[Senate Hearing 111-48]
[From the U.S. Government Publishing Office]
S. Hrg. 111-48
MODERNIZING CONSUMER PROTECTION IN THE FINANCIAL REGULATORY SYSTEM:
STRENGTHENING CREDIT CARD PROTECTIONS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
ON
REFORMING THE PRACTICES OF CREDIT CARD COMPANIES AND PROVIDING NEW
PROTECTIONS FOR CONSUMERS
__________
FEBRUARY 12, 2009
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html
U.S. GOVERNMENT PRINTING OFFICE
50-815 WASHINGTON : 2009
-----------------------------------------------------------------------
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512�091800
Fax: (202) 512�092104 Mail: Stop IDCC, Washington, DC 20402�090001
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York JIM BUNNING, Kentucky
EVAN BAYH, Indiana MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey MEL MARTINEZ, Florida
DANIEL K. AKAKA, Hawaii BOB CORKER, Tennessee
SHERROD BROWN, Ohio JIM DeMINT, South Carolina
JON TESTER, Montana DAVID VITTER, Louisiana
HERB KOHL, Wisconsin MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia KAY BAILEY HUTCHISON, Texas
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado
Colin McGinnis, Acting Staff Director
William D. Duhnke, Republican Staff Director
Amy Friend, Chief Counsel
Lynsey Graham Rea, Counsel
Drew Colbert, Legislative Assistant
Deborah Katz, OCC Detailee
Julie Chon, International Economic Adviser
Mark Oesterle, Republican Chief Counsel
Andrew Olmem, Republican Counsel
Dawn Ratliff, Chief Clerk
Devin Hartley, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
----------
THURSDAY, FEBRUARY 12, 2009
Page
Opening statement of Senator Dodd................................ 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 4
Senator Brown................................................ 5
Senator Akaka................................................ 6
Senator Menendez............................................. 7
Senator Schumer.............................................. 7
Senator Reed................................................. 9
Senator Tester............................................... 9
WITNESSES
Adam J. Levitin, Associate Professor of Law, Georgetown
University Law Center.......................................... 10
Prepared statement........................................... 44
Response to written questions of Senator Shelby.............. 215
Kenneth J. Clayton, Senior Vice President and General Counsel,
Card Policy Council, American Bankers Association.............. 12
Prepared statement........................................... 72
Response to written questions of Senator Shelby.............. 221
James C. Sturdevant, Principal, The Sturdevant Law Firm.......... 13
Prepared statement........................................... 96
Response to written questions of Senator Shelby.............. 224
Todd J. Zywicki, Professor of Law, Mercatus Center Senior
Scholar, George Mason University School of Law................. 15
Prepared statement........................................... 115
Response to written questions of Senator Shelby.............. 226
Lawrence M. Ausubel, Professor of Economics, University of
Maryland,
Department of Economics........................................ 18
Prepared statement........................................... 154
Response to written questions of Senator Shelby.............. 230
Travis B. Plunkett, Legislative Director, Consumer Federation of
America........................................................ 19
Prepared statement........................................... 170
Response to written questions of Senator Shelby.............. 232
(iii)
MODERNIZING CONSUMER PROTECTION IN THE FINANCIAL REGULATORY SYSTEM:
STRENGTHENING CREDIT CARD PROTECTIONS
----------
THURSDAY, FEBRUARY 12, 2009
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:10 a.m., in room 538, Dirksen
Senate Office Building, Senator Christopher J. Dodd (Chairman
of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Chairman Dodd. The Committee will come to order. My
apologies to our witnesses and my colleagues. Today is the
200th anniversary of Abraham Lincoln's birthday and I took my
daughter up to Lincoln's cottage this morning up at the Old
Soldier's Home where there was a ceremony this morning to
unveil a wonderful statue of Abraham Lincoln and his horse Old
Boy that he used to ride every morning for about a quarter of
his Presidency from the White House to the Old Soldiers Home
where he lived for a quarter of that Presidency and he wrote
the Emancipation Proclamation. So I thought I would take my
daughter out of school this morning for a bit of history and I
am sorry to be a few minutes late getting back here this
morning, so apologies to everybody for being a few minutes late
for enjoying a moment of history with a 7-year-old.
Well, let me begin with some opening comments, if I can. I
will turn to Senator Shelby. We are honored to have such a
distinguished panel of witnesses with us this morning on an
issue that many of my colleagues know has been a source of
interest of mine for literally two decades, the issue of reform
of the credit card industry. And so this hearing this morning
will give us a chance to reengage in that debate and
discussion, and I want my colleagues to know at some point, and
I say this to my good friend, the former Chairman of the
Committee, at some point, I would like to be able to mark up a
bill in this area. I know he knows that, but I wanted to say so
publicly.
So good morning to everyone, and today the Committee meets
to look into an issue of vital importance to American
consumers, their families, and to the stability of our
financial system, and that is the need to reform the practices
of our nation's credit card companies and to provide some tough
new protections for consumers.
In my travels around my State, as I am sure it is true of
my colleagues, as well, we frequently hear from constituents
about the burden of abusive credit card practices. In fact, the
average amount of household credit card debt in my State is
over $7,100. Actually, the number is higher, I think,
nationally. Non-business bankruptcy filings in the State are
increasing. In the second quarter of last year, credit card
delinquencies increased in seven of eight counties in my State.
Across the country, cardholders are paying $12 billion in
penalty fees annually, every year. It is a major problem
throughout our nation. At a time when our economy is in crisis
and consumers are struggling financially, credit card companies
in too many cases are gouging, hiking interest rates on
consumers who pay on time and consistently meet the terms of
their credit card agreements. They impose penalty interest
rates, some as high as 32 percent, and many contain clauses
allowing them to change the terms of the agreement, including
the interest rate, at any time, for any reason. These practices
can leave mountains of debt for families and financial ruin in
far too many cases.
When I introduced Secretary Geithner earlier this week as
he unveiled the framework of the President's plan to stabilize
our financial system, I noted then for too long, our leading
regulators had failed fully to realize that financial health
and security of the consumers is inextricably linked to the
success of the American economy. In fact, for too many years, I
think people assumed that consumer protection and economic
growth were antithetical to each other. Quite the opposite is
true.
I noted that unless we apply the same urgent focus to
helping consumers that we apply to supporting our banks'
efforts to restart lending, we will not be able to break the
negative cycle of rising foreclosures and declining credit that
is damaging our economy.
In this hearing, the Committee examines abusive credit card
practices that harm consumers and explores some very specific
legislative ideas to end them. These kinds of consumer
protections must be at the forefront of our efforts to
modernize our financial regulatory system.
Why is this both important and urgent? Well, today, far too
many American families are forced to rely on short-term, high-
interest credit card debt to finance their most basic
necessities. And as layoffs continue, home values plunge, and
home equity lines of credit are cut or canceled, they are
increasingly falling behind. This December, the number of
credit card payments that were late by 60 days or more went up
16.2 percent from last year.
Banks increasingly worried about taking more debt, bad
debt, into their balance sheets are monitoring their credit
card portfolios very closely, slashing credit lines and
increasing fees and interest rates even more for consumers who
have held up their end of the bargain. That puts consumers,
including many of my constituents and others around the
country, in the worst possible position at the worst possible
time.
For too long, the use of confusing, misleading, and
predatory practices have been standard operating procedures for
many in the credit card industry. The list of troubling
practices that credit card companies are engaged in is lengthy
and it is disturbing: Predatory rates, fees, and charges;
anytime, any reason interest rate increases and account
charges; retroactive interest rate increases; deceptive
marketing to young people; shortening the period consumers have
to pay their bills with no warning. Even the Federal financial
regulators, of whom I have been openly critical for a lack of
appropriate oversight throughout this subprime mortgage market
crisis, recognize the harm these sinister practices pose not
only to credit card customers, but also to our economy.
Last May, the Federal Reserve, the Office of Thrift
Supervision, and the National Credit Union Administration
proposed rules aimed at curbing some of these practices. These
rules were a good step and I applaud them, but they are long
overdue. But they fell far short of what is actually needed, in
my view, to protect American families.
Just as we have seen in this housing crisis, when companies
lure people into financial arrangements that are deceptive,
abusive, and predatory, it only means mountains of debt for
families, bankruptcy, and financial ruin for far too many. It
also proved catastrophic, of course, for our economy.
Today as the Committee examines how best to modernize and
reform our outdated and ineffective financial regulatory
system, we have a clear message to send to the industry. Your
days of bilking American families at the expense of our economy
are over. Today, we will discuss proposals to reform abusive
credit card practices that drag so many American families
deeper and deeper and deeper into debt, including the Credit
Card Accountability, Responsibility, and Disclosure Act, which
I recently reintroduced.
We must protect the rights of financially responsible
credit card users so that if a credit card company delayed
crediting your payment, you aren't charged for this mistake. We
must prevent issuers from changing the terms of a credit card
contract before the term is up. And perhaps most importantly,
we must protect our young people who are faced with an
onslaught of credit card offers, often years before they turn
18, or as soon as they set foot onto a college campus. These
practices are wrong and they are unfair. And mark my words, in
the coming months, they are going to end.
Of course, we must do all we can to encourage consumers to
also act responsibly when it comes to using credit cards. But
we should demand such responsible behavior when it comes to the
companies that issue these cards, as well.
The need to reform credit card practice has never been more
important. It is not only the right thing to do for families
and our consumers, it is the right thing to do for our economy,
as well. I have been working on reforms in this area for many,
many years and I am determined to move forward on these
reforms.
With that, let me turn to our former Chairman and Ranking
Member, Richard Shelby.
STATEMENT OF SENATOR SHELBY
Senator Shelby. Thank you, Chairman Dodd.
Although problems with mortgage-related assets have taken
center stage in our ongoing financial crisis, credit card
lending has also rapidly declined as our economy has
deteriorated. The securitization market, a key vehicle for
financing credit card transactions, remains severely
constrained, at its best. The absence of a robust secondary
market has deprived many financial institutions of the
financing needed to support credit card-based lending. Unable
to securitize their credit card portfolios, many banks have
been forced to cut back their customers' credit limits or even
terminate their customers' credit cards altogether.
In the midst of these challenging market conditions, the
Federal Reserve, along with the Office of Thrift Supervision
and the National Credit Union Administration, finalized new
rules last December that will drastically alter the credit card
industry. The rules prohibit a variety of business practices
and impose a new layer of complex regulation. They also update
and enhance certain consumer protections.
The new rules will be implemented over the next year and a
half, but already, financial institutions are drastically
altering their credit card practices, as they should. Recent
reports suggest that the new rules will cause a substantial
contraction in consumer credit.
While I believe that there are many credit card practices
that need reforming, as Senator Dodd mentioned, I also believe
that regulators need to be especially careful in this time of
financial stress not to take actions that unduly restrict the
availability of credit. Limiting the ability of consumers of
low and moderate means to obtain credit could have unfortunate
consequences. If they can't get credit from regulated banks,
they may seek it outside the banking system. Regulators must
exercise caution to ensure that the appropriate balance is
struck between adequately safeguarding consumers, which is
important to all of us, while not eliminating access to credit
for millions of American families.
Regulators also need to make sure that they do not stifle
innovation or unduly restrict consumer choice. Many innovative
products that have been demanded by and have benefited
consumers, including zero percent financing, may be eliminated
or severely curtailed because of the recent regulatory rule
changes.
We can all agree that abusive products should be addressed,
and soon, but we should also be careful not to eliminate
legitimate products in doing that. An overly broad approach
risks giving consumers a false sense of security. Too often,
consumers fail to consider whether a particular financial
product is right for them because they believe that Federal
regulators have already determined which products are safe and
which are dangerous. Yet in many cases, whether a financial
product is appropriate for a consumer depends on the consumer's
own financial position. If the financial crisis has taught us
anything, it is that all sectors of our economy, from big
commercial banks to retail consumers, need to do more due
diligence before they enter into financial transactions. No
regulator can protect a consumer as much as they can protect
themselves if they have the necessary information, which is why
clear, complete, and understandable disclosure, as Senator Dodd
has pushed for years, is so critical.
Several bills have been introduced that seek to codify the
recent rule changes, and in several instances would go beyond
those rules to enact even more severe regulations. I believe
before we legislate in this area, I think we should be careful.
I would prefer that we give regulators the necessary time to
implement the rule changes and then we can evaluate how those
rules have worked and what changes are needed.
In this time of economic turmoil, we need to proceed
carefully, but we do need to proceed. We need to be especially
careful not to undermine the ability of our financial system to
accurately price risk. The advent of risk-based pricing has
helped our financial institutions expand the availability of
credit. Undermining the ability of banks to employ risk-based
pricing could reverse this very positive development.
As this Committee begins to consider regulatory reform, I
believe it is important to keep in mind the need to balance
carefully our strong desire to protect consumers and the
absolute necessity of preserving an innovative and diverse
marketplace. These are not mutually exclusive concepts and it
is our job--our obligation--to craft a regulatory structure
that can accommodate them both, and I hope we will.
Senator Johnson.
[Presiding.] The Chairman has stepped out momentarily to
confer with Secretary Geithner and Mr. Summers. Does anyone
want to comment briefly before we get to the panelists? Senator
Reed?
Senator Reed. I will pass, Mr. Chairman, and defer to my
colleagues if they would like to speak.
Senator Johnson. Anybody?
STATEMENT OF SENATOR BROWN
Senator Brown. Mr. Chairman, I would like to make a couple
of comments. Thank you, Mr. Chairman, Senator Johnson.
I think a lot of us--I appreciate the comments both of
Senator Shelby and the Chairman. A lot of us are particularly
concerned about credit card targeting of young people. Go to
any college campus across this country, in my State, Ohio
State, the largest university in the country, you will see that
college students are inundated with credit card applications.
Ohio State's own Web site counsels students to, quote, ``avoid
credit card debt while you are a college student.'' We know
what kind of debt students face anyway and I think that just
paints the picture of how serious this is.
There are other examples of what has happened with small
business and it is so important. I just underscore how
important this issue is and that we move forward on more
consumer protections.
I yield my time back.
Senator Johnson. Senator Akaka, you have a comment to make?
STATEMENT OF SENATOR AKAKA
Senator Akaka. Yes. Thank you very much. I appreciate the
Chairman holding this hearing.
Too many in our country are burdened by significant credit
card debt. Not enough has been done to protect consumers and
ensure they are able to properly manage their credit burden. We
must do more to educate, protect, and empower consumers.
Three Congresses ago, or the 108th Congress, I advocated
for enactment of my Credit Card Minimum Payment Warning Act. I
developed the legislation with Senators at that time, Senators
Sarbanes, Durbin, Schumer, and Leahy. We attempted to attach
the bill as an amendment to improve the flawed minimum payment
warning in the Bankruptcy Abuse Prevention and Consumer
Protection Act. Unfortunately, our amendment was defeated.
My legislation, which I will be reintroducing shortly,
requires companies to inform consumers how many years and
months it will take to repay their entire balance if they make
only minimum payments. The total cost of interest and principal
if the consumer pays only the minimum payment would also have
to be disclosed. These provisions will make individuals much
more aware of the true costs of credit card debt.
The bill also requires that credit card companies provide
useful information so that people can develop strategies to
free themselves of credit card debt. Consumers would have to be
provided with the amount they need to pay to eliminate their
outstanding balance within 36 months.
My legislation also addresses the related issue of credit
counseling. We must ensure that people who seek help in dealing
with complex financial issues, such as debt management, are
able to locate the assistance they need. Credit card billing
statements should include contact information for reputable
credit counseling services. More working families are trying to
survive financially and meet their financial obligations. They
often seek out help from credit counselors to better manage
their debt burdens. It is extremely troubling that unscrupulous
credit counselors exploit for their own personal profit
individuals who are trying to locate the assistance they need.
My legislation establishes quality standards for credit
counseling agencies and ensures that consumers would be
referred to trustworthy credit counselors. As financial
pressures increase for working families, credit counseling
becomes even more important. As we work to reform the
regulatory structure of financial services, it is essential
that we establish credit counseling standards and increase
regulatory oversight over this industry.
Mr. Chairman, I appreciate your inclusion of this in your
bill, of a provision that mirrors the minimum payment warning
provisions in my bill. Thank you very much, Mr. Chairman.
Senator Johnson. Thank you, Senator Akaka.
Senator Menendez, do you have a very brief statement to
make?
STATEMENT OF SENATOR MENENDEZ
Senator Menendez. I will make a brief statement. I don't
know about very brief, Mr. Chairman. I will make a brief
statement.
Senator Schumer. Moderately brief.
[Laughter.]
Senator Menendez. Moderately brief. Let me thank the
Chairman for holding this hearing. Credit card reform has been
one of the top priorities that I have had both in the House and
in the Senate since I arrived here, and I think this hearing
couldn't come at a more important time, when millions of
Americans are increasingly using their credit cards to float
their basic necessities from month to month. As a result,
Americans have almost $1 trillion of credit card debt
outstanding. It seems to me that it is a dangerous cycle that
is piling up.
And while that debt is piling up, people in our State and
across the country are discovering that their credit card
agreements often conceal all kinds of trap doors behind a layer
of fine print. If you take one false step, then your credit
rating plummets and your interest rate shoots through the roof.
Many of my constituents have contacted me after facing sky-
high interest rates they never expected after accepting one
offer, only to learn later that the terms seem to have been
written in erasable ink, or after watching in horror as their
children in college get swallowed in debt.
So for far too many people, credit card is already a
personal financial crisis and I believe it is a national
crisis. Our economy will not recover if debt ties down
consumers tighter and tighter, and making credit card lending
practices fairer would be the right thing to do under any
circumstances, but under these economic conditions, it is an
absolute necessity.
Mr. Chairman, I have legislation, as well. Some of it has
been incorporated in what I think Chairman Dodd is going to
include. I appreciate those efforts and I hope that the Federal
Reserve's guidelines, which are a good step, could actually be
accelerated, because waiting a year and a half to get those
guidelines into place at a critical time in our economy is only
buying us more and more challenges.
With that, Mr. Chairman, I ask that the rest of my
statement be included in the record.
