Category: Financial Regulation

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Banking Financial Regulation

Wyoming Wants to Be the Crypto Capital of the U.S.

As I’ve written previously, Bitcoin and other cryptocurrencies aren’t just risky assets for those who own them: risk in the financial sector impacts all of us.

For Slate, I wrote about Wyoming’s push to lure blockchain companies into the state, and how an obscure banking law from the 1860s gives small states like Wyoming outsize power in our financial landscape.

If you prefer video to text, you can hear me discussing this article with Sam Seder on the show Majority Report on NBC’s streaming service Peacock (I don’t think you need a Peacock account to watch the show from a browser, but you may need a Peacock account to watch it on your TV/Roku).

Categories
Banking Debt Financial Regulation

How bankers get away with breaking the law

screenshot of Slate's website

For Slate, I wrote about CashCall vs. CFPB, a case where a subprime lending tycoon systematically broke laws of states like Virginia, New York, and North Carolina that make it illegal to charge sky-high interest rates. In most states with anti-usury laws, if you give out an illegal loan, the borrower isn’t obligated to pay any of the loan back: therefore, the Consumer Financial Protection Bureau argued that CashCall should have to refund all the interest it collected to consumers as restitution. CashCall argued it didn’t realize it had broken any laws (lol…), and judges seem to have found this argument persuasive.

Categories
Banking Financial Regulation

New visions for banking

Image of linked article on front page of The Outline

For The Outline, I sat down with the founders of the Pagan Credit Union project to hear about their aspirations for the financial sector.

People who want to start ethical alternatives to big banks are up against significant obstacles. According to data from the National Credit Union Administration, we lost about 800 credit unions from 2014 to 2018.

Categories
Credit Cards Debt Financial Regulation

How the lessons of Tide Pods could clean up the credit card industry

An image of a Tide Pod (which is blue, green and white) and an Arm and Hammer detergent pod, which is only white and is less visually appealing

While popular, Tide Pods are staggeringly dangerous for young children and people with disabilities.

Proctor and Gamble launched the Tide Pods in 2012.  In 2011, 2,862 children were hospitalized because of laundry-detergent related injuries. In 2013, that number was triple: 9,004 children were driven to hospitals by laundry detergent.  

The problem isn’t that Tide Pods are uniquely toxic, or contain chemicals never used before. The problem is that they’re cute. They’re colorful. And they’re small. It’s the good things about Tide Pods that we have to change to make them safer.  

What Tide Pods teach us about consumer product safety is that it’s not always the “bad parts” of products that make them risky: products aren’t always risky because of a gear that breaks and causes an accident, faulty wiring, or a toxic ingredient.  Tide Pods drove children to the hospital not because they had more bad parts than other detergents, it’s because they had more good parts: they looked better and felt better. A bill put forth in the New York State Assembly would force detergent packets sold to be in “opaque, uniform colors” — unlike the squishy, candy-like, blue-white-and-orange Tide Pods sold today. Seems like a good thing to me: changing the color scheme may make the product less popular, but won’t make the product any less effective.  

To help get Americans out of debt, regulators need to force banks to make their financial products less like squishy, colorful candy. We need ugly detergent that is just as good at cleaning clothes but poisons fewer children. We also need financial products that are equally good at helping families navigate a challenging economy but that tap into fewer of our weaknesses and biases.

Despite a handful of useful credit card regulations passed in 2009, too high of a percentage of Americans paychecks still get lost to loan interest and fees. While student loan debt dominates the news cycle, more American families hold credit card debt than any other form of loan: roughly half of all Americans carry an interest-bearing balance on credit cards.  Last year, Americans paid more than $104 billion in credit card fees and finance charges: an average of $823 per American family.  In the face of unstable and low-paying jobs, credit cards and other consumer lending products can sometimes help families plug goals and pay gaps, but clearly turning over $823 from American paychecks to big banks ultimately makes the problem worse.

Credit limit increases and credit card rewards are two “features” that make credit cards dangerous — and both “features” could be regulated in ways that wouldn’t make it harder for the Americans who actually face short term borrowing needs.

Banks should be required to get the customer’s permission before raising their credit limit. 

