Posted on 05/28/2009 9:10:17 AM PDT by library user
Credit-card companies are getting a lot of grief in the blogosphere (not to mention Congress) lately. Most of these critiques are just a bunch of shaggy dog stories, but the very smart Rortybomb has an extremely numerate post in which he points out that when the interest rate on your plastic goes from 8% to 28% because you’re two days late on a payment, it’s highly unlikely that this is a pure reflection of a change in your probability of default. His analysis indicates that the way this price (i.e., interest rate) change is determined is not by the change in creditworthiness that is indicated by the new piece of information, but instead by the price sensitivity that is indicated by this new piece of information:
One model is that the credit card companies are lying to you – they think of you less as an individual to have a dynamic risk factor dynamically assigned to you, and instead as part of a portfolio to have a specific rate of return extracted from. So they have statisticians and psychologists not to create a credit risk, but instead to figure out who is likely to pay what when, and use that to keep their returns very high. Quants to study how much they can squeeze from someone – not too much, but not too little. So it is less about the awesome part of markets, the price information and the convergence and feedback, and something more feudal.
His conclusion is that credit-card companies are, morally speaking, “scumbags.”
In my experience, and very broadly speaking, he is correct about the logic by which price changes (including interest rates, fees, and other contract terms) are determined. The credit-card company is making decisions with the intent of maximizing their shareholder value, consistent with the law. In other words, this is a normal consumer market in which the guy selling you something is not looking out for you, but is trying to make money for himself. This is just like a car company, search engine provider or private university. Why is the guy who sells you a credit contract responsible if you are later unhappy about the decisions that you made?
In the specific example that Rortybomb cites, a reasonably prudent person should be aware that he or she has just signed a contract that gives the counterparty the right to increase the interest rate on a debt contract from 8% to 28%, or to the so-called penalty rate, if you miss a payment. If you have a credit card, go to your cardholder agreement and search for “penalty rate.” In any normal such agreement, you will almost certainly find a specification of the penalty rate, and the conditions under which this rate may be invoked. Expecting that your counterparty will not act to serve their own interests under a contract is the attitude of a child. If you didn’t want this deal, you shouldn’t have signed the contract.
Now, fraud is generally forbidden in these markets, and is for credit cards as well. There can get to be a gray area — what amount and type of disclosure is required and so on. Second, there is normally some kind of (speaking non-technically, and without a specific legal meaning to the term) implied warranty. Even if my purchase agreement with GM doesn’t say “this car will not explode in a ball of flame if you tap the accelerator twice and then hit the brakes,” they are subject to legal action if this occurs.
What we are really debating is where to draw the line on these two questions. That is, to what degree does the issuer have to emphasize risks, what degree of complexity should be allowed in the contract and so forth?
The Center for American Progress is typical of current sophisticated liberal thought in emphasizing this:
Credit cards are convenient, but difficult to use responsibly. Credit cardholder agreements are written in language that is above the level at which about 50 percent of U.S. adults read, and information within them is poorly organized. Moreover, issuers appear to “price” the cost of using credit cards by taking advantage of cardholders’ behavior biases. For example, credit card issuers take advantage of the fact that cardholders underestimate the probability of paying late or going over the credit limit, and punish this behavior with fees and increases in the penalty rate.
The right information at the right moment can help cardholders make better decisions. A text-messaging system by itself would not prevent issuers from continuing to price credit cards however they like, but it would orient cardholders toward the best outcomes, such as paying on time and not going over their credit limit. This approach recognizes that most individuals don’t behave like homo economicus—the “economic man” of economic textbooks who maximizes every financial decision and has perfect information to do so. Most cardholders could benefit from a “nudge” toward a more beneficial choice.
But why is it the credit-card company’s job to “nudge” you to “more beneficial choices”?
It is an unfortunate reality that there are many people who are not equipped to get along in a capitalist system. They lack some combination of (rarely) the basic intelligence and (much more frequently) the emotional maturity and self-discipline required to make their way in a world in which others are not looking out for them. Much of the rationale for traditional notions of child-raising, education, and social organization is to prepare people to live in such a world. That is, to produce actual adults. To the extent that we can count on people to act responsibly, we can have a less regulated economy that will tend to produce greater freedom and growth. But the problem of how to deal with the semi-incompetent is a real problem that will never go away entirely.
