitary whole. That's hardly the case for consumer banking. The United States currently has three consumer banking systems. They have somewhat separate regulation and market segments, but they are fundamentally in competition with each other. 

The first system is the too-big-to-fail commercial banks. They are almost all structured as national banks, regulated by the Office of the Comptroller of the Currency. The second system are the community banks and credit unions.  They tend to be regulated by the FDIC and NCUA, but also by the Fed or state banking supervisors.  And the third system are the nonbank finance companies (payday lenders, title lenders, even pawn, etc).

Despite the competition between these sectors, they have cooperated to a surprising degree recently, particularly community banks and credit unions with commercial banks. For example, on both bankrutpcy cramdown and the Durbin Amendment, there were carve-outs for small institutions (<$10B net assets), but the small banks still fought furiously despite being exempted. I'm frankly puzzled why they are willing to carry water for the big boys (do they want to be part of the club?). Maybe someone will explain in the comments. But below the break I'll lay out the case for why the smaller banks should actually be strongly supportive of recent consumer finance regulatory initiatives. 

Google Wallet-Regulatory Implications

Yesterday, Google unveiled its Google Wallet near field communications payment app for Android phones. As far as I can tell, Google Wallet basically stores your payment card information for multiple cards (credit, debit, prepaid) and then lets the phone act as the NFC device instead of a RFID chip in a card. That's not particularly remarkable. What is cool about Google Wallet is that it integrates a loyalty/coupon system (Google Offers) with the payments. I haven't been able to figure out if the loyalty/coupon system integrates locationally-based offers (e.g., GPS in phone says you're 5 blocks from a Home Depot so you get a SMS text message telling you about the proximity and with a link to a digital coupon that has to be used within 2 hours).

Interchange and Elections

American Banker has a really interesting article about the way the interchange fight is affecting the reelection prospects of Sen. Jon Tester (D-MT), which could decide the control of the Senate in the next Congress.   (Also worth reading is this piece in The Hill that shows a pretty direct connection between Tester's advocacy of a bill to delay implementation of the Durbin Interchange Amendment and a surge in campaign contributions.)

I think many people have the plague o' both your houses reaction of the unnamed Senate aide who compared the interchange fight to the MLB labor relations:  millionaires vs. billionaires.  I think that's unfortunate because I think there's a real consumer welfare issue involved.  (Sort of like the fate of the fans and the game of baseball.) For me the interchange issue boils down to a pretty simple question: who do you think is more likely to be able to squeeze consumers harder, banks or merchants?

Both groups are profit-motivated actors, not eleemosynary institutions. But both also operate in a world where competitive forces place limits on their pricing. My sense is that these forces place much stronger limits on merchants than banks (indeed, we limit entry into the banking space), so merchants are more likely to pass thru savings to consumers than banks. Moreover, merchants are likely to pass-thru savings to all consumers, whereas banks are likely to pass-thru savings regressively to high-net-worth consumers. To be sure, there are plenty of other interesting issues involved with interchange regulation, but I think this is the essential question--are banks on average more competitive than merchants?

The Anti-Consumer Agenda

I often find myself annoyed by left-wing (and occassionally right-wing) anti-business screeds that decry corporations, big business, etc.  I don't find anything inherently troubling about corporate form or business size, and I have no problem with profit-motivated actors (individual or corporate), so long as they play fair. Mindless attacks on the business community have the unfortunate effect of undermining perceived validity of more targeted, thoughtful concerns through a guilt-by-association phenomenon. 

But business and consumer interests often diverge. Now, it should hardly be controversial that there is an unequal playing field between businesses and consumers. Generally, businesses know more about their products than consumers and have more bargaining power than consumers. (Yes, there are information assymetries running the opposite way, which is a particularly salient problem for credit and insurance products.) For many businesses, it is important to maintain this assymetry of information and bargaining power, as there's profit in it.

In theory, and I emphasize in theory, competition should eliminate many of the problems these assymetries create for consumers, but there's no such thing as a perfect, complete market, just varying degrees of market imperfection, so competition alone cannot be relied upon to solve everything. What, if anything else, should be done is an open question, but when one looks at a range of seemingly unconnected recent public policy issues, a troubling common theme emerges.