Imagine you’re on a diet and you’re trying hard to cut back on sweets. Many of us find it hard to turn down the plate of cookies sitting out in the break room, even if we’d be unlikely to go down the block to buy dessert. Similarly, for the many Americans struggling to make ends meet, a high credit limit is an unwanted invitation to take on debt they know will cause stress and heartache. Researchers Scott Schuh from the Federal Reserve Bank of Boston and Scott L. Fulford of Boston College found that for Americans who borrow money on their credit cards “nearly 100% of an increase in credit limits eventually becomes an increase in debts.”  There’s a huge psychological difference between applying for a new loan versus using credit that’s already available on a credit card you have. You might not apply for a new loan to go to your cousin’s wedding, even if you’d charge it to an existing card without knowing when you’ll pay it back. Moreover, too many consumers think of the credit limit as the amount banks think they can ‘safely afford’ to borrow. 

The U.S. regulatory framework says a high credit limit is a good thing, implying issuers shouldn’t need your permission to raise your credit limit, but a quick scan of Twitter reveals that many consumers feel different when they say things like: “Got an email that my credit limit has been raised and that is so dangerous how do I decline ”  If customers had to request credit limit increases they actually wanted, instead issuers raising customer credit limit without customers prior consent, a high unused credit line wouldn’t be looming over so many Americans heads as an unwanted temptation to enter a debt trap. Australia and the United Kingdom are both good case studies here. Australia prohibits banks from raising credit limits except at the customer’s request, and in the United Kingdom, banks can’t raise the credit limits of people who haven’t been able to repay their card balance in full at least once over the last year. 

Credit card rewards are another trojan horse. For some consumers of course, the airline miles or cash back is huge boon — there’s no doubt that for Americans who pay their bill in full every month, getting 1% or 2% back on purchases is a nice perk. But Schuh has shown that to cover the cost of these rewards, banks have to charge high “interchange” fees to merchants, which in turn result in higher prices for consumers. Perhaps more importantly, credit card rewards make it even more tempting for people to spend money they don’t have. The European Union and Australia have both capped these credit card processing fees charged to merchants, which effectively eliminated rewards credit cards in those countries. And good riddance. Simpler products with fewer distinct terms make it easier for people to select the lowest cost option: consumers would find it easier to identify the lower-interest-rate cards if they weren’t also benchmarking the value of airline miles. And there’s no reason low-income Americans who don’t qualify for credit cards to begin with should pay higher prices at merchants to allow wealthy Americans with Chase Sapphire Reserve cards can fly first class to Japan. 

While payday lenders charge exorbitant rates and fees, the one thing you can say in defense of payday loans is that they are typically used by people who are explicitly conscious of the fact they’re borrowing money, and are aware it’s not going to be cheap. By contrast, credit cards are slippery, intractable instruments in a country where only 38% of jobs pay enough for people to afford a middle class life, and living within your means can be a constant struggle. Occasionally borrowing on a credit card is the right answer for a family: economists Kyle Herkenhoff and Gordon Phillips have found that unemployed Americans with more credit card liquidity are able to extend their job searches by putting bills on their credit card, ending up with higher paying jobs as a result. But many Americans come to find that despite their irregular income or unexpected expenses, using a credit card to smooth things over just makes their budget shortfalls more and more severe as time passes. Ending unsolicited credit limit increases and taking steps to curb credit card rewards wouldn’t limit Americans from accessing credit when they need it — unlike capping credit card interest rates, as Bernie Sanders and Alexandria Ocasio-Cortez have proposed, which would undoubtedly increase how many Americans get declined when they apply for new credit.

 By going after some of the seemingly attractive features of credit cards, we can make them less like multicolored detergent pods, and stop the banks from taking Americans to the cleaners. 

Categories
Banking Credit Cards Debt Financial Regulation Road Trip

The space between want and need

I’m now on Day 13 on my road trip at my aunt and uncle’s farm in Blue Earth County, Minnesota — today is the first day of the planting season for corn. It’s getting a late start because of all the rain. My next stop will be in Iowa.

