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Source link: http://archive.mises.org/9957/what-will-happen-if-the-credit-card-reformers-win/

What Will Happen if the Credit Card Reformers Win?

May 15, 2009 by

What will happen when Congress passes and President Obama signs the pending credit-card legislation?

Probably everyone will pay higher interest rates on cards in the first place, and some people will be denied cards who otherwise would have got them. And where will those people turn when they can’t get credit through their credit cards? As The Onion has explained, their only choice may be a loan shark — who will be unconcerned with federal legislation and rather less pleasant in his collection practices. This will be especially so in states, such as mine, that have banned “payday lending.”

Sure, probably fewer people will go to loan sharks than would have run up debt on cards, since the loan shark is less convenient and the penalties for late payments perhaps more obvious. But those who need short-term credit (and remember, very short-term credit on a card is free) will be deprived of a much safer, more consumer-friendly option.

There are reasons why a fully free market might result in less credit-card issuance and use, but adding more legislation on top of our current system only infringes on consumer freedom and, contrary to the politicians’ supposedly good intentions, may expose the most vulnerable to more risk of serious harm.

(More from me on credit-card legislation and regulation here, here, and here.)

{ 26 comments }

Michael A. Clem May 15, 2009 at 10:39 am

The more things the government outlaws, the more we become outlaws. Funny how that works.

Inquisitor May 15, 2009 at 11:17 am

Hahaha it’s funny how you can quote the Onion as opposed to a “real” news source and it might even make more sense…

Ireland May 15, 2009 at 11:43 am

Well, opposing another goverment intervention is sound and fine. I just don’t get the sentiment about the loan sharks, as related to disappearing credit.

Because if we managed to get rid of the main government interventions, the easy money and credit, bank socialization, and other moral hazards, then it’s reasonable to expect the market rules for getting credit to be tighter than whatever Obama ever dares to dream about. As is correctly noted in the second part of the blog entry. Yeah, tough world it is.

kmeisthax May 15, 2009 at 11:56 am

My father actually took me and my brother into a room and spent an hour explaining the terms and conditions on a credit card. So I’ve known from day one all the stupid tricks they pull and I avoid them. Everyone else should, too. It’s not a greed problem but an education problem. Most of the people I know pay off their bills on time and enjoy the free very-short-term credit. If everyone were to decide to do this, we wouldn’t have the tricks.

And to tie this into economics, hasn’t the government been doing everything in it’s power to get people spending out the nose and mortgaged to the hilt? Maybe we should point the blame, not to credit card companies, but to the economic policies of creating unsustainable booms where everyone is spending out the wazoo. Populist consumer advocates are looking in the wrong direction, because they want the government to solve the problem. So they can’t say that government is the problem.

MattB May 15, 2009 at 12:42 pm

There are many reforms needed in the Credit Card industry. Though I am skeptical the govt will reform correctly, self modifying contracts need to end. Open ended one sided contracts are hardly free market. I believe govt job is to enforce legal contract law. If the rate they offer is 6000% so be it, but must be put in writing / contract right up front.

Justin May 15, 2009 at 12:46 pm

Let me preface this comment by saying that I am a libertarian and an Austrian. However, I am not buying the argument as presented here. Allow me to play devil’s advocate; I fully hope and expect others will respond.

Huebert states,

“It would limit card companies’ ability to raise interest rates on an existing balance when a cardholder turns out to be a greater risk.”

A few months ago I exceeded the allotted minutes on my cell phone plan by approximately 15%. The resulting bill was nearly 300% higher than average. To be consistent, I assume Huebert would have to claim that these charges offset the additional load I placed on the cell phone network, and yet as a former telecom employee I can assure you this is not the case.

A reality check is in order. Like overage charges on cell phones, many of these credit card fees and practices are essentially “gotcha” clauses. Sure, they are a leverage for risk primarily because they are highly profitable. At what point, if at all, do such clauses become unenforceable? At what point, if at all, do they become illegal?