Instead of a laboratory of experiements to help level the b2c playing field, we see a different trend emerging:  a distinct anti-consumer agenda that aims to reduce consumer bargaining power and information.  Consider the common theme that runs through the following issues: 

• AT&T v. Concepcion (waiver of class actions in arbitrations)
• Attempts to bust up public employee unions (and attacks on unions in general, such as the failure of Card Check legislation)
• Citizens United (corporate speech rights)
• Attempts to retain the current corrupt swipe fee system (failure of antitrust)
• Attacks on public health insurance (prohibition on Medicare bargaining over prescription drug prices and the death of the public option)
• Attempts to first kill off and now to maim the Consumer Financial Protection Bureau

It Is All Clear Now

Although I don't think today's Dilbert was about a particular industry, I do now understand a lot more about the problems with unauthorized and excessive fees in the consumer finance industry:

The Politics of Swipe Fees

The HuffPo has a major piece on the debit card swipe fee legislative fight, which seems to be a stand-alone K-Street Full Employment Act. It's well worth the read. I'm proud to say that Credit Slips has probably had longer, more continuous, and more in-depth coverage of swipe fees than, well, anyone. Back to Sept. 21, 2007, to be precise. 

I'd add a few points to the HuffPo piece, however: the Booger Rule of Antitrust, the Small Banks and Small Businesses (with help from Wrestlemania III), and Consumer Advocates. 

Dora the Explorer on Debit Interchange: Swiper No Swiping!

Nancy Reagan taught us to "Just Say No!"  Now Dora the Explorer tells us some words of wisdom about uncompetitive debit card swipe fees:  "Swiper No Swiping!"  Swiper is the incorrigibly rapacious fox who is always trying to steal stuff from Dora and her friends. I'll let the metaphor speak for itself. (And what could that crown represent, Simon Johnson?) Consider it a modern tale from Aesop.  

  

[Update:  This is too good to be true.]  

Less than family-friendly beneath the break...

Another Robo-Signing Problem

The other shoe drops: allegations of robo-signing in credit card collections (courtesy of the AP and CNBC). If it is happening in assembly-line mortgage foreclosures, there is no reason to think it is not happening in other assembly-line debt collections.

The Solomonic Test of Swipe Fee Reform: Reverse Political Economy

King Solomon's judgment regarding the two women claiming to be the mother of the same child is a familiar story--the King proposed chopping the baby in two and giving each mother half of the child. One mother consents, while the other says that she will forfeit the child. The one who prefers receiving 0 child to .5 child is then awarded the whole baby because the real mother would never consent to the child being harmed.  A market test of value. 

We can apply similar logic to the question of debit swipe fee or interchange reform.  A major question in swipe fee reform is the degree to which merchants' savings from reduced swipe fees will be passed through to consumers. If the savings would be pocketed by merchants, it would just be a redistribution from banks to merchants. That's the right result under antitrust law, but it doesn't make as compelling of a policy argument as protecting consumer surplus.  

So what does this have to do with King Solomon?  It means we should give the baby (swipe fee reform) to the party that values it least because that's the party that will pocket the smallest part of the consumer surplus.  

My sense is that the banks are vastly outspending the merchants on lobbying.  The merchants don't seem to have put in a lot of money.  They ran a cartoon strip in some Capitol Hill papers a couple of years back, but they certainly aren't putting in nearly as much money as the financial services industry. There are entire metro cars in DC plastered with (really ineffective) posters opposing swipe fee reform, and even anti-reform TV commercials (YouTube link anyone?).  

Banks are spending more money than merchants on the lobbying because they think that they'll keep more money if there is no reform than the merchants would make if there is reform. The reason the merchants don't think they'll make much money from reform--because they anticipate the savings flowing through to consumers.  So applying Solomonic wisdom, we should give swipe fee reform to the merchants because they value it less than the banks.  Going full speed ahead with swipe fee reform is the best route for consumers. 

How Credit Card Companies Get Around the Card Act

Want to do a riddle?  Try this.

Mrs. Marquez wrote herself a $5,000 check from her credit card company....you know, those ones that come in the mail with the bill? Her family makes just $40,000 a year, but the card company approved this loan, under an offer advertized as 0% interest for one full year, starting April 1, 2010, a transaction clearly covered by the Card Act. In July of 2010, Ms. Marquez needed another $5,000, so the company allowed her to take out another $5,000, same terms, with the 0% deal expiring on July 1, 2011. The fee was $150 per transaction, not bad in and of itself. The Marquez' diligently paid on the loan so that they'd pay the whole first $5,000, in full, by April 1, 2011. Now the credit card company says they owe interest at some huge amount, on an amount close to $5,000? Can the company do this? Hint:  The Card Act requires that payments be applied to the highest interest portion of the loan first (after the minimum payment), but both loans are allegedly interest only.

