New Credit Card Law Limits Consumer Choice, Leads to Less Credit, Higher Rates
CEI Analysis of Credit Card Law
Washington, D.C., May 22, 2009—Today President Obama signed a major new law regulating the credit card industry, a move that will likely hurt consumers. John Berlau, Director of CEI’s Center for Investors & Entrepreneurs, explains:
The goal of simplifying disclosure for consumers in credit card marketing, as professed by President Obama and members of Congress, is one that I share. Unfortunately, however, the so-called “Credit Card Holder Bill of Rights” signed today by the president goes beyond disclosure and imposes paternalism that limits consumers’ choices as well as sound risk-based pricing practices by banks that issue credit cards. This will result in less availability of credit and actually force card holders to pay higher rates in many instances. In addition, responsible credit card holders who pay off most of their bills at the end of the month may now be hit with the return of annual fees and a reduction in reward programs to make up the costs from the restrictions on risk-based pricing for higher-risk card holders.
The House and Senate did wisely, however, reject proposals for price controls on merchant interchange fees – a naked effort to enrich retailers at the expense of consumers. Below is a rundown of the effects of provisions that made it into in the bill and those that were defeated. There will be unintended effects of this bill, and future negative consequences if Congress continues with this paternalistic regulatory model for credit.
Analysis of the terms of the Credit Card Holder Bill of Rights:
Universal default: Congress is codifying the unwise decision of the Federal Reserve last year to ban so-called universal default. Under this longstanding practice, credit card issuers would sometimes raise rates as a result of defaults on a different credit card or loan, because these defaults may have signaled a weakening in a consumer’s credit profile. This is a sensible risk management practice similar to insurance companies raising rates for drivers who get traffic tickets, even if it wasn’t while driving the car that was insured. The issue is that the overall risk profile is changed because of certain types of behavior, and issuers could price this into rates.
With the looming ban of this practice from the Fed rules – even before this law was enacted – credit card issuers may have reacted by limiting credit lines for all card holders because of the loss of the ability to engage in this type of risk-based pricing. So responsible card holders who never miss a payment are now paying the price for these misguided rules and will likely pay a higher price with the implementation of these rules being rushed in the bill that was signed today.
Introductory or “teaser” rates: The sharp restriction of card issuers offering introductory rates for new credit card holders – a lower rate that increases after a set period – will most likely mean that consumers simply never get the benefit of the lower rates and pay the higher rate right from the beginning. Today, savvy consumers with good credit can sign up for new cards year after year and continue the lower rates almost indefinitely. Consumer web sites and other forums tell consumers effective methods to do this, and competition in credit card issuing resulted in a variety of rates for consumer to choose from. Deceptive or misleading practices can be dealt with without raising rates for consumers, as the restrictions in this bill will do.
Restrictions on college students: 18-20 year-olds are old enough to fight for their country and make other adult decisions. The bill’s restrictions on credit card eligibility solely based on age are discriminatory and paternalistic. These severe restrictions also go against the goal of establishing good credit for young adults and teaching them to manage credit wisely. These restrictions may also have unintended effects of forcing college students to work more hours to get cash if their access to credit is cut off.
Interchange fees: The House’s rejection of the measure by Peter Welch (D-VT) and Bill Shuster (R-PA) and the Senate’s rejection of the amendment by Dick Durbin (D-IL) and Kit Bond (R-MO) to put back-door price controls on merchant interchange fees was a wise decision in the best interests of consumers. The amendment would have been a massive subsidy for some of the nation’s biggest retailers at the expense of consumers and the community banks and credit unions that issue credit cards.
Experience with interchange fee controls in Australia demonstrate that consumers pay for this cost shifting through higher fees on the consumer side and fewer “rewards” such as airline miles, with no corresponding decline in retail prices. Conservatives and liberals in Congress, such as Debbie Wasserman Schultz (D-FL), have recognized that price controls on interchange fees can harm consumer interests. Congress acted wisely in separating the issue of merchant fees from consumer fees and should continue to reject this massive retailer subsidy at the expense of consumers.