If there’s one comment that has come up in most of my interviews with the people who wished they hadn’t borrowed money on a credit card, it’s that they used the card for things they realized they “didn’t really need.” That word “really” hints at the notion that there is actually a lot of ambiguous space in between want and need.

Peggy in St. Charles, Missouri started borrowing money on a credit card when she was pregnant to buy a new mattress — carrying around another person inside made it too hard to get in and out of her old water bed. Tasha in Milwaukee had “known” not to borrow money on a credit card for non-essentials. However, at times, she’d semi-consciously use up the money in her checking account on the things she wanted so that she’d have no choice but to borrow money on her credit card for the things she needed. It was a mental trick she used to let her evade her own rules of thumb.  

One of the greatest sources of ambiguity between “want” and “need” is family and tradition. All over the world, people who have been scraping by have found ways to set aside cash to celebrate weddings and to give their loved ones dignified funerals, whether that would mean working 14-hour days or by forgoing more quotidian “needs” like putting plumbing in their house. You can look at these choices as the actions either of status-obsessed people bowing to social pressure, or a recognition of the fact that our relationships to our families and communities are the greatest source of meaning and purpose that most of us have.

In one of the interviews I did before this trip, Joe in Washington, D.C., told me he wished he had forgone getting into credit card debt to buy new clothes, but that he’d never regretted borrowing money to buy last-minute plane tickets to see his long-distance girlfriend when she was feeling down. And similarly, when Kathryn thought about the credit card debt she’d accrued attending her sister’s and best friend’s weddings while in grad school, she said that while she now felt like she was “stuck in peanut butter” financially, it was hard for her to imagine not having stood beside the people closest to her.

Of course, throwing children in the mix complicates things further. I’ve talked to so many people who will figure out how to make things work and accumulate some savings on shoestring budgets when they’re only looking out for themselves. Yet, when it comes to their children, they have a hard time saying no. Is buying a uniform so your kids can join a sports team a want or a need? What about spending the $10 so they’re not the only one in their class left out of a field trip? Parents want so badly to provide for their children not only a sense of security, but also of normalcy, and of the magic of childhood — perhaps explaining why Federal Reserve data indicates that Americans accumulate an extra $19 billion of credit card debt in the fourth quarter of each year (around Christmas) compared to the rest of the year.

I’ll never forget one interview I did many years ago with a woman in Boston who’d accumulated most of her credit card debt bailing her kids out when they’d gotten into trouble — replacing a car they’d wrecked, or floating them when they couldn’t find work. She said that all her life she’d tried to make responsible choices, but that now she had no idea if or when she’d be able to retire (she was in her 60s). “I couldn’t bear to say no to my kids if I was able to afford it — but, in hindsight, the fact that I got into debt means that I never was able to afford it all along.”*

One of the ways that credit cards can mess with our heads is that it’s so easy to think of our credit limits as an “asset” or a “resource” that we can draw down. That way of thinking is so dangerous! Obviously a credit limit has a literal meaning — the amount we can charge on that particular credit card todayif we want to — but attributing any further meaning to that number gets so many people in trouble. The credit limit isn’t necessarily how much credit we could easily get access to. Many people with even below-average credit scores could get more in days or weeks by applying for credit limit increases with their existing cards, or by applying for new credit cards or loans. And the credit limits are certainly not how much money we could afford to pay back. By having available credit on her credit cards, it felt to the woman in Boston that she was able to say ‘yes’ to her adult children. She probably wouldn’t have felt that way if saying ‘yes’ to them had meant applying for a new loan.  

In the words of Alexandria Ocasio-Cortez, we need to reject a society that tells people, “If you choose to have any expense beyond mere animalistic survival – an iced coffee, a cab after an 18 hour shift on your feet – you deserve suffering, eviction, or skipped medicine.”

At the same time,  the personal finance advice that tells people to be careful about spending money on things they want but can’t afford today, because it could lead to suffering, eviction, or skipped medicine tomorrow, is true! Borrowing money for wants today usually means forgoing money for wants and/or needs tomorrow, and sadly, borrowing money for needs today can mean forgoing even more dire needs tomorrow.

