Consumer (Bankcard) debt and regulation--are things working?

Author:Finley, John T.
Position::Abstract
 
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INTRODUCTION

When credit cards were first issued it can be argued that the average consumer was not ready for what was to become a new wave of relatively easy credit in a time (1950s and early 1960s) of increasing consumerism and overall desire for the good life--which the within the American social fabric increasingly dealt with material wealth. Between business and regulation there tends to be a continuous contention or even opposition. What is of prime concern to business (the market) arguably differs from the main concerns of governments whose duty it should be to protect its citizens (in this case consumers/cardholders). The key question here is the ability for the consumer to make sound decisions. The recent changes in the regulatory landscape as related to credit cards can be duly compared and contrasted to the imminent regulation that took place in the 1930s with regard to the securities industry (e.g. the formation of the SEC in 1934). It becomes a basic question of transparency. That which is abstract can tend to baffle the average person. In the case regarding this paper, the abstractness that has been dealt with by recent regulation is associated with elements world of credit cards such as minimum payments, disclosure of payment information such as that which enables a cardholder to know the impacts of certain payment levels (i.e. years remaining to payoff given different payment levels), and changing interest rates.

Prior to the "Great Recession" of 2008, consumer over-indebtedness associated with credit cards was positively correlated to the degree to which the bankcard industry was deregulated. The increased deregulation allowed card issuing banks and other organizations to create their own rules and provide or offer certain options in an environment characterized by increasing access to credit. There was a great deal of "easy money" and spending addictions seemingly ensued. Did bankcard products defy economics in the sense that pricing would no longer deter consumers from satisfying wants due to cost inhibitions? I believe the answer to this question is, intrinsically, no--however a lack of transparency in the world of bankcards tended to make things more difficult for the average consumer to know where they were regarding spending habits. A classic anecdotal account of the person who thought they had only charged a few hundred dollars worth of goods that ends up reaching levels in the $1000s became relatively common. There are also factual cases of individual with poor credit scores applying for a credit card with a $400 credit limit but due to fees and other charges were only able to charge a few hundred dollars worth before maxing out that card--known as "fee harvesting" in the bankcard vernacular.

Prior to the recession it began to seem as if these instruments of unsecured/revolving debt hindered pricing mechanisms so that fulfillment of seemingly limitless wants and desires did not take place naturally per market forces. Were consumers truly aware of what they were doing financially with this credit product? A series of regulation leading up to these heady days of the mid 2000s (2003-2007) did exist. There was regulation such as the Truth in Lending Act-1968 (introduced difficult-to-read small-print disclosures accompanying credit cards--sometimes considered to be written in "legalese") , Fair Credit Reporting Act-1970 (while providing consumer credit rights--did not do much to help consumers make debt-related decisions), and the Fair Credit Billing Act-1975 (an amendment to the Truth In Lending Act--did not do much for the cardholder expenditure impact decision process). Such regulation did not seem to work that well in light of debt levels reached.

The role of deregulation is arguably correlated with the increasing balances experienced by cardholders. Several examples of deregulation include the 1978 Marquette decision on interest rates (a tool that essentially deregulated interest rates--extreme example at 79.9%--subprime card issuer First Premier Bank in South Dakota), the 1996 Smiley ruling on fees (states cannot limit fees when charged by national banks) and the Gramm-Leach-Bliley Act of 1999 (wider-reaching deregulation of the financial services industry).

Credit cards have enabled consumers to conduct online purchases, reserve hotel rooms and rental cars in many different countries, decrease the need to exchange currency when traveling, and reduce liabilities in losses of cash. In the 5 years leading up to the recession starting in 2008. The consumer economy had become arguably overly-compulsive during these pre-recession years yielding average balance-carrying American households ongoing card debt of $16000 compared with about half that just 7 years prior. The revolving debt in the US in 2011 reached just over $800 billion as pertaining to 50 million households revolving credit card debt. (Federal Reserve RCC, 2012).

Cards are used for a variety of expenditures such as discretionary spending, convenience and, in some cases, basic needs. The macroeconomic effects of unemployment especially influence the use of this high-priced credit product to meet basic necessities while other options aren't readily apparent. Banks that issue credit cards do so because of the potential profitability of that financial product. With interest rates that climb as high as 25-30%, (averaging between 12.5% and 15%) the industry continues to reap the benefits of consumer credit usage that has drastically increased in the last half century. In recent decades, bankcards have become a commonplace item in the possession of consumers of developed countries and usage is growing rapidly in less developed regions. Prior to deregulation of the credit card industry in terms of interest rates and fees, the credit card business tended to lose money. With deregulatory changes however, the credit card business became one of the banking industry's most lucrative businesses. This is the backdrop of the recent wave of regulation and determination of whether it is working--for the consumer, at least.

BANKCARD FUNDAMENTALS/BACKGROUND

The credit card has doubtless added a great dynamic to the consumer economics landscape. Even before the Great Depression of the 1930's, several "charge" cards without a revolving credit feature issued by individual hotels, oil companies and department stores were in existence. (Mandell, 1972) During the early 1950's, more substantial entities issued charge cards such as Diners Club, Carte Blanche and American Express. The differentiating feature with the product issued by these latter entities was the capacity to use at different merchant locations instead of being restricted to one, as was the case with the prior cards. Revenues for these latest financial instruments were solely based on annual fees paid by the cardholders and the discount percentage of the purchase price paid by the merchant to the issuing entity. (Mandell, 1990) This revenue generation proved insufficient in terms of supporting the costs to issue and maintain the cardholder accounts. Nocera (1994) refers to an event that took place in 1958 in Fresno, CA as the "drop" (1994) which was when the California-based Bank of America issued and sent 60,000 live and unsolicited "revolving" credit cards via mass mailings.

The financial product specifically treated in this work has the following basic characteristics:

* The product is called a credit card (debit cards will not be part of this study)--a card issued by a bank that extends credit to the...

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