Senator Johnson. Senator Schumer, do you have a very brief
statement?
STATEMENT OF SENATOR SCHUMER
Senator Schumer. I also have a moderately brief statement,
like my colleague from across the Hudson River, but I thank you
for calling on me. It is an issue that I have been involved
with and care about for a long time.
We know how important this is. Average credit card debt for
the average--the average American family has $8,500 in credit
card debt on a yearly income of $52,000. That ought to make you
stop and think right then and there.
I have been working on this issue for a long time. When I
started in the 1980s, there were two schools. Some said
disclosure is enough and competition would take hold. Others
said, let us put limits. I was in the former school. I said,
free market, let disclosure work. I worked long and hard on
legislation and the Fed and the result was something that
became known as the ``Schumer Box,'' clear, concise disclosures
of important credit card terms in an easy-to-read table, and it
worked.
Before the Schumer Box, credit card interest rates were at
19.8 percent. Every company somehow came up with the conclusion
that was the exact right rate. There was no competition. The
box came in and rates came down. Good old fashioned American
competition did the job. So it worked. Disclosures at that
point seemed to be a good balance between consumer protection
and fostering business and innovation.
But now, credit card companies have become so clever at
inducing consumers to buy and use cards and trapping them with
high interest rates and fees that I believe disclosure is no
longer enough. Over the past few years, we have seen explosion
of debt. The card industry began using many of the same sales
tactics as mortgage brokers, below-market fees or interest
rates that shoot up for the most minor of infractions, and fine
print, as Senator Menendez mentioned, containing dozens of fees
that a consumer has to pay.
Now, recently, the Federal Reserve updated the Schumer Box.
I was glad to see that. But more has to be done. Consumers are
trapped in a business model that is designed to induce mistakes
and jack up fees. That sums it up. And then the fees go from 7
percent to 19 percent for some minor infraction on all the
debt, something is very wrong and disclosure is not enough.
The type of trip-wire pricing is predatory. It has to end.
One issuer went so far as to provide its customers with
incorrectly addressed return envelopes to ensure that consumer
payments wouldn't arrive on time and allowed the company then
to charge late payment fees. That is outrageous. Other
companies charge fees so often, so many fees so often,
borrowers end up paying over the limit fees because their
credit has been maxed out by the previous round of fees, a
vicious treadmill cycle.
So as I said, the Fed has made a good step, but the rule,
which doesn't go into effect until July 2010, that is too far
from now. Too many families are struggling to make their
minimum payment. And while the Fed's intentions are now good,
we cannot be too shortsighted. There is going to come another
time when credit will be loose and issuers will seek to roll
back some of the important protections the Fed has implemented.
That is why we must legislate.
I have introduced the bill on the Senate side along with my
friend, Senator Udall, that Congresswoman Maloney, my
colleague, has introduced and successfully passed on the House
side. And I know that Senator Dodd is considering many of the
points in that legislation, as many of my other colleagues'
legislation, when he puts together a bill, and I hope we will
move one quickly, Mr. Chairman.
Senator Johnson. Does anyone else feel absolutely compelled
to make a comment?
Senator Reed. Can I make a very, very, very brief comment?
Senator Johnson. Senator Reed.
STATEMENT OF SENATOR REED
Senator Reed. I think what my colleagues have said is that
despite the first step by the Federal Reserve, we have to be
very, very sensitive to the capacity and willingness of the
Federal Reserve to actually protect consumers when it comes to
credit cards, and I think that issue has to be before our panel
and I am glad the Chairman has brought the issue to us and to
this panel of witnesses.
Thank you, Mr. Chairman.
Senator Johnson. Senator Tester?
STATEMENT OF SENATOR TESTER
Senator Tester. I will be brief, Mr. Chairman.
In the good old days, you used to take a loan and you used
to pay it back. Under the current scheme that goes on with
credit card companies, you take out a loan and then they start
attaching fees and increasing interest rates, and by the time
you get done, you are paying it back, but none of it is going
to the principal.
There are a lot of issues out here. My friend, Senator
Brown, talked about how the college kids are being roped into
this kind of thing. I just think it puts everybody in a bad
boat. I think the Federal Reserve did take a first step, but it
was only a first step. I look forward to working on this bill.
Senator Johnson. Anyone else? If not, I am pleased to
welcome Mr. Adam Levitin to the Committee. Mr. Levitin is an
Associate Professor at Georgetown University's Law Center
specializing in bankruptcy and commercial law. Before joining
the Georgetown faculty, Professor Levitin was in private
practice at Weil, Gotshal and Manges, LLP, in New York and
served as a law clerk at the United States Credit Appeals for
the Third Circuit.
Our next witness will be Mr. Ken Clayton. Mr. Clayton has
been with the American Bankers Association since 1990 and is
currently the Senior Vice President and General Counsel of the
ABA Card Policy Council, the group responsible for recommending
policy within the ABA on all card-related issues. Mr. Clayton,
we welcome you to the Committee.
Mr. Jim Sturdevant is founder and partner of the Sturdevant
Law Firm in California and is an experienced litigator who has
represented consumers in a number of significant consumer
justice cases. In addition to his active litigation practice,
Mr. Sturdevant is the Past President of the Consumer Attorneys
of California and a member of the Board of Directors of the
National Association of Consumer Advocates. We welcome you to
the Committee.
We welcome Professor Todd Zywicki. Professor Zywicki
teaches at the George Mason University School of Law in the
area of bankruptcy and contracts. From 2003 to 2004, Professor
Zywicki served as Director of the Office of Policy and Planning
at the FTC.
Next will be Professor Lawrence Ausubel. Mr. Ausubel is a
Professor of Economics at the University of Maryland and he has
written extensively on the credit card market and other aspects
of financial markets. Professor Ausubel, we welcome you to the
Committee.
Last will be Mr. Travis Plunkett. Mr. Plunkett is the
Legislative Director of the Consumer Federation of America, a
nonprofit association of 300 organizations. He is a regular
witness in this Committee and we welcome him back.
I welcome you all to the Committee and look forward to your
testimony.
Mr. Levitin, why don't we proceed with you.
STATEMENT OF ADAM J. LEVITIN, ASSOCIATE PROFESSOR OF LAW,
GEORGETOWN UNIVERSITY LAW CENTER
Mr. Levitin. Good morning, Mr. Chairman, Ranking Member
Shelby, and members of the Committee. I am pleased to testify
today in support of the Chairman's Credit Card Accountability,
Responsibility, and Disclosure Act and other legislation that
would create a more efficient and fair credit card market and
would encourage greater consumer responsibility in the use of
credit.
Credit cards are an important financial product. They offer
many benefits and conveniences to consumers. But credit cards
are also much more complicated than any other consumer
financial product, and unnecessarily so. Auto loans, student
loans, closed-end bank loans, and all but the most exotic
mortgages are relatively simple. They have one or two price
terms that are fixed or vary according to an index. Not so with
credit cards. Credit cards have annual fees, merchant fees,
teaser interest rates, purchase interest rates, balance
transfer interest rates, cash advance interest rates, overdraft
advance interest rates, default or penalty interest rates, late
fees, over-limit fees, balance transfer fees, cash advance
fees, international transaction fees, telephone payment fees,
and probably several other fees of which I am unaware.
In addition to these explicit price points, there are also
numerous hidden fees in the form of credit card billing
practices. The card industry has been ingenious in creating
tricks and traps to squeeze extra revenue out of unsuspecting
consumers. These billing tricks cost American families over $12
billion a year.
Credit card billing tricks make cards appear to be much
cheaper than they actually are, and that leads consumers to use
cards too much and to use the wrong cards. By disguising the
cost of using cards through billing practices, card issuers are
able to maintain uncompetitively high interest rates and to
generate greater use of cards. That produces additional revenue
from interchange fees for the issuers as well as over-limit
fees, late fees, and penalty fee revenue.
The complexity of credit card pricing makes it impossible
for consumers to accurately gauge the price of any particular
credit card, and unless consumers can gauge the cost of using a
card, they cannot use it efficiently and responsibly. Markets
cannot function without transparent pricing because demand is a
function of price. The lack of transparency in credit card
pricing has resulted in inefficient and irresponsible use of
credit, and that has resulted in dangerously over-leveraged
consumers, who are paying too much for what should be a
commodity product with razor-thin profit margins rather than
one with a return on assets that is several multiples of other
banking activities.
Consumer over-leverage is a factor that should concern all
of us, especially today. There is nearly a trillion dollars of
credit card debt outstanding. The average carded household owed
almost $11,000 in credit card debt last year. That is a drop in
the bucket compared with household mortgage debt, but even the
most exorbitant subprime mortgage rate is rarely over 10
percent annually, whereas the effective APR on many credit
cards--the effective APR--can easily be five times as high. And
the harm to families is palpable. A single repricing due to a
billing trick can cost a family between an eighth and a quarter
of its discretionary income.
These levels of credit card debt are not sustainable.
Dollar for dollar, a consumer with credit card debt is more
likely to file for bankruptcy than a consumer with any other
type of debt. And to the extent that consumers are servicing
high-interest-rate credit card debt, that is money they cannot
use to purchase new goods and services from merchants. The
money siphoned off by credit card billing practices does not
create value. It cannot be spent in the real economy.
The card industry's arguments that Congress should not
interfere with their finely calibrated risk-based pricing are
malarkey. Only a very small component of credit card pricing
reflects risk. Almost all credit card pricing is a function of
the cost of funds, the cost of operations, and the ability-to-
opportunity price, not the function of risk.
Moreover, to the extent that credit card prices reflect a
risk premium, it is a pool-based premium. It is not an
individualized risk premium. The card industry is not capable
of pricing for risk on an individual basis. The technology is
not there. This means that there is inevitably subsidization of
riskier consumers by more creditworthy ones.
Nor is there any evidence that connects the so-called risk-
based pricing to lower costs of credit for creditworthy
consumers. While it is true that base interest rates have
fallen, that is almost entirely a function of the lower cost of
funds, and the decline in base interest rates has been offset
by increases in other credit card prices. According to the GAO,
for 1990 to 2005, late fees have risen an average of 160
percent, and over-limit fees have risen an average of 115
percent.
Since the 1990s, credit card pricing has been a game of
three-card monte. Pricing has been shifted away from the up-
front, attention grabbing price points, like annual fees and
base interest rates, and shifted to back-end fees that
consumers are likely to ignore or underestimate.
The card industry's risk-based pricing story simply doesn't
hold up on the evidence and is not a reason to refrain from
much-needed regulation of unfair and abusive credit card
billing and pricing practices that have had a deleterious
impact on the economy and society. Legislation like the Credit
Card Accountability, Responsibility, and Disclosure Act is a
crucial step in restoring transparency and fairness to the
credit card market and to letting American consumers
responsibly enjoy the benefits of credit cards. Thank you.
Senator Johnson. Thank you, Mr. Levitin.
The panel should know that we will limit your remarks to 5
minutes in order to have a proper question and answer period.
Mr. Clayton?
STATEMENT OF KENNETH J. CLAYTON, SENIOR VICE PRESIDENT AND
GENERAL COUNSEL, CARD POLICY COUNCIL, AMERICAN BANKERS
ASSOCIATION
Mr. Clayton. Thank you, Senator, members of the Committee.
My name is Kenneth J. Clayton, Senior Vice President and
General Counsel of the ABA Card Policy Council. I appreciate
the opportunity to testify today.
Credit cards are responsible for more than $2.5 trillion in
transactions a year and are accepted in more than 24 million
locations worldwide. It is mind boggling to consider the
systems needed to handle 10,000 card transactions every second
around the world. It is an enormous, complicated, and expensive
structure, all dedicated to delivering the efficient, safe, and
easy payment vehicle we have all come to enjoy.
As the credit card market has evolved to provide greater
benefits and broader access, it has become more complex. As a
result, legitimate concerns have been raised about the adequacy
of disclosures and other regulations. In response to these
concerns, the Federal Reserve and two other regulators released
comprehensive rules that fundamentally change the protections
offered to cardholders. In many respects, these rules reflect
the input from those on this Committee and others. They have
heard you.
Federal Reserve Chairman Ben Bernanke noted that the new
rules were, and I quote, ``the most comprehensive and sweeping
reforms ever adopted by the Board for credit card accounts.''
These changes have forced the complete reworking of the credit
card industry's internal operations, pricing models, and
funding mechanisms.
As this Committee considers new restrictions on credit
cards, it is important to understand the sweeping nature of the
Fed's rule and the extent to which it has already addressed the
core concerns of cardholders. The rule essentially eliminates
many controversial card practices. For example, it eliminates
the repricing of existing balances, including the use of
universal default. It eliminates changes to interest rates for
new balances for the first year that the card is in existence.
It eliminates double-cycle billing. It eliminates payment
allocation methods perceived to disadvantage customers. And it
eliminates high up-front fees on subprime cards that confuse
consumers over the amount of credit actually available.
The rule likewise ensures that customers will have adequate
time to pay their bills and adequate notice of any interest
rate increase on future balances so they can act appropriately.
Perhaps most importantly, the rule provides significant
enhancements to credit card billing statements, applications,
solicitations, and disclosures that ensure that consumers will
have the information they want in a manner they will understand
and in a format they will notice so they can take informed
actions in their best interests.
These new rules will have even broader implications for
consumers, card issuers, and the general economy. The rules
affect every aspect of the credit card business, from how cards
are funded to how they are priced to how they are marketed and
to how credit is allocated among customers with different
credit histories and risk.
For example, because of the limitations on the repricing of
risk, the rules will reduce credit availability and increase
the price of credit. The rule will also impact the ability of
card lenders to fund consumer loans in the secondary market as
pricing restrictions coupled with increased delinquencies in
this recession make investors very wary of buying asset-backed
securities backed by card receivables. These securities fund
about half of all card loans, to the tune of $450 billion. This
can have enormous implications for the U.S. economy going
forward and it is why the Fed and Treasury are currently
working hard to unlock this market.
Finally, the rules will impose enormous operational
challenges for card issuers. Card lenders must completely
overhaul internal processes, software, billing, product lines,
advertising, customer service, and a host of other internal
workings. Risk management models must be completely revised.
The Fed understood the enormity of this challenge and
stressed that adequate time to implement it is critical to
avoid significant harm to consumers, and I want to stress that
last point about the harm to consumers because there is a real
concern that moving the date up on some of these rules will
actually end up harming the consumers more than it benefits
them.
In closing, we would urge that any discussion over further
legislation in this area be viewed in the context of the recent
Federal Reserve rule, recognizing its sweeping nature,
protection to consumers, impact on operations, and most
importantly, its potential impact on our broader economy and
the provision of credit to consumers and small businesses.
Thank you. I would be happy to answer any questions you
have.
Chairman Dodd.
[Presiding.] Thank you very much. I appreciate your
testimony and your presence here.
Did you introduce all the witnesses?
Senator Johnson. Yes.
Chairman Dodd. You did? Well, then Mr. Sturdevant, we
welcome you, as well.
Mr. Sturdevant. Thank you, Mr. Chairman.
Chairman Dodd. I read your testimony last evening, as I
read all of yours, and it is very, very helpful.
STATEMENT OF JAMES C. STURDEVANT, PRINCIPAL, THE STURDEVANT LAW
FIRM
Mr. Sturdevant. Thank you very much, Mr. Chairman. I am
pleased to be here. I was here 2 years ago, in January of 2007,
when you last convened a hearing on this subject. By way of
background and simply to address the Federal Reserve's efforts
in this regard, it began a quest in 2007, as well, with
Solicitor comments. They finally came up with a set of rules
late last year, but those rules won't take effect until 2010,
which is why we need legislation this year and why I strongly
support your legislation, Mr. Chairman.
By way of background----
Chairman Dodd. Who is the next witness here?
[Laughter.]
Mr. Sturdevant. By way of background and to put the fees
that have been identified both in numbers and names and amounts
into some perspective, I tried two cases, one in the late 1980s
and one in the early 1990s, one against Wells Fargo Bank and
another against First Interstate Bank, which now no longer
exists, and the issues in the case were whether or not $5 late
fees and $10 over-limit fees were excessive damage amounts for
a simple breach of contract by the customer. We proved to a
jury in the Wells Fargo case and to an experienced judge in the
First Interstate case that $5 exceeded the damages resulting
from breach of contract for late payments and that $10 was $9
too much for someone who exceeded the authorized credit limit.
As the Committee knows, beginning in 1996 with the U.S.
Supreme Court's decision in the Smiley case, which allowed
credit card companies to export anything they could charge in
the home State where the credit card company was based, they
could export interest rates and then, according to the
Comptroller of the Currency, interest rates included late
payment fees, advance fees, over-limit fees, membership fees,
quick-look fees, whatever, all of these penalty fees then went
from $10 or $15 to the present average level of $39. If they
couldn't justify $5 or $10 in the late 1980s or early 1990s,
they couldn't come close to justifying anything approximating
$39 today.
I was also co-lead counsel in a nationwide case against
Providian Bank in the late 1990s and early years of this
century. Providian's challenges were practiced from A to Z. Its
entire credit card operation was abusive, predatory, and
designed to lure low-income customers into situations where
instead of a regular loan, they weren't paying off any of the
principal. They were simply paying penalty fees, higher
interest fees, balance transfer fees, et cetera. In order to
stay in business, the Comptroller of the Currency required
Providian to pay $300 million. The company was sued in private
litigation and also by the City and County of San Francisco.
And while Senator Schumer was here, he remarked on two of
the then-shocking practices of Providian. One was to do a
nationwide search to see where to locate its credit processing
office, and they found that New Hampshire was the place where,
on average, it took the longest amount of time for a letter to
be mailed from any point in the country. But still, that wasn't
enough to trigger enough late fee revenue at $39 a payment.
They then issued bar code payment envelopes that would never
reach the payment processing center in New Hampshire and were
investigated on three separate occasions by the United States
Postal Service for that. One can only imagine what would have
appeared at trial had we not settled the case several years
ago.