When I worked in the credit card industry on developing the policies for credit limit increases, I would often zoom in to the level of individual borrowers to see what the proposed policy would have meant for them. Especially if a new rule would mean we were giving out credit to fewer people, I would see what that decision would mean in terms of purchases a given impacted customer would have to forgo. Often you see purchases that are pretty basic: $30 on groceries or gas, a few hundred dollars at a Mr. Tire. Other purchases are obviously discretionary: a Carnival cruise, fireworks, iTunes. Many others it would be impossible to say from the outside — spending at Walmart might be electronics or groceries, or at Lowe’s you might be fixing a broken window or replacing something that just looks dated. It might even be impossible to say from the inside!

Unsolicited or “automatic” credit limit increases to existing customers are a major part of how banks and credit card companies give out credit, and in turn, how Americans end up in debt. Just the other day, I talked to one of my cousins whose first credit card gave him a $500 limit, a limit which is now over $10,000. That trajectory is extremely common.

Banks could and should stop granting “automatic” credit limit increases to customers who are still paying interest on discretionary purchases they made months ago — they shouldn’t be trying to profit off of financial decisions that are going to cause Americans to struggle. This idea isn’t about looking at people and judging them in a moral sense – saying “shame on  you, you shouldn’t have bought that iced coffee.” It’s about not pushing people into holes they’re going to struggle to get out of. Operationally, I can say with great certainty that implementing this type of proposal at a bank would be no more complicated than all the things banks do on a quarterly basis to increase profits. And compared to Bernie Sanders and Alexandria Ocasio-Cortez’s proposal to cap credit card interest rates at 15 percent, this change would similarly prevent a massive proportion of  the high interest credit card debt that causes people to struggle, without having as large of an impact the access to credit that so many people rely on to make ends meet when there’s so safety net in place (like when people put their cancer medications on their credit cards while they’re arguing with their insurance companies to reimburse them.) The interventions in banking that make sense to implement today, in our current world, where people have few places to turn when things go wrong, are very different than the interventions in banking that would make sense to implement in a country with universal healthcare and basic income.

Of course, the idea that banks should stop raising credit limits of people who are still paying interest on past discretionary purchases would be fairly difficult to write into law: it’s more the type of thing a credit union or bank could choose to do on to better serve their customers, and hence, not something we should be expecting when it means they’d be forgoing big profits. One NerdWallet study reported that 86% of Americans with credit card debt regret it. If it was their primary goal, I have no doubt banks could find ways to do many fewer loans at terms or in circumstances where the borrower would ultimately feel regret, while barely making a dent in credit access under the terms and in the circumstances where the loans helped people succeed. To hear those proposals, keep reading in the weeks and months ahead.

—

* Just a quick comment that this particular quote is a paraphrase, unlike all other quotes that appear on this blog.  This conversation was before I started the research for this project, and hence, unlike all the interviews I’ve conducted over the last 9 months, I don’t have a recording and/or time-of notes.

Categories
Financial Regulation

Cryptocurrencies are pointless. You should pay attention to them anyway.

I have never been hyped up about Bitcoin, the “blockchain,” or cryptocurrencies.

The basic premise behind Bitcoin is that it’s a currency you can send anywhere nearly instantly. The computing power of the millions of bitcoin “miners” is used to solve math problems which create a secure record of every Bitcoin transaction – that record of transactions is called the “ledger.” The miners get paid for keeping the system running by receiving a share of the small amount of new Bitcoins that are being continuously released. Anyone can see the code, and everything is “decentralized” — instead of a single central bank or government holding the power, lots of people participate and everyone can ‘verify’ each other, which makes it a “trustless system.” In theory, you can count on things working without putting faith in the other players. Other “cryptocurrencies” generally share important parts of that architecture – especially the decentralized record-keeping called the “blockchain.”

Now, it’s clear that in places where the local currency has completely broken down, it’s clear that Bitcoin can be really useful.

Venezuela has been struggling with chronic food shortages. President Nicolas Maduro’s government won’t let its citizens exchange bolivars into foreign currencies at a price that any international exporters will accept, making incredibly difficult to import food into Venezuela. Malnutrition is skyrocketing, and estimates suggest that infant mortality has increased more than 100-fold since their economic and currency crisis started. Jim Epstein has reported that many members of what used to be Venezuela’s middle class and upper classes have stopped other work to mine Bitcoin. Former doctors, lawyers, and engineers use Bitcoin to buy Amazon giftcards, and then use the Amazon giftcards to buy food which gets shipped to Miami, and then sent to Venezuela at a hefty fee. Yeesh.

