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Brooks Wilson's Economics Blog: Why Do We Need The Credit Cardholders' Bill of Rights (HR 627)?

Friday, May 15, 2009

Why Do We Need The Credit Cardholders' Bill of Rights (HR 627)?

An old 1992 single frame cartoon shows a man and woman standing in front of a tombstone that reads, "Here Lies a Good Man and a Banker."  The woman asks the man, "When did they start burying two people in one grave?"  As a former banker, I can firmly state that bankers are less popular now they they were then.  It is precisely when a group becomes the target of public and private scorn that we need to be vigilant in guarding their rights.
The White House is pushing legislation that would "protect" consumers from "unfair" credit card lending practices.  The Treasury Department (US Treasury Dept. Supports HR 627-Need For Credit Card Reform) provides a bullet list of the protections that the bill provides as well as a longer explanation of each bullet item.  The bullets are,

  • Ban Unfair Rate Increases
  • Prevent Unfair Fee & Interest Rate Charges
  • Plain Sight / Plain Language Disclosures
  • Consumer Right to Know
  • Accountability
  • Protections for Students and Young People

I have seen two lines of reasoning supporting the legislation.  Some supporters of the bill argue consumers are the easy prey of ruthless bankers who force credit onto naive borrowers.  Once credit is extended and the consumers are hooked, the lenders raise the rates to exorbitant levels based on fine print rules that nobody can read or understand.  Others argue that borrowers have no willpower, and take out credit until they can only meet minimum payments.  These arguments are old and tired and underestimate the intelligence of the average borrower and the competitive nature of consumer credit markets.

Todd Zywicki, in an EconTalk interview with Russ Roberts ("Zywicki on Debt and Bankruptcy", March 2, 2009) describes evolution of consumer credit market.  Fifty years ago, consumers borrowed from friends and family.  Pawnshops also provided credit as did retail lenders who provided installment loans or lay-away plans.  High interest rates of 30 to 40% were hidden in the price of purchases.  Financial innovation separated the purchase from the loan, increasing both transparency of the transaction and consumers' choices. Credit cards offer more flexible payment options and lower interest rates.  I might add that the Internet makes it easy to compare and shop terms and rates.  MSN Money is one of many sites that allow shoppers to compare terms and conditions offered by different lenders.  Consumer credit markets are now national and very competitive.  If a consumer doesn't like terms of your current account, they can switch lenders.  Even when borrowers get in trouble, they have a way out.  Bankruptcy laws in the United States are generous, the most generous in the world.  Finally, current levels of consumer debt are not historically high, Zywicki observes.  Debt appears high because we focus on a relatively new type of debt, credit card debt, that has replaced older forms of debt.   

The rhetoric is certainly aimed at banks, as is the majority of the proposed law's text, but make no mistake, you cannot make it more expensive to lend and not affect the amount of credit offered in markets.  Nor is all of the text aimed at lenders.  Using the section of the bill dealing with students as an example, it is easy to see how less credit will be extended.  A THOMAS (Library of Congress) summary of the bill states,
(Sec. 7) Prohibits extensions of credit to consumers under age 18, unless they are emancipated under state law, or the consumer's parent or legal guardian is designated as the primary account holder.

Prescribes procedures for the issuance of credit cards to full-time, traditional-aged college students. Limits the maximum amount of credit which may be extended to a college student for whom no one else assumes joint liability to the greater of: (1) 20% of the student's annual gross income; or (2) $500. Limits the aggregate credit limits of all such credit cards to 30% of the student's annual gross income in the most recently completed calendar year.
Do you believe consumer credit markets are not competitive, that consumers are abused, stupid, or just lack willpower?  Perhaps I have created a straw man.  Are there other arguments for supporting the Credit Cardholders' Bill of Rights?  Maybe, just maybe, consumers do not need rescuing and government action is not necessary.

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