And finally, two cases, Badie v. Bank of America, which I
tried in the mid-1990s and won on appeal, and Ting v. AT&T
challenged the attempts by Bank of America, on the one hand,
and AT&T to impose mandatory pre-dispute arbitration clauses on
their customers. In the Bank of America case, it was an attempt
through a bill stuffer sent with statements which are multi-
page documents and other marketing materials to alert its
customers that it was replacing the civil justice system with a
private system of arbitration.
And then in the Ting case, we challenged AT&T's attempt to
impose not only mandatory arbitration, but several different
unconscionable provisions, as well, unconscionable under
California law because they prohibited class-wide adjudication,
they imposed a secrecy gap on the consumer, they limited
remedies otherwise available in litigation.
The latest abuse, revealed last week by Chase, was to send
out a bill stuffer which required many of its customers to
increase the minimum payment from the standard in the industry,
which had been 2 percent of the balance, to 5 percent. For low-
income people, an increase of 250 percent per month is more
than significant and absolutely almost universally triggers
default. For people at higher-income brackets, making a payment
that usually was $99 a month and then trying to pay $250 a
month is difficult in these financial times, as well.
Chase also thought it appropriate to impose a $10
administrative fee because I think the industry had simply run
out of names for the fees that it charges. I have included in
my written testimony a list of the fees that Professor Levitin
mentioned.
Mr. Chairman, I support your bill. I support provisions of
the bill introduced a year ago by Senators Levin and McCaskill.
I support Congressman Maloney's bill. Consumers in this country
need legislation and they need a combination of enforcement by
Federal officials, by State officials, and by private
litigation, where necessary, to enforce the prohibitions that I
hope this Congress will enact and President Obama will sign.
In closing, let me say this. Professor Elizabeth Warren
from Harvard, who chairs the TARP Committee, has written a
paper and advocated something akin to the Consumer Product
Safety Commission for financial services, which I know you are
aware of and hopefully other members. This will elevate for
education purposes to consumers and to students, who Senators
Brown and Tester talked about, the serious traps for the unwary
that the credit card industry in its current form presents.
Thank you for inviting me to testify. I would be happy to
answer any questions.
Chairman Dodd. Well, I thank you very, very much. The
complexity of it all for consumers is not accidental, in my
view.
Mr. Zywicki, thank you.
STATEMENT OF TODD J. ZYWICKI, PROFESSOR OF LAW, MERCATUS CENTER
SENIOR SCHOLAR, GEORGE MASON UNIVERSITY SCHOOL OF LAW
Mr. Zywicki. Mr. Chairman and members of the Committee, it
is a pleasure to appear before you today. Let me make clear at
the outset, I have no relationship with the credit card
industry. I fight with them just like everybody else does. I
disagree with them, just like any other company from which I
buy goods and services, and you may find this hard to believe,
but sometimes I even disagree with my elected representatives
on various issues.
And I am really quite ruthless and not the slightest bit
sentimental about leaving one card and switching to another if
a better deal comes along. I don't care whether the industry
makes a lot of money or a little bit of money. What I care
about is maximizing consumer choice and maximizing competition
in a manner that will be consumer welfare-enhancing, and I fear
there are many provisions in this legislation that may have
unintended consequences that will lead to higher interest rates
for consumers, will stifle market and regulatory innovation,
and will restrict consumer access to credit at a particularly
inopportune time.
Unlike almost any other good or service, credit card
issuers are forced to compete for my loyalty every time I pull
out my wallet to make a payment. I have got four credit cards.
I decide at any given time which one is the best one for me to
use, whether I am buying gasoline or shopping online. In such a
competitive environment, credit card issuers face relentless
competition to retain my loyalty, and as I said, I am not the
slightest bit sentimental about switching if a better deal
comes along.
Federal Reserve surveys indicate that 90 percent of credit
card owners report that they are very or somewhat satisfied
with their credit cards, versus 5 percent who are somewhat
dissatisfied and only 1 percent, that is one out of 100, who
say that they are very dissatisfied with their credit cards.
Moreover, two-thirds of respondents in a Federal Reserve survey
also reported that credit card companies usually provide enough
information to enable them to use credit cards wisely, and 73
percent stated that the option to revolve balances on their
credit cards made it easier to manage their finances, versus 10
percent who said this made it more difficult. So let us not
throw out the baby with the bath water.
Nonetheless, the myriad uses of credit cards and the
increasing heterogeneity of credit card owners has spawned
increasingly complexity in credit card terms and concerns about
confusion that may reduce consumer welfare. Nonetheless, we
should not sacrifice just for the sake of making credit card
simpler some of the benefits that we have generated from credit
cards. Consider some of the more troubling provisions in the
legislation to my mind.
First, there are some provisions that will likely lead to
higher interest rates and other costs for consumers. For
instance, and many of these are in the Federal Reserve rules
but I still am troubled by them, and to the extent that they
are phased in rather than posed immediately, I believe that
will be better for consumers. First, for instance, it prohibits
the application of any rate increases on an outstanding balance
on credit cards, often called retroactive rate increases. The
way credit cards operate is they are revolving credit. They are
month-to-month loans. That means at any given time, I can
cancel my card and go to a lower interest rate card. To the
extent that issuers are unable to raise the interest rate when
situations change but I am allowed to switch to a lower
interest rate when situations change, the end result of that is
that issuers are going to be less likely to offer lower
interest rates on the front end. If I can lower my interest
rate but it can't be raised if circumstances change, they are
going to be less likely to offer lower rate interest cards.
Second, the provision that has to do with application on
outstanding balances suffers from the same sort of problem.
Second, I am concerned that some of the things in this
legislation will stifle innovation. For instance, the provision
that requires an ongoing payoff, a timing disclosure that
includes, for instance, a statement to the consumers how long
it would take to pay off the card balance by only making the
minimum payment. This would go on every billing statement.
According to research by Federal Reserve economist Thomas
Durkin, this provision would be of interest to approximately 4
percent of credit card users, being those who intend to pay off
their balance by making the minimum payment and intend to stop
using the card.
It is an open question whether or not it is worth mandating
a brand new disclosure for 4 percent of consumers, much less
one that would be conspicuously disclosed. Why is that a
problem? Because the more things that you require to be
disclosed and the bigger you require it to be disclosed, the
more distracting and more difficult it becomes for consumers to
find out what they actually want.
More fundamentally, I think this illustrates a one-size-
fits-all strategy to consumer protection that is not accurate
in the context of credit cards. The reason why credit cards are
so complicated today is because consumer use of credit cards is
so multi-faceted. Consumer cards offer an endless array of
terms that respond to the endless array of demands of different
consumers. Some consumers never revolve. Some consumers revolve
sometimes. Some consumers revolve all the time. I never
revolve. I have no idea what my credit card interest rate is. I
don't care. I don't shop for a card on those terms. I care
about what my annual fee is and what my benefits are.
To the extent that we mandate certain disclosures, it makes
it more difficult for consumers to shop on the terms that they
actually want, and the empirical evidence on this is clear.
Consumers do shop on the terms that they want. Those who
revolve, unlike me, do know what their interest rate is, by and
large, and they shop very aggressively on that. The best
evidence we have is that those who revolve balances actually
have a lower interest rate on their credit card than those like
me who don't pay interest and so don't shop on that particular
term.
To the extent, then, that we also place limits on penalty
fees and that sort of thing, we are going to reduce risk-based
pricing by requiring interest rate raises for everybody else.
The final thing I would like to close on is the concern
that this might reduce credit access. We know what has happened
during this past year as credit card access has dried up and
credit limits have declined. Reports indicate that middle-
class--some people have been forced to go without things they
wanted. Other reports indicate that those who are unable to get
credit cards have been, for instance, forced to turn to layaway
plans. They brought back layaway this fall because people
couldn't get credit cards. Other people have had to turn to
payday lenders. Other middle-class people have turned to pawn
shops.
To the extent that the impact of this law is to reduce
access to credit, it will harm those who we intend to help, and
in particular, I would urge caution, although it is obvious
college students often misuse credit cards, I would urge
caution at this particular time at doing things that might
limit access to credit for college students. We know that the
student loan markets are not performing very well right now
either, and we know that a lot of college students drop out
when they can't get access to credit. So it may be that on net,
some of those are appropriate, so let us not be overzealous in
a way that might lead to reduced access to credit.
Thank you.
Chairman Dodd. Thank you very much.
Dr. Ausubel.
STATEMENT OF LAWRENCE M. AUSUBEL, PROFESSOR OF ECONOMICS,
UNIVERSITY OF MARYLAND
Mr. Ausubel. Good morning, Chairman Dodd, Ranking Member
Shelby, and members of the Committee, and thank you for
inviting me here. My name is Lawrence Ausubel. I am a professor
of economics at the University of Maryland and the author of
perhaps the most cited article on credit cards in the scholarly
literature.
Penalty interest rates or risk-based pricing, this is the
question of the day. Consumer advocates assert that when the
typical issuer raises the credit card interest rate by 12 to 15
percent following a late payment, this is penalty pricing
intended to take revenues from their most vulnerable customers.
However, industry representatives respond that consumers who
miss payments are the most likely to eventually default and all
they are doing is requiring the riskiest consumers to shoulder
their true cost.
My testimony will seek to address which characterization is
more accurate. The consumer view would justify legislation,
such as the Dodd bill, while the industry view would suggest
that such rules are misplaced.
Unfortunately, the data necessary to answer this question
are typically confidential and out of reach. However, in 2008,
Morrison and Foerster issued a data study on behalf of lenders
which tracks various delinquency events such as going 16 to 30
days past due or going three or more days past due on two
separate occasions, and it reports the percentage of consumers
who ultimately default. Using their reported numbers, one can
perform simple back-of-the-envelope calculations that answer
the question of the day.
The data enable me to reach the conclusion that the
increases in interest rates bear no reasonable relation to
default risk, i.e., these are penalty interest rates that
demand regulation. Here is a simple calculation. Accounts that
were 16 to 30 days past due in May 2006 experienced higher
defaults than accounts that were current. Twenty-point-seven
percent of these balances went into default, as defined by the
study, over the following 22 months as compared to 9.3 percent
for accounts that were current.
Converting these percentages into annual rates of net
credit losses gives an increased economic loss per year of 4.5
percent. However, the standard repricing in the marketplace is
a 12 percent to 15 percent increase. Let me repeat that.
Economic loss of 4.5 percent versus standard repricing of 12 to
15 percent. This is three times greater. By any standard, this
is penalty pricing, not risk-based pricing.
Moreover, this calculation is overly generous to the
industry in several respects. For example, the data study omits
late fees, typically $39, which are imposed above and beyond
the interest rate increases. Further, to be more than fair, I
selected 16 to 30 days late as my selection criterion. Using a
trigger of just two to 5 days late, as some banks do, one can
get the economic loss down below 2.5 percent per year. And
again, the standard increase is 12 to 15 percent.
At the end of the day, the economic conclusion is
inescapable that these are penalties based not on cost, but on
demand factors, and observe that the demand of consumers facing
penalty rates is rather inelastic. They are often borrowed up,
distressed, and have diminished alternative borrowing
opportunities.
I should also emphasize that a retroactive penalty rate
increase for distressed consumers is precisely the opposite
policy prescription that we apply in other areas of lending.
For example, there is a growing consensus today that in the
mortgage area, loan modification, i.e., reductions as opposed
to penalties, are needed.
To summarize, economic analysis of recent data supports
stricter regulation of the credit card industry, particularly
with respect to penalty interest rates imposed on existing
balances. The Fed has taken some action in this area, but
regrettably, the regulations are weak and the effective date is
not until July 1, 2010. The current economic crisis makes it
all the more urgent that Congress adopt the Dodd bill sooner.
So to close, Chairman Dodd, I support the bill you
introduced yesterday.
Chairman Dodd. Thank you very much, Doctor. I appreciate
that very much.
Travis Plunkett has been before the Committee on numerous
occasions with the Consumer Federation of America. We thank you
for being here.
STATEMENT OF TRAVIS B. PLUNKETT, LEGISLATIVE DIRECTOR, CONSUMER
FEDERATION OF AMERICA
Mr. Plunkett. Thank you, Chairman Dodd, members of the
Committee. I am Travis Plunkett, the Legislative Director at
the Consumer Federation of America. I am testifying today on
behalf of CFA and five other national consumer organizations. I
appreciate the opportunity to offer our analysis of the very
serious national consequences that unfair and deceptive credit
card practices are having on many families in this recession as
well as what this Committee can do to stop these traps and
tricks. American families cannot become the engine of economic
recovery if they are burdened by high credit card debt that can
further escalate at a creditor's whim.
I would like to summarize five points that I will leave
with the Committee and then come back at the end of my
testimony and provide a little detail on each point.
First, the number of families in trouble with their credit
card loans is approaching historic highs, as Senator Dodd said.
Based on loss trends the card issuers are reporting, 2009 could
be one of the worst years on record for credit card consumers.
Second point, credit card issuers share a great deal of
responsibility for putting so many Americans in such a
vulnerable financial position through their reckless extension
of credit over a number of years and use of abusive and
unjustified pricing practices, which seem to be accelerating at
this time when consumers can least afford it.
Third, the need for quick action to end abusive lending
practices is more urgent than ever now because taxpayers are
propping up major credit card issuers through several
enormously expensive programs. If the government is going to
attempt to spur credit card issuers to offer more credit, it
must ensure that the loans they are offering now are fair and
sustainable.
Fourth, the recent credit card rule finalized by the
Federal regulators is a good first step in curbing abusive
practices. It does have significant gaps, though, and as we
have heard, it doesn't take effect until July of 2010.
Fifth, Senator Dodd's comprehensive Credit Card Act fills
in many of these gaps, as do a number of other legislative
proposals that have been offered by members of this Committee.
It will make the credit card marketplace fairer, more
competitive, and more transparent.
So let us talk a little detail here. On loss trends,
Senator Dodd went through some of the most worrisome factors.
One thing to watch is something industry insiders look at a
lot. It is called the payoff rate. This is the amount of money
that credit card consumers pay on their credit card bill every
month and it has just dropped at the end of last year
precipitously for credit cards. It is now at one of the lowest
levels ever reported, showing that cardholders are having a
harder time affording their bills and that the amount of money
they can pay every month is dropping.
Charge-offs and delinquencies--charge-offs is the amount of
money proportionate to how much is loaned that credit card
issuers write off as uncollectible--it is looking like they may
approach the highest levels ever by the end of this year, and
they are already quite high and have shot up very fast.
Personal bankruptcy is up by about a third.
On the responsibility that issuers have for this problem,
just so you don't think this is last year's news or old news,
let me just cite a few recent problems with some of the pricing
practices you have heard about. They involve issuers adding new
fees, increasing the amount of fees that they are charging,
using harmful rather than responsible methods to lower credit
lines, and a number of other abusive practices.
Citigroup last fall back-pedaled on its promise to note
increase interest rates any-time for any-reason, and then
increased interest rates on a large part of their portfolio.
Chase, as we have heard, has suddenly started charging people
$120 a year for their accounts. These are cardholders who were
promised a fixed rate for the life of their balance. Bank of
America has used a variety of questionable methods for
cardholders who appear to have done nothing wrong to violate
their agreement, citing risk-based pricing and not providing
clear information to these cardholders about the problem.
Capital One and a number of other issuers over the last year,
year and a half, have used very vague clauses in the cardholder
agreements that allow them to increase interest rates for large
parts of their portfolio for so-called market conditions.
Let me be clear. Issuers do have the right to try and limit
their losses in a recession, but these kinds of arbitrary and
unjustified practices for cardholders who thought they were
playing by the rules are very, very harmful.
On the need for quick action because of government support,
a couple of days ago, Treasury Secretary Geithner announced the
expansion of a program that is supposed to provide taxpayer
dollars to support securitization of credit card loans. They
want more credit card lending. We have urged the Secretary to
establish minimum fair practices standards for credit cards now
so that our tax money isn't supporting unfair loans.
On the Federal Reserve and regulator credit card rule,
several positive aspects that we have heard about to the rule
related to double-cycle billing, restrictions on increasing
interest rates on existing balances, payment allocation. There
are gaps, though. Fees are not addressed at all. Credit
extension is not addressed at all. Bringing down rates if
cardholders say they have a problem, then they pay on time for,
say, 6 months, not addressed. And as we have heard, it doesn't
take effect for a long time.
The Credit Card Act and a number of other bills introduced
in the Senate address many of these gaps. No any-time, any-
reason repricing. That is the excuse Chase used. Limiting
unjustified penalty fees by requiring that fees be reasonably
related to the cost issuers incur, a very important part of the
Credit Card Act. Limiting aggressive marketing and
irresponsible lending to young consumers and lowering rates if
consumers perform well after a problem occurs.
Let me just close by saying that we have heard a lot about
fears that fair regulation of the credit card market will lead
to less credit, will lead to people who need it not having
access to credit, especially lower-income or minority
consumers. I always get a little worried because this context,
or the context for this discussion is to ignore what has
happened through essentially self-regulation of the market. I
mean, where are we now? Issuers have been able to write their
own rules for a very long time and they are cutting back on
credit, especially to more vulnerable borrowers, especially to
lower-income and minority borrowers. Plus, we have to deal with
the kind of uncompetitive, not transparent marketplace we have
heard about.
So it sounds like the worst of all possible worlds to me,
and that is why we support Senator Dodd's bill and fair
regulation of the marketplace.
Chairman Dodd. Thank you very much, and I appreciate your
comments, and all of you here this morning for your counsel on
this issue, which is, again, a complex one and one that
deserves our attention.
I want to also make two points. One is credit cards are a
tremendously valuable and worthwhile tool for consumers. I
think it is very important. This is not a Committee, or at
least an individual here that is hostile to the notion of
credit cards at all. Quite the contrary.
Second, I respect immensely that Ben Bernanke and the
Federal Reserve moved on the issue of regulation, and while
there are gaps and problems I have with what they have done, he
is the first Chairman of the Fed that has actually moved in
this area, despite the issue having been raised for a long
time, and I certainly want to reflect my appreciation for the
steps they have taken. I am disappointed that you have got to
wait until July of 2010 for them to become effective, but
nonetheless I want the record to reflect it.