In most of the world though, including in most of the developing world, if you have money to spend, moving your money where it needs to go isn’t a big problem. Remittances–sending money between countries–can still be costly, but for “low-tech” reasons that Bitcoin isn’t really able to solve.

There just aren’t that many reasons why people in the United States who aren’t trying to commit crimes or buy banned goods would find Bitcoin useful, and while it is kind of fashionable today to express the opinion “oh, I think ‘the blockchain’ is very promising even though I’m not a believer in cryptocurrencies,” personally I’m not even that optimistic about what blockchain technology will accomplish for the reasons explained by Kai Stinchcombe here.

Once I learned enough to feel like I understood the basics, I started mostly tuning out cryptocurrency news.

My general assumption was that if Bitcoin, Ethereum, or other smaller ‘coins’ either fizzle out or simply fail to ‘take off,’ it would be a big bummer for the people who invested heavily, but that life would continue on as normal the rest of us.

After a great conversation about this topic with a mentor in Durham (Check out his paper on CTFC regulation of bitcoin derivatives), I’m starting to think differently on why cryptocurrencies could end up mattering a lot, even if they aren’t “successful.”

Things often grow from small and “addressable” to big and scary without making a lot of noise along the way

Of course, Bitcoin, Ethereium and other coins have already seen both massive ups and downs in their prices. Early this year, Bitcoin’s price fell by 60% without causing any obvious problems majority of people who don’t own cryptocurrencies. We can’t take that to mean though that contagion wouldn’t spread in future crashes.

Today, cryptoassets represent a relatively small part of the economy, and an especially small amount of what is held by important institutions like governments, retirement plans, or deposit-holding banks. Imagine cryptoassets as the sapling of a plant that would be comparatively easy to rip out of the ground now – a plant that could blossom into something a beautiful flower, intractable kudzu, or nothing at all. It’s tempting to wait to and see what happens – but by the time the trajectory is obvious, it may be too late to forestall big problems.

Importantly, derivatives allow the amount of exposure held in the economy related to a particular asset to grow far beyond the size of the underlying asset class. I might have one mortgage, but in theory, an infinite number of people can place bets on whether or not I’ll repay my mortgage. Similarly, there might be $X in bitcoin in circulation, but there can be 10 times that amount in outstanding ‘bets’ on whether bitcoin’s price will go up or down.

The ideal time to place regulations on mortgage-backed securities wasn’t in 2009 in the midst of the crisis, or even in 2006 just before the crisis started, but probably a decade or more before as the asset class was growing and evolving.

What do we do?

Push back on government entities holding cryptocurrencies or associated derivatives:

Voters and citizens should be concerned with the investments held by the cities, states, and countries where they live. For most of us in the United States, the most important government investments are the pension funds of our state governments. In many parts of the country, including my home state of North Carolina, pension funds are managed by an elected State Treasurer. When state pension funds struggle, either former public servants get short-changed, or ordinary taxpayers are suddenly on the hook to fund the promises made. State pension funds can be tempted into ‘novel’ investments, especially if they’re worried about making ends meet down the road – but voters should push back on government entities holding cryptocurrencies or associated derivatives.

There are huge, important differences between investing in a stock and investing in a currency. If you bought 100% of the stock of a company, you would then own that company – you would then get to keep all of the profits from that company’s activities, and you’d also own any of that company’s assets.

If you bought 100% of a currency, that currency wouldn’t be very useful anymore.

Stocks are productive assets – on average, while some companies will fail, companies on average grow and become more valuable over time, which makes the underlying stocks more valuable over time for “good reasons.” Currencies on average do not become more valuable over time – unlike the stock market where most people can be “winners,” investing in currencies almost always zero-sum game where you’re betting on one currency becoming more valuable in relation to another currency. Investing in stocks or bonds lets you direct money to governments or businesses that need funding to do research or build things like roads or factories – but when money is sitting in currencies, it really isn’t “doing’ anything. You could say that investing is putting your money into places where adding money is likely to create growth, while speculating is finding someone who will take the opposite side of a bet with you that something is going to grow or change on its own. We often need our governments to invest on our behalf – but we should ask them not to speculate on our behalf.