But Huebert goes on to state that without these practices, we would be deprived of a needed service, short-term credit:

“But those who need short-term credit (and remember, very short-term credit on a card is free) will be deprived of a much safer, more consumer-friendly option.”

Again, we need to face reality here. Every study of consumer behavior with respect to credit cards has shown that they are consumption engines – as a general rule, people spend more with credit cards than they otherwise would. The view of credit cards as fulfilling the need for short-term credit is an economic ideal that doesn’t adequately describe what is happening, and Huebert acknowledges this tentatively:

“Sure, probably fewer people will go to loan sharks than would have run up debt on cards, since the loan shark is less convenient and the penalties for late payments perhaps more obvious.”

I am not necessarily supporting this legislation, but merely pointing out that I do not find this argument convincing, especially for those who are not already keen on the free market.

Bastiat79 May 15, 2009 at 1:21 pm

@ Justin

“To be consistent, I assume Huebert would have to claim that these charges offset the additional load I placed on the cell phone network, and yet as a former telecom employee I can assure you this is not the case.”

No, these charges are one of many possible ways to distribute fixed costs among customers. As long as you are made aware of them, I find nothing “unfair” about them. It’s not different from taking the plane and realizing not everybody has paid as much as you did for their ticket, because you were last minute.

Justin May 15, 2009 at 1:43 pm

Thanks for your reply Bastiat.

You are exactly right. These charges exist to maximize profits. If there were a more profitable way to distribute the cost among customers, credit card companies would pursue that option.

Would your answer be, then, that “gotcha” clauses are never unenforceable? The devil is in the details – what constitutes being “made aware”?

iawai May 15, 2009 at 1:45 pm

I don’t ever recall an agent from Visa, Mastercard, or anyone else for that matter, holding a gun to my head telling me that I must sign up for a credit card account. I look through the terms and choose a provider, to meet my needs for secure data-based cash transactions (buying stuff from the internet and gas stations).

I expect that if I am late on payments, there will be consequences – just like if I was late making any other payment for a service or loan. Just because I am not specifically aware of the particular consequences doesn’t absolve me from having signed the contract.

There are legitimate business reasons to want higher loan rates and lower credit lines for people that are late – just like a bank would do the same.

If there were a way for one Credit card company to give better terms while still making a profit – wouldn’t they already be doing it?

Alex Koumparos May 15, 2009 at 1:50 pm

“To be consistent, I assume Huebert would have to claim that these charges offset the additional load I placed on the cell phone network”

Assume what you will, but Huebert emphatically need not claim that these charges offset the additional load you placed on the cell phone network, for at least the following reasons: first, the appropriateness of the analogy has not been established, and as you suggested the analogy, the burden is on you to demonstrate the appropriateness. Second, even if the analogy is appropriate, Huebert stated that the legislation would “limit card companies’ ability to raise interest rates on an existing balance when a cardholder turns out to be a greater risk.” For this statement to address the situation you suggest he would have had to state something like, “limit card companies’ ability to raise interest rates on an existing balance ONLY when a cardholder turns out to be a greater risk AND SUCH INCREASE IN RATE ONLY PROPORTIONATELY TO THE INCREASE IN RISK”.

“At what point, if at all, do such clauses become unenforceable? At what point, if at all, do they become illegal?”

Why should they ever become unenforceable or illegal? If party A wishes to contract for services with Party B and the price of the service varies depending on usage (e.g., 0% if payment is made within 30 days, 20% if made thereafter; or $0.01/minute for the first 500 minutes and $0.10/minute thereafter) and both parties desire to contract in this way, who should have the right to substitute their own preferences for the contracting parties? Both parties expect to profit from the arrangement (Party A presumably expects to make his payments within 30 days or use fewer than 500 minutes per billing period and thus obtain a bargain compared to a flat rate. Party B presumably expects Party A to make his payments after 30 days or go over 500 minutes and thus make more money than by charging flat rates). Ultimately, the party who best anticipates the future will make the most profit in actuality.