I was very impressed, Mr. Levitin, with this study and I
highly recommend to my colleagues. It is lengthy in some ways.
It is a number of pages long, some 20 pages long, this analysis
of the credit card industry and how it works. But one thing
that struck me at the outset of the report is something I think
we kind of blow through, and that is the credit instruments
that we use as Americans are tremendously valuable--the home
mortgage, the car loan, the student loan. And the point that
you make, or that this report makes is, of course, the pricing
points, and I think it is a very worthwhile point to make.
In almost every one of these other transactions, pricing
points are rather clear. They are one or two or three, maybe
four, but you have a pretty clear idea. You know with almost
certainty what your mortgage is going to be, what your car
payments are going to be, what your other payments are
regardless if you take credit.
When you get into this area, it is exactly the opposite,
and I was stunned at the pricing points and why, in terms of
taking on this responsibility, knowing what your
responsibilities are going to be, you are faced with the
following, just on pricing points, an astounding array of
points--annual fees, merchant fees, teaser interest rates, base
interest rates, balance transfer interest rates, cash advance
interest rates, overdraft interest rates, default interest
rates, late fees, over-limit fees, balance transfer fees, cash
advance fees, international transaction fees, telephone payment
fees. These are all the pricing points in credit card
negotiations.
To expect a consumer to appreciate and absorb that many
pricing points when you are trying to determine whether or not
taking on that financial responsibility--now, again, we are not
going to eliminate all of these, but the idea that a consumer
is able to juggle and understand that many different pricing
points when you are making a determination as to whether or not
you ought to engage in a service or a product purchase.
I was stunned, as well, on the issues of bankruptcy and the
like in terms of driving these costs up and the complexity of
dealing with it.
Again, I draw my colleagues' attention to this report. I
think it is extremely useful. It gets into the issue of the
risk-based pricing issue, as well, that Dr. Ausubel referenced,
but I think it is an important point, as well.
It is an industry that started out making its money on
interest rates, and that was where the money was made. It has
transferred itself from interest rates to fees, and that is the
$12 billion increase in fees that have occurred that have added
so much cost and confusion.
Mr. Clayton, thank you for being here. One of the issues
that is obviously of concern to many of us is the universal
default. I think most people understand it, but the idea that
if you are current on your credit card responsibilities, but if
you are late on an electrical bill or a phone bill or the like,
that we have seen examples where the issuers will then raise
fees or rates as a result of your late payments on unrelated
responsibilities, financial responsibilities.
Now, it is true that, in a sense, the new rule to some
degree eliminates the universal default. But under the rule, as
well, and having conversations with the Fed about this, issuers
can still look to off-comp behavior to increase interest rates.
And so while it talks about banning it on one hand, it still
tolerates the issue of actually accounting for off-balance
behavior to increase rates that consumers pay. I would still
call that universal default. If, in fact, the issuer can raise
rates by considering these late payments in unrelated matters
to the credit card, then it still seems to me that universal
default exists. How do you respond to that?
Mr. Clayton. Well, Senator, I know there has always been
this discussion about how universal default is defined and I
understand respect the fact that people take different
perspectives. But it is our understanding that the Fed permits
the changing of interest rates on existing balances under four
conditions and four conditions alone.
The first condition is if it is a promotional rate card,
essentially, and it is disclosed ahead of time and that
promotional rate expires.
The second one is if it is a variable rate card tied to
some kind of index.
The third one is if there is a delinquency in excess of 30
days.
And the fourth one is if it is a violation of a work-out
agreement.
I am unaware of any other circumstance where, when this
rule becomes effective, that institutions can consider off-
account information in determining the interest rate on that
existing balance.
Chairman Dodd. Mr. Sturdevant, do you have any comment on
this, or any of you who are familiar with it?
Mr. Sturdevant. I am concerned about the Federal Reserve's
rule, particularly in light of your comments, not simply today,
but 2 years ago about this very issue, and in terms of consumer
expectations under agreements that now exceed 30 pages in
length about what they are getting when they get a credit card.
I mean, I think Senator Tester is right, and you were right,
Mr. Chairman, on auto loans. You know what you are getting. You
know what you are paying. In the old days of banking, they
loaned the money out and they took deposits in. We don't do
that anymore.
And the problem with universal default is consumers do not
understand that if they have a problem with a utility bill or
some other relationship, that the interest rate is going to
skyrocket, that the penalty fees are going to be imposed. That
is what universal default does. It is a complete trap for the
unwary and it needs to be prohibited, not regulated.
Mr. Plunkett. Senator, to answer your question, universal
default would be allowed prospectively. The Federal Reserve
rule deals with increases on existing balances.
Chairman Dodd. But not going forward?
Mr. Plunkett. But not going forward. So they could decide
that they didn't like my library fines or my utility payment
and increase my--you know, send me a notice saying that going
forward, as long as they met other requirements of the law----
Chairman Dodd. Despite the fact that you are absolutely
current. What I am suggesting, if you are late and various
things, under reasonable rules, having fees and penalties and
so forth. We are not talking about that. We are assuming that
that consumer is absolutely current in their payments on their
credit card responsibility, and then still because they are
late on some other charges, that then justifies increasing the
rates on that consumer going forward.
Mr. Plunkett. Our reading of the rule is that that would be
allowed going forward.
Chairman Dodd. Can you imagine the effect it would have if
you were late on your credit card and the phone company or the
electrical company decided, we are going to increase your rates
because you didn't pay your credit card on time? What would be
the reaction? Do you have a comment?
Mr. Clayton. Senator, can I jump in for a second? First of
all, card companies don't consider whether you are late on a
telephone bill or utility bill as part of what is in their
credit records.
The other thing is that consumers have absolute control
here. This is about future balances. And I would note, by the
way, that the Fed said that you cannot increase future balances
for the first year of the card. That is the first thing. Plus
they gave you notice of that effect. And it gives you the
choice of walking. If you don't like what the card company is
doing, there is a lot of competition out there and choice for
people, and that is the ultimate controlling mechanism here.
Consumers can just say no. And it is not that hard and we
need----
Chairman Dodd. Why do you have to--why all these fees and
rates and so forth? Is that really the answer to consumers? If
you don't like this, what we are loading you up with and
charging these fees, just take a walk?
Mr. Clayton. Well, but that is what you do every time when
you walk by and decide whether you are going to buy a sweater
in a store or not. But the other thing that is important to
note that gets lost in this, credit cards, while they are
loans, are fundamentally different. They are not secured. They
are completely used with incredible flexibility for consumers
at any time. You can use it 24/7 virtually anywhere in the
globe. There is a huge amount of risk in making those loans
available.
What we worry about, and we understand are sympathetic to
the concerns being raised, the Fed has acted and we will
obviously enforce that with all the strength we can. But the
point is----
Chairman Dodd. So the comments are coming then in favor of
the Fed rules?
Mr. Clayton. We didn't necessarily agree with everything
the Fed said, but it is the rule of law today and it is what we
will have to comply with going forward and we will do our best
to----
Chairman Dodd. Are you in favor of them?
Mr. Clayton. There are concerns that people have raised
about the impact it will have on availability of credit.
Chairman Dodd. My time is up. Let me turn to Senator
Corker. I have extended my time.
Senator Corker. Mr. Chairman, thank you for having the
hearing. I am going to be very brief. I have got something
starting in about 3 minutes.
But let me just, Mr. Clayton, I just recently met with a
number of folks that are in the credit card business and I got
the sense that it wasn't a particularly rosy time. Could you
give us a sense as to how the industry itself right now is
performing from the standpoint of making profits, losing money,
just generally the state of the credit card issuers' business
today?
Mr. Clayton. Sure. Credit card issuers are subject to the
same economic influences that are out there affecting everyday
consumers and every other lender in the country. Card companies
are under particular stress right now. A number of them are
losing money and have indicated in recent reports significant
losses on their card portfolios, which actually reflects the
underlying risk of this product. I mean, people talk about how
much consumers are getting in debt or can't pay it back. Well,
lenders who make loans to those people are the ones at risk
here of not getting paid. So there is a significant amount of
stress right now.
Senator Corker. Mr. Chairman, I have got two daughters that
are in college and every time we have a hearing or some
discussion about credit cards, I literally call them that day--
the credit card industry won't like this--to make sure they do
not have a credit card, OK, that they have only a debit card or
a check card. So I actually appreciate many of the fears that
people and many of the concerns that people have laid out today
regarding the credit card companies.
I have to tell you, I feel like I am semi-sophisticated--
semi--and I get incredibly confused by all these things I get
in the mail, and candidly, throw most of them in the trash. I
just don't understand. So the marketing practices, I think, are
things that need to be looked at.
So the only thing I would say is that we have this rule of
unintended consequences that continues to sort of haunt us with
actions that we take. While I think that certainly there have
been abuses in fairness, at the same time, I think we have to
be very careful. It seems that when we do things like this, in
many cases, it is the lowest-income people that end up getting
hurt the worst by our good efforts by virtue of having a lack
of availability of credit. So I hope as we move through this,
we will do this in a balanced way that does take into account
some of the concerns that have been raised and I think are very
fair. But at the same time, we understand that at the end of
the day, these businesses are going to do those things in their
self-interest, and when they do that, it may, in fact, end up
harming the very people that this legislation is intended to
help.
So thank you very much for this great hearing.
Chairman Dodd. I appreciate that very much, Senator. We
always appreciate that point. It is a worthwhile one. This is
an ongoing issue.
I just say regarding young people and unsolicited mail, I
have a 3-year-old that got a credit card the other day and they
wanted to thank her for her wonderful performance as a
consumer. She is a delightful consumer, I want you to know
that, but the idea that she warrants a credit card at the age
of three is troubling, needless to say. And the idea of having
some ability to demonstrate you can pay or some cosponsorship,
I think these are basic things that one would require. Let me
stop there.
Senator Johnson?
Senator Johnson. Mr. Plunkett, the new Fed rules prohibit
banks from increasing interest rates on credit card debt that a
consumer has already accrued, increase the amount of time
consumers have to make payments, change how a consumer's
balance is computed each billing cycle, ensure that consumer
payments go first to balances with the highest interest rates,
and crack down on credit cards with low credit limits and APs.
What other areas would you like to see improvements regarding
consumer protections for credit cards?
Mr. Plunkett. Thank you for the question, Senator. A couple
more areas we would like to see improvements. First, as we
heard, fees have been growing faster than the cost of living.
In many cases, penalty fees in particular seem to bear no
relationship to the costs incurred by issuers if somebody pays
late or goes over limit. So we like Senator Dodd's provision
that fees should be reasonably related to the costs incurred by
issuers.
We like the provisions in that bill and others related to
lending to young people. Two things there. Senator Dodd talked
about extending credit responsibly to young people or having a
cosigner with income who can pay for the loan and not offering
the loan to young people without much income.
The second issue in the bill, give young people a choice of
whether they want to accept--a real choice--whether they want
to accept credit card solicitations. So the bill has an opt in.
You don't get solicited between 18 and 21 unless you
affirmatively choose to allow it.
A third issue is bringing down rates after somebody makes a
mistake. In many cases, issuers appear to be reserving the
right to charge those rates for a long time, you know, many,
many, many months. What the Dodd bill says is after 6 months,
if you have been on time, if you haven't violated your
agreement, rates have to come back down again.
Senator Johnson. I believe the time is incorrect.
Chairman Dodd. Just keep going.
Senator Johnson. Mr. Clayton, I understand that the Fed's
rules are not effective until July 2010. We have heard from
some that this is too long and that legislation needs to be
passed now to shorten this to a few months. Why do you think
the Fed gives the industry so much time to put the rules in
place?
Mr. Clayton. Thank you, Senator. One of the things that the
staff and the regulators were careful to articulate when they
issued this rule was the immensity of what was involved in
changing what they are requiring. There are significant
operational changes in terms of everything under the sun, in
terms of how banks actually send out billing statements, how
they coordinate, how they do anything that you see in paper has
to be obviously tested, because there are significant
compliance concerns that go with this and significant penalties
for failure to get it right.
They also have to significantly rewrite how they price for
risk because the rule places significant limitations on that.
And as a practical matter, that takes time to figure out what
is acceptable to consumers as well as what is acceptable to
regulators and others.
The third point, and this is something I wanted to stress,
is the funding aspect of this. As others have noted and I have
tried to note in my testimony, the credit card industry and
consumers are essentially dependent on funding from investors.
Half of the credit card funding that is provided for credit
card loans comes out of the asset-backed securities market. It
is why, in fact, the Treasury Department and the Federal
Reserve are trying to come up with a way to unlock that market
because it is currently locked right now.
The problem is, those securities were issued with the
expectation by investors that there could be a risk-based
repricing in the process, and so it has built into the models
of those securities that people will actually pay back at
certain rates and that the institutions have the right to
change those rates in order to compensate for higher risk in
the marketplace.
If you move this date up, in addition to all the
operational headaches you run, you are going to end up changing
the nature of that calculation and reducing the ability of
credit card companies to meet the requirements of those
securities. As a result, investors start running. They get
nervous. They won't purchase it going forward, which actually
operates in direct conflict with what the Treasury and the Fed
are trying to do in unlocking this market, and it runs the risk
in the worst case scenario, and we are not saying this happens,
that some of these trusts have to be devolved. What that means
is the hundreds of billions of dollars of repurchases back off
from these receivables and you have to hold tens of billions of
dollars in capital against that. That will significantly
contract the availability of credit in the marketplace.
Senator Johnson. Mr. Ausubel, in recent months, we have
seen lenders cut back the amount of new credit that they offer
and reduce credit card lines. How has this impacted consumers?
Mr. Ausubel. Clearly, the financial crisis has led to the
reduction in credit lines and this has been adverse to
consumers. However, there is no evidence that credit card
regulation or the Dodd bill would cause any further contraction
in the availability of credit or increase the cost of credit.
This has all been presented as industry rhetoric with no hard
evidence.
The other thing just to add is people are using things--
this is always done--people are using random recent events,
like the cutback in the securitization market--I should say the
freezing of the securitization market to raise red flags here.
The reason for the securitization market's freeze is the
financial crisis and it is not a matter of concern whether
banks can impose penalty rates on consumers.
Senator Johnson. Thank you. I yield back.
Chairman Dodd. Thank you very much.
Senator Reed?
Senator Reed. Thank you, Mr. Chairman.
Following on Senator Johnson's question about this 18-month
interval, just to be clear, Mr. Clayton, is there anything in
the rules that would prevent credit card issuers from raising
interest rates and increasing fees in that 18-month period?
Mr. Clayton. No.
Senator Reed. Would there be an incentive to do so if these
fees can be maintained after 18 months?
Mr. Clayton. Not necessarily, because ultimately the card
companies have to answer to the marketplace, and if they raise
rates, there is always the opportunity for consumers to take it
to another company. So it is not-- credit card companies are
not in the business of hurting their customers. Ultimately,
they want them for the long term and long-term profit. So they
are not looking to drive people away. If there are choices in
the marketplace to provide a better deal, they know the
consumers will take it.
Senator Reed. Professor Levitin, what is the spread between
the rates here? What is this price competition that Mr. Clayton
has referred to that goes on so vigorously?
Mr. Levitin. Well, here is the problem with Mr. Clayton's
story. It is that he is saying you can just say no. If a
consumer doesn't like a prospective rate increase, the consumer
can walk away. But that is not costless. There is a lot of
lock-in with credit cards. If you want to walk away from a card
because you don't like what the issuer is doing, it is not that
simple. You have to go and find a new card. That takes some
time. There are some transaction costs there, not high, but
there are some, and you take a hit to your credit report. If
you have a line of credit that was functioning just fine and
you close it, that hurts your credit score.
Walking away is not costless, and I believe Professor
Ausubel has a study on this and I should defer to him for a
characterization of it, but if I recall, I think he estimated
the costs of switching a card being around $150 in total costs
to a consumer.
Senator Reed. Before I go to the Professor, just a response
to my initial question. There is no disincentive to raising
rates, and another particular question, there are certain
categories of fees or charges that are prohibited after the 18-
month period. If those fees or charges exist on that date for
card customers, will they stay in effect or would they have to
be conformed?
Mr. Levitin. Regarding your second question, I am not sure.
Regarding the first question, there really is no disincentive
for raising the cost because if you have a consumer who is
locked in, if you raise their rates some--I mean, consider
this. Right now, consumers can already walk away, but yet we
see Citibank going and raising interest rates. On one of my
Citi credit cards, Citi raised the rate. It went up--it was a
70-percent increase, seven-zero percent. Citi had to be
calculating that I wasn't going to walk away.
Now, that card is way above the rate that I have from other
cards, but the idea that Citi wouldn't do this, I mean, if Citi
is smart and if banks are self-interested, as Mr. Clayton says,
they wouldn't do this unless they know that I am not going to
walk away, that they know that there is a serious lock-in
effect. And that is why I don't think we are going to see that
going forward the Fed rules are going to help us much.
Senator Reed. Well, let me----
Mr. Plunkett. Senator, on your second question----
Senator Reed. Mr. Plunkett, please.
Mr. Plunkett. I think the understanding is that the rule is
prospective. So the baseline will be what issuers are doing at
the time the rule takes effect in 17 months and it will not be
retroactive in any way. It will affect behavior from that point
on.
Senator Reed. Let me ask another question. So a new
customer comes online. They would still be subjected to the
same policies and practices, just essentially grandfathered,
even though they have come online after 2010?
Mr. Plunkett. Well, going--on July 1, 2010, no matter when
the customer comes on, they will be prohibited from certain
things, like raising interest rates on existing balances if
somebody is--unless somebody is more than 30 days late.
Senator Reed. OK. But that existing interest rate is the
baseline starting in 2010?
Mr. Plunkett. Yes, sir.
Senator Reed. Professor Ausubel, Professor Levitin referred
to your study. Could you comment?
Mr. Ausubel. Sure. One thing just to say on that last point
is I do have serious concerns that issuers might exercise their
prerogative under their any-time, any-reason clauses on June
30, 2010, to raise interest rates on existing balances.