More Bogus Lobbying Numbers from the Banks: Debit Interchange Rates

You gotta love the American Bankers Association. These guys just don't stop trying. They're the Hamburgler of the lobbying world. The ABA now has a little piece out now entitled "Merchant Interchange Rates are Steady—Transaction Volumes Are Rising". This piece is incredibly dishonest; they couldn't even get any academic or even hired-gun econosultant to sign on to it. All that's missing is a claim about death panels or al-Qaeda.  

Allocating Scarce Dollars: Payment Hierachy

When Americans have fewer dollars, creditors need to position themselves at the top of the pile to get paid each month. This is called payment hierarchy, and traditionally mortgage creditors have been at the top and unsecured creditors, and perhaps ubiquitous credit card creditors, near the bottom. At the Consumer Financial Protection Bureau conference on the anniversary of the CARD Act, I learned that the payment hierarchy has been upended. In 2010, consumers are paying their credit cards ahead of their mortgages. (Click on CFPB conference link above, then click on "Credit Card Profitability" by Credit Suisse and go to slide 7 to see the full data). Two key explanations for this change: 1) people may be more willing to risk losing their home when its value is plummeting and they are not certain they can hang onto it, and 2) credit card companies reduced the amount of credit lines and closed old accounts, making people more concerned about "preserving" their good standing with their credit card company. Another way to think about this is that homes used to be families' piggy banks, tapped when it is time to send a child off to college or do a home renovation. With no equity, Americans need to rely more on the credit card as their safety net. Unemployment rates are high, the economy remains fragile, medical costs are uncertain. In this economy, it seems entirely rational and reasonable to me for families to highly prize access to unsecured credit from cards.

When there are too many unsecured creditors to go around, however, how do consumers chose who gets their scarce dollars? A new research paper, Winning the Battle but Losing the War: The Psychology of Debt Management, uses a series of experiments to explore this question. The authors find that consumers focus on making payments that reduce the number of open accounts, which the researchers call "debt account aversion," rather than solely on paying off the debt with the highest cost interest rate. The latter would ultimately reduce the total cost of credit, an approach that the researchers term "perfectly rational."  In a series of stylized debt games played by students, not even one student consistently repaid in multiple rounds of the game all of their available cash to the open debt account with the highest interest rate. The pattern of debt account aversion--using some cash to pay off small accounts--held across a variety of conditions, although the researchers find some interventions that reduce the practice, such as prominently highlighting the amount of interest accumulated on each debt between rounds. But is debt account aversion really a "mistake"? Should policymakers be discouraging this behavioral trait?

Teachers and the Durbin Interchange Amendment

The National Education Association, the largest teachers' union, has come out in opposition to the Durbin Interchange Amendment.

It's unusual to see labor siding with financial institutions, but the lines are often blurrier than one might recognize. There are no less than 151 credit unions with "teacher" in their name (see it for yourself here). In addition, some of the myriad municipal and county employee credit unions are in part teachers' credit unions. I am left wondering if this is the NEA representing teachers or representing teachers' credit unions.

Small Banks and Debit Interchange Reform: Winners or Losers?

The banking industry is making a full court press to get the Durbin Interchange Amendent implementation delayed. Given that a year of delay is worth about $15-16 billion in swipe fees, the banks are quite motivated, and they've managed to get legislation introduced to delay the rule-making so the Fed can study the issue further.  

A potent force in attempts to delay the Durbin Amendment's implementation are community banks and credit unions. While most debit swipe fees go to a handful of very large banks, small banks have been quite concerned about the impact of the Durbin Amendment. And community banks and credit unions carry outsized political influence because of their presence and standing in every community. The local Chambers of Commerce and Rotary Clubs, etc. are filled with the CEOs of community banks and credit unions, not the local branch managers of Bank of America or Citibank.  

But are the small banks right to be so worried about the Durbin Amendment? It's not so clear, and a recent American Banker reader poll indicated that a majority of readers thought that small banks would actually benefit from the Durbin Amendment (I've made a similar argument about credit unions benefitting from the CARD Act.) The Machiavelli of the card industry himself, Andrew Kahr, even opined in the American Banker that small banks would benefit from Durbin. In his words, the claim that Durbin hurts small issuers is "Poppycock." It's pretty hard to argue with Kahr's math, when it observes that it can only help small banks if they get 100bps vs. 30bps for the big banks. So what gives?

