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Big Brother Is Looking After You

posted by Adam Levitin

The NYTimes has a story about how American Express is analyzing where its cardholders are making purchases and using that information to determine whether to likely to default and adjusting credit limits and rates accordingly.  

This sort of behaviorally-based pricing is nothing new in the card industry.  We've seen a form of this for quite a while in the form of cross-default clauses and their successor any-time/any-reason term change clauses.  It's also popped up in litigation.  For example, the FTC's complaint against CompuCredit for unfair and deceptive acts and practices (settled for $350 million and a consent decree).  FTC alleged that CompuCredit was changing terms on cardholders depending on whether they used their card for things like marriage counseling, tire retreading, or massage parlors.  The NYTimes story indicates that Amex is not just analyzing on-us transactions, but also looking at things like home prices in your area and your mortgage lender. 

None of this is surprising.  The card industry probably knows more about consumer behavior than any other industry in the country; they have access to an unparalleled source of data on consumer consumption--there's really no other industry that can see as broad of a swath of consumer purchases as the card industry.  What's more, the industry invests significant resources in behavioral research and analysis, designs, markets, prices and reprices products based on this research.  This knowledge and analysis of consumer behavior has both positive and negative features.  

On the plus side, it allows card issuers to to a better job in detecting fraud and minimizing fraud losses.  It also allows them to craft products that better match consumer preferences and usage patterns.  But on the downside, it can be invasive of privacy, the card industry doesn't always get its analysis right, and it crafts it products (quite reasonably) with the goal of profit maximization, not consumer welfare enhancement, so when a product better matches consumer preferences, it might also exploit consumer weaknesses detected by behavioral analysis.  

Currently, card issuers only receive sufficient data on consumer transactions to tell the name and the industry category of a merchant; they can't tell what you purchased at the grocery store or the adult video shop.  But they're trying to change that.  The card networks are now trying to get access to item-level (SKU) data from merchants in the name of anti-fraud protection.  On some level, this is very sensible.  Chances are that Grandma (or at least my grandma) isn't buy 40 oz bottles of malt liquor or high-end electronics, or that a college student is going to be buying geritol.  

Fraud prevention is important; fraud costs are often socialized.  But there are also some obvious steps card issuers could take to reduce fraud, like not printing account numbers on cards or requiring a pin number or some other two-stage identifier and not requiring merchants to retain significant amounts of card data.  Merchant data retention creates a huge target for hackers, as my cousin Boris in Odessa, who may or may not be involved in such questionable activities, tells me.  (Привет Боря!)  

There's also a real potential downside for consumers and merchants of card networks getting item-level purchase data.  For consumers, there's a serious privacy cost.  It's one thing for the merchant to know about your purchases (which are largely anonymous), but it's another thing for your bank to know.  And for things like pharmacy and hospital purchases there are serious HIPAA issues involved.  

There's also a risk that your purchases will end up making your credit more costly.  For example, if you purchase OTC anti-depressants, like St. John's Wort or you purchase a pharmacy item used for treating a terminal cancer, that might indicate to your card issuer that your income is or will be impaired.  It might also indicate that you won't be real careful about paying your bills, etc.  And that could trigger increases in rates, decreases in credit lines, etc.  

For merchants, there's also a real cost.  Merchants would have to share a very valuable commodity--data--with card networks without receiving any compensation.  This is a tremendous wealth transfer. Many merchants already sell consumer data.  The value of their data will decline if card networks have it too both because the data supply will increase and the demand for data (from the card industry) will decline.  What's particularly notable, though, is that the card networks, if they can get SKU level data will know far more than any merchant possibly can.  Merchants know what you bought at their store.  But they can't easily match that up with many other characteristics about you or other purchases.  The card networks, however, would have that ability.  This will allow much more targeted solicitations from card issuers, as well as from anyone they sell the data to.  

Whether or not this is a good thing isn't clear--are you the type of person who wants to ferret out products you want or who wants them offered to you? Arguably, this type of proactive product solicitation encourages discretionary spending.  Again, that may or may not be a good thing, depending on where one is in the system.  

From a net social welfare perspective, though, I am suspicious of it.  Consumers are bad at budgeting and easily convinced of the need to purchase extraneous products.  (Yes, I know we like to think that we operate with totally free wills, but there's a wealth of research showing that we aren't as independent in our actions as we'd like to believe.  That's not to say we have no control, only that it isn't perfect and is manipulable at the edges.)  Thus, encouraging additional discretionary spending can also encourage consumers to save less than a socially optimal amount (as saving is a consumption decision) and lead to debt overload problems.  


Adam, we have been preparing a bill to outlaw merchant / lender blacklisting here in MD, and I think we will continue notwithstanding AmEx's change of heart.

The SKU issue is as troubling as it is predictable. Do you think we can institute a ban on sharing that information at the state level? It seems too divorced from core banking functions to be pre-empted, but I'm sure we'll hear that from the Bankers.

thats so sweet

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