One practical effect of proposed credit-card legislation would be to make it illegal for party A to voluntarily engage in a credit contract with party B that has some specific elements that might be abused by an irresponsible person. Why should this freedom of contract be restricted for responsible people? Because the guy who lives down the street might use the same contract to drive himself into personal bankruptcy with Cheetos, beer, and big-screen TVs?
Maybe, actually. If (i) the abuse problem were severe enough, (ii) the productive uses of such credit extremely rare, and (iii) there were no other practical remedies, this could be a theoretically poor, but practically-workable, compromise. But I don’t think any of these assumptions holds. First, the vast majority of people who use credit cards don’t default, and second, they continue to voluntarily use this source of credit.
Further and most importantly, I think there is a different and better approach. I don’t think our basic strategy should be to forbid contracts that are only suitable for actual grown-ups, but instead to provide safe havens for the less competent. This could, in theory, include things like requirements for a “simple card” alternative and so on. I’ve tried to describe such an overall approach to financial regulation as “walls, not brakes.” It would not eliminate the problem of some sympathetic people getting over their heads in credit-card debt, but should reduce it, while not giving up on the dynamism enabled by freedom of contract.
Some lawyers attempt to safeguard one’s legacy against governmental predation. We aren’t all evil personified.
Good post!
I can’t believe that posters here are backing the liberal idea that people aren’t capable of doing basic everyday things without help.
You must be from the typo police. Rather than address the issue, you are attacking the typos.
I feel like I’m surrounded by liberals here....
You and me both.
“Constructive self-interest has been replaced with first jealousy, then lust, and now blatant greed.”
Let me be a bit nit-pickey. It isn’t jealousy that is the problem, it is envy. Jealousy is motivating and envy is destructive. If you are jealous of your neighbor’s “stuff” you will me motivated to pull yourself up to his level. If you envy your neighbor’s “stuff” you will advocate the destruction of his stuff to push him down to your level.
Look, I can cut up my credit card. I have no problem with that. But that is not the answer. And some silly suggestion that I warn my friends and family is so lame, it hardly bares a response. All the credit card companies are charging 28 to 30% interest within a year or two. What good does it do to tell my friends and family?
Then I’m left with a balance I have to pay out thirty years to pay off. When I say that, it’s the proverbial I, since I can afford to pay these accounts down. A lot of people today are under extreme financial pressure. They can’t. And they are trapped in a system where they have to service these accounts and can’t get out from under them.
Your suggestions completely ignore these people.
If they make a payment one day late, it shows up on their credit report. If the credit card company charges 35%, you don’t seem to criticize them for it. Why it’s just “cut up your credit card”.
Not everyone has pristine credit. They need access to credit. Finances are tight and you never know when something will happen and you need to place a repair bill on the card, a medical bill on a card, or some other emergency type bill on a card.
People can’t get new credit, so they try to use the credit they have. When they do, they are charged fees that make it nearly impossible to pay down the principle.
That is wrong.
TO: XXXX
Subject: Interest rate increase on account number XXXX
To whom it may concern,
We have been XXXX card customers for many, many years. Our records here indicate that we have never missed a payment date. Over the years, we have had several accounts there, several of which we paid off in full. In fact, we recently received a letter from you indicating that two of those inactive, zero balance accounts were unilaterally closed by you. Having heard that closing an inactive account can negatively impact a credit score, we resisted doing so. We shall retain a copy of your closure letter in the event that YOUR closing that account affects our credit status.
However, our primary reason for this letter is to protest your recent notification that our interest rate will increase from the old APR of 8.24% to – for XXXX anyway – a new, improved (and clearly USUROUS) rate of 19.24%. And the “Transaction Fee” thing is a nice touch. You’re not making enough with the new APR? I think we now know where Tony Soprano found employment since his “family” left the airwaves: He’s working there at XXXX!
Then there’s that 25 BILLION in TAXPAYER dough now almost certainly working its tail off for XXXX. We congratulate XXXX XXXXX for dodging most of the sub prime debacle and for wishing to return the 25 B to help Obama fund his utopian welfare state/worker’s paradise. Is that the “Why” of the higher interest rate? To replace the taxpayer dough the other banks may want to keep?
Unlike many of your other “customers,” we have an option not available to them. Despite the current market decline, we have sufficient reserves to PAY OFF this account in full and take our credit business – which this experience will cause us to drastically reduce – elsewhere.
Bottom line here?
