Monday, August 4, 2008
IN MANY ways, the credit card industry is an American success story. Only 30 years ago, access to "plastic" was the prerogative of a prosperous minority; today about three-quarters of U.S. households have at least one credit card. Not surprisingly, between 1989 and 2006, total credit card charges increased from $69 billion a year to more than $1.8 trillion. Yet at the same time, annual fees have mostly disappeared, and interest rates on most cards have moderated. Though U.S. consumers currently owe a scary-sounding $962 billion in revolving debt, most of them are able to manage it without major distress. In short, more people can buy what they want and need more efficiently than ever before.
The question, though, is whether credit card expansion has reached a point of diminishing returns -- from society's point of view. The U.S. economy has grown dependent on debt-fueled consumption. And there are significant consumer protection issues. The boom in credit card issuance, like the recent growth of home mortgage lending, reflects the advent of "risk-based pricing." Computers measure each individual's creditworthiness in microscopic detail and render it as a credit score; banks then adjust credit limits, interest rates and fees accordingly. This lets them extend credit to relatively risky folks who previously would have been denied cards.
But as card issuers, like subprime mortgage originators before them, plumb the depths of the risk pool, they sometimes adopt questionable practices. Among them are so-called fee-harvesting cards, which charge huge upfront fees for as little as $50 per month in credit. More broadly, the companies have come under criticism for allocating customer payments to debt at lower interest rates first, allowing debt at high interest rates to compound; raising customers' interest rates based on their failure to keep up with debt other than that on their credit cards; and charging hair-trigger late fees.
The banking industry says that these practices are necessary for risk-based pricing and that without them bankers will have to raise interest rates, deny cards to riskier borrowers, or both. The Federal Reserve Board, no enemy of the banks, has so far disagreed; it has proposed new rules to eliminate most of the controversial practices. A bill to accomplish the same goal, sponsored by Rep. Carolyn B. Maloney (D-N.Y.), passed the House Financial Services Committee last week. We don't doubt that these reforms would come at a cost, as the industry says. We do doubt that the cost would be dramatic or that it would outweigh the benefits of increased transparency and consumer confidence. So far, light regulation of the credit card business has been a good thing. But it is possible to have too much regulation.