Ronald Mann, one of the nation’s leading experts on payment systems and author of Charging Ahead!, a book due out later this month, shares his thoughts about a new report from the Federal Reserve on credit cards: The debates leading to BAPCPA gave short shrift to the idea that credit cards might have something to do with skyrocketing bankruptcy filing rates. Section 1229 of BAPCPA, however, did obligate the Federal Reserve to study the industry, in response to a sense of the Congress that some issuers might extend credit without considering the likelihood of repayment or in a way that encourages the accumulation of debt and that those practices might be a major contributing factor to consumer insolvency.
The Federal Reserve has now issued its report, without collecting any new data or giving serious consideration to any information that would support Congress intuition. Given the traditional reluctance of the Federal Reserve to move aggressively in this area, it should be no surprise that the report stops short of criticizing the industry. Unfortunately, however, the report is so facile that it will only contribute further to the lack of serious policy debate.
The Fed punts on the possibility that issuer practices contribute to consumer insolvency. Searching for possible explanations, the report suggests that a decline in stigma might explain the increase in filings, mentions literature suggesting that increased debt levels might be relevant, but ultimately concludes that it is impossible really to be sure why there are so many filings. This is unfortunate, because there are a multitude of academic studies that provide answers one of which is a significant link between card use and financial distress. Indeed, this is covered in my forthcoming book Charging Ahead (www.chargingahead.net). As I explain there, there are significant relations between card spending and overall debt levels and between card debt levels and bankruptcy filing rates.
The report also misses the point when it reframes the repayment question. The Fed emphasizes the care with which lenders assess information when they decide to make loans. But that is quite different from asking whether they are trying to determine if the loans can be repaid. The business of credit card lenders is making money, and they can make quite a lot of money from credit card borrowers even if the loans are never repaid. The trick is to get borrowers in what I call the sweatbox where they pay small sums of money for long periods. If the loan accrues interest at a high rate and the borrower pays minimum payments on the loan for several years before defaulting, the lender can profit handsomely even on loans that are not repaid.
Perhaps the most serious error in the report is the Federal Reserve’s continued focus on low debt-service burdens. Debt-service burdens are relevant only if the loans are amortizing. Relatively low debt-service burdens coupled with ever-increasing debt loads lead predictably to borrowers hopelessly mired in debt, even if they can successfully make very small payments to defray the interest more or less indefinitely. Where lending business models put customers in that predicament, it is a waste of time to pretend to examine the consumer credit situation without considering the amount of outstanding debt.
The Federal Reserve received a golden opportunity, backed by Congressional mandate, to do what regulators in countries like the UK and Australia have been doing for years: to undertake a serious fact-finding inquiry that would illuminate exactly what is going on in the credit card industry. Here are just a few of the questions the Fed could have asked:
What is the repayment profile of a typical credit-card portfolio? How many people are carrying large balances for long periods without substantially reducing them?
What effect did the recent increases in minimum payment amounts have? How many borrowers were unable to pay after those minimum increases, how much did they owe, and how long had they been paying on it?
What is the relation between late payments or overlimit transactions and subsequent default? Are high late charges and overlimit fees opportunistic or cost-based?
But the Federal Reserve did not ask those questions. Asked for a report on the health of the consumer-finance market, the Fed blithely said all is well, without taking a temperature, blood pressure or pulse. It did so because it had all the information it needed: the industry is still profitable and willing to extend credit. The fact is, we might not need any more evidence to conclude that there are serious problems in our consumer-finance industry. But we certainly can’t conclude that all is well simply because 95% of those carrying credit-card debts in any given month haven’t yet succumbed.