As far as what Professor Levitin referred to, it is well
established in the economics literature that consumers are
subject to what are variously called search costs and switch
costs. Search cost means the expense in time, resources of
finding a better deal. Switch cost simply means the expense in
time and resource of switching over, say, to a new card issuer.
If you actually look at consumer-level data, consumers behave
as if these search costs and switch costs are quite large.
Part of it is that it does take a while to restructure your
financial affairs and move to a cheaper lender. Another thing
that comes up is simply consumers behave as if they are, you
might say, overly optimistic. So they have a $3,000 balance
right now, but sure, I am going to pay it off in a few months
so the interest rate differential doesn't matter that much and
I don't put as much effort into it.
Senator Reed. Let me, if I may, a final question. If there
is data out there, Professor, there is a search cost, but if
the interest rate is not significantly lower, people make a
rough calculation that those search costs are too expensive,
what is the differential rate between Card A, Card B, and Card
C? Again, I ask this because I don't know. It just strikes me
as that most of these cards sort of parallel consciousness seem
to have similar rate structures, similar terms, and maybe there
is some differential, and I ask this because I don't know the
answer, not to be rhetorical.
Mr. Ausubel. I would say in terms of the basic deal, there
is a lot of similarity. I think what they are referring to is,
say, take a consumer who has triggered a penalty rate. So it
may be that they have access to credit card offers which end up
having ongoing rates of 10 percent, 12 percent, and it might be
because they were 5 days late on a repayment. Their existing
issuer is charging them 26 percent. So that is where you are
going to find the largest differentials.
Senator Reed. But if they switch, the information of their
default goes with them, or will it catch up with them?
Mr. Ausubel. Yes and no, and it looks like Travis might add
to what I say. If it is triggered by less than 30 days past
due, I believe that standard practice is that that is not
reported to credit bureaus so it might not be obvious. On the
other hand, if it is triggered by certain other things,
including universal default, they had to learn about it some
way, other issuers would learn about it the same way.
Senator Reed. Mr. Plunkett?
Mr. Plunkett. That is correct, Senator, and the obvious
point here is if there is a record on a credit report, for
example, somebody is more than 30 days late or there is another
issue with their credit report that would allow the issuer to
use universal default to reprice them, they are not going to
switch in this climate. They are not going to be able to
switch. It is going to be much harder. Issuers are being much
more cautious and their ability to change cards will be very
limited.
Senator Reed. Thank you very much. Thank you, Mr. Chairman.
I apologize for going over.
Chairman Dodd. Not at all.
Senator Bennet, Michael?
Senator Bennet. Thank you, Mr. Chairman.
I just have a couple questions about interchange fees, and
maybe for Mr. Plunkett and Mr. Clayton. The first question is,
is there a way that I, as a card user, know what interchange
fee is being charged by my credit card company or imposed on
the merchants from whom I am buying products?
Mr. Levitin. It is impossible to know that as a consumer.
The interchange fee schedules are incredibly complex. You would
have to know what category your card falls in out of several
categories. You would have to know what category a merchant
falls in under several categories. So is the merchant
considered a grocery store or is it considered a warehouse
club, or is it considered a gas station or a restaurant? Some
of these are fairly simple to figure out, some are not. Then
you would have to know within those how much business the
merchant does. So grocery stores that do over some hundred
million dollars of business have a different rate than those
that do less. And then you don't know what kind of--for a few
very large merchants like Wal-Mart, they are able to get a
sweetheart deal by basically being put in a special interchange
category. There is really no way of knowing what costs you are
imposing on the merchant.
What is important to note, though, is interchange means
that it is not free to use a credit card. If you are a pure
transactor like Professor Zywicki, there is still a cost for
using the credit card. There is no free lunch here. You go to a
merchant and you make a purchase with the card, and let us say
the interchange rate is 2 percent on that card. That is 2
percent for what we should assume is really about a 15-day
extension of credit. You make most--maybe your purchases on
average are made in the middle of the month, so you have the
extension of credit to the end of the month. On 2 percent for a
15-day extension of credit as an APR, it puts you at something
around 52 percent APR.
There is a real cost for just using a card to transact,
even if you aren't borrowing, and that is not a cost that is
apparent to consumers because it is passed on to merchants in
what is called the merchant discount fee and merchants are not
allowed by credit card network rules to pass that on to card
consumers. So people who are using credit cards, and especially
people who are using fancy, high-cost credit cards are being
subsidized by other consumers. They are being subsidized by
people who use cash, by people who pay with checks, by people
who pay with Food Stamps, and that is a really inequitable
subsidization.
Senator Bennet. I want to come back to that in a second,
and I want to give Mr. Clayton a chance to respond, but is
there a way, and anybody can answer this, but given how opaque
that is and untransparent that is, are there things we could do
to address that issue so that consumers and merchants have the
information?
Mr. Zywicki. Well, it is a more--Senator, it is a more
general issue. There are costs to every payment mechanism.
There are interchange fees for credit cards. There are check
clearing fees when you write a check that we are not aware of.
There are costs to print currency when we use money.
Senator Bennet. Let us stick with credit cards, though.
Mr. Zywicki. So we have a general sort of problem with
respect to consumers who never bear the full cost of whatever
their payment mechanism is. And so I would ask the question, if
we are going to insist on making it more transparent for credit
cards, should we also make it more transparent when you write a
check or when you use a dollar bill, the full cost that goes
into processing those transactions, and how exactly would
consumers be better off? It is not clear to me that consumers
would be better off if we forced revelation of that information
for every payment device that they use.
Senator Bennet. I don't know, maybe we should, but I think
that what I have heard from the small businesses in my State is
that this is an enormous cost of doing business. Obviously, the
convenience of having customers use credit cards is important
to them, as well. But when we are talking about the consumers
being able to make choices in a marketplace and some of the
most important information is actually obscure to them and
there is not any way in the present environment for them to
know what the true cost really is, I think that is a problem.
And so I would like to come back to how we would address it,
but Mr. Clayton, maybe you would like to respond.
Mr. Clayton. Yes, Senator. There are so many issues in
there we would be glad to have further conversations with you
when time allows for a little bit more conversation, but
essentially interchange is a cost of doing business. It is not
really any different than the cost of labor, than the cost of
turning on the lights, than the cost of paying for cash
registers and the like. And as a practical matter, if you want
to disclose all of that to consumers, you can do that. But it
is inherent to the business and it is not any different than
that.
What we are really seeing here is, and this is our
perspective, obviously, and not shared by the merchant
community, but the merchant community trying to transfer the
costs of this off of their backs and onto the consumers,
because as a frank matter, this is something that provides
enormous benefit. It provides ticket lift, which means more
purchases coming for a merchant. It provides a great deal of
security. Remember, as soon as that card is swiped through the
machine, all of a sudden, the risk of being paid back moves
from the merchant to the lender. Now, all of a sudden, the
lender is the one that takes on all that risk of borrowing and
all that risk on the debit card side and everything, whether
they will actually have money in the account to pay. So there
is a significant risk here to the lender involved.
And I want to stress something, too. This is an every-bank
issue. I mean, every community bank in America that issues a
debit card, which is nearly every one of them, uses interchange
fees to help support its ability to offer product and services
to its local communities. If you go in and snuff out the
ability to have any kind of return on this investment and to
take those risks, then you are telling them that they cannot be
competitive with the largest institutions in America. We think
that is a bad idea.
Senator Bennet. Doctor, did you have something?
Mr. Ausubel. Mr. Clayton is overstretching a bit in saying
that an interchange fee is just like, what did you say, the
cost of labor and things like that. The difference is that
there is market power to be exercised in setting the
interchange fee. The interchange fee is set by Visa, by
MasterCard, and a few other select organizations. There is
market power there which is not present in most of the other
costs facing small businesses.
Mr. Clayton. There is, by the way, a consolidated lawsuit
in New York to determine whether, in fact, market power has
been illegally exercised, and we can determine that. We would
argue that it is not the case and that there is competitive
pricing in that market, but that court will determine it.
Mr. Levitin. Also, the European Union's antitrust
enforcement body has actually said that interchange fees are
anticompetitive. That is being appealed, but we at least have a
broad several countries that have recognized the problems with
interchange fees.
I think it is important to note, though, that what
Professor Zywicki said is incorrect about interchange fees.
There is a serious difference between interchange fees on
credit cards and the cost of cash or checks or payment devices
like that. If a merchant wants to charge more for cash, that is
the merchant's prerogative. The merchant cannot surcharge for a
credit card. If the merchant does so, the merchant is violating
its agreement with its acquirer bank.
Also, 45 percent of the cost of interchange fees, that is
just going to fund rewards programs. Merchants don't get any
benefit from that. That is going for frequent flyer miles for
rewards junkies. So at least 45 percent of the cost of
interchange has really no benefit for merchants.
There is no evidence of ticket lift, contrary to what Mr.
Clayton says. If you want to find out how happy merchants are
when they have adopted credit cards, talk to McDonald's.
McDonald's adopted credit cards thinking that they would get
some ticket lift. Everything I hear is they have not been real
pleased with it, but they have had to sink in a lot of money
and that they are kind of trapped in that now.
Mr. Zywicki. May I have an opportunity to respond briefly?
Senator Bennet. I am out of time, so it is up to the
Chairman.
Chairman Dodd. Respond briefly, if you will.
Mr. Zywicki. The issue is whether or not consumers are
paying the full cost of the transaction that they are using,
and the fact is, when a consumer writes a check, that is
subsidized by the Federal Reserve. When a consumer uses cash,
that currency is printed by the government. So every payment
device has a subsidy somewhere in it. Sometimes it is the
Federal Reserve. Sometimes it is printing currency. And so the
issue I was referring to is whether or not consumers are
subsidized in their transaction device, not the particular
issue that Professor Levitin responded to.
Chairman Dodd. Thank you. One of my concerns about this,
and we have had long discussions in the past about interchange
fees, it is about a $48 billion revenue stream this year alone,
the estimates are, just from interchange fees coming in. What
it does, it creates the climate of sort of the liar loan
problem we saw with the residential mortgage market because
there, the idea is then the sheer volume of the number of cards
out there create a revenue stream, just by the volume of the
cards out. And the incentive then to determine whether or not
the borrower actually is creditworthy reduces tremendously
under this system.
That is one of the concerns I have about it and one of the
reasons we ought to have--again, I am not trying to deny
someone the access to a credit card, but at least having some
responsibility and some understanding of that, that when you
have a revenue stream of $48 billion coming in, on the average,
it is 2 percent, I think is the average interchange fee, more
or less, coming in. That is a remarkable revenue stream and the
disincentive to have some verification of the ability of the
consumer to meet those obligations, and that contributes, I
think, to that environment, which is important.
Senator Tester?
Senator Tester. Thank you, Mr. Chairman, and I think it is
in order to congratulate you for having a daughter, a 3-year-
old daughter that has effectively used a credit card very, very
well.
[Laughter.]
Senator Tester. You know, there have been some comparisons
here between using credit cards and buying sweaters, and I
think it is OK to make those kind of comparisons, but very
seldom when I go home back to Montana do I see three or four
sweaters laying on the kitchen table for my kids. This is
about--and my concern isn't about adults who know better. I am
talking about folks who have been in the business world a bit
or the workforce a bit. My concern is about credit card
companies that put out an offer that is just too good to be
true, and then once the fish is hooked, then the fees go up,
people starting getting jerked around, and it is just totally
not right. It is simply not right.
There has been talk of several bills here today. I have got
another one. I think just about every one of these can be
incorporated, not to squash the credit card companies, but
quite frankly, when I go home, and they don't know the earning
history of any of my kids, and they have got a decent earning
history now--and I hope they don't get credit cards because I
said that--but the truth is that when they were in college,
they didn't have much earnings history. When they were in high
school, they certainly didn't have much of an earnings history.
Then you go home and there are these credit cards laying there.
So the question is this. It is for Mr. Clayton, because
several times today during the testimony, you talked about
these are significantly risky loans that are out there. If
these really are significantly risky loans out there, why is
there no requirement for any sort of earnings history
whatsoever when you give a person a card, particularly a young
person, but it could apply to anybody, and say, here it is.
There is a line of credit for X-number of dollars. Go out and
have fun.
Mr. Clayton. Well, first of all, card companies do look at
income and employment history and otherwise to make----
Senator Tester. Well, just real quick, if they are looking
at income and earnings history, I can guarantee you they don't
look very doggone deep, because when kids in school, when a 3-
year-old daughter gets a credit card application, what kind of
earnings history are they looking at?
Mr. Clayton. I don't think that 3-year-old daughter
actually got a card, nor could they be obligated to pay under
that card, so--look, marketing, people get letters because they
are on some other lists. It doesn't mean they are going to get
a credit card. And so to be real clear, I doubt--Senator,
please feel free to correct me--I mean, it is a solicitation
and so it is nothing more than an advertisement to apply.
Credit card companies look carefully at trying to cultivate
relationships with 18-year-olds, 20-year-olds, 22-year-olds,
24-year-olds, because they recognize they are in for the long
haul. They take that responsibility seriously, and in fact,
they take special care. They make sure that their minimum
limits are actually--their credit limits are low, and they
start off typically with a $500 credit limit and it doesn't
grow that quickly. And they work with care to make sure they--
and monitor the card account to make sure they don't get into
trouble.
One of the things that gets lost in this debate is that, in
fact, students perform well in their use of credit cards. There
are lots of different studies and different numbers. The
numbers that we see are that they perform as well as or if not
better than the general population, and they have average
balances that are much lower than the general population. So as
a practical matter, the vast majority of students are using
their cards responsibly and well.
Do people get into trouble? Absolutely. Should we be
sensitive to that and figure out better ways to address that? I
think we would be willing to work with you and figure out how
to best do that.
Senator Tester. And I appreciate that because I think it
does need to be done. The fact is, and I will go back to
Senator Brown's comments because he brought it up with the Web
site from Ohio State. If, in fact, this is true, then why do we
see consumer debt going up for kids, going through the roof?
And quite frankly, if we are paying tuition with credit cards,
we are heading way, way, way down the wrong road there.
Mr. Clayton. And that clearly is an underlying problem that
has nothing to do really with the credit card but the
underlying cost of----
Senator Tester. You had a point you wanted to make, Mr.
Levitin?
Mr. Levitin. Yes. As the Chairman noted, all credit card
loans are stated income loans. They are all liar loans. When I
get a credit card solicitation, I fill in what my income is,
there is no way to check on that. The credit card issuers might
look at a credit report, but that doesn't say what my income
is. That only says whether I have been paying past bills. So if
they are looking to be repaid from a future income stream,
there is no way to tell.
Senator Tester. Right.
Mr. Levitin. And I think it is also--I just want to try and
link up two pieces of this, because I think often interchange
and the consumer side are seen as separate issues. These are
very intimately linked. This is a complete cycle. So
interchange funds rewards programs. Rewards programs and teaser
rates, those are the honey that lure in the consumer flies into
this venus fly trap of sticky interest rates, of hidden fees,
and so forth. So if you are concerned about an unsafe and
unsound underwriting model, it is not enough just to go out to
try and focus on solicitations. You have to look at the entire
business model with this.
Senator Tester. I appreciate that. I want to talk a little
bit, and I know that the House Financial Services Committee
yesterday had an extensively reported hearing on what is going
on with the TARP money. I just want to ask, and I think if
there is anybody else that this question applies to, answer,
and I don't mean to direct them all to you, Mr. Clayton, but
have any of your members raised rates on credit cards that
received TARP funds?
Mr. Clayton. Let me step back for a second and look at the
Fed's recent G-19 report on interest rates, and they basically
have shown that interest rates, while they have ticked up a
bit, are still approximately 12 percent and are like 136 basis
points below what they were a year ago today. And so interest
rates are, in fact, on average, relatively low. Are card
companies adjusting their interest rates because of the
perceived and real risk in the marketplace? Yes.
Senator Tester. So what you are saying is they did increase
the interest rates if they received TARP funds. That was----
Mr. Clayton. I don't think that there is more than one
relationship. I don't think that has anything to do with the
TARP funds. I think they are focusing on the risk in the--I
mean, one of the things that gets lost is the complete
flexibility and unsecured nature of this product. I mean, I
know you look at this as a negative, but also remember there is
a positive to this. The flexibility it provides to consumers at
two o'clock in the morning when the car breaks down and the tow
truck has to take you home, or to pay for some kind of medical
service or some kind of treatment for a child if you don't have
the money but they need to pay for that is all provided in this
little card. And lenders take risks in doing that because
people may not pay them back. We talk about liar loans. We are
talking about promise loans. These are promise loans made to
hundreds of millions of people every day.
Senator Tester. OK. Go ahead, Travis.
Mr. Plunkett. Senator, no one is denying credit cards are
convenient and useful for consumers. The question is are their
practices fair. I mean, the first thing to say to Mr. Clayton
is why are interest rates ticking up when the Federal funds
rate has dropped through the floor?
The next thing to say is that many national banks, as you
point out, have received TARP financing, and then Secretary
Paulson set up and Secretary Geithner says he will expand this
new program called the Term Asset-Backed Securities Loan
Facility to support credit card lending. It is not just a
question of interest rates. Are the terms fair that will be
supported through this program?
Mr. Clayton. Let me jump in for a second in terms of
answering that first question. Interest rates are not just
determined by how much it costs, the Fed prices its loans.
Interest rates are determined by lots of other things,
including delinquencies in the marketplace, which have gone up,
as well as the cost of securitization, where spreads have
increased significantly. What that means is investors are
demanding more return in order to underwrite or fund card
loans.
Senator Tester. Real quickly, Doctor.
Mr. Ausubel. Credit cards are extremely useful, but that is
not an excuse for completely opaque pricing. I mean, the whole
issue--lots of other products, price competition works better
because, first of all, it is easier to figure out the true
price that the consumer is paying, and second, the price is
predictable. Most other consumer products do not have any-time,
any-reason clauses.
Senator Tester. Thank you. Just very quickly, Mr. Chairman.
Thank you very much for holding the hearing. Thank you very
much for putting your bill in. I will just tell you that you
try to teach the next generation the right thing to do. My
parents said, you aren't going to have a credit card, and in
the days when I got my first credit card, I paid a fee and the
interest rates were pretty clear cut. That has all changed now,
I think. I know it has changed.
