The Bipartisan War on Credit Hurts the Poor

Photo Credit: Getty

Donald Trump is taking aim at the credit card industry. “While working Americans catch up, we’re going to put a temporary cap on credit card interest rates,” he said recently, adding, “We can’t let them make 25 and 30 percent.” In Congress, numerous bills are aimed at the industry. The Biden administration is introducing regulations capping credit card late fees. Other regulators are targeting aspects of credit card financing like airline miles programs. The Department of Justice is suing Visa for illegal monopolization of the debit card network. Put these together and you have a war on credit.  

Attacks on those who offer credit are nothing new. Most societies have had usury laws restricting interest rates, and some even have outright bans on charging any interest at all. In ancient Israel, every fiftieth year saw a Jubilee where many debts were entirely forgiven. In such societies, offering credit at profitable terms is a very risky business. 

It’s also easy to see why societies have been hard on credit. Debt can become a serious problem – as I know from personal experience. People can get in over their heads and find large swathes of their income going to merely service loans taken out years ago. These are important considerations when asking what the correct policy should be over credit. 

Yet we mustn’t lose sight of why we moved away from usury laws and debt jubilees in the first place. Societies that insist on them remain rigidly hierarchical. The poor remain poor. This is because increasing wealth requires access to capital. People who own property have that capital. Those who don’t need a way of acquiring it. 

Someone with little capital who wants a chance in life needs a way of getting an unsecured loan. There are many traditional, culture-based ways of doing this. In the US, mutual aid societies had programs for getting cash to those who needed it, for example. Yet that would generally involve moral judgments about the character of the person needing the loan, or judgments about the necessity of the proposed purchase. 

The creation of the credit card changed all that. A credit card is a judgment-free loan for whatever purposes the applicant wishes based mainly on what the credit company knows about the applicant’s ability to repay. 

If you do not have much of a credit history, then there are basically two ways the company can hedge its risk in providing you with the line of credit. It can charge you a higher annual fee for the facility, or it can charge you a higher interest rate. The latter, for obvious reasons, is the better choice for many starting out their credit, hence the creation of the “starter credit card” – which is how I began to build my credit rating, having arrived in the country as a 32-year-old immigrant. 

This judgment-free industry doesn’t exist in a vacuum. It has a whole infrastructure to back it up. Various banks offer cards and the credit that goes with them, with a variety of different incentive programs that need to be paid for – air miles, cash back programs, affinity programs and so on. There is intense competition in this industry. 

Those cards all need payment networks to travel through. This is where the branding people most associate with cards appears. Visa and Mastercard don’t actually offer cards themselves. Instead, they run the networks and bear many of the risks associated with them, such as fraudulent or returned charges. They compete on quality, reducing the costs of fraud and the like. Other networks like Discover and American Express do offer cards, and so compete with banks.  

These networks don’t deal directly with the merchants that accept credit cards. That role is taken by the payment processors, which provide the point-of-sale terminals and other services like bookkeeping to vendors. Merchants bridle at having to pay these fees, but the alternative – not accepting credit and debit cards – is clearly a far worse option. Consumers vastly prefer the convenience of card payments to carrying around cash. A vendor who does not accept card payments could be leaving a small fortune on the table. 

This payment infrastructure has to be paid for. The primary way that is done is through a series of fees often called interchange fees. These are fees generally paid by the merchant to the banks, although the consumer ultimately pays for them as the costs are generally passed on from the merchant. When interchange fees on debit cards were capped after the Dodd-Frank Act passed, prices did not generally fall. 

Interchange fees are the subject of significant lobbying. On the debit card side, the Federal reserve has proposed lowering the cap on interchange fees for those transactions, meaning that networks will have to either make up lost revenue on higher fees on credit or sacrifice spending on features like security. 

In addition, the Credit Card Competition Act, introduced by Democratic Sen. Dick Durbin (who authored the cap on debit card fees) and Republican Sen. Roger Marshall, would force banks to offer merchants the choice of two or more networks, only one of which may be Visa or Mastercard. These newer competitors do not have the capability to compete on security with Visa or Mastercard, and so compete on price. It will be no surprise which sort of network merchants are more likely to pick. The result will be lower costs for merchants, especially the larger ones, and increased security risk for consumers. 

A Federal Reserve study in 2022 found that this aspect of credit cards – the transaction function – is barely, if at all profitable for card issuers. It is therefore odd that it should be the subject of so much regulatory pressure. 

Fees charged directly to consumers are currently under increased regulatory scrutiny as well. The Consumer Financial Protection Bureau has recently signaled a willingness to prosecute starter credit card companies that it says bait or trap consumers into signing up for high fee cards, for instance. Late fees are also under attack as part of the administration’s general crack down on what it calls “junk fees.” 

Yet late fees are a major motivator to make people pay their bills on time, ensuring steady revenue streams that make credit possible. Without them, more people will pay their bills late. These fees also represent only about 15 percent of cards’ profitability, according to the Federal Reserve. 

Read more at The Daily Economy