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Credit Card Legislation

posted by Adam Levitin

The most significant credit card reform legislation since the 1968 Truth-in-Lending Act cleared its last major hurdle today, when it was overwhelmingly approved by the Senate.  There are some not inconsequential details to iron out in conference (House version, Senate version), but the bill is as good as passed. 

It's worthwhile stepping back for a second to gain some perspective on this bill.  Since 1968 there has been only minimal regulation or legislation relating to credit cards.  Four years ago, the card industry pushed through the BAPCPA and then poured money into defeating Tom Daschle's reelection bid.  The industry looked invincible.  The banking industry showed that it still has significant political muscle when it defeated cramdown legislation last month. 

That there would be any regulation of the card industry today is quite remarkable.  Some of the credit goes to the card industry's greed---for all that the industry knows about consumer behavior, it didn't realize that when consumers are squeezed too hard for too long, there will be legislative pushback.  But a lot of the credit for the legislation goes to the Congressmen and their staffs that really pushed the issue, especially Representative Maloney and Senator Dodd, as well as to advocates and academics who worked very hard for the legislation.  From the consumer groups, Travis Plunkett and Ed Mierzywinski deserve particular plaudits.  And some of Credit Slips' Finest had a hand in the legislation:  Robert Lawless, Katie Porter, and Elizabeth Warren, and non-Slipster Lawrence Ausubel.  Congratulations!

The news reporting on the legislation has been rather mixed.  Andrew Martin wrote an odd story in the New York Times that bit hook line and sinker into the card industry's spin.  Other commentary, such as Ron Lieber's analysis in the Times has been more critical.  So, let's pause for a second and take stock of what the legislation accomplishes and what it does not. 

(1)  The legislation addresses many of the current abusive credit card practices toward consumers.  The Senate version is more comprehensive, but both versions address a lot (but not quite all) of the bad practices:  double-cycle billing, automatic overlimit, application of payments to lowest APR balances, aggressive marketing to college students, etc..  I've detailed some of these practices in past blog posts here, here, and here (addressed only in the Senate bill). 

(2) The legislation isn't going to cause credit costs to skyrocket or credit availability to dry up.  There will be some effect on credit card pricing.  But let's be really careful in evaluating it.  There is an unfortunate tendency to equate the cost of credit cards with the purchase APR.  But that's just part of the cost of using cards.  To really know if there's been a price increase, we'd need to examine all the price points and factor in things like cost of funds and cost of operations.  The truth is that it's near impossible to do, which is why we fall back on a very misleading metric like purchase APR.  But any claim about card pricing that doesn't address the total cost, not just APRs isn't telling the full story.  

It will be very difficult, if not impossible, to sort out the legislation's effects on card pricing and credit availability.  Not only will there be anticipation effects to address, but there is the financial crisis and issuers' existing cutbacks on credit lines plus a frozen securitization market, but cheap funds directly from the Fed.

While we might not be able to sort out the pricing impact neatly, I think it's safe to say this much: the card industry's story of inevitable price increases and credit scalebacks is overblown.  First, over 85% of the cost of cards is a function of the cost of funds and cost of operations.  These aren't affected by the legislation.  The remaining 15% or so accounts for risk as well as for opportunistic pricing. It's just not realistic to think that card rates will go through the roof as a result of the legislation.  The worst case scenario, then, would be a 15% impact on card pricing.  To put that just in APR terms, it's like a 14% APR going up to 16.1%.  Not a huge deal. 

(3) Congress isn't taking away issuers' ability to price for risk.  Issuers still get to do the initial underwriting  and are able to cut off credit lines or adjust for risk prospectively with reasonable notice.  Congress is taking away issuers' ability to engage in opportunistic pricing in time period 2 to compensate for riskier behavior in time period 1.  The simple solution to this is for issuers to just do a better job pricing credit up front. 

(4)  The legislation has its limits:  this legislation addresses the problems of today, but it doesn't solve the problems of tomorrow.  The card industry has shown that it is quite skilled at adaptation, and economic theory tells us that regulation has a hydraulic effect--if practice A is banned, the market will simply move to practice B.  This is just plain vanilla term substitution.  If there is an interest rate cap, the cost is shifted to annual fees and the like.  The same can and will happen with other billing practices. 

Thus, I worry that within the next year we will see a host of new, creative fees:  unused limit fees, high-risk transaction fees, account review fees, line increase fees, etc.  If card industry executives are doing their job, they have already deployed lots of lawyers and economists and pyschologists to come up with new product features and have already been doing market tests.  I fear that the consumer victory from this legislation will be very short-lived. 

(5) So what do we do?  The answer is that we have to embrace a new model of regulation.  We have to recognize the hydraulic effects of regulation and use that to channel market forces to help consumers.  As long as credit product structure remains in the control of the card industry, regulation will always be met with term substitution.  A better route would be to restrict product structure:  limit card issuers to a few price points (availability fee, transaction fee, single interest rate) and mandate standardized terms for the entire industry.  This would leave issuers free to compete on price (and product structure within these limits) and service, and prevent them from playing the three-(credit)-card monte game of "hide the cost".

