After the recent market tumble, Alan Greenspan expressed his shock at the way the markets had behaved, and noted flaws in his assumptions about how and why institutions would protect themselves. At the same time, there's also been a discussion of the need perceived by some to shift away from capitalism. That's a specific response and fairly broad brush. Until and unless we're ready to just throw out capitalism altogether, I think the really important observation in Greenspan's remarks is that there are assumptions built into the policies we make, both about the problems to be solved and about the likely effects of the cures we create. We need to make those assumptions explicit, make sure our policies are really doing what we intend, and make sure there are not unintended side effects.
One of the assumptions built into the credit card model is that customers are able to negotiate a better rate or terms. Contract law, in general, is not a theory that pre-establishes the fair price of individual arrangements, nor does it assume that some government establishes a fair price. Rather, it assumes that two parties enter into a contractual arrangement voluntarily, each with something to gain, and moreover each knowing that if the arrangement is not suitable, they would walk away from the deal.
While credit cards do vary in interest rate and fees, there are many ways in which they do not vary, and in which all credit cards offer a pretty similar array of terms. And that's that. There's no way to respond to a credit card offer by saying, “I like this term but not that one. Can I get a modification?” And unless another card offers the modification you want, you take what you are offered or you take nothing. Because for many people in many circumstances, it's pretty much the only game in town.
Robert Krulwich did a nice report a while back, perhaps for television, on why credit card companies don't seem to be competitive about their rates. I searched for a record of it on the web and didn't find it; if someone has a pointer to it, I'd appreciate it. Meanwhile, I'll cite merely my recollection, in which I believe he identified three key kinds of customers, none of whom constituted a reason for the credit card companies to lower rates to woo business:
Customers who will never pay credit card interest because they pay in full every month. The credit card companies don't actually like these people because they aren't a good source of income. They're referred to in the industry as “freeloaders” and since they won't be paying interest anyway, how the credit card sets the interest rate is of no concern to them.
Customers who think they will never pay credit card interest, but are wrong. These are people the credit card companies definitely want, not just because they will pay interest fees but because their finances are close enough to being in order that they'll be good credit risks. Unfortunately, these customers don't care about the interest rate since they don't plan to pay interest, so there is no tactical advantage for the credit card company to lower their rates to attract this kind of customer.
Customers who know they will be paying lots of interest. The fact that these customers are arriving knowing they will run up bills that require paying interest means they don't have their finances totally in order. As I recall, the credit card companies aren't motivated to make it better for these people either because they're not sure how much of their business they want.
Exactly because the terms tend to be so unfavorable, some people suggest never using credit cards at all. But that's tricky to manage in modern society. Just for starters, there are many things in society that require paying by credit card.
And sometimes there are times where you haven't planned well and end up in a bind that only a credit card can easily dig you out of. I'll be writing more about that case in an upcoming post, but for now I'll just quote the old American Express slogan, “Don't leave home without it.” There's a lot of truth in that advice.
Credit cards are often necessary to use, and yet they are not particularly subject to market forces. Even now, when the government is very concerned about lowering interest rates to get the economy moving, credit card interest rates offer no echo of that downward movement.
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This is one in a series of posts on credit cards.
“Round Up the Usury Suspects” (3 Dec 2008)
“Hair-Trigger Credit Card ‘Default Rates’” (6 Oct 2008)
Name Your Own Credit Card Rate! (15 Dec 2008)