Kahrdinal Sins

November 2, 2009

--a response to Andrew Kahr by Jim Blaine, State Employees' Credit Union, North Carolina

Andrew Kahr sure takes Messieurs Bubb and Kaufman to task in his blog response! Perhaps he should be more gentle, a bit more patient. After all, Bubb and Kaufman are admittedly just young, budding, novice economists; give them some space, surely their worst work still lies ahead!

Actually, I was well pleased with both the tone and stridency of Mr. Kahr's rebuttal. Having watched his interview on FRONTLINE's 2004 program, Secret History of the Credit Card, I had always assumed that Mr. Kahr's views had been "over-edited" to the verge of villainy. His blog post corrected my doubt.

In Mr. Kahr's view of the consumer financial marketplace, there are no uncertain terms, there are no unintended consequences. Our universal human frailties are well understood. The subtle credit card tripwires and "gotchas" are purposeful; the "violations" anticipated; the "high punitive rates and fees" finely calculated; the potential for family financial catastrophe fully intended -- fully intended and fully ignored. The consumer financial "sucker punch" is delivered by Mr. Kahr and his ilk without remorse nor regret.

Mr. Kahr has simply reaffirmed his 2004 interview belief as to the "swiss cheese" porousness of all financial regulations and his personal conviction that there is always "another angle," there is always a "work around" to any rule. In the blog post Mr. Kahr says: "We figured out how banks could avoid state rate regulation;" and, one must assume that, unconstrained by conscience, Mr. Kahr can once again find "creative" ways to compromise fairness. Mr. Kahr avers that reasonable card regulations may eliminate choices for "some of us who are clever or righteous enough to merit exemption." Ah, hubris and the pungent whiff of several sins cardinal ... or shall we say Kahrdinal?

Can there be a better symbol, or symptom, than Mr. Kahr of why the American financial system is currently in such disarray and held in such low esteem worldwide? It's not that our financial system suffers from "moral hazard;" it's that we have succumbed to "amoral hazard." We suffer mightily from the disregard and disdain of creative financial geniuses, whose vocabulary finds no degree of moral distinction between words such as persuade, cajole, tease, tempt, entice, mislead and deceive. As we now see with much clarity, in a financial system where "anything goes," eventually "everything goes." While Mr. Kahr may pass, with highest marks, tests of his intelligence, he seems at best unaware that he may well come last on several of the most basic tests of our humanity.

Emperor Kahr wears no clothes and is now nakedly revealed as a false prophet of false profits, a dangerous Kevorkian of American family finance. Next Halloween, to really scare the neighborhood kids, I'm dressing up as Andrew Kahr!

Still Waiting: Unfair and Deceptive Credit Card Practices Continue

October 29, 2009

"I think this new Pew report -- just out this week -- says it all." --Lowell Bergman, correspondent for the FRONTLINE/New York Times joint report The Card Game, airing November 24th.

One hundred percent of credit cards offered online by the leading bank card issuers continue to include practices that will be outlawed once legislation passed in May takes effect next year, according to a new report by the Pew Health Group's Safe Credit Cards Project. The report also found that advertised credit card interest rates rose an average of 20 percent in the first two quarters of 2009, even as banks' cost of lending declined. With the Federal Reserve currently developing rules to ensure penalty charges are "reasonable and proportional" as required under the Credit CARD Act, the report also includes policy recommendations for regulators.

Key findings of the report show that:

-- 99.7 percent of bank cards allowed issuers to increase interest rates on outstanding balances -- a jump from 93 percent in December;

-- 95 percent of bank cards permitted issuers to apply payments in a way the Federal Reserve found likely to cause substantial financial injury to consumers; and

-- 90 percent of bank cards had penalty rate hikes with the vast majority imposed by "hair triggers" of one or two late payments in a year.

View the full report here.

Andrew Kahr's Response to Bubb and Kaufman

October 21, 2009

--Kahr is a financial services consultant

Ryan Bubb and Alex Kaufman are wrong

Whatever the merits of its other provisions, the new credit card legislation will not make bank pricing either more economical for consumers, or fairer to us.

On the contrary, consumers will get less satisfaction from the more restricted set of card offers that will be available. Late payers will pay less in fees, and those who pay on time will pay more. People who borrow and don't pay are not, as Bubb alleges, paying for my vacation. Rather, they increase the rates and fees you and I have to pay.

According to The Washington Post, "To make up for declining revenue, many banks are boosting fees," including not just card but checking account fees. Chase, a very responsible lender which has not encountered either regulatory or financial problems, has already raised one key fee -- balance transfer -- by 67 percent in response to the new legislation and regulation. Higher balance transfer fees penalize consumers for moving their balances to obtain more advantageous terms, and thereby make card competition less effective.

Banks will find numerous additional ways to make up the revenue that the new law takes away from late fees and default rates. Rates on cards have risen since the law was passed and are still rising, while other interest rates are not.

If someday there is going to be EFFECTIVE price regulation for cards, rather than the usual grandstanding, then for sure we will all have fewer accounts and less credit. And there will be far less consumer satisfaction. Example:

When Arkansas capped rates below 10 percent, there were few cards and small lines there -- until we figured out how banks could avoid state rate regulation. At that point HIGH RATE cards flooded into Arkansas. Surprise! Consumers wanted them. They found this preferable to not having a card, or having only a small line of credit.

Those who say they want banks to lend more and want them to place more reliance on proven and conventional products such as credit cards, rather than on credit default swaps and SIV's [Secured Investment Vehicle], will be able to achieve these goals only by maintaining retail bank price flexibility -- not by again restricting it as this law undertakes to do.

