When Plastic Nickels and Dimes
One of the particularly exasperating characteristics of the current financial crisis is that the institutions responsible for the crisis are on kamikaze missions: as they go down, they exact maximum damage on their customers and on the economy at large before crashing and burning. This is, in part, simply due to organizational decision making: an organization's leadership will attempt to keep a firm afloat as long as possible, no matter the larger social and economic costs.
Credit card companies are currently on such a destructive mission. Credit card defaults, long feared as the financial crisis's second coming (after housing defaults), are at their highest level in 20 years with so-called "charge offs" - the amount a credit card company believes it will never be repaid - rising significantly in recent months to 8.7% at American Express and 9.33% at Citigroup. As a consequence, credit card companies are squeezing their remaining customers dry. As James Surowiecki pointed out in last week's New Yorker:
[C]redit-card companies have had to rein in their lending and shed accounts . Since that risks shrinking profits, they're also trying to get as much as they can out of their existing customers, by doing things like sharply increasing their interest rates.
Apologists call these increased interest rates "risk-based pricing", which they claim allows credit card companies to keep credit widely available. But Adam Levitin at CreditSlips undermines this claim, made recently by Meredith Whitney in the Wall Street Journal:
Just as an insurer cannot decide premiums after the coverage event occurs, so too can a lender not decide what interest rates apply after the borrowing. Pricing after a risk materializes isn't risk-based pricing. It's rent extraction.
The larger story involved with consumer-adverse lending practices is laid out in an interesting article by Thomas Geoghegan in next month's Harper's ("At interest rates of 25 percent, or 50 percent, or 500 percent, lenders don't really want the loan to be repaid - they want us to be irresponsible, or at least to have a certain amount of bad character."). But the particular pain being exacted on individual consumers and on small business owners (are you listening, John Boehner?) by increased interest rates at a particularly bad economic time for American households is the simple and all-too-familiar story of failed regulation.
Just over a year ago, Rep. Carolyn Maloney introduced legislation - the Credit Cardholders' Bill of Rights - to prohibit credit card companies from instituting these very interest rate increases on outstanding card balances. The House passed the legislation last September, but it died in the Senate. At the same time, the Federal Reserve has drafted its own rules to regulate credit card lending which, to the Fed's credit, include a provision mirroring that of the Cardholders' Bill of Rights. The problem is that the Fed's prohibition on retroactive interest rate hikes does not take effect until July of 2010.
As the economy continues to sour and unemployment rises, credit defaults will only worsen and credit card companies will extract even higher interest rates and more fees from vulnerable households and small businesses. The lack of regulation not only eased us into this financial crisis, but is exacerbating the pain it inflicts on us.