Now Back to Our Regularly Scheduled Programming (i.e., Interchange!)

It's been a while since I've blogged about interchange.  But I've been meaning to share a personal story about how weak signature debit fraud protection is.  Recently Mallory Duncan, the General Counsel at the National Retail Federation was kind enough to speak to my Consumer Finance class about interchange regulation. I took Mallory out for coffee at Starbuck's afterward. I treated. But I asked Mallory if he would do the transaction, with my Visa signature debit card. I stood off to the side while Mallory purchased the coffee with my card.  

It turned out to be a signatureless transaction, so Mallory didn't sign anything. And my card has my photograph on the front. You be the judge of whether anyone is likely to confuse me and Mallory based on physical appearance. Pictures after the break. 

Visa's Identity Theft (I Mean Superbowl) for Life Promotion

In the midst of the Bears' ignominious defeat at the hands of the Packers, I saw a commercial advertising Visa's Superbowl for Life promotion.  It's a sweepstakes.  Users of Visa's signature debit and credit products are automatically entered with every purchase, but you can also enter by writing in.  If you use a Visa PIN debit product (Interlink), however, you do not get a shot at the tickets. 

The estimated odds of winning:   1 in 9,685,871,298.  Compare that with the odds of having your identity stolen by using a signature debit product.  

CARD Act Compliance Costs Outweigh Fee Benefits?

The American Banker has an interesting piece on the impact of the Credit CARD Act.  It's behind a paywall, but here's the key insight: 

Credit card issuers were expected to raise fees and cut rewards to compensate for lost revenue from new regulations. But some have done the opposite, eliminating fees they are still permitted to charge. Most banks have increased certain costs, such as purchase annual percentage rates, and added annual fees for some cardholders in response to the Credit Card Accountability, Responsibility, and Disclosure Act's new restrictions on rate increases, penalty fees and other terms. The ones that have also eliminated fees — including Bank of America Corp. and Wells Fargo & Co. — claim they did so as part of an effort to be more transparent. Some experts offer another explanation: it may simply be cheaper for issuers to drop these fees rather than bring them into compliance.

At the very least, this indicates that the impact of the Credit CARD Act is more complex than its critics would have it.   

Memo to Elizabeth Warren: How to Do Things With Documents

Elizabeth Warren has proposed, as one of her first initiatives, that banks should simplify their standardized credit card contracts with customers to insure that customers understand what they are signing.This proposal has generated lots of enthusiasm among centrists as a modest, relatively non-political initiative, something that hardly anyone could be against, but that holds out the possibility of reducing fraud and confusion in the credit markets by at least ensuring that consumers know what they are getting into.

Credit Cards to Payday Substitution?

Over at Volokh Conspiracy, Todd Zywicki spent Christmas Eve crowing about a Wall Street Journal article about the boom in payday lending. Todd sees the article as vindication for his insistence that regulation of consumer credit will inevitably result in a substitution of another type of credit. For Todd, the substitution hypothesis makes regulation not just pointless, but actually harmful because it will eventually push consumers into the arms of loan sharks.  

There are a whole bunch of problems with the substitution hypothesis, as well as for Todd's interpretation of the WSJ article. Todd writes that: 

Maybe instead we ought to acknowledge that there will be unintended consequences, such as by making credit cards less available regulation will drive many consumers to substitute to more expensive types of credit, such as payday loans? And just wait until the well-intentioned bureaucrats at the CFPB really start protecting those poor folks, then they are really going to get it.

For starters, Todd doesn't accurately summarize the WSJ article. He implies that it was referring to credit cards in general. It wasn't.  It was referring to subprime credit cards. The WSJ article quotes a payday lender as stating, "We believe that we're starting to see a benefit of a general reduction in consumer credit, particularly ... subprime credit cards."  

It turns out that subprime credit cards are often as or more expensive than payday loans. The Credit CARD Act severely curtailed a type of subprime card called "fee harvester" cards. A 2007 NCLC study shows that the costs of fee harvester cards rival or exceed payday loans. So if there's substitution here, it might actually be a good thing. The article is certainly not evidence for middle class consumers getting driven into the arms of payday lenders. Instead, at best, it shows some substitution of fringe financial products and it isn't clear that it is harmful substitution. 

