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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Michael Spence and Root Causes

Michael Spence is a Nobel Prize winner in economics for his analysis of markets with asymmetric information. In a Financial Times Economist Forum titles, "Balance sheets and income statements: breaking the downward spiral" he gives his opinion about the causes of the current financial crisis and recommendations on how to solve it.

I recommend this article. For those who do not wish to read it, here is a quick synopsis. The financial crisis which is international in scope was due to extreme leverage, an underestimation of risk, and the growing correlation of risk between assets. As an example of the correlation of risks between assets, the risk that housing prices in Atlanta would fall at the same time that housing prices in Las Vegas fell increased. The falling housing values were also linked to the default rate on mortgages. Assets and liabilities are found on balance sheets and the correlations were not limited to housing.

Developed economies have to deleverage, lower asset values, and temporarily reduce consumption, but the process may be going too far. Investment, consumption and employment, all part of our national income statement have entered a feedback loop with the balance sheet that is creating a sort of negative bubble. Asset values are being reduced too much, and this in turn results in too great a reduction in investment, consumption and employment. The loop then passes through the loop again.

Spence recommends a large stimulus package, hopefully international in nature, as well as announced in advance. He notes that addressing asset deflation is crucial and very difficult. He also recommends that governments buy assets. He notes that under current conditions, governments will make many mistakes, opening themselves to critics. He ends by noting that it is fortunate that the government's deeds will be done before the critics pens have cooled.

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Two Views on Housing Policy

Yesterday, Greg Mankiw linked to two articles commenting on a Treasury Department proposal to issue mortgages at 4.5%; Glenn Hubbard and Christopher J. Mayer approved of the plan, Edward L. Glaeser and Joseph Gyourko do not. While Mankiw's observation is correct, I offer a second--Hubbard and Mayer are recommending a short term solution to the current crisis and Glaeser and Gyourko are recommending a long term solution to regional housing problems.

Glenn Hubbard and Christopher Mayer

Recent news articles suggest that the Treasury Department is considering a plan to offer a 4.5% mortgage for home buyers for a period of time. Let's hope it does. It would help arrest the decline in house prices that is at the base of the ongoing financial crisis and recession...Raising the demand for housing makes sense now.

Edward L. Glaeser and Joseph Gyourko

These are two distinct problems that require two different solutions — neither of which involves subsidized lending...The first problem, the shortage of housing for the poor, is best solved by providing more housing vouchers... [The second problem], the fact that homes in San Francisco and New York [and other coastal areas] remain extremely expensive by historical standards. Prices are far above construction costs because robust housing demand, fueled by rising economic productivity, has collided against barriers to supply, like minimum lot sizes and height limits...The only path towards widespread affordability is to build more, which requires reducing NIMBYist [Not In My Back Yard] regulations. Localities tend to put their own interests ahead of the nation’s interest by restricting building in order to keep prices up and reduce congestion. The federal government should increase its efforts to counter this tendency.

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