“as a general rule, people spend more with credit cards than they otherwise would. ”

Sure some people spend more with credit cards than they otherwise would. There is nothing necessarily wrong with that. I may want to see a film at the theatre tonight that finishes its run tomorrow but I don’t get paid till next week. If I can’t purchase my ticket on credit I may not make that purchase at all. That doesn’t at all imply that I shouldn’t have made that purchase on credit nor that I would regret it afterward.

“The view of credit cards as fulfilling the need for short-term credit is an economic ideal that doesn’t adequately describe what is happening,”

Some people may carry a balance on their credit cards (including myself) but it doesn’t imply that all people carry a balance on their credit cards. As long as there is one person who uses the facility in the “ideal” way, who are you (or Obama) to prevent them? Moreover, even for those of us who currently carry a balance (at the higher rate), we may still intend or expect in the future to use our facilities differently (and pay the card off in full each month) and therefore judge that we are better off, on balance, than we would be in the alternative.

Justin May 15, 2009 at 2:24 pm

Thanks for your reply Alex.

The analogy was never intended to be robust, but merely to point out that these practices are in place because they are the most profitable. Nothing more and nothing less. You are right; Heubert made no such claim.

“Why should they ever become unenforceable or illegal?”

It seems to me that this is the core of the issue. Would a contract that required a year of indentured service for a late payment be enforceable? Or 75% of that person’s income for the rest of their life? What if these terms were buried in the fine print? If I drafted such a contract and offered it to a million people, I might perhaps catch a few.

This is of course a reductio ad absurdum argument, and again it is not meant to be robust. I am simply pointing out that unless you are prepared to accept all contracts as enforceable, you must at some point support legislation to determine which ones are not.

Alex Koumparos May 15, 2009 at 2:53 pm

@Justin

“It seems to me that this is the core of the issue. Would a contract that required a year of indentured service for a late payment be enforceable? Or 75% of that person’s income for the rest of their life? What if these terms were buried in the fine print? If I drafted such a contract and offered it to a million people, I might perhaps catch a few.”

I think there are various positions on this issue from libertarians, more around the issue of alienability of the will and the possibility of slave contracts than on the objective reasonability of particular contract terms. Stephan Kinsella has written some interesting things on what constitutes a contract and things like shrinkwrap (etc) software licenses. My personal view is that the specific term you suggest should be enforceable if the parties agree to it. From recollection, most credit card contracts have a box that you sign that explicitly affirms you have read the agreement (including the small print). If someone wants to fraudulently claim that they read the print, that’s up to them, but I don’t see why they should subsequently be regarded as a victim.

Mike May 15, 2009 at 3:09 pm

Look who sponsored the Senate version of the credit card reform bill (S. 414), none other than the corrupt Christoper Dodd. Gets even better with the list of cosponsors including Kerry, Schumer, Harkin, Durbin, Levin, Leahy, and socialist Bernie Sanders. And look at section 603 which temporarily increases the borrowing authority of the FDIC from $30 billion to $100 billion, and the NCUA from $100 million to $6 billion. Don’t you just love the little things like that they tack on?

http://www.govtrack.us/congress/bill.xpd?bill=s111-414

damocles May 15, 2009 at 9:00 pm

Credit cards are Darwinian devices; for the intelligent they provide a wonderful service at absolutely no cost (can’t beat that!); for the stupid or undisciplined, they can be addictive and lead to expensive debt. Not nearly as expensive as borrowing from the legbreakers, however.

sheridan May 15, 2009 at 9:07 pm

> And where will those people turn when they can’t get credit through their credit cards?

I guess that’s where family comes in.

Yancey Ward May 15, 2009 at 9:21 pm

What is really hilarious is that these reforms are at cross-purposes to the government’s insane desire to expand credit again. We are ruled by morons.

Anonymous May 15, 2009 at 9:29 pm

I am actually hoping that this legislation goes through. Hear me out, I’m not crazy.

