Last week there was a great deal of buzz and coverage surrounding future regulations of the credit card industry. I’m surprised that everyone stopped talking about it so quickly. I believe these regulations will have a serious impact on the growth of both the US and Canadian economies. The credit card is the least discriminating form of credit widely available to humans. Regardless of how old you are, what you do for a living, what assets you own and what you want to do with the money - you can get a credit card.
Consumer spending represents over 70% of America’s GDP and personal credit cards facilitate a great deal of that spending. This entails that the US GDP growth is joined at the hip with individual consumer spending. Restrictions on credit cards will hinder consumer spending resulting in slower economic recovery. At the same time, the American consumer clearly needs to be protected from fast and easy credit given the ridiculously high levels of consumer debt they’ve accumulated.
So what exactly are the proposed changes? In the US, a bill was recently passed by the Senate making it harder for people under 21 to get a credit card. It also stops the banks from raising the interest rate on a consumer unless he or she is more than 60 days late on making minimum payments. Relatively minor changes thus far, but will there be more?
This New York Times article hints that card companies will employ a completely different scheme for credit cards in the future among this changing regulatory landscape. They say there will be more user fees and a reduced (or eliminated) grace period where no interest is charged. This would affect customers that pay on time every month the most, which is estimated to be 40% of credit card holders in the States.
I find this hard to believe because consumers that pay on time don’t actually need the credit, in most cases. Many people only get credit cards because of all the perks they can earn, not because they need the financing. If they had to pay ridiculous amounts of interest and high user fees, it would cease to be an attractive option.
In addition to this, the credit card companies make money from vendors. A standard charge that Visa or Mastercard might impose on a vendor is 3% of the purchase price on each transaction, which might be capped if the vendor reaches a certain volume level each month. The reason these vendors have these credit card machines is because customers like paying with credit cards, and accumulating points. If credit card companies make their "gold" cards unattractive to their prime customers, they will start to lose revenue at the stores as well.
Let’s change focus to the majority of American credit card holders (the 60% that carry a balance from month-to-month). What the banks are implying is that everyone will be treated the way these customers are treated, extremely high interest rates and very little perks. Eerily similar to the business model of subprime lending, the incredibly high and volatile interest rate schemes serve to protect the credit card companies from a naturally high rate of default. Remember, they are giving you a completely unsecured loan to purchase whatever you like. At least with a subprime mortgage there is a house that the bank can takeover should someone default. With credit cards, the rate of interest has to be high enough to compensate these companies for all the customers that never pay back the loan. There is nothing else to fall back on.
In Canada, everything works exactly the same, except 70% of Canadians pay their bills on time so they never pay interest. This CBC news brief notes that Canada is also working on regulating the industry. Because of the diligent client base, our regulatory changes are not likely to be as drastic as in the US.
I want to share a story with you about my father in 1989, right around the time that the recession was surfacing in Canada, and credit became tight. He had been using an electronic typewriter for all his business communications, but once he learned about the word processor, he realized that it would save him an incredible amount of time. He would be able to customize documents for each sales pitch faster, meaning he could fit more appointments in each day.
He purchased an 80-86 computer (if you recall the progression, it was the one before 286, 386, 486, Pentium, etc). It had a monochrome orange monitor that weighed as much as a big screen TV even though it was 15 inches in diameter. He paid $100 extra to install an 8 MB hard disk (it came with no disk space) which was barely enough space to load the start-up disks and a word processor called "8-in-1." Add another $100 for a dot-matrix printer to complete the set.
He didn’t actually have the money to purchase this computer. What he did was use his credit card to make the purchase, and then obtain more credit cards to make minimum payments each month in order to avoid default or harm to his credit rating. This was by far the most expensive way to purchase a computer (let’s not even mention the fact that it was going to be obsolete in two years). He was fully aware that time was against him, and that ultimately he would run out of room on those credit cards and would be unable to make minimum payments this way. But he got through it, and he had the credit card companies to thank for it. Sure, they charged him an incredibly high rate of interest, but without them his business would never had made the jump that all the other businesses were making with the word-processor.
It certainly helped that the banks didn’t ask about how he was borrowing money from friends to make mortgage payments. Nor did they ask about how regular his income was. That is the reason he was able to get through a very tough time. Ultimately, he was a positive contributing member in the Canadian economy for years to come. Regulations will make credit card companies think twice about extending more credit to people like my father this time around. For example, if regulation forces card companies to reduce rates, then they will only lend to customers worthy of the reduced rate. Each time a rule is created designed to protect the customer, the card companies must re-assess how to maximize profits.
Expect more severe regulations to reduce the amount of credit available in the future through these cards and curtail consumer spending altogether. Reduced American consumer spending will slow the recovery of both the US and Canadian economies. But more importantly, these subtle tweaks to the rules will change the way we take risks. The new credit card will change how we live our lives.
Consumer spending represents over 70% of America’s GDP and personal credit cards facilitate a great deal of that spending. This entails that the US GDP growth is joined at the hip with individual consumer spending. Restrictions on credit cards will hinder consumer spending resulting in slower economic recovery. At the same time, the American consumer clearly needs to be protected from fast and easy credit given the ridiculously high levels of consumer debt they’ve accumulated.
So what exactly are the proposed changes? In the US, a bill was recently passed by the Senate making it harder for people under 21 to get a credit card. It also stops the banks from raising the interest rate on a consumer unless he or she is more than 60 days late on making minimum payments. Relatively minor changes thus far, but will there be more?
This New York Times article hints that card companies will employ a completely different scheme for credit cards in the future among this changing regulatory landscape. They say there will be more user fees and a reduced (or eliminated) grace period where no interest is charged. This would affect customers that pay on time every month the most, which is estimated to be 40% of credit card holders in the States.
