Do consumers really want credit card reform?

Federal Reserve Bank of Kansas City - Economic Review,  Third Quarter 1999  by Combs, Kathryn L,  Schreft, Stacey L

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Implications for consumer

The bottom line from this analysis is that a cap on GE fees is likely to hurt, rather than benefit, consumers. At a minimum, convenience users are worse off because of adjustments to price terms and product features or because of credit rationing. And all consumers can be harmed if interchange rates are raised and passed on in higher product prices.

VI. THE 1980 EXPERIENCE

The United States has one recent experience with binding interest rate ceilings on credit card accounts. This case vividly illustrates that pricing restrictions can indeed lead to rationing and to adjustments in the unrestricted components of effective price (Schreft). In fact, U.S. consumers have that experience to thank for the annual fees they pay today.

As discussed in section I, in early 1980 market interest rates soared, bumping against state usury ceilings that capped interest rates on consumer credit. This subjected most card issuers to a binding limit on their APR. As a result, their cost of funds exceeded what they could earn on credit card loans, making card lending a losing proposition.

At the first opportunity, card issuers changed card fees and account terms. A congressional survey of 59 card issuers offering 96 distinct charge cards found that the most common response was for issuers to impose an annual fee on their cards. Annual fees were imposed on 49 percent of the cards surveyed. Issuers also rationed credit by not accepting new card applications on 42 percent of cards and by raising credit standards on 41 percent of cards.

Issuers sought to offset the interest rate ceiling more directly by changing the terms of accounts to increase the amount of interest owed on outstanding balances. On 41 percent of cards, the finance charge was calculated differently. On 35 percent of cards, the APR was increased; those increases occurred when and where feasible. And on 23 percent of cards, the minimum monthly payment was raised. For example, Exxon announced that it would include in the minimum monthly payment all single purchases under $40. Since the cost of the typical tank of gas was well under $40 in 1980, this change would force most cardholders to pay their bills in full each month. Issuers applied these changes retroactively to outstanding balances on 86 percent of cards, although federal law required that customers be allowed to pay their outstanding balances before the changes took effect. The 1980 experience thus confirms the prediction that issuers, when faced with restrictions on one component of effective price, will adjust other components and possibly ration, reducing the likelihood that the restriction will be beneficial.

VII. DO CONSUMERS BENEFIT FROM CREDIT CARD REFORM MEASURES?

Many efforts at credit card reform have aimed to benefit consumers by restricting issuers' pricing practices. But as this article has shown, it is not at all clear that such efforts can achieve their objective. Consumers as a whole are unambiguously better off only under very unusual circumstances-circumstances that do not prevail in today's card industry. More likely, pricing restrictions at best have no effect because issuers get around them by making adjustments in the unrestricted effective-price components. At worst, such restrictions lower the effective price to consumers, but credit rationing occurs, keeping at least some consumers from getting the credit they want. Such an outcome is likely-and was observed in the United States in 1980, when binding restrictions on card interest rates were experienced.