Point of Purchase Bank Card Surcharges: Will They Help or Hurt Consumers?

Did you know that merchants are considering tacking on a point-of sale fee for purchases made with a debit or credit card?  In other words, at 2%, a $100 purchase would cost $100 in cash, but $102 when charged. I have seen this sort of thing in Europe, so will it happen here?  If so, who will it hurt and help?  The argument for imposing such a fee is that cash customers are now bearing part of the cost of processing all those bank card payments. In other words, the cost of goods is going up because without bank card purchase costs to absorb, merchants could charge all of us less for their products. As a credit card doubter and a vehement proponent of a cash economy, I was on board with this thinking. Why should I support all those card carrying members of the debt society?

Kardashians Abandon the K-Kard

Thanks Mike Dillon for letting us know the Kardashian Kard is no longer being endorsed by the Kardashians. Perhaps, Katie, they are worried about becoming fat as a result of these cards too? No really, it is more likely that they dumped their card because they are being criticized for high fees, not to mention being investigated by Connecticut Attorney General Richard Blumenthal for being tantamount to predatory lenders.  Oh well, just another day in the life of the rich and financially unsavvy.  I mean, did they not know these were not great products?  Problem is, this card is not alone, as many other cards are just as bad.

Credit Cards Make You Fat

I know, I know, I am willing to say anything in my blog title to get you to read my post (see here for an oldie but a goodie). In my recently read pile is How Credit Card Payments Increase Unhealthy Food Purchases: Visceral Regulation of Vices by Manoj Thomas, Kalpeseh Kaushik Desai, and Satheeshkumar Seenivasan, which points to an association between what types of foods consumers purchase and how they pay at check-out.  The authors' basic hypothesis is that paying in cash is painful, or at least more salient, than credit or debit cards, which they characterize as "less vivid and emotionally more inert modes of payment." They do several studies but the first one uses data from actual shopping behaviors of 1,000 households over six months. The authors find  that these households buy a higher proportion of food rated as impulsive or unhealthy when they use credit or debit cards to pay for the purchases. They stress that the mode of payment did not affect the number of virtue products (such as vegetables) purchased. Another nugget of knowledge about consumer behavior; will we start seeing weight loss programs advise members to carry cash?

Principles Aren't Always Enough; Rules Are Needed Too.

In my last posting, I discussed the tradeoffs of regulation on the consumer side, and the extent to which disclosure would be sufficient to resolve consumer protection issues.

Here, I pose a simple problem to illustrate why principles based regulation would be inadequate.

What's in Your Wallet Part II: Let's Shop for Credit Cards

I have been enjoying talking to my UNM colleagues about Katie’s post on what's in our wallets.  There are different credit cards for every demographic imaginable.  For example, there are cards with rights to all airport clubs and even the right to a personal shopper, for the truly rich and famous.  There is plenty of free pizza to be had with the cards touted to college students.

New Consumer Regulation: Education and Disclosure Is Not Enough

Elizabeth Warren’s appointment as special advisor to the president was widely hailed as an achievement for consumer advocates. Professor Warren has long been a strong advocate of the middle class and famously compared financial products to flaming toasters.

The creation of a new agency brings new possibilities and new risks for consumer advocates. Most importantly will be the agency’s approach to regulation. In a two-part posting, I will comment on two key aspects of the new agency’s direction. The first revolves around understanding of consumer behavior and the second around firm behavior.

Part 1:

A core component of the CFPB mission is based around the idea that banks provided risky products to consumers that didn’t understand them. There is abundant evidence that consumers didn’t understand the products they bought; however, it’s far from clear that this is a sufficient role for the CFPB. I’ll argue here that in addition to disclosures, education and information, we need explicit regulation of the products as well.

Effectively, this boils down to a simple question: if banks want to offer a risky product (a flaming toaster) to consumers that fully understand its dangers, should the bank be permitted to offer it?

Modern Redlining in Historical Context

A paper that I wrote while an employee of the Federal Reserve System a couple years back documents the presence of ‘redlining’ in the issue of credit cards. Credit Slips picked it up here (link).

(To ensure there are no misunderstandings, this paper did not and does not represent the views of the Federal Reserve Bank of Boston or the Federal Reserve System; in fact, both entities did their utmost to prevent its release) ... continue…

To be more specific: I find that credit issuers use the racial composition of a neighborhood in determining how much credit to give to individuals that live in it. I use the term ‘redlining’ with historical reference: this idea is that particular areas have been identified as high risk. What I find is that the ‘high risk’ areas are highly correlated with the presence of minorities.