I find this hard to believe because consumers that pay on time don’t actually need the credit, in most cases. Many people only get credit cards because of all the perks they can earn, not because they need the financing. If they had to pay ridiculous amounts of interest and high user fees, it would cease to be an attractive option.
In addition to this, the credit card companies make money from vendors. A standard charge that Visa or Mastercard might impose on a vendor is 3% of the purchase price on each transaction, which might be capped if the vendor reaches a certain volume level each month. The reason these vendors have these credit card machines is because customers like paying with credit cards, and accumulating points. If credit card companies make their "gold" cards unattractive to their prime customers, they will start to lose revenue at the stores as well.
Let’s change focus to the majority of American credit card holders (the 60% that carry a balance from month-to-month). What the banks are implying is that everyone will be treated the way these customers are treated, extremely high interest rates and very little perks. Eerily similar to the business model of subprime lending, the incredibly high and volatile interest rate schemes serve to protect the credit card companies from a naturally high rate of default. Remember, they are giving you a completely unsecured loan to purchase whatever you like. At least with a subprime mortgage there is a house that the bank can takeover should someone default. With credit cards, the rate of interest has to be high enough to compensate these companies for all the customers that never pay back the loan. There is nothing else to fall back on.
In Canada, everything works exactly the same, except 70% of Canadians pay their bills on time so they never pay interest. This CBC news brief notes that Canada is also working on regulating the industry. Because of the diligent client base, our regulatory changes are not likely to be as drastic as in the US.
I want to share a story with you about my father in 1989, right around the time that the recession was surfacing in Canada, and credit became tight. He had been using an electronic typewriter for all his business communications, but once he learned about the word processor, he realized that it would save him an incredible amount of time. He would be able to customize documents for each sales pitch faster, meaning he could fit more appointments in each day.
He purchased an 80-86 computer (if you recall the progression, it was the one before 286, 386, 486, Pentium, etc). It had a monochrome orange monitor that weighed as much as a big screen TV even though it was 15 inches in diameter. He paid $100 extra to install an 8 MB hard disk (it came with no disk space) which was barely enough space to load the start-up disks and a word processor called "8-in-1." Add another $100 for a dot-matrix printer to complete the set.
He didn’t actually have the money to purchase this computer. What he did was use his credit card to make the purchase, and then obtain more credit cards to make minimum payments each month in order to avoid default or harm to his credit rating. This was by far the most expensive way to purchase a computer (let’s not even mention the fact that it was going to be obsolete in two years). He was fully aware that time was against him, and that ultimately he would run out of room on those credit cards and would be unable to make minimum payments this way. But he got through it, and he had the credit card companies to thank for it. Sure, they charged him an incredibly high rate of interest, but without them his business would never had made the jump that all the other businesses were making with the word-processor.
It certainly helped that the banks didn’t ask about how he was borrowing money from friends to make mortgage payments. Nor did they ask about how regular his income was. That is the reason he was able to get through a very tough time. Ultimately, he was a positive contributing member in the Canadian economy for years to come. Regulations will make credit card companies think twice about extending more credit to people like my father this time around. For example, if regulation forces card companies to reduce rates, then they will only lend to customers worthy of the reduced rate. Each time a rule is created designed to protect the customer, the card companies must re-assess how to maximize profits.
Expect more severe regulations to reduce the amount of credit available in the future through these cards and curtail consumer spending altogether. Reduced American consumer spending will slow the recovery of both the US and Canadian economies. But more importantly, these subtle tweaks to the rules will change the way we take risks. The new credit card will change how we live our lives.
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2 comments:
Actually, the progression of Microprocessors went 80-86, 80-88, 286, etc. Just being a proud owner of an 8088 back in the day, I felt like making this point.
Regardless, the more stringent the CC company's become the more they will shoot themselves in the foot.
It seems that one of the main reasons these cards are used by people who pay their bills on time is for online transactions, and if people will be penalized for using their card their use will likely decrease (what with alternatives existing).
What has struck my fancy recent is the release of the chip (as opposed to magnetic stripe) based debit ards. This seems like a real opportunity for Banks to get their feet in on the online market (Yes, credit cards have them to, but bear with me).
As it is not a stretch to imagine that PCs in the future will come equipped with a chip reader - much as SD card readers are becoming standard issue on new PCs. So that you can download an application from your bank which will allow you to insert your card into your PC, have it authenticated by your bank, then the transaction would be directly debited from your account. Of course, this ability is only available through higher level service packages from your bank.
But on topic: the lack of easily available credit (if I'm not mistaken) has already been seen to cause contractions in the economy, how can this be construed as being beneficial to anyone?
A comment!
Lots of great points here.
I think part of this is the CC companies throwing threats at the regulators. I mean, they really really really don't want these regulations. So this is a worst-case scenario they are painting for us using the media because there's still time to lobby.
You are absolutely correct, the tightening of credit will only help to reduce economic growth. In general I have not really found any economist or thinker that believes we'll eventually reach the type of growth we were experiencing, because there is an underlying assumption that regulations of all credit and financial markets will prevent us from taking the same magnitude of risk.
But at the same time, it will make the economy more stable. The American consumer needs to learn how to do very simple fundamental things with his/her finances, like saving money, and living within one's means.
People absolutely love to compare this recession with the depression, and they always conclude it's not a fair comparison but they also say it's the most similar situation from the past that we might be able to learn from. Something I noticed is that a big reason for post-war growth had to do with the enhancement of store credit and credit cards. The reason why everyone had a TV in the 1950s was not just because real wealth had risen, but it was also the fact that you could buy so many more things on credit and just make minimum payments. That option won't be there this time around because they've maxed out.
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