But I can tell you that I have so many examples of young
people under the age of 35 that get a credit card. They use it,
they go on a vacation, their payment comes in late, and the
fees and the interest rates take up all the money that was
going to the principal. I have got to tell you, that is flat
not right.
My time has long since run out, but I will just tell you,
it is not fair, it is not right, and it is not the way the
program should work. People are getting into people's pockets
by making it darn easy to sign up with these things, and then
if they make one mistake, they put the boots to them.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator, very much.
Senator Merkley?
Senator Merkley. Thank you very much, Mr. Chair.
Professor Zywicki, I think from your comments I could
describe you as an advocate for the--there is a competitive
market here between cards. But it has been pointed out by
Professor Ausubel that that credit market would be stronger if
consumers had the ability to have more transparency to
understand the rates better, the terms better, if they weren't
so complicated, they didn't have so many hidden ways of
charging you later, will you pretty much agree with that, or
would you contest that?
Mr. Zywicki. Thank you for that. First, Senator Tester is
leaving. I will just note that with respect to the cost of
credit card operations, the cost of funds are about 30 to 40
percent of total costs. Charge-offs are about 30 to 40 percent,
and operating costs are about 20 to 30 percent. So the reason
we don't is exactly as Mr. Clayton was saying. The reason is
when charge-offs go up and risk goes up, the amount that goes
obviously to charge-offs goes up and so that dampens any
interest-rate effect. So I just thought that would be some
facts to put on the record.
And I appreciate your question, Senator, because I think it
is the most important question here and one that is worth
focusing on. This is about complexity, right? These are very
complex products. They do have a lot of price points that can
confuse consumers. But the reason they are complex is precisely
because consumers use these in so many different ways. They use
an auto loan to buy a car. They use a mortgage to buy a house.
They use a credit card to do a cash advance, to make a
purchase, to revolve debt, to travel to Europe, to do all the
different sorts of things that they do with it. So there are a
lot of price points, but it is precisely because of the myriad
different ways in which consumers use these products.
We do need a better way of dealing with this. The market is
already ahead of us. There is a new Web site called
Cardhub.com. I have nothing to do with Cardhub.com. What
Cardhub.com is is a Web site you can go to and you can
basically get tailormade disclosures. You could say, I am
interested in a card that has no annual fee, low transaction
fees for travel to Europe, and gas benefits when I use my card,
and they have about 1,000 credit cards in their system and you
can basically create a tailormade disclosure for exactly the
fees that you are looking for.
What I get concerned about this is that we take a one-size-
fits-all proposal and put it on top of a market where consumers
are using cards for all myriad sorts of things. So regulation,
I hope, can encourage and be a mechanism for encouraging
further innovation, development in these cards, and allowing
consumers to get what they want.
If I could just add one last fact----
Senator Merkley. One quick point. Go ahead.
Mr. Zywicki. Sure. One last fact is there has been some
talk about fees, interchange fees. Just to kind of get the
facts on the record, according to the GAO report, about 70
percent of credit card revenues come from interest. About 20
percent come from interchange fees. And about 10 percent come
from fees. The fee amount of 10 percent has basically been
constant over time. What we have seen is it used to be 10
percent were annual fees, and now they have gone down. Annual
fees have basically disappeared. Late fees and that sort of
thing have gone up to 10 percent. So the total amount that are
fees has remained about 10 percent. Just the nature of the fees
has changed.
Senator Merkley. OK. Well, let me get another perspective
on this. I will tell you that I use checks in just as many
complicated ways as I use a credit card, so I am not
particularly persuaded by your argument on that, but let us get
another perspective from Professor Ausubel. And could you also
address the fee rate, as well, point?
Mr. Ausubel. Right. First of all, on fees, it is well
documented that the level of fees has gone up at a very rapid
pace over the past 10 years. I mean, you can see it very
clearly if you just look at any particular fee, like if you
look at the level of the late payment fee that was present in
the past and you look at the $39 now.
Mr. Zywicki. How about the annual fee?
Mr. Levitin. May I jump in, Senator?
[Laughter.]
Senator Merkley. Let Professor Ausubel finish and then we
will let you jump in.
Mr. Ausubel. I am talking about fees in aggregate. What was
the next thing?
Senator Merkley. Well, the first was the complexity of
purchases----
Mr. Ausubel. Oh, the complexity. So here is a way to think
about the business model in the credit card market. What
happens is there is a certain number of terms of the credit
card account that people pay the most attention to. So, for
example, at a certain point, people might have been paying
attention to annual fees. Competition steps in and annual fees
get competed down. But simultaneously, the banks add new fees
which are not on consumers' radar screens which generate real
revenues and which take a while for consumers to catch up to.
So if you ask, why has the number of fees multiplied, it is to
have new revenue sources that are not on consumer radar
screens.
Can I give you one quick example that is unambiguous? Most
issuers have 3 percent fees if you purchase anything in foreign
currency. Note that there is absolutely no cost associated with
this because the currency conversion fees are already built
into the whole operation.
Senator Merkley. Thank you. I am out of time. Can we allow
another person to respond?
Chairman Dodd. Please go ahead.
Senator Merkley. Mr. Levitin?
Mr. Levitin. Yes. I think it is really important to note
that while some credit card fees do relate to particular usage
patterns, the credit card billing practices that are really
problematic have no relationship to the way anyone uses a card.
Double-cycle billing? How does--I just can't see how that
relates to the different ways consumers use cards. Any time,
any reason term changes, the same thing. It is not based on
usage patterns. These are just hidden fees--these are billing
points that function as hidden fees and don't relate to the way
consumers actually use cards. They just relate to an ability to
snooker consumers in with low teaser rates and then whack them
over the head with back-end fees that they aren't expecting.
Mr. Sturdevant. Senator----
Senator Merkley. My time has expired.
Mr. Sturdevant. I had one point----
Chairman Dodd. Go ahead.
Mr. Sturdevant. There is no more complexity in how
consumers use cards today than there was in 1964 when Bank of
America introduced them except that we have the Internet now.
People make purchases in the same way, in the same variety of
ways, and as Senator Tester, I believe, pointed out, in 1964--
and the Chairman did, as well--you had a membership fee, maybe,
and you had an interest rate.
And that is how the product was marketed until the late
1970s when interest rates hit an historic high of 21 percent
and the credit card industry said, we can't make any money. We
can't make money anymore from the interest rate to the customer
and the interchange fee. So all of a sudden, we had the
introduction of the over-limit fee and the late payment fee.
And then as time went on, we had more and more fees, the access
fee, the quick look fee, the returned check fee, the
administrative fee, the extra card fee, et cetera, et cetera,
et cetera.
As interest rates came down--interest rates were very slow
to come down in credit cards and none of the fees went away.
The only thing that happened is that the amount of the dollars
increased sharply. So in 1996, the credit card industry earned
$1.7 billion in penalty fee revenue. In 2004, it earned $14.8
billion. If you combine penalty fees, cash advance fees, and
annual fees, those three items alone, that reached nearly $25
billion in 2004, and they were sitting in the Dirksen Building
and Senator Dirksen was famous for his remark that a million
here and a million there, we are talking about real money. In
today's climate, a million is nothing and even a billion seems
to be nothing. But where I come from, $25 billion is a
significant revenue stream.
As we have heard today, credit card companies have engaged
in conduct to create late payments, to prevent timely payments,
to receive the payment and not post the payment, anything it
can do to trigger that. With respect to over-limit
transactions, the credit card companies through its systems
totally control usage. They want over-limit transactions so
long as the customer continues to make a payment, and they use
the $39 fee when the customer calls to complain to enable the
company to raise the credit limit so that there is more debt
out there so that the minimum payment is higher on that dollar
value.
But nothing principally has changed in the marketplace
since 1964 except the escalation of the types of fees and the
amount of dollars imposed on those fees.
Mr. Clayton. Senator, I know I am belaboring the point
here. I would say that GAO in a 2006 study basically said that
total aggregate fees, comparing 1990 to 2004, remained
relatively stable, meaning they didn't change. There was a
transfer from annual fees to these other types of kind of
transaction fees, all of which were basically transferring a
fee that a consumer had no control over, an annual fee, versus
one--late fees and other things, over-limit fees--that they
have some control over.
Chairman Dodd. I appreciate the point. I mean, an annual
fee, that is in terms of the pricing points, that when you pay
an annual fee, you know what it is. The question then of when
these additional fees kick in, how they kick in, has been the
source of the contention. In too many cases, they appear to be
for reasons that should be unrelated to the performance of the
consumer when it comes to the credit card, and we have talked
about them before, the universal default issue, the double-
cycle billing. Now, some of these have been changed, I agree
with the things, but clearly these fees were not ones that a
consumer can price necessarily when they increase them in ways
that seem not terribly relevant to the behavior by the
consumer.
I don't think anybody is suggesting that when a consumer
behaves poorly, if you will, in this matter that there are
obviously going to be charges associated when that occurs. The
question is, it is not so much performing poorly but rather
what appears to be, I say to you, that designs to rather get
around the fact, because the annual fee wasn't producing the
kind of revenues. The competition reduced it, so what other
ways can we do this, to find that?
And obviously, look, marketing--I know this is probably
true no longer, but there was a while not long ago when the
parlance of the industry, if you were someone that paid off
whatever the obligations were on a monthly basis, you were
called a deadbeat, because frankly, you weren't very good
financially. Someone who pays that thing off every month, you
are not making much money off of them.
The ideal consumer is someone who is paying the minimums
here each month because that person is going to pay a lot more
for that service or product over an extended period of time
than the person who pays it off immediately. And it seems to me
that by marketing to a lot of people, in a sense, who are in
that situation, obviously raises certain concerns.
Again, I have got credit cards. I understand the value of
them, the importance of them for people, and I want the
industry to know this is not a hostile situation we are talking
about. We are talking about trying to make it work right for
people in a sense at a time of great difficulty, when people
are feeling a tremendous pinch.
And obviously we have got securitization of this industry,
which is another incentive in a way. If you are able to
securitize that debt and sell it off someplace, then the
incentives for you to want to manage it better are reduced,
much as it was in the residential mortgage market. When you can
securitize that product and sell it, your interest in having
underwriting standards and so forth and to demand greater
accountability begin to diminish significantly, and this has
been a significant problem.
In fact, it is one of the problems the banks have, because
they are looking down the road and they are seeing a lot of
this debt coming at them, not only in commercial real estate,
but also in student loans and in credit card obligations. So
obviously one of the reasons they are not lending a lot, I
suspect, is because they recognize they have got these
obligations coming.
Why are they coming? Because they market a lot of products
to people who couldn't afford them, in a sense. And had they
done a little more work and determined whether or not that
person out there was actually going to be able to meet those
obligations instead of basically giving them out to anybody and
everyone, then we wouldn't be facing this situation, much as we
are facing in the residential mortgage market. There are
distinctions, obviously, between a mortgage and a credit card
obligation, but nonetheless, a little more adherence to those
principles would reduce the very problems we are looking at in
real estate as well as in commercial transactions such as
credit cards.
So it is sort of a self-fulfilling prophecy, in a way, we
are dealing with in this issue. There is less accountability,
marketing to more people who can less likely afford the
obligations. Obviously, a lot to be made off of it because
obviously someone who has to pay every month something on that
over a long period of time increases tremendously the amount
they will pay for that.
That is why I disagree with you, Mr. Zywicki. I know you
don't--I don't disagree with your point, the point I think you
were making. I think there is some legitimacy to this. If you
load up a load of consumer warnings, there is a point at which
no one reads any of it. It is like on prescription drugs or
something, or over-the-counter stuff. You begin to read so much
that you just--you can't remember any of it.
But I do think the idea of saying to people, let me show
you that if you purchase a product and make just the minimum
monthly payment on this, how much more you are likely to pay
for a product, I think that warning to a consumer has value. If
you know that, I think you are going to have second thoughts
that that item doesn't cost $50, but it is rather going to cost
you $150 by the time you are through with it. It has a value.
And I don't disagree that if you load it up with a lot of
stuff, no one reads any of it, but I think it is an important
point.
I raised the issue on the securitization and I wonder if
you--I will raise the question if any of you want to respond to
it. The securitization of credit card loans permitted companies
to engage in at least lending practices that are less vigilant.
Mr. Clayton, what about that?
Mr. Clayton. Securitization was engaged in to lower the
cost of borrowing so that we could lower the cost of credit.
Chairman Dodd. But doesn't it also basically--in other
words, the incentive for the issuer to make sure that the
borrower is going to be more creditworthy diminishes when you
know you are going to be able to sell that debt off. Isn't that
also true?
Mr. Clayton. There is a significant difference between
credit card securitizations and mortgage securitizations.
Mortgage securitizations involve, as I understand it, a great
deal of pooled loans from a lot of different issuers and
underwriters. Credit card loans, they come from one company and
that company's reputation and cost of future issuances is
dictated by the performance of that underlying securitization.
Chairman Dodd. Yes.
Mr. Clayton. So as a practical matter, it is--they hold the
risk, and if these trusts unwind, that comes back on the
balance sheet. So there are real risks and checks and balances,
which is what I think you are referring to, in this area. If
the marketplace believes that this doesn't work, the cost of
borrowing for that company goes up significantly. So there are
real prices to be paid.
Chairman Dodd. Anyone else? Yes, Mr. Levitin?
Mr. Levitin. There is another significant difference
between credit card and mortgage securitization. Mortgage
securitization, a typical securitization deal, the originator
sells off the loans and has no further interest in them. That
is not, as Mr. Clayton points out, that is not what happens
with credit cards. The card issuer retains essentially the
residual interest. Every month, if after--if the cards generate
enough income to pay off all the mortgage-backed security
bonds, anything left over goes to the card issuer. That is
called the excess spread.
What this means is that the card issuer holds all the
upside, but it has sold off most of the downside to investors.
This gives card issuers an incentive to apply more late fees
and over-limit fees because that will result in some people
defaulting on the debt entirely, but others, it will result in
them paying more. This increases volatility. For credit card
securitization, the more volatile the accounts are, that all
accrues to the benefit of the issuer, and the downside of the
volatility goes to the investors.
Chairman Dodd. Yes, Mr. Ausubel?
Mr. Ausubel. I would generally agree with what has been
said. I mean, that securitization in the credit card market is
fundamentally different than the mortgage market because the
credit card issuer remains the residual claimant in the whole
business operation.
The place where you can find some similarity is that when
consumers get distressed, there are some parallels between it
giving bad dynamics in one market than the other. I mean, so
you have been hearing on the mortgage market you have this
problem that the whole system may be better off because--the
whole system may be better off if there were some forgiveness,
like you modify the terms. When we securitize it, you have one
group of people who own the mortgage, another set of people who
service the mortgage. The people who service the mortgage may
not want to relax the terms because it is not in their benefit.
You have the same thing in the credit card market with
universal default and that sort of thing, that if a consumer
gets into trouble, all the banks, the entire system may be
better off if there were some forgiveness, but instead what
each bank does is they try to load up what is owed to them and
they try to collect as rapidly as possible from the consumer
before the consumer goes bankrupt. So you have the same sort of
divergence of interests which leads to a sub-optimal level of
forgiveness.
Chairman Dodd. Well, listen, this has been very worthwhile,
and Mr. Clayton, I appreciate very much your being here. You
know the industry obviously very well and I speak with some
frequency to obviously my own bankers in Connecticut and others
who have strong views on the issue, as well. My interest is
doing something balanced and responsible as we move forward.
I am concerned about the lateness of this July effective
date in terms of what happens between now and then, and
regulations and rules, while they are important and they are
not insignificant, statutory changes have a way of bringing
more permanency to a process than obviously the vagaries of
rulemaking, which can be undone pretty quickly. And so there is
a reason, I think, if we can come to some common understandings
about some of these points here, that we will be all better off
in some ways.
But I think all of us up here--I believe all of us up
here--have no interest in destroying the credit card industry.
We realize the value of it and the importance of it, and I
think it is a very important point to take away from a hearing
like this, how best we do that.
And going back to the point that I hope we learned, because
we certainly got away from it, and I am sounding like a broken
record on this point, but for too long, I think there was the
assumption that consumer protection laws were more than just an
annoyance. They were antithetical to the notion of economic
growth and prosperity. And we have learned painfully over the
last several years how dangerous that mentality is, that, in
fact, had consumer protection been very much on the minds of
people, on regulators and others, we wouldn't be in the mess we
are in today. This was not a natural disaster. This is one that
was avoidable.
And so it is very important, if we learn anything out of
all of this as we try to get back on our feet again, is that
that notion of consumer protection ought not to be seen--there
are unintended consequences. Bob Corker makes a legitimate
point. You want to be careful how you proceed in all of this.
But the notion once again that we could ever start thinking
about regulation, reform, and creating new architectures for
the 21st century, very much a part of that has to be that that
end user, that consumer user of products, be they credit cards,
mortgages, car loans, student loans, they have got to be
paramount in our minds. And when they are, then we have strong
economies that grow well, create wealth, create prosperity.
When we avoid it and subjugate it or reduce it in its
importance, then I think we get ourselves into the kind of mess
we have seen recently.
So I am very grateful to all of you for your testimony
today. We will leave the record open. I am sure there are
members who may have some additional questions. You may have
some additional information and material you think it would be
worthwhile for us to consider in our discussions here as we go
forward and we will certainly leave the record open for that.
With that, the hearing stands adjourned. I thank you.
[Whereupon, at 12:28 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
follow:]
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM ADAM J.
LEVITIN
Q.1. Access to Credit: A potential outcome of the new rules
could be that consumers with less than a 620 FICO score could
be denied access to a credit card. Such an exclusion could
affect 45.5 million individuals or over 20 percent of the U.S.
population.
Without access to traditional credit, where do you believe
that individuals would turn to finance their consumer needs?