I’ll be clear, I cannot definitely prove that lenders use race—I’m an economist, not a lawyer! Regardless, I’ll present the point that the practice is still redlining even if lenders never use race, but use location-based information that is correlated with race.

Cash Is (Still? Again?) King

Payments innovations aside, Scott Schuh gave a preview of the soon-to-be-released results of the 2009 Survey of Consumer Payment Choice. The 2008 data are already available and provide a detailed portrait of payment practices of consumers (this is an excellent new study for researchers and reporters to use.) He reported as a preliminary finding that cash use had gone up notably from 2008 to 2009. After some discussion about who uses cash (hint: very few people who attend a payments conference!), one of the large banks pointed out that two of the fastest-growing population groups in terms of size and spending in America are Hispanics and Gen-Yers. Both groups have a predilection for cash. This suggests that the pull back toward cash may be a somewhat enduring trend because it could at least partly reflect demographic changes in the population of consumers. Scott Schuh also pointed out that there had been a huge increase in the availability of cash when stores began to offer cash back, essentially putting an ATM in every point-of-sale terminal.

And, of course, the recession looms large as an explanation for people returning to cash. Whether its because their credit cards have been cancelled, or people are afraid to borrow, or people think they can control their spending and save more with cash isn't clear. But Walmart Financial Services offered some insight on just how much hurt  American families are feeling. In the last year, Walmart stores have seen a huge (sometimes triple digit percentage increase) uptick in sales starting right at midnight on the 1st of the month and continuing all that day. Why? Because people are literally waiting at Walmart for their benefits or paycheck to become available, out of food and household basics for their family.

Payment Possibilities

If "What's in Our Wallets?"  left you bored, this is the counter post. Last week I attended an event called Innovations in Payments organized by David Evans, an expert on credit cards. My take-away: if I want to be at the cutting edge of payments technology (and be able to teach my students the law they'll need to deal with popular payments 20 years from now), I need to step it up and start acquiring new payments tools. Exactly which one to get though, in the face of so many businesses wanting my consumer dollars?

What's in Our Wallets?

Capital One made the slogan famous, but it's more fun when it's not just a hypothetical question. Many of the Credit Slipsters research at least some kinds of payments, such as credit cards, and some of us teach payment systems courses in law schools. If, and perhaps it is a big if, you think that means we know something about payment systems, I thought it might be revealing to see how we do or do not translate our knowledge to our own behavior as consumers. So I polled the Credit Slipsters, and a few other people who teach payments law (some of whose responses will appear in comments to this post), and here is what they said about what they carry and how they pay.

I'll go first: I have an LL Bean Visa credit card. I like it because it is offered by Barclays rather than a TARP rescued gigantic card issuer, and perhaps not unrelatedly, because it has very low fees, such as a $15 late fee. I usually pay in full but sometimes I procrastinate (anybody who reads this blog will know this about me already). I also find the free shipping/returns/monogramming is a reward that I actually use, whereas with airline miles they just accumulated and whenever I wanted to use them all the seats were gone. I also have a Visa branded debit card issued by a local bank in Iowa. If possible, I always enter my PIN with this to save the merchant some money (interchange fees for PIN-based debit are cheaper than signature (Visa/MC) debit). If I had to guess, I would say that I use debit and credit each about half the time, but probably use the credit card primarily for travel, which tends to be large ticket items, such as hotel and airline tickets. I also make regular use of one stored value/prepaid/gift card, which is at Starbucks. It has a budgeting effect--when it's out at the end of the month, I at least pause before reloading the card. If you think I'm not exactly the most rational actor in the world, keep reading! 

The 79.9% APR Credit Card

A while back I blogged about a 79.9% APR credit card offer from First Premier, a subprime card issuer. The point I made in that post was that although the APR was off-the-charts high, it was basically an equivalent pricing to First Premier's other cards, which had lower APRs, but much higher fees.  At the time I did that post, I wasn't able to find a copy of the cardholder agreement for the 79.9% APR card. But thanks to the Credit CARD Act and the Federal Reserve, here it is in all of its glory.

An Aside

Payment systems are not usually my beat, but returning from a conference this morning, I was again subjected to the continued stubbornness of the U.S. credit card companies regarding "chip and pin" technology, so it seems like a good time to rant. 

