Horace Cooper

For some Americans credit cards are a remarkably useful financial tool which improves their lives and those of their families. For others they are the equivalent of handing a bottle of bourbon to an alcoholic.

Whether the law makes one assumption over the other is the difference between control and liberty. Particularly during an economic downturn, all Americans should be sensitive to the temptation to trade liberty for control. Why? Because during economic hardships those who prey upon our fears find it is easier to persuade us to accept greater government control over our lives in exchange for the security they offer.

In an ideal world credit card companies would loan money for nearly no interest and allow an unlimited time to pay it back. Of course in that ideal world the card would be issued by “Grandma Express.” Curiously, in the real world credit card issuers are depicted as mafia dons looking for any and all excuses to break our legs and arms if and when we violate our credit card agreements. The truth is that credit cards issuers are neither doting grandparents nor crime bosses. They are businesses run for a profit.

But in the wake of President Obama’s recent meeting with the major credit card executives it appears that he and Democrats in Congress see now as the time to strike against the credit card industry while the iron is hot; and it’s up to us to decide if the loss of our liberty in the process is a fair trade.

Consider: during an economic downturn even otherwise responsible credit card users may choose to supplement their household needs with greater card use. While taking on more debt seems counter-productive during a downturn, for these people this choice is a rational and superior way to bridge a temporary job loss or income reduction when juxtaposed against selling their house or forcing their children to quit college. But if the credit card rules being considered in Washington go into effect this choice could be taken away.

In the name of ending credit card company abuses, the Obama Administration is pushing a proposal that would cap over-limit fees, ban interest charges on fees, prevent fees for on-line or phone payments, bar almost all interest rate hikes as well place new limits on borrowers under the age of 21 among other changes; all designed to help American credit card borrowers. While each proposal may seem innocuous on its face, these changes if enacted will have negative consequences that will outweigh their benefits and primarily result in greater government control and more loss of individual liberty for credit card holders.

Candidly, not every use of a credit card use is prudent and neither is every use profligate. And most Americans instinctively know the difference between charging on a whim a three day weekend in Vegas and swiping the credit card for a new muffler. One of the main benefits of the credit cards is that every individual card holder is able to make the decision for themselves when and where to use the credit.

This freedom by every card holder to decide when and where they will make a purchase comes with significant risks for the credit card issuers. Instead of having a banking manager approve each and every financial decision prior to extending credit as was the case by and large for most of the 20th century, the credit card holder himself makes the decision. As a result it is crucial that credit card issuers have the ability to continuously evaluate credit card holders both before issuing a credit card and also afterwards (during the time the card is active).

Additionally unlike loans for autos or even houses, credit card issuers have little to no way to secure their risks, they can’t simply come and repossess the items that are purchased on the cards. As a result they use a variety of techniques – not simply relying on credit scoring organizations like Experian – but also employment trends, geography, consumer purchasing habits etc. as a basis for determining the levels of risk and thus the related interest and fee charges associated with that risk.

Notably, credit card issuers don’t simply offer cards to the rich and elites. Today they have programs for almost every risk group high and low. While a small percentage of Americans are familiar with the so-called American Express Black Card (with its nearly unlimited credit line which opens a door to private jets and a lifestyle of unparalleled luxury) far more are familiar with a basic Visa or Master Card with the one or two thousand dollar credit line and the derided 18% interest rate.

But if the so called credit card reform proposals are enacted into law, the impact on credit card users will be felt across the board. Recently laid off and other recession impacted people (and even those who live next to them) will be adversely impacted as credit card companies will be rightly concerned that there is too much risk and no return for doing business with this group. These marginally risky customers might have to choose between the secured credit route and simply being shut out of the credit card market altogether. And even relatively good credit risks will see changes. For them it will be harder to get a credit line increase. They’ll likely see the end of short term teaser rates below 5% because of the need for cross-subsidization (which means keeping rates across all risk lines higher to offset the mounting losses from credit card abusers who default).

And all credit card holders will see other changes. Because credit card holders can’t balance risks with income from fees and rate hikes, it will be more important than ever on the front end to determine risk more precisely. This harder and more intensive evaluation process (creating the digital equivalent of the bank manager) will also be more costly for issuers and users and result in fewer new accounts being issued and requiring more mandatory and higher annual fees. Even new accounts that pass the first threshold will see lower credit lines and will likely be issued for shorter lengths – instead of 2 or 4 year long authorized activity periods for a given credit card, cards might be issued for as few as 6 weeks at a time.

What about the abusers? For them this policy is a windfall. That abuser purchasing that must have Battlestar Galactica action figure will see several positives: they’ll likely find their credit lines lowered every couple of months and as a result they’ll soon climb out of debt as they can’t keep piling up more charges – something they’d never do voluntarily, and more significantly no matter how many times they are late with their payments neither their interest rate nor their credit card fees can ever increase. Finally they will no longer have to worry about getting additional cards to run up debt with because their applications will be declined as a result of the more stringent application process. But even these “benefits” come at a high cost for everyone else.

Hate them or love them, credit cards are a valuable commodity in the American economy and over-regulation of this industry will hurt far more Americans than they will help. As light follows day, these restrictions will lead to reductions overall to credit access. Many marginally creditworthy users will find their credit access denied and even responsible credit users who diligently pay their bills and fulfill all of their obligations will see higher costs for credit card use. And doing so during the downturn will prove even more painful for all credit card holders as they find a valuable financial tool increasingly unavailable.


Horace Cooper

Horace Cooper is a legal commentator and a Senior Fellow with the Institute for Liberty.