Like all legislation, this legislation will have unintended consequences. This price control legislation will prevent lenders from pricing in risk, Lenders will respond by refusing to issue credit to irresponsible borrowers. So this bill will end up screwing over the people it was supposed to help. I think this would be beneficial. Our society is overloaded with consumer debt and this legislation might hamper the amount of future consumer debt. In short, this legislation will prevent the most irresponsible people from obtaining credit cards.

Anyone else with me?

DS May 16, 2009 at 7:44 am

Hopefully the unintended consequence will be less people using credit cards to FUND their everyday purchases, as opposed to using credit cards to FACILITATE their everyday purchases.

Until then I will enjoy a nice subsidity: Somebody above said it perfectly, I use my credit card for every purchase I can because I get airline miles. I pay my balance every month so I incur no cost for this very useful service, other than a $90 fee once a year – of which is a bargain based on the utility it provides me. The idiots who carry a balance and pay interest charges every month are subsidizing my usage because this service would certainly cost me more than $90 a year otherwise.

To all the sheep who pay for this service for me, thank you.

If you NEED credit to buy anything, you really need to take a hard look at your lifestyle and financial choices. You are walking on the edge of a cliff, and paying through the nose for that privilege.

Also, by looking at the sponsors of this bill in congress and the president, and knowing who their biggest campaign contributors are, I’m sure the banking industry will engineer this legislation to their benefit, all the while their proxies will sell it as favoring the little guy over the big credit card companies.

Chad Rushing May 16, 2009 at 4:09 pm

Anonymous: “In short, this legislation will prevent the most irresponsible people from obtaining credit cards.”

Maybe it will in the short term. However, if that happens, then there will be cries of “discriminatory” rules for credit eligibility (“Having a credit card is an inalienable human right!”) followed by “corrective” legislation that forces credit card companies under the new system to resume offering credit cards at lower rates (or at all) to individuals who are certainly not responsible and/or creditworthy, simply compounding the problems that already exist. Just wait and see.

matskralc May 16, 2009 at 11:02 pm

Just picking a nit here, but all of you who think credit cards are “free” as long as you pay off your balance in full every month: don’t think for a second that businesses aren’t baking the 2% they have to pay VISA for the privilege of using their computers to get your money into the cost of the good you just purchased!

DS May 17, 2009 at 7:25 am

“Just picking a nit here, but all of you who think credit cards are “free” as long as you pay off your balance in full every month: don’t think for a second that businesses aren’t baking the 2% they have to pay VISA for the privilege of using their computers to get your money into the cost of the good you just purchased!”

That may be true, but most places don’t give you a different price if you use cash (there are a few exceptions), so you’re paying for it regardless. That only goes away if the establishment you are buying from stops accepting credit cards. If you’re paying for it anyway, you might as well use the service.

x May 21, 2009 at 1:45 am

Anonymous: “In short, this legislation will prevent the most irresponsible people from obtaining credit cards.”

and…if responsible people stop using credit cards then the card issuers will no longer be able to indirectly charge all of us the 2-3% DS “you’re paying for it anyway” sales tax for some meager perks.

x May 21, 2009 at 1:47 am

Anonymous: “In short, this legislation will prevent the most irresponsible people from obtaining credit cards.”

and…if responsible people stop using credit cards then the card issuers will no longer be able to indirectly charge all of us the 2-3% DS “you’re paying for it anyway” sales tax for some meager perks.

x May 21, 2009 at 1:48 am

Anonymous: “In short, this legislation will prevent the most irresponsible people from obtaining credit cards.”

and…if responsible people stop using credit cards then the card issuers will no longer be able to indirectly charge all of us the 2-3% DS “you’re paying for it anyway” sales tax for some meager perks.

ronn June 13, 2009 at 7:27 am

I guess my main concern is what is going to happen to people like me who depend on credit cards as a way of life to get by. I got myself in a situation where I need my credit card to survive. Will my credit card possibly get closed? I have one through Citi Bank.

georgewhite September 13, 2010 at 4:08 pm

By georgewhite

In short, all the irresponsible people are prevented through the legislation and if they are responsible then they will stop using credit cards………

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