I arrose at 6am and made my way to the Luxembourg RER station, to catch the train to the airport. The ticket machines at this station do not accept cash -- not even coins -- and they are the older type, which means they also don't accept U.S. credit cards because we don't have a "smart" chip in our cards. Once again I was stranded at a European train station by this issue -- the last time was in Amsterdam, where, ironically, my INGDirect debit card was rejected.

The War on Bank Profits?

The Wall Street Journal had a peculiar opinion piece today about bank regulation.  I won't pick the low-hanging fruit of its bizarre statements about potential CFPB Director nominees, but I think it's noteworthy for the revealing language it uses.  It says that Washington should "call off the war on bank profits" and allow[] banks to make profits."  

The conceit of the piece is that a subset of businesses have an entitlement to be profitable.  That's deeply inconsistent with a belief in markets.  The fundamental rule of American capitalism is "Go Forth and Profit, but Fairly."  It's one thing to debate what sort of practice is fair or not.  But that's not what the WSJ piece argues.  It argues that legislation like the Credit CARD Act and the Consumer Financial Protection Act are wrong because the restrict banks' profitability.  This is a serious misunderstanding of financial services reform, and if this is how the financial services industry as a whole understands regulatory reform, we've got serious problems as a society.

The Fed's Apparently Nonexistent Interest

Last week, Katie proposed that we might have a blog category for "Beyond the Comfort Zone." I'll add another new category: "Things Bob Does Not Understand." It's sure to have lots of entries. Here is what I don't understand today.

As illlustrated by a Wall Street Journal article from last week, a number of media sources reported that credit card interest rates are rising. The conventional story is that credit card lenders are hiking rates to recoup income lost from new restrictions on fees and penalty rates. Even if credit card interest rates are rising, it would not necessarily mean the regulatory changes have backfired. The point was not to make credit card borrowing free, but just to make its costs more transparent. To the extent the regulatory changes have moved the costs into easily understood front-end interest rates instead of "gotcha" penalty fees at the back end, these changes have accomplished their purpose. But here is the thing, I don' t understand how the world has come to the conclusion that credit card interest rates are rising.

Student Loans Now Greater Than Credit Card Debt

Total outstanding student loan debt now exceeds credit card debt, as reported yesterday in the Wall Street Journal which in turn elaborated on a web article by Mark Kantrowitz, publisher of FinAid.org. Revolving consumer credit according to the Federal Reserve is $826 billion. Kantrowitz calculates outstanding student loan debt at almost $830 billion.

Make Your Home Finance Audit Fun While Fighting Back Against Bank Fees

The article Katie posted on bank fees was right on. The fees have gotten so creative that we invented a new household game to combat them, in which we compete for a pre-determined prize.  The prize makes it fun.  We do a competitive home finance audit over a glass of wine or two on the 5th or the 6th of the month, once the statements are all complete on line. Today is the 6th. Game on!! Stewart and I like competition.  To play, we scour all bank and credit card statements as well as certain purchases. The prize goes to the one that incurred the least interest or fees of any kind on anything, except the home mortgage. If there are no fees at all, no one wins the prize, but we both win!

Chasing Card Companies

The New York Times Wall Street Journal did a nice story a few days ago on the compliance issues swirling around the Credit CARD Act. It details the kinds of new fees that consumers are seeing and explores the legality of these practices. The article provides some ideas of things that the Bureau of Consumer Financial Protection might explore in its early days. Several of these practices seem legal under the new law but perhaps would fare less well under an unfair, deceptive, or abusive practices analysis. If nothing else, the Bureau would presumably be a one-stop repository for collecting and tracking the changing practices of card companies, a task now that the federal government largely delegates to news reporters!

Why Is the Government Paying High Interchange Fees?

The American Banker (subscription required) reports that Senator Dick Durbin has "added an amendment to an appropriations bill that would require credit card payments accepted at government agencies to be given the lowest available market interchange rates, which typically can only be negotiated by large supermarket chains."

The amount of money at stake is relatively small--perhaps $28 million/year. But it is rather astonishing that the US government doesn't already get rock-bottom interchange rates. If interchange is supposed to reflect the merchant's risk (an argument sometimes made), the US government should be getting the risk-free rate. It hasn't been. Frankly, I'm not sure why the government should settle for getting the best rates available to large supermarket chains-that's not a risk-free rate. If interchange is about risk-based pricing, surely supermarkets should pay a premium over the government?