Some entities have great reasons to buy currencies or associated derivatives. If you are a manufacturer that buys raw materials in the United States, manufactures something in Mexico, and then sells it to a European market, a big swing in the exchange rate between dollars, pesos, or euros could really put a wrench in your business, so you may want to ‘stockpile’ some of the currencies, or buy “derivatives” that let you lock in a future exchange rate. While an importer or exporter might want to buy foreign currency or foreign exchange derivatives to manage their exchange rate risk, there’s really no good reason for a state pension fund to do so — and there’s not an obvious reason why anyone needs to be betting on the relative positions of dollars and cryptocurrencies.

This general point of view was expressed by the head of the California State Teacher’s Retirement System, the nation’s second-largest public pension fund when a spokesperson told CNBC: “CalSTRS has not considered investing in bitcoin or cryptocurrencies in general […] We consider them the ultimate intangible and, at least right now, there’s no value behind them other than what other people will pay.” But CNBC reported in the same article that other institutional investors may be “on the fence.”

Reconsider how we regulate crypto-assets

There are a lot of variations of what this could look like.

Regulation can prevent or discourage some investors from holding cryptoassets. As an example, the fact the Security and Exchange Commission hasn’t approved any cryptocurrency “exchange traded funds” (ETFs) doesn’t prohibit investors from holding cryptoassets, but creates a hurdle that makes it less likely that institutional investors will choose to do so.

It may similarly make sense for Congress to pass legislation on the presence of cryptocurrencies or related assets in retirement plans – both pensions and 401(k)s – either through a cap on the percentage of of a retiree’s investments that can be held in cryptoassets, or an outright prohibition on the presence of these assets in retirement plans. Conceptually, this isn’t so different from the Employee Retirement Income Security Act of 1974, which prevented companies from putting more than 10% of a pension plan’s holdings in the company’s own stock.

Of course, it is completely possible that cryptocurrencies have a bright future, that they transform how ordinary people make payments and that they’ll become genuinely useful. My real point is that being a pessimist about cryptocurrencies is not a good reason to tune them out entirely.

 

Categories
Credit Cards Financial Regulation

Are credit card rewards even good for consumers?

When shoppers use a credit card rather than a debit card, processing fees are three times as high. Who's paying?

Earlier this week, the Wall Street Journal reported that merchants like Home Depot, Target, and Amazon are becoming increasingly frustrated with the high fees they pay to accept rewards credit cards, and are seeking relief from the courts or through negotiations with Visa and Mastercard.   Particularly, merchants are looking for the networks Visa and Mastercard to end their ‘honor all cards’ rules, which say that if you accept any Visa credit card you need to accept all Visa credit cards, and ditto with Mastercard.

Today, if you spend $100 at a large grocery store, Visa would charge the store a $2.20 processing fee if you used a top-tier rewards credit card from their Visa Infinite line (like Chase Sapphire Reserve), a $1.75 fee you used a Visa Signature rewards credit card (like the Bank of America Travel Rewards Card), and $1.25 fee for any other Visa credit card, which are generally those without rewards.  By comparison, to accept a debit card, the processing fee would be 75 cents or less.

How much a large grocery store pays to accept your Visa Card for a $100 purchase; source Visa USA Interchange Reimbursement Fees

The article points out that rewards credit cards are incredibly popular with consumers – but do consumers actually win in the current system where merchants pay a fee to the networks (Visa, Mastercard, Amex and Discover), the networks pay issuers (Chase, Citi, Capital One, etc.), with much of the final fee getting sent back to customers in the form of rewards?

On the surface, the Americans who avoid paying interest on their credit card by paying their bill in full each month are getting a great deal – a family spending $1,000 per month on their credit card can easily net $200 per year in “free cash” from rewards.  Beneath the surface, things get more complicated.