Consumers have overwhelmingly chosen cards with long 0 percent periods and rich rewards -- even when these have high punitive rates and fees, imposed if they violate card agreements. We consistently prefer these cards over the low rate cards which, contrary to Bubb and Kaufman's theory, have long been widely available from many smaller banks as well as from other institutions.

Consumers understand $35 late and over-limit fees. There's nothing confusing or complicated about these fees. We prefer 0 percent and reward products with punitive features because we're confident we can avoid penalties. And most of us prefer not to notice when we ARE punished.

Bubb and Kaufman evidently feel that many, or almost all of us, are so benighted that someone has to protect us from the "bad" choices we want to make -- such as accepting a card that will ding you $35 if you are one day late.

Why are they so shy about the implications of this? Surely there are some of us who are clever or righteous enough to merit exemption from their "protection" -- so that we can continue to benefit from a 0 percent rate for a year or more and earn attractive rewards. Why don't Bubb and Kaufman propose a national examination, or an IQ or education or credit score standard so that the rest of us at least aren't forced to take products we like LESS, just to protect what he sees as a foolish multitude?

Interventions by regulators and Congress are not invariably benign and salutary. Minimum credit card payments were greatly increased by the OCC [Office of the Comptroller of the Currencey] a couple of years ago, by regulatory fiat. Did that make consumers wealthier, happier or less likely to default? I don't see it. Card customers are defaulting in record numbers. If payments are higher, fewer people can or will pay. Who gains from that?

Would you want to have to go to a credit union to get a card, as Bubb and Kaufman envision? Or maybe to a mutual S&L [savings and loan], or mutual savings bank? All these institutions are unsuccessful competitors, with miserable market share for cards or anything else. They offer limited services and no convenience.

The epitome of a "mutual" institution is the trade unions, also losing market share. Believe it or not, AFL-CIO also offers cards. Take a look at them. Given the choice, most of us, including most trade union members, have chosen to accept cards issued by major banks such as Chase and Wells Fargo.

Bubb and Kaufman say we're wrong -- you're wrong -- and we should be restricted to types of cards that we have overwhelmingly rejected. Is he right? Or are you?

A Fairer Credit Card? -- Priceless

October 21, 2009

--from Ryan Bubb and Alex Kaufman, doctoral candidates in economics at Harvard

Industry representatives would have you believe that the Credit Card Accountability, Responsibility and Disclosure Act enacted in May spells the end of the credit card as we know it. President Obama's proposal last week to create a Consumer Financial Protection Agency to enforce the law has increased the industry's concerns.

But the example of cards issued by credit unions puts the lie to these claims. Credit unions largely conform to the new rules already, while profitably maintaining the basic features that users know and love.

The credit card act is under fire for limiting a number of fees commonly used in credit card contracts, like the charge for going over the credit limit and the increased interest rate that applies once a borrower has missed a payment. These changes might look like a boon for the average card user, but industry advocates claim that fees on delinquent borrowers subsidize the perks for those who pay on time. Take away the lucrative fees, the argument goes, and credit card issuers will be forced to ax free plane rides, slash generous credit limits and impose hefty annual dues for all.

Some in the industry even say that profitability would require issuers to charge interest from the moment of purchase, thus eliminating the grace period of interest-free lending that borrowers have long enjoyed.

These fears are largely unfounded. We have performed a study that compared credit cards issued by investor-owned banks to those issued by customer-owned credit unions. We found that credit unions are less likely to charge the fees and penalties that the new act hopes to eliminate -- and when they do, they charge less than other issuers.

While virtually all banks and other for-profit issuers increase the interest rate if the borrower fails to make a minimum payment on time, most credit unions do not. Similarly, credit union fees for exceeding the credit limit are on average just half those of other issuers. But contrary to industry assertions, more responsible card users don't pay the price. Credit union cards actually offer lower annual fees and longer grace periods than regular cards.

Is the lending model used by credit unions feasible for banks and other issuers? Absolutely. Banks and credit unions compete for customers in the same market. The primary distinguishing characteristic of credit unions is that they answer to a different group of owners: profits that are not reinvested are paid to the union's shareholder-customers as a dividend, much as investor-owned banks reinvest or pay dividends to their shareholder-investors.

True, unlike typical banks, credit unions have the advantage of being exempt from corporate income taxes, thus some might argue that this gives them an edge. But this is a proportional tax on profits. In other words, if credit unions were not exempt from the tax, their model would still make profits, they would just retain less of them.

Credit union cards are a great test case for how regular cards will perform under the new law. The evidence so far suggests that the credit card act is likely to bring about moderate, and even positive, changes. Card issuers, after all, need to retain customers. Any bank that attempts to pad its bottom line by, say, levying large annual fees will likely see its customers flee to credit unions or to banks that emulate the credit union model.

To be sure, the new law will require some sacrifices. Our data indicate that rewards programs, for example, may become less generous or less common. But is this necessarily a bad thing? While you may be reluctant to sacrifice your airline miles, rewards programs are anything but free for the nation as a whole. Debt-laden and often low-income borrowers tend to pay high fees to subsidize the vacations of those who manage to pay on time.

Credit union cards demonstrate that punishing fees are not an essential ingredient of profitable lending. This should help assuage fears that the credit card act will bring disaster for credit cards. Rather, it should nudge them toward the gentler credit union model that many Americans already enjoy.

[This article was first published June 23, 2009 in The New York Times.]