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The Fed's Apparently Nonexistent Interest

posted by Bob Lawless

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.

The Federal Reserve tracks credit card interest rates, as well as a whole host of other data such as levels of various types of consumer debt, through statistical release G.19. It reports two interest rates for credit cards. The first is an interest rate for "All Accounts," and the second is an interest rate for "Accounts Assessed Interest." Looking over the past five years, the rate for "All Accounts" has been rising, but the rate for "Accounts Assessed Interest" has stayed relatively stable. Obviously, "All Accounts" must include accounts not assessed interest, but what does it mean to have an interest rate on an account that is not assessed interest? The explanatory note for the statistical release does not provide much illumination.

Yes, I get the idea that all credit cards have an APR even if the holder is a convenience user who is not revolving the balance and hence not actually paying the APR. The rate for "All Accounts" might be misunderstood as the rate convenience users will pay if they begin to revolve, but it's not that because it includes both convenience users and revolvers. Moreover, if a convenience user starts revolving a balance, the interest rate they pay will be counted as part of the "Accounts Assessed Interest."

The only meaningful figure would seem to be the interest rate for credit card accounts actually assessed interest. That number is not rising, which seems quite important given the complaints of the credit card industry that the new regulations would lead to increased costs for consumers. If I am not understanding the Fed's numbers, I am sure one of our informed readers will explain in the comments.

Comments

The rate on accounts not assessed interest is the stated (contract rate) APR. Reg Z requires the disclosure of this rate even if no finance charge is assessed due to the application of a grace period, or because the finance charge only applies to balances in excess of the account balance.

I think the point of the argument against this law is that it transfers the fees (wealth) from people diligent in their finances to those that aren't. A good analogy would be to outlaw coupons to 'reflect the true value' of goods and services.

"All accounts" is the stated rate, or the cost of borrowing additional funds in the future. "Accounts assessed interest" captures the rate borrowers actually paid on money they actually borrowed. So we have both prospective and retrospective rates.

It makes sense that the "accounts assessed interest" rate is constant. That number the ratio of total finance charges to total average daily balances, two variables that are not independent. When daily balances are high, there are more dollars to charge finance charges against. As daily balances fall, there are fewer dollars and lower total finance charges. Average daily balances should rise and fall depending on the stated rate: higher rates would discourage borrowing while lower rates would encourage it. If I ran a bank, I would want my credit card income stream to have as little variability as possible, so I would try my hardest to ensure that rate changes had the lowest possible effect on the total finance charges that my borrowers incurred. In the Fed numbers, we can see that while the cost of borrowing (the stated rate) is going up, the actual rate remains (mostly) constant, probably because people are borrowing less on their credit cards.

Or at least that's my 15-minute analysis--I'm sure I'm missing something. It would be interesting to know whether the stated rate was different for borrowers and nonborrowers. An alternative explanation is that the actual and stated rates are equivalent for each cohort, that the rate for people who are already borrowers is staying constant, and that the increase in the average stated rate is reflective of an increase in the rate for nonborrowers.

I understand the difference between the two figures. What I don't understand is why we think the prospective rate is a useful figure to understand the trend in credit card interest rates. Isn't it somewhat like using the price on a futures contract to determine the cost of some commodity instead of just looking at the spot price in the current market?

Bob, you're right that the average stated interest rate is meaningless for non-revolving accounts, but I'd suggest that even for revolving accounts, just knowing the average rate doesn't necessarily tell us very much. It could be that everyone is getting hit with a higher rate or it could be that borrowers who previously generated lots of fees are now paying much higher interest rates, while there is no effect on everyone else's rate.

We can't say anything about what is happening with card interest rates with any confidence, much less venture statements about causality; there's no way to separate out the Credit CARD Act, the Fed's regs (pre-and-post CARD Act) and general economic conditions.

Bottom line: we have truly lousy data on credit card interest rates and terms. Some studies resort to looking at the terms of offers, but those are often "up to 24.99%," which doesn't tell you what the actual rate is... And interest is only one price component--we don't know what's going on with fees (although they are more clearly disclosed). The biggest failure of the Credit CARD Act was the omission of the data provision from the final bill.

Jeffrey Paulson--balances will rise and fall depending on the stated rate only if borrowers know what that rate is. Virtually no one does with precision. Market discipline isn't at work here, alas.

I am not sure I understand what you do not understand. Here is what I understand. Our credit card (remaining anonymous) was at a 4.9% rate of interest for revolving charges. This was pre-Credit Card Act. The credit card company gave us 8 months to pay the current balance to zero or begin paying 17.94% interest on the outstanding balance. We revolved for convenience when bills were out-of-control. Today, we have the bills more under control. I would agree with others who are stating credit card interest rates are rising. We never had any issues with so called back-door fees and charges. The interest rate was low enough to enable us to make purchases that we would otherwise not have made. This does not mean we are spending beyond our means. There are many times when multiple priorities and emergencies do not allow for prudent action when it comes to purchases on credit and the ability to pay on time.

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