Wednesday, May 20, 2009

What's in the (Credit) Cards?

There is a flurry of stories in the media this morning regarding a bill passed by the U.S. Senate yesterday regarding credit card reform. It is reported that the House of Representatives will now take up the bill, and if passed it could be on President Obama's desk by next week. The Wall Street Journal, The Washington Post and The New York Times all have major stories (and all free content at this writing), many of them with very good graphics and even some video that outline the major changes.

Many of the changes highlighted in the stories run along the line of what's good about the proposed legislation, i.e. what will benefit consumers. And there is a lot in the Senate bill that stands to benefit consumers. (The final bill will have some changes, so it's worth following the progress.) Issues like interest rate restrictions, how payments are to be handled, grace periods, fine print, and credit cards for minors are part of the bill. Many, if not all of these, are covered in some of the graphics in the story. The graphics alone are worth taking a look at.

The downside of these proposed changes is a bit more complex and the explanations are not easily explained by graphic presentation, evidently. But as we know from studying economics, there's the TANSTAAFL principle. (There Ain't No Such Thing As A Free Lunch.) The consequences range from the intended - the cost of credit being shifted to people who pay their balance in full - to the unintended - less credit available for people with poor credit. Some of these discussions have been fleshed out more on a number of blogs such as this one and this one, both at The Wall Street Journal.

However, I would recommend a book that, while not talking exclusively about credit cards, does explain our fascination with credit and the evolution of credit availability from a privilege (only those who can afford it get it) to a right (everyone is entitled to access to credit). It's title is Money of the Mind and it's by James Grant. The book is 15 years old and, as a consequence, only takes us up through the 1980s. However, the pattern of bringing more and more credit to more and more people provides some insight into what happened through the 1990s and into this decade, and the resulting consequences.

As to what all this means for your students, while the bill has not taken its final shape, the intent is for it to go into effect early next year. One of the things you can do now is discuss the ramifications of the legislation along these lines:

1. What will be the impact on size of the credit market - how many people will be eligible to get credit cards - based on some of the proposed changes?
2. If demand (the number of customers) changes, what happens to the price of credit?
3. If banks cannot cover risk or make a profit at a given price, what can they do to the supply of credit to change the price?
4. If people (consumers) get less (fewer benefits) and are charged more, are they likely to change their spending patterns?
5. Given that using credit is usually a choice, what incentives to use or not use are created by the changes?
6. Do these changes create externalities (costs or benefits that accrue to parties outside the transaction) that will complicate the pricing of the service?

Given the current state of the economy, and the circumstances that helped to bring it about, I find the method and the timing on credit card reform interesting. In some ways it is predictable, and maybe even overdue. In others, it would seem to be counterproductive.

Please share your thoughts or encourage your students to share theirs.

This post relates to the following Keystone Economic Principles:
1. We all make choices.
2. There ain’t no such thing as a free lunch.
3. All choices have consequences.
4. Economic systems influence choices.
7. Economic thinking is marginal thinking.
9. Prices are determined by the market forces of supply and demand…and are constantly changing.

1 comment:

Tim Schilling said...

A former colleague at the Federal Reserve Bank of Cleveland sends this link

to a story by a NY Times economics reporter and his personal credit story. It's lengthy, but it's interesting.