We need to get the APR BACK to 8.24% or we send you a check and go away. I think even Tony understands that 8.24% of SOMETHING is more than 100% of NOTHING.
Then there’s some Old Testament Americans seem to have forgotten:
“The rich ruleth over the poor, and the borrower is servant to the lender.” Proverbs 22:7
I believe actions such as yours will trigger a mass exodus away from credit cards back to the pay as you go/cash system prevalent when I was growing up. And that will be a GOOD thing for us all. Most of us have too much totally unnecessary “stuff” anyway.
An editorial comment on the events that brought us all here:
Barney Frank, Chris Dodd and the other Capitol Hill Cretins who pressured FANNY and FREDDY into forcing banks to give home loans to folks with no prospect of making the payments in what can only be considered a stupid vote-buying scheme at best and utter insanity at worst should be drawn and quartered and their heads displayed on pikes on the Mall.
And I have no words to describe the too, too clever idiot “Masters of the Universe” who then bundled this JUNK into so-called Mortgage Backed Securities and “Derivatives” and the complete morons who bought that crap sans any due diligence. The only possible benefit from this – this MESS is that the phrase “The full faith and credit of the United States” is expunged from our language. According to Obama, “We’re out of ‘money’.” He SHOULD have said OUR GREAT- GRANDKIDS are out of ‘money’ and he could have added faith and credit as well.
At your earliest convenience, please consult with Tony when he returns from the Bing and respond via email so we can determine which way we need to go.
Thanks,
Whether your complaints about credit card companies are valid or not, the responsibility still lies with the person that holds the card and uses it. Nobody forces them to do so.
And you have a very dim view of people’s intelligence. Contracts are not that difficult to comprehend. Your condescension and elitist attitude bespeaks much.
Yes, you will find a way to pull yourself up be it through a government handout, welfare, or demand a redistribution of the wealth. Others of course will be motivated to put in the hardwork...
Nope, I think jealous is exactly what I meant.
jealous: hostile toward a rival or one believed to enjoy an advantage
envy: painful or resentful awareness of an advantage enjoyed by another joined with a desire to possess the same advantage
Credit inquiries will sure kill your credit.
I had 52 in the past 18 months...that hits me from 75 to 125 points depending on who’s talking.
This might come as a shock to you, but I don't think you understand capitalism and self-reliance. Greed is a good thing. Greed is independence. Wealth is created, not distributed.
If I can add a couple of things.
Everyone wants to blame 0bama, but when they overhauled the bankruptcy laws was when the CC companies turned the dogs loose. That was under Bush and the Republicans. CC companies used to try to work with people to get them to pay their debts off, as if the individual declared bankruptcy, they got nothing. Now, they have no fear of jacking up the interest rate and tacking on fees. They want people so far in debt that they'll never pay it off. It's almost like a defined annuity for them.
Also, many of the CC companies sell off the debt, but continue to service the loans. This means they have a vested interest in inducing people to go over line or make late payments. Hence, the sitting on payments, sending out monthly bills late, making payments due on Saturday, Sunday, or a holiday, crediting payments made after noon on the following day, and arbitrarily upping the required payment by fifty dollars one period, hoping your automatic payment will be short.
I concur.
A few years ago, when I paid by check, my Shell gas card did not post my payment until the day after it was due even though I sent it a week before it was due. I got dinged a little over $4.00 in interest. I didn't get that mad, but I got even. I sent them more than I owed and for the next few months they sent me a statement with a credit balance. In January, they had to cut me a check and mail it to me. I would have kept doing this for years, but I cut up the card earlier and never used it again. I figure I cost them more than the interest they charged me.
for example they open and offer a $10K credit line
You don't use the line or don't carry a balance .. then they reduce the line ... thereby reducing your credit to debt ratio
then use that change in debt ratio (credit score) to raise your rate
It's not pure serendipity
.
If a person uses their credit rating by applying for credit, their credit score suffers.
If a person closes a credit account they are not using, their credit score suffers.
If a person doesn’t take out more credit their credit score suffers.
If a person doesn’t close a credit account they are not using, their credit score suffers.
If a person uses the credit they already suffered a hit to their credit rating, their credit score suffers.
Credit is a racket.
“The idea the credit card companies have to raise rates from 7% to 30% overnight, just because a person is a day or two late with their payment, is ludicrous.”
They are raising rates on EVERYONE. Our rate just went to 29.99%. We always pay early and keep a low balance. We’re closing the card this week.
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