A.2. I am unsure to which ``rules'' the question refers; I
assume it refers to the recent unfair and deceptive acts and
practices regulations adopted by the Federal Reserve, Office of
Thrift Supervision, and National Credit Union Administration
under section 5 of the Federal Trade Commission Act. If so, I
strongly but respectfully dispute the premise of the question;
the scenario that is presented is exceedingly alarmist. The
question wrongly implies that all individuals with FICO scores
of 620 or lower currently have access to ``traditional'' credit
cards. They assuredly do not. First, nearly 10 percent of the
United States adult population is ``unbanked,'' and that means
almost by definition that they do not have credit cards; card
penetration into the unbanked market is de minimis. Thus, at
least half of the impact implied by the scenario is not
possible. For the remaining 10 percent or so who have FICOs
under 620, many do not currently have access to ``traditional''
credit. Instead, they have access to predatory new credit
products like ``fee harvester'' or ``secured'' credit cards.
Even if these non-traditional products were included in the
term ``traditional,'' I think it is also dubious that all or
even most of them would cease to be able to get ``traditional''
credit; nothing in the proposed regulations limits issuers'
ability to protect against credit risk through either lower
credit limits or higher interest rates or other fees.
To the extent that these individuals are not able to get
credit cards or choose not to accept them because of onerously
high interest rates, the answer to where they would turn for
financing needs depends on the particular circumstances of the
individual, but I believe that many consumers would first cut
down or eliminate non-essential expenses, which would reduce
their financing needs. Demand for credit is not entirely
inelastic. For these consumers' remaining financing needs, many
would turn to family and friends for assistance. See Angela
Littwin, Testing the Substitution Hypothesis: Would Credit Card
Regulations Force Low-Income Borrowers into Less Desirable
Lending Alternatives? 2009 Ill. L. Rev. 403, 434-35 (2009)
(noting that borrowing from family and friends is the most
frequent form of borrowing for low-income women). It is also
important to note that empirical evidence suggests that
``credit cards are actually among low-income consumers' least-
preferred sources of credit, meaning that there is no ``worse''
alternative to which they would turn if credit card access were
reduced.'' Id. at 454.
Beyond family and friends, there are also other legitimate,
high-cost sources of credit besides credit cards--pawn shops,
rent-to-own, and overdraft protection, e.g. There, of course,
is a possibility that some low-income consumers will turn to
illegitimate sources of credit, such as loan sharks, but this
possibility could be tempered by community-based small loan
programs. Indeed, given that the Federal Government is
currently subsidizing credit card lending through the Term
Asset-Backed Securities Lending Facility (TALF), it seems quite
reasonable to support other forms of consumer credit lending.
Indeed, in Japan, where there is a 20 percent usury cap, credit
rationing and product substitution are significantly tempered
by a government-supported small loan system. Nor is it clear
that the terms on which ``loan sharks'' lend are actually worse
than some subprime credit card products. As Woody Guthrie sang
in the Ballad of Pretty Boy Floyd:
Now as through this world I ramble
I see lots of funny men
Some will rob you with a Six gun
And some with a fountain pen.
But as through your life you travel
As through your life you roam
You won't never see an outlaw
Drive a family from their home.
Woody Guthrie, American Folksong 27 (1961).
Finally, given the terms on which individuals with FICO
scores of under 620 are able to obtain ``traditional'' credit,
I think it is quite debatable whether ``traditional'' credit is
in any way beneficial to them; fee-harvester cards and other
subprime credit card products are as likely to harm consumers
with poor credit ratings as they are to help them; these cards
can improve consumers' credit scores over time, if the consumer
is able to make all the payments in full and on time, but by
definition a consumer with a FICO of under 620 is someone who
is unlikely to be able to do that.
Q.2. Risk-Based Pricing: Banks need to make judgments about
the credit-worthiness of consumers and then price the risk
accordingly. Credit cards differ from closed-end consumer
transactions, such as mortgages or car loans, because the
relationship is ongoing. I am concerned by the Federal
Reserve's new rules on risk-based repricing for a couple of
reasons. First, without the ability to price for risks, banks
will be forced to treat everyone with equally stringent terms,
even though many of these individuals perform quite differently
over time. Second, without a mechanism to reprice according to
risk as a consumer's risk profile changes, many lenders will
simply refuse to extend credit to a large portion of the
population.
Do you believe that consumers will have access to less
credit and fewer choices because of the Fed's new rule? If so,
is this a desirable outcome?
A.2. Again, I respectfully disagree with the premise of the
question. The new uniform Unfair and Deceptive Act and
Practices regulations adopted by the Federal Reserve Board, the
Office of Thrift Supervision and National Credit Union
Administration under section 5 of the Federal Trade Commission
Act (``Reg AA'') do not prohibit risk-based pricing. Reg AA
only prohibits retroactive repricing of existing balances. Card
issuers remain free to increase interest rates prospectively
with proper notice or to protect themselves immediately by
closing off credit lines.
That said, I would expect that Reg AA would likely reduce
credit availability to some degree, although perhaps not to all
consumers. This is not necessarily a bad outcome. Credit is a
double-edged sword. It can be a great boon that fuels economic
growth, but that is only when credit does not exceed a
borrower's ability to repay. Credit can also be a millstone
around the neck of a borrower when it exceeds the ability to
repay. Overleverage is just as bad for consumers as it is for
financial institutions. To the extent that Reg AA reduces
credit availability, it might be a good thing by bringing
credit availability more in line with consumers' ability to
repay.
Q.3. Consumer Disclosure: You state that the sheer number
of price mechanisms make it difficult for consumers to
accurately and easily gauge the cost of credit. You cite things
such as annual fees, merchant fees, over-the-limit fees, and
cash advance fees. You seem to suggest that credit cards should
become much more plain vanilla because people simply can't
understand the different uses and costs for those uses.
Don't these different pricing mechanisms also provide more
choices for consumers as they make purchasing decisions?
A.3. That depends on the particular pricing mechanism. Many
of them provide dubious choices or value for consumers.
Consider over-limit fees, late fees, cash advance interest
rates, and residual interest and double cycle billing.
(1). LOverlimit fees. A consumer has no right to go overlimit
and cannot assume that an over-limit transaction will
be allowed. Moreover, overlimit can be the result of
the application of fees, rather than of purchases.
Therefore, overlimit is not exactly a ``choice.''
(2). LA late fee is no different than interest, just applied
in a lump sum. I am doubtful that most consumers would
prefer an up-front lump sum late fee rather than a
higher interest rate. For the large number of ``sloppy
payers'' who pay their bills a few days late, a higher
interest rate is much better than a large flat late
fee, but because consumers systematically underestimate
the likelihood that they will pay late, they are less
concerned about the late fee than the interest rate.
(3). LMost cards charge a higher interest rate for ``cash
advances.'' A cash advance, however, is not necessarily
the payment of cash to the consumer. Instead, cash
advances include the use of so-called ``convenience
checks'' that card issuers send to consumers with their
billing statements. (Incidentally, convenience checks
present a considerable identity theft problem because
they lack cards' security features and the cardholder
has no way of knowing if they have been stolen. They
expose issuers to significant fraud losses and should
be prohibited as an unsafe and unsound banking
practice.) Convenience checks permit cardholders to use
their card to pay merchants that do not accept cards,
like landlords, utilities, and insurers. This allows
consumers to pay these bills even when they do not have
funds in their bank account. But convenience checks
carry the cash advance interest rate plus a fee (often
a flat 3 percent with a minimum amount). These terms
are usually disclosed on the convenience checks only
partially and by reference to the cardholder agreement.
It is doubtful that most consumers retain their
cardholder agreement, so whether consumers understand
the cost of using convenience checks is a dubious
proposition.
(4). LSimilarly, billing tricks and traps like residual
interest or double cycle billing are hardly a
``choice'' for consumers; these are not product
differentiations that are tailored to consumer
preferences, as few consumers know about them, let
alone understand them.
Restricting card pricing could limit innovation in the card
market, but it is important to recognize that not all
innovation is good. There has been very little innovation in
the card industry over the last twenty years, either in terms
of technology or in terms of product. Cards still operate on
the same old magnetic stripe technology they had in the 1970s.
The card product still performs the same basic service. To the
extent there has been innovation, it has been in the business
model, and it has frequently not been good for consumers. Even
things like the 0 percent teaser rate are hardly unambiguous
goods. While 0 percent teasers are great for consumers who can
pay off the balance, they also encourage consumers to load up
on credit card debt, and if there is a shock to the consumer's
income, such as a death, an illness, a divorce, or
unemployment, the consumer is much more exposed than otherwise.
I recognize that it is important to protect the ability of
the card industry to innovate in the future, and that is why I
believe the best solution is to set a default rule that
simplifies credit card pricing, but to allow a regulatory
agency, such as the Federal consumer financial product safety
commission proposed by Senators Durbin, Kennedy, and Schumer
and Representative Delahunt (S. 566/H.R. 1705, the Financial
Product Safety Commission Act of 2009) to have the power to
card issuers to introduce new products and product features
provided that they meet regulatory consumer safety standards.
Q.4. Bankruptcy Filings: As the recession worsens, many
American families will likely rely on credit cards to bridge
the gap for many of their consumer finance needs. Mr. Levitin
and Mr. Zywicki, you seem to have contrasting points of view on
whether credit cards actually force more consumers into
bankruptcy, or whether credit cards help consumers avoid
bankruptcy.
Could both of you briefly explain whether the newly enacted
credit card rules will help consumers avoid bankruptcy or push
more consumers into bankruptcy?
A.4. The newly enacted Federal Reserve credit card
regulations will not have any impact on bankruptcy filings
presently, as they do not go into effect until summer of 2010.
When they do go into effect, their impact on consumer
bankruptcy filings will likely be mixed.
Credit card debt has a stronger correlation with bankruptcy
filings than other types of debt. But this is not necessarily a
function of credit card billing practices. Card debt reflects
the macroeconomic problems of the American family--rising costs
of health care, education, and housing but stagnant wages and
depleted savings. The card billing tricks and traps targeted by
the Fed's rules amplify this distress, but the Fed's rules will
not solve the fundamental problems of the American family. To
the extent that they limit the amplifying effect that card
billing tricks and traps have on card debt levels, it will help
some consumers avoid bankruptcy.
If the rules result in contraction of credit availability,
it might push consumers into bankruptcy, but that would have to
be netted out against the number that are helped by a reduction
in the amplification effect, and I am skeptical that there
would be much contraction.
I agree with Professor Zywicki that credit cards can help
some consumers avoid bankruptcy. If a consumer has a temporary
setback in income, credit cards can provide the consumer with
enough funds to hang on until their financial situation
reverses. But credit cards can also exacerbate financial
difficulties, and even if the consumer's fortunes pick up, it
might be impossible to service the card debt. Moreover, there
are many consumers whose financial situations are not going to
pick up, and for these consumers, card debt just adds to their
distress.
Q.5. Safety and Soundness and Consumer Protection: I
believe firmly that safety and soundness and consumer
protection go hand-in-hand. One needs only to look at the
disaster in our mortgage markets, for clear evidence of what
happens when regulators and lenders divorce these two concepts.
A prudent loan is one where the financial institution fully
believes that the consumer has a reasonable ability to repay.
Do you agree that prudential regulation and consumer
protection should both be rigorously pursued together by
regulators?
A.5. Yes, but not by the same regulators. There is an
essential conflict between safety-and-soundness and consumer
protection. A financial institution can only be safe and sound
if it is profitable. And abusive and predatory lending
practices can often be extremely profitable, especially in the
short term, and can compensate for the lender's other less
profitable activities. The experience of the past decade shows
that when Federal regulators like the Office of Comptroller of
the Currency, the Office of Thrift Supervision, and the Federal
Reserve are charged with both safety-and-soundness and consumer
protection, they inevitably (and perhaps rightly) favor safety-
and-soundness at the expense of consumer protection. These
functions cannot coexist in the same agency, and consumer
protection responsibilities for financial products should be
shifted to a single independent Federal agency (which would not
claim preemptive authority over state consumer protection
actions) to protect consumer protection.
Q.6. Subsidization of High-Risk Customers: I have been
receiving letters and calls from constituents of mine who have
seen the interest rates on their credit cards rise sharply in
recent weeks. Many of these people have not missed payments.
Mr. Clayton, in your testimony you note that credit card
lenders have increased interest rates across the board and
lowered credit lines for many consumers, including low-risk
customers who have never missed a payment.
Why are banks raising interest rates and limiting credit
apparently so arbitrarily?
A.6. Banks are raising interest rates on consumers and
limiting credit to cover for their own inability to
appropriately price for risk in mortgage, securities, and
derivatives markets has resulted in their solvency being
threatened. Therefore, banks are trying to limit their credit
card exposures and are trying to increase revenue from credit
card accounts by raising rates. If banks are unable to
competently price for risk for mortgages, where there is often
robust underwriting, what confidence should we have in their
ability to price for risk for credit cards where every loan is
a stated income ``liar'' loan? The current financial debacle
should cause us to seriously question banks' claims of risk-
based pricing for credit cards. The original pricing failed to
properly account for risk and the new arbitrary repricing
certainly fails to account for risk on an individualized level.
The only risk being reflected in the new pricing is the bank's
default risk, not the consumer's.
Does this result in low-risk customers subsidizing people
who are high-risk due to a track record of high-risk behavior?
Yes, it probably does because it is being done so
arbitrarily.
Q.7. Effects on Low-income Consumers: I want to put forward
a scenario for the witnesses. Suppose a credit card customer
has a low income and a low credit limit, but a strong credit
history. They use their credit card for unexpected expenses and
pay it off as soon as possible, never incurring late fees. With
the new regulations approved by the Federal Reserve, banks will
be restricted in their use of risk-based pricing. This means
our cardholder could see his or her interest rates and fees
increased to pay for the actions of other card holders, many of
whom have higher incomes.
Do any of the witnesses have concerns that moving away from
risk-based pricing could result in the subsidization of credit
to wealthy yet riskier borrowers, by poorer but lower-risk
borrowers?
A.7. No. The issue is a red-herring. As an initial matter,
it is important to emphasize that the Federal Reserve's new
regulations do not prohibit risk-based pricing. They only
prohibit retroactive repricing of existing balances. In other
words, they say that card issuers only get one bit at the risk
pricing apple, just like any normal contract counterparty. Card
issuers remain free to price however they want prospectively or
to reduce or cutoff credit lines if they are concerned about
risk.
Second, it is important to underscore that to the extent
that card issuers engage in risk-based pricing, it is only a
small component of the cost of credit. I discuss this at length
in my written testimony, but I will note that Professor Zywicki
has himself written that 87 percent of the cost of credit cards
has nothing to do with consumer risk; it is entirely a function
of the cost of operations and the cost of funds. Todd J.
Zywicki, The Economics of Credit Cards, 3 Chap. L. Rev. 79, 121
(2000). The remaining 13 percent represents both a risk premium
and opportunity pricing. In many cases the opportunity-pricing
component predominates. Therefore, there to the extent that
credit card issuers do risk based pricing, it only has a
marginal impact on the total cost of cards. As Professor
Ausubel demonstrated in his written and oral testimony, a
significant component of some credit card fees, like late fees,
are opportunity costs. Likewise, in my written testimony, the
section comparing my own credit cards, three of which are from
the same issuer, but which have different rates that do not
correspond with credit limits, indicates that there is
significant opportunity pricing in the card market. Regulations
that make cards fairer and more transparent would be unlikely
to have much impact on consumer pricing.
Third, it is not clear why cross subsidization should be a
particular concern. It is a common fact of life. Consider flat-
fee parking lots. Those consumers who park for 5 minutes
subsidize those who park for hours. Similarly, at by-the-pound
salad bars, consumers who eat only carrots subsidize those who
eat only truffles. When cross-subsidization is regressive, it
elicits additional concerns, but there are far more serious
regressive price structures, not the least of which is the
Internal Revenue Code.
That said, I believe the cross-subsidization in the
scenario to be unlikely because the risk that matters to card
issuers is nonpayment risk, not late payment risk, and income
and wealth generally correlate with low nonpayment risk. In
sum, then, I think the cross-subsidization scenario presented
is unlikely, and to the extent it occurs, the cross-
subsidization will only be de minimis because of the limited
extent of risk-based pricing. The problem presented by the
scenario is a red herring concern and not a reason to shy away
from regulating credit cards.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM KENNETH J.
CLAYTON
Q.1. Access to Credit: A potential outcome of the new rules
could be that consumers with less than a 620 FICO score could
be denied access to a credit card. Such an exclusion could
affect 45.5 million individuals or over 20 percent of the U.S.
population.
Without access to traditional credit, where do you believe
that individuals would turn to finance their consumer needs?
A.1. It is likely that consumers perceived to have higher
levels of risk--including those that are new to credit--will
bear the brunt of credit reductions resulting from the rule.
Thus, as noted in your question, the inability to price risk
effectively may well mean less access to credit for very
deserving individuals just because card issuers are unsure of
the credit risk involved and will not be able to price for that
risk as it becomes more apparent. As the credit needs of these
individuals are unlikely to disappear--and, in fact, may
actually increase due to exigent economic circumstances, e.g.,
unemployment--these consumers will likely be forced to turn to
non-federally regulated lenders including payday lenders and
loan sharks.
Q.2. Risk-Based Pricing: Banks need to make judgments about
the credit-worthiness of consumers and then price the risk
accordingly. Credit cards differ from closed-end consumer
transactions, such as mortgages or car loans, because the
relationship is ongoing. I am concerned by the Federal
Reserve's new rules on risk-based repricing for a couple of
reasons. First, without the ability to price for risks, banks
will be forced to treat everyone with equally stringent terms,
even though many of these individuals perform quite differently
over time. Second, without a mechanism to reprice according to
risk as a consumer's risk profile changes, many lenders will
simply refuse to extend credit to a large portion of the
population.
Do you believe that consumers will have access to less
credit and fewer choices because of the Fed's new rule? If so,
is this a desirable outcome?
A.2. The new rule will affect every aspect of the credit
card business, from how cards are funded, to how they are
priced, to how they are marketed, and to how credit is
allocated among customers of differing credit histories and
risk. Because the rules are so strong, card lenders may have to
increase interest rates in general, lower credit lines, assess
more annual fees, and reduce credit options for some customers.