A regressive system 

The most obvious flaw with the current system of processing fees and rewards is that stores raise prices to cover the fees – and because giving out a 1% or 2% percent discount to people who are paying with cash or a debit card can be clunky, those prices are usually higher for everyone, not only those paying with a rewards credit card.  On balance, that system is regressive, given that the Americans who primarily shop using their credit card are wealthier than the Americans who primarily shop using cash and debit.   Researchers at the Federal Reserve of Boston found that because of the price effects associated with credit card rewards, the lowest-income households, those that make $20,000 or less annually, pay an extra $21 per year in higher prices, and the highest-income households, making $150,000 or more annually, receive an extra $750 every year in rewards.

It was with these prices effects in mind that Australia and the European Union both passed rules limiting credit card processing fees to less than 1%.

But there’s another, more subtle, reason why credit card rewards may not be the boon to consumers that they’re made out to be.

Confusing the shopping experience

While some consumers use credit cards purely for the  rewards and convenience, 60% of active credit card users are “revolvers” who borrow money and pay interest on their credit cards.

For consumers that are going to borrow money using their credit card, picking out their credit card based on the rewards is like buying a house because you like the color they painted the bedroom – it just really shouldn’t be the most salient feature.

Credit card interest rates vary significantly – for customers with the best credit scores, Discover, BarclayCard and Capital One offer APRs as low as 13.74%, while subprime customers can expect to pay upwards of 25%.  That 12 percentage point spread is pretty significant when you consider the best credit card rewards hover around 2%.  And because interest compounds, the difference can become even more significant.

Consider a customer with a good credit score who spends $3,000, and pays off $100 each month.   At a 13.74% interest rate, they’ll pay $696 in finance charges.  Raise that rate by one percentage point and their finance charges will go up by $69.  Raise it by 2%, and the charges go up $141, landing at $837 paid to borrow $3,000.  By comparison, their rewards on that spend would have only been $60.

TV advertisements and popular comparison websites like CreditKarma and CreditCards.Com, paid by the banks to advertise their products, focus almost exclusively on rewards and perks, at the expense of comparing interest rates and fees.

This has been a meaningful shift over the last ten years.  The 2017 CFPB Consumer Credit Card Market Report found that while in 2002, only 20% of credit card mail solicitations advertised rewards, today, roughly 60% do.

In a world without credit cards rewards and perks, issuers would start competing again on interest rate, drawing people’s attention back to where it should have been all along.   The graph below pretty clearly shows how U.S. consumers focus has drifted – in 2004, Americans Googled credit card APRs and credit card rewards at a similar rate, while in 2018, credit card reward searches were more than three time as common.

Much of the change here has happened at the subprime end of the market, where consumers are the most vulnerable, and the least likely to pay their credit card bills in full.  In the three years between 2011 and 2014, the percentage of new subprime credit cards offering rewards rose to 58%, up by 37% points.

A “shrouded equilibrium” 

Mary Zaki, an economist at University of Maryland, has called the current credit card market a “shrouded equilibrium,” noting that lenders can avoiding competing on price because consumers have so much difficulty assessing how an interest rate translates into the cost to borrow.

Perhaps it’s not surprising that consumers would prefer to think about and compare based on rewards, which are ‘fun,’ compared to fees and finance charges, which are painful.

Some academics and experts, like Lauren Willis, Professor of Law at Loyala University, have proposed that regulators require credit card companies to start using ‘Smart Disclosures.’  While standard disclosures like the famous “Schumer Box” are a table of key terms, a ‘Smart Disclosure’ would leverage each consumer’s own pattern of purchases and payments to predict the total amount of fees, interest, and rewards that person would accrue.  There’s a lot to like about those proposals – but we might be better off in a world where most financial products were just simpler to begin with.

Categories
Banking Credit Cards Financial Regulation

What’s happening with consumer financial protection around the world

In the United States, there hasn’t been much positive policy action on consumer financial protection recently, at least not at the federal level.

But regulators and policy-makers in the United Kingdom, Australia and Singapore have been trying a range of solutions, some incremental and some radical, to make life better for borrowers in their countries.

You can read more in my post for the Duke Global Financial Markets Center’s FinReg blog.