Subprime mortgages, collaterized debt obligations and credit default swaps do not effectively stand as symbols of America’s debt-fueled economic disaster. They are simply collections of paper and terms, and very few Americans ever actually interact with them in a direct way. Credit cards, however, are totally different. There are more than 984 million credit cards in the United States, and, after President Obama signs a bill reforming the industry, they will be radically different.
Unlike other, über-exotic financial instruments, credit cards are relatively easy to understand and are directly used by millions of people. There is also a very clear connection between the use of credit cards and economic expansion. Credit cards give consumers access to more money than they would otherwise have, which lets them stimulate the economy through spending or build the economy through investing in a small business. But the positive effects of credit cards do not justify a credit card industry that preys on irresponsibility and dishonesty. The Credit CARD (Card Accountability Responsibility and Disclosure) Act recently passed by the House and Senate, which curtails credit card companies’ ability to engage in shady and dishonest practices, is a a step in the right direction.
Some of the most drastic changes will apply to students. The bill bans credit cards for minors, unless they’re emancipated. For adults less than 21 years old, they can only apply for a card if they can prove income, and their credit limit is capped at 30 percent of that income. And unless a parent or another adult signs for joint responsibility of the card, the credit limits will be capped at $500 or 20 percent of per year income for students, whichever is greater. Although these reforms will significantly curtail the spending power of students, it will also take away the opportunities for credit card companies to lure young people with the possibility of low teaser rates and increased ability to spend, only to trap them in a revolving cycle of higher interest rates and fees.
But credit card companies’ shady practices are targeting more than just students. Those who pay the entirety of their balance every month, and thus don’t pay interest or any fees, are showered with various rewards and benefits, from airline miles to discounts on gas. But the profit margins credit card companies earn on these customers are low. So, for the customers that only make minimum payments, not only are they hit with interest payments, but their card issuers can change the rates retroactively, and any notification of the change is often buried in fine print that most people ignore or cannot discern.
There are also the infamous low teaser rates, which banks will then raise with little or no clear warning. The bill mandates that any promotional rate must last for at least six months. Another clear example of how credit card companies encourage and then profit off of consumer irresponsibility is by letting consumers exceed their credit limits without any warning. For credit card companies, this makes sense; once a customer goes over the limit, the company can start hitting them up for more and more fees and interest rate increases. Now, under this bill, credit card companies have to give 45 days of notice before interest rates go up.
Even though all these practices are all a little sketchy, they reflect a basic principle. The riskier a cardholder is, the higher interest rates should be. If a customer falls behind on his payments, the card issuer should be able to charge fees and a higher rate, but only to a certain extent. But when you read the practices the bill reforms or bans, it quickly becomes clear that credit card companies aren’t just pricing risk.
For example, the bill mandates that all agreements and terms be printed in 12-point font, that customers not be charged for paying their fees online, that banks have to disclose that only paying the minimum payment will result in higher interest rates, that bills must be sent 21 days before they’re due and that if the check clears at 5 p.m., the bill is on time. Each of these practices that the bill bans have nothing to do with pricing risk, and had everything to do with making it as easy as possible for cardholders to act irresponsibly and then start paying fees and higher rates.
So what are the likely outcomes of this legislation? For one, the credit card industry will be worse off. As the economy took a turn for the worse, companies cast their lots by trying to trick and connive their way into as much money as possible from the people least able to provide it and are now going to pay a price. Also, there’s a chance that responsible and wealthier cardholders, who pay off their entire balances every month and benefit from numerous reward programs, could be negatively affected. Banks are planning to bring back annual fees and pare back on the perks they give to their most reliable customers.
But would this really be so bad? If people are just using credit cards for convenience and rewards, we shouldn’t feel too sorry for them if they’re slightly inconvenienced, especially if it means that credit card companies will stop preying on the disadvantaged, naive and under-informed. A credit card industry that cannot scam its customers will certainly be smaller, but maybe, just maybe, that’s a good thing.