The risk here is that it makes it harder to bring innovation to market.  But it doesn't make innovation impossible.  Rather it merely shifts the burden of innovation to industry.  Instead of lawmakers having to play catch-up, what's the harm in making the industry seek regulatory approval of innovation?  An agency like a federal consumer financial product safety commission would be able to perform that very task. 

The key thing to remember in credit card regulation is that we are regulating a commodity.  BoA's credit is just as good as Citi's (and not just because they are both taxpayer-brand credit...)  Commodities should be all about price competition and standardization.  Credit is simply the flip-side of insurance, and standardized contracts are a hallmark of insurance regulation (and one of the things insurance regulation does right.)  The card industry does everything it can to avoid commodization--lots of bundling and not-very-meaningful add-on features--but in the end let's recognize that cards are just an access device to the ultimate commodity--credit--and regulate on those grounds with an eye to making an ultra-efficient commodity market.  


thanks for giving the card industry men ideas...

Can't argue that the legislation was not deserved, but your position that credit cards should be regulated as commodities and that innovation should be approved by regulators such as a financial products safety commission is a different matter. Isn't innovative commodity an oxymoron? The use of innovation and regulator in the same breath also makes me wheeze. Actually, as a payments lawyer I should not object, as there will be lots of work for lawyers trying to get approvals from the commission. I also fear that it would not only be large banks that are regulated this way, but also the many smaller entities that are the source of much of the innovation in payments.

That's just what we need, the government to approve of any changes a company wants to make to their product. That would stifle innovation and hurt consumers.

If you think that insurance regulation is standardized, you are sorely mistaken. Each state has their own laws and regulates insurance independently. A company wishing to business nationwide has to comply with 50 different sets of regulation. Good luck finding an insurance policy that is the same in all 50 states.

Be careful because what you ask for you may get. Adding disclosure requirements will benefit consumer lawyers, and the consumer will be no more educated than they were suppose to be in 1968. But all can rest well, Congress will have oversite and those who are entitled to credit cards will be the high income consumers only.

We've worked really hard, over the years, to get something like this passed. It's a step in the right direction-- AT LEAST. You should at least acknowledge that, guys. Never underestimate the power of small... a small group of concerned citizens, that is...

I just wanted to add my congratulations to all those here who have been working in support of the bill. It will be interesting to see the actual response from the credit card industry.

Jeff writes: "It's a step in the right direction-- AT LEAST. You should at least acknowledge that, guys."

There is a terrific line in Peter Drucker's work to the effect of: the biggest waste of effort is to improve something that should not be done at all.

I think that line applies to most incrementalist regulation, of which this is an example. What ordinary consumers need is not incrementalist steps like this but hard caps on rates and fees at much lower rates. If that results in less credit being extended, good. American society needs less borrowing to fund consumption.

Adam's post describes this law as the most important since TILA but the problems with consumer and mortgage debt over the last decade prove that TILA has proven to be a hideously inefficient law, generating lots of unread paperwork and compliance expenses for no gain in consumer creditworthiness or solvency. A federal usury law would have been and would be so much more efficient than these laws.

Sux that they chose credit card reform (weak) over bankruptcy reform. Guess the Mortgage lobby has more working capital (bail-out money) than the Credit Card Lobby. Credit cards are not tanking peoples bankruptcies, it's exotic mortgages....

Fair point by Broox about the innovation/regulation conundrum. Let's unpack what innovation means in the card industry. There isn't any innovation whatsoever in the basic product--credit. That's always been the same. Instead, innovation has taken place in two ways. First, there's been quite a bit of innovation in pricing structure. For example, the 0% teaser rate. Great for some folks, but it only works economically if there are enough suckers. This sort of price structure innovation should require regulatory approval. I would lump rewards programs into that category, as bundling is a pricing move. Second, there's innovation in the packaging and behind-the-scenes features of cards. This is things like CapOne's CardLab, which lets you choose whether you want a picture of your cat, your dog, or your kids on the card. Really not a meaningful consumer benefit or innovation. This is just changing the packaging of the product, but the product (credit) is still the same. There's also innovations that consumers don't see--things like improved security measures. I'm less concerned about requiring regulatory approval for this sort of innovation--my sense is that it is basically consumer welfare neutral or perhaps positive, although the specifics matter (e.g., loss allocation rules for fraud might fall into the pricing bucket).

I want to emphasize that my concern here is primarily credit products, not payment products. There has been a lot of innovation in the payment space, but it has been from non-credit products: PayPal, Obopay, Green Dot, etc. What I am suggesting in terms of requiring regulatory pre-approval of products would have bite primarily in the credit area. Simple payment instruments or systems that lack credit components don't pose nearly as many consumer welfare issues as credit payment systems. Whether there should be regulatory approval for non-credit payment systems is separate matter, although I would suggest that there would be benefits from having a single federal regulator for money transmitters, rather than 50 state regulators.

why couldn't people "just say no?" the motivating factors to borrow are still out there. people will just be pushed into poverty faster.

The legislation of the credit card bill is good news. Finally we, consumers, will be protected with surprise increase of interest rates and others. This is all in favor to us and I cannot find the reason why we have to react with pessimism. With regards to the debt issue. It is a simple logic actually - we borrow - we consume what we borrow and we pay. There is no escaping. It is our responsibility. If we do not want to be burden with debt, then do not apply for one.

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