The full impact of these changes will likely not be fully known
for several years as business practices are changed and as the
credit availability works its way through the economy.
The new rule may also lead to higher interest rates or fees
(such as annual fees) for all cardholders in order to
compensate for the inability to price risk effectively. Thus,
the least risky borrowers must now bear the cost for higher
risk borrowers because the higher-risk borrowers will no longer
bear the full cost of the exposure they pose to lenders. It may
also be the case that payment allocation requirements will lead
to the elimination of low-rate balance transfers that consumers
and small businesses previously used to lower overall debt
costs. Simply put, the sum total of all these rules will likely
lead to reduced access to credit and higher prices to all
consumers, in addition to many fewer choices on card products.
We do not believe this is a desirable outcome for both
consumers and the broader economy.
Q.3. Safety and Soundness and Consumer Protection: I
believe firmly that safety and soundness and consumer
protection go hand-in-hand. One needs only to look at the
disaster in our mortgage markets, for clear evidence of what
happens when regulators and lenders divorce these two concepts.
A prudent loan is one where the financial institution fully
believes that the consumer has a reasonable ability to repay.
Do you agree that prudential regulation and consumer
protection should both be rigorously pursued together by
regulators?
A.3. A system linking bank regulation and consumer
protection forces more balanced supervision without the turf
battles and inefficiency inherent in bifurcated jurisdiction.
The two are highly integrated, and that one aspect cannot and
should not be divorced from the other. This ensures that, for
example, safe and sound lending would not be compromised by fee
and rate restrictions envisioned by a consumer regulator only
concerned with driving consumer costs down unencumbered by a
need to consider the impact such restrictions may have on
adequate return.
Q.4. Subsidization of High-Risk Customers: I have been
receiving letters and calls from constituents of mine who have
seen the interest rates on their credit cards rise sharply in
recent weeks. Many of these people have not missed payments.
Mr. Clayton, in your testimony you note that credit card
lenders have increased interest rates across the board and
lowered credit lines for many consumers, including low-risk
customers who have never missed a payment.
Why are banks raising interest rates and limiting credit
apparently so arbitrarily?
Does this result in low-risk customers subsidizing people
who are high-risk due to a track record of high-risk behavior?
A.4. The rising interest rates and limitations on credit
are due primarily to three factors. First, in the present
challenging economic time, lenders are being more careful.
Delinquencies on credit card accounts have significantly
increased as a result of rising unemployment and uncertainty in
the economy. This substantial increase in repayment risk
affects the ability of lenders to make new loans, and requires
companies to carefully evaluate and minimize their risk across
the board so that they may stay in business and continue to
make new loans.
Second, funding costs have increased dramatically in the
secondary market, which funds nearly half (or approximately
$450 billion) of all credit card loans made by commercial
banks. Investors are extremely sensitive to changes in the
terms and conditions of the underlying asset, as has been
evident in the current market, where investors have shunned
nearly all forms of asset-backed securities over fears in the
underlying economy. This drives up the cost of funding new
credit, and leads to higher costs to consumers.
Third, all businesses are concerned for the future, as
borrowers' ability to repay may become severely compromised.
This is particularly true with respect to credit card loans,
which are open-end lines of credit, unsecured and greatly
subject to changing risk profiles of borrowers. Banks need to
ensure they will be paid for the risks they have taken in
credit card loans; otherwise they will not be able to continue
to make loans. As a result, many institutions must raise rates
and reduce risk exposure in order to continue to lend. This
results in all borrowers having to bear the cost of higher risk
generally, a trend that will be exacerbated by the new
regulations that limit the ability of lenders to price
particular individuals for the risk they pose.
Q.5. Effects on Low-income Consumers: I want to put forward
a scenario for the witnesses. Suppose a credit card customer
has a low income and a low credit limit, but a strong credit
history. They use their credit card for unexpected expenses and
pay it off as soon as possible, never incurring late fees. With
the new regulations approved by the Federal Reserve, banks will
be restricted in their use of risk-based pricing. This means
our cardholder could see his or her interest rates and fees
increased to pay for the actions of other card holders, many of
whom have higher incomes.
Do any of the witnesses have concerns that moving away from
risk-based pricing could result in the subsidization of credit
to wealthy yet riskier borrowers, by poorer but lower-risk
borrowers?
A.5. Reducing the ability of lenders to manage risk forces
them to apply more general models to all account holders. The
consequence of applying general models is that all account
holders pay somewhat equally. Lower-risk borrowers at all
income levels bear the brunt of this burden.
Q.6. Role of Securitization: It is my understanding that
during the height of the credit boom nearly half of all credit
card debt outstanding was held in securitization trusts. Over
the last 18 months much of the securitization market has been
severely constrained. The Federal Reserve wants to revive the
securitization markets through the Term Asset Lending Facility
(TALF), but it is not yet operational.
How important is a rebound in the securitization market to
the availability of consumer credit? In other words, how much
greater will the contraction be in the credit card space
without securitization?
A.6. The rebound in the securitization market is a critical
component to the availability of credit in our economy. Credit
cards are funded from two primary sources: deposits and
secondary market funding, each accounting for about half--
approximately $0.5 trillion dollars--of the total funding of
card loans to consumers. Funding in the secondary market relies
on investors' willingness to hold securities that are backed by
credit card receivables. Any change in the terms of issuance
can greatly impact the receptivity of investors to holding
these securities. If investors perceive that there is greater
risk, they are less likely to hold these securities, or may
require significantly higher interest rates or other
enhancements to compensate them for the risk. This means that
less funding will be available, and if available, more costly.
This translates into less credit available at higher cost to
customers. It is hard to speculate as to the extent of greater
contraction caused by a non-functioning securitization market,
as lenders will have to turn to a limited number of
alternative--and higher priced--funding mechanisms. However, we
do believe the additional contraction would be very
significant, and is reflected in the Administration's concern
over this important aspect of the marketplace.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM JAMES C.
STURDEVANT
Q.1. Access to Credit: A potential outcome of the new rules
could be that consumers with less than a 620 FICO score could
be denied access to a credit card. Such an exclusion could
affect 45.5 million individuals or over 20 percent of the U.S.
population.
Without access to traditional credit, where do you believe
that individuals would turn to finance their consumer needs?
A.1. Did not respond by publication deadline.
Q.2. Risk-Based Pricing: Banks need to make judgments about
the credit-worthiness of consumers and then price the risk
accordingly. Credit cards differ from closed-end consumer
transactions, such as mortgages or car loans, because the
relationship is ongoing. I am concerned by the Federal
Reserve's new rules on risk-based repricing for a couple of
reasons. First, without the ability to price for risks, banks
will be forced to treat everyone with equally stringent terms,
even though many of these individuals perform quite differently
over time. Second, without a mechanism to reprice according to
risk as a consumer's risk profile changes, many lenders will
simply refuse to extend credit to a large portion of the
population.
Do you believe that consumers will have access to less
credit and fewer choices because of the Fed's new rule? If so,
is this a desirable outcome?
A.2. Did not respond by publication deadline.
Q.3. Safety and Soundness and Consumer Protection: I
believe firmly that safety and soundness and consumer
protection go hand-in-hand. One needs only to look at the
disaster in our mortgage markets, for clear evidence of what
happens when regulators and lenders divorce these two concepts.
A prudent loan is one where the financial institution fully
believes that the consumer has a reasonable ability to repay.
Do you agree that prudential regulation and consumer
protection should both be rigorously pursued together by
regulators?
A.3. Did not respond by publication deadline.
Q.4. Subsidization of High-Risk Customers: I have been
receiving letters and calls from constituents of mine who have
seen the interest rates on their credit cards rise sharply in
recent weeks. Many of these people have not missed payments.
Mr. Clayton, in your testimony you note that credit card
lenders have increased interest rates across the board and
lowered credit lines for many consumers, including low-risk
customers who have never missed a payment.
Why are banks raising interest rates and limiting credit
apparently so arbitrarily?
Does this result in low-risk customers subsidizing people
who are high-risk due to a track record of high-risk behavior?
A.4. Did not respond by publication deadline.
Q.5. Effects on Low-income Consumers: I want to put forward
a scenario for the witnesses. Suppose a credit card customer
has a low income and a low credit limit, but a strong credit
history. They use their credit card for unexpected expenses and
pay it off as soon as possible, never incurring late fees. With
the new regulations approved by the Federal Reserve, banks will
be restricted in their use of risk-based pricing. This means
our cardholder could see his or her interest rates and fees
increased to pay for the actions of other card holders, many of
whom have higher incomes.
Do any of the witnesses have concerns that moving away from
risk-based pricing could result in the subsidization of credit
to wealthy yet riskier borrowers, by poorer but lower-risk
borrowers?
A.5. Did not respond by publication deadline.
Q.6. Transactional Users vs. Revolving Users: Mr. Zywicki
has said in previous Congressional testimony that prior pricing
mechanisms--which relied to a large degree on annual fees--
forced transactional users of credit cards to subsidize the
actions of consumers who carry revolving debts. I do not
believe that the two categories should be treated in the same
manner. The new regulations seem to limit the ability of
lenders to use tools to distinguish between the borrowers
characteristics.
Do you believe that borrowers' rates and fees should be
determined based on their own actions and not on those of
others?
Do you think that credit card offerings from the past,
which had high APR's and annual fees for all customers were
more consumer friendly than recent offerings that use other
tools to determine fees and interest rates?
A.6. Did not respond by publication deadline.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM TODD
ZYWICKI
Q.1. Access to Credit: A potential outcome of the new rules
could be that consumers with less than a 620 FICO score could
be denied access to a credit card. Such an exclusion could
affect 45.5 million individuals or over 20 percent of the U.S.
population.
Without access to traditional credit, where do you believe
that individuals would turn to finance their consumer needs?
A.1. This is the most worrisome aspect of well-intentioned
consumer credit regulations that will have unintended
consequences of driving borrowers, especially credit-impaired
borrowers, to other less-attractive forms of credit. Those who
ore unable to get a credit card will likely be forced to turn
to alternatives such as payday lending. Those unable to get
credit from a payday lender will likely be forced to turn to
pawn shops. And those who are unable to gain access to pawn
shop credit may find themselves unable to get legal credit at
all.
Consumers often have emergencies or necessities for which
they need credit. For instance, a young person needs credit to
start a life away from home--clothes for a job, furniture for
an apartment, etc. Consumers may have emergencies such as car
repairs, for which they will have to find credit somewhere. If
good credit is not available consumers will turn toward less-
attractive terms of credit instead.
Q.2. Benefits of Credit Card Use: Professor Zywicki, in
previous testimony you suggested growth in credit cards as a
source of consumer credit has replaced installment lending,
pawnshops, and payday lending. I am concerned that the newly
finalized rules may result in a lack of available consumer
credit. I believe that there were clearly some egregious
practices that the Federal Reserve and others should
appropriately eliminate, but many who have criticized the
credit card industry for facilitating excessive consumer debt,
fail to point out the benefits of open access to consumer
credit.
Does the consumer benefit from access to open ended
consumer credit over other less regulated forms of credit such
as pawn shops, payday lenders, and installment lending?
A.2. Consumers absolutely benefit from access to open-ended
consumer credit. The dramatic growth in credit card use in
recent decades testifies to this fact. Installment lending,
such as retail store credit is limited because it requires
consumers to ``buy'' goods and credit as a bundle. Personal
finance company loans are typically both more expensive for the
buyer to apply for, offer higher interest rates and other
costs, and impose a rigid repayment schedule. A borrower also
might be unable to get a personal finance company loan at the
moment that he needs it. Payday lending and pawnshops are
obviously inferior to credit cards and these other options.
Credit cards offer consumers many benefits that these other
products do not. Credit cards have flexible use and repayment
terms. Borrowers can pay as much as they want and can switch
easily among alternative card issuers. They are also generally
acceptable, thereby allowing the unhooking of the credit
transaction from the goods transaction. This allows consumers
to shop more vigorously in both markets. General-acceptance
credit cards also permit small businesses to compete on an
equal footing with large businesses and department stores by
relieving those small businesses of the risk and cost of
maintaining their own in-house credit' operations. According to
one survey conduct by the Federal Reserve, 73 percent of
consumers report that the option to revolve balances on their
credit cards makes it ``easier'' to manage their finances
versus only 10 percent who said this made it ``more
difficult.'' Durkin, Credit Cards: Use and Consumer Attitudes
at 623.
Q.3. Risk-Based Pricing: Banks need to make judgments about
the credit-worthiness of consumers and then price the risk
accordingly. Credit cards differ from closed-end consumer
transactions, such as mortgages or car loans, because the
relationship is ongoing. I am concerned by the Federal
Reserve's new rules on risk-based repricing for a couple of
reasons. First, without the ability to price for risks, banks
will be forced to treat everyone with equally stringent terms,
even though many of these individuals perform quite differently
over time. Second, without a mechanism to reprice according to
risk as a consumer's risk profile changes, many lenders will
simply refuse to extend credit to a large portion of the
population.
Do you believe that consumers will have access to less
credit and fewer choices because of the Fed's new rule? If so,
is this a desirable outcome?
A.3. This is likely to be the case, for exactly the reasons
stated. If lenders are permitted only to reduce interest rates
but not raise them, they will have to charge a higher interest
rate to all borrowers to compensate for this risk. Moreover,
this would give borrowers an opportunity to reduce their
interest rates by switching to another card but lenders would
be unable to raise interest rates in response to a change in
the borrowers risk profile.
Credit cards are structured as revolving debt for a reason:
unlike other loans, it amounts to a new loan every month. Thus,
every month the borrower has the option to switch to another,
lower-interest card.
Q.4. Bankruptcy Filings: As the recession worsens, many
American families will likely rely on credit cards to bridge
the gap for many of their consumer finance needs. Mr. Levitin
and Mr. Zywicki, you seem to have contrasting points of view on
whether credit cards actually force more consumers into
bankruptcy, or whether credit cards help consumers avoid
bankruptcy.
Could both of you briefly explain whether the newly enacted
credit card rules will help consumers avoid bankruptcy or push
more consumers into bankruptcy?
A.4. By making credit cards less-available and less-
flexible, new stringent regulations will likely push more
consumers into bankruptcy. Consumers in need of credit will
seek that credit somewhere. Reducing access to good credit,
like credit cards, will force these borrowers into the hands of
much higher-cost credit, such as payday lenders. Moreover,
credit cards are especially valuable because they provide a
line of credit that the borrower can access when he needs it,
such as when he loses his job and has medical bills. By
contrast, if the borrower is required to apply for a bank loan
after a job loss, he is likely to be rejected, which will
accelerate his downward spiral. Moreover, credit cards are
valuable in that they can be used to purchase almost any good
or service. Again, the flexibility of credit cards is valuable
to consumers.
Q.5. Safety and Soundness and Consumer Protection: I
believe firmly that safety and soundness and consumer
protection go hand-in-hand. One needs only to look at the
disaster in our mortgage markets, for clear evidence of what
happens when regulators and lenders divorce these two concepts.
A prudent loan is one where the financial institution fully
believes that the consumer has a reasonable ability to repay.
Do you agree that prudential regulation and consumer
protection should both be rigorously pursued together by
regulators?
A.5. Yes. But not all safety and soundness issues related
to consumers are also consumer protection issues. For instance,
there were obviously a number of ordinary homeowners who
essentially decided to act like investors with respect to their
homes by taking out nothing-down, no-interest mortgages and
then walking away when those homes fell into negative equity.
If the consumers failed to understand the terms of those
mortgages, then that is a consumer protection issue. If,
however, the consumer consciously made this choice to speculate
and the lender made the loan anyway, then while this would
trigger a safety and soundness concern it is difficult to see
how this would amount to a consumer protection issue.
Q.6. Subsidization of High-Risk Customers: I have been
receiving letters and calls from constituents of mine who have
seen the interest rates on their credit cards rise sharply in
recent weeks. Many of these people have not missed payments.
Mr. Clayton, in your testimony you note that credit card
lenders have increased interest rates across the board and
lowered credit lines for many consumers, including low-risk
customers who have never missed a payment.
Why are banks raising interest rates and limiting credit
apparently so arbitrarily?
Does this result in low-risk customers subsidizing people
who are high-risk due to a track record of high-risk behavior?
A.6. Did not respond by publication deadline.
Q.7. Effects on Low-income Consumers: I want to put forward
a scenario for the witnesses. Suppose a credit card customer
has a low income and a low credit limit, but a strong credit
history. They use their credit card for unexpected expenses and
pay it off as soon as possible, never incurring late fees. With
the new regulations approved by the Federal Reserve, banks will
be restricted in their use of risk-based pricing. This means
our cardholder could see his or her interest rates and fees
increased to pay for the actions of other card holders, many of
whom have higher incomes.
Do any of the witnesses have concerns that moving away from
risk-based pricing could result in the subsidization of credit
to wealthy yet riskier borrowers, by poorer but lower-risk
borrowers?
A.7. Interference with risk-based pricing makes it more
difficult for lenders to tailor prices to the details of the
behavior of particular consumers. As a result, lenders have to
price card terms on less fine-grained assessments of risk. This
leads to pricing risk across broader categories of borrowers,
and in turn, increases the cross-subsidization among consumers.
I can see no good policy reason why this should be encouraged.
Q.8. Restriction on Access to Credit: One suggestion being
made in order to encourage students not to become overly
dependent on debt is to restrict access to credit to
individuals under the age of 21.
Mr. Zywicki, could you explain for the Committee the
potential benefits and detriments of this policy?
A.8. Benefit: A potential benefit, in theory, is that some
younger consumers may avoid getting into debt trouble. I am not
aware of any rigorous empirical evidence of how common this is.
Detriments: There are several detriments:
(1) LStudents who do not have access to credit cards may be
tempted to take out more in the way of student loans.
Because repayment on student loans is deferred until
after graduation, this could cause students to take on
more debt than they would if they had to pay some of
their balance every month.
(2) LEmpirical studies find that one major reason that causes
students to drop out of college is a lack of access to
credit. Many students eventually tire of ``living like
a student,'' i.e., living in dorms and eating dorm food
and Ramen noodles. They want an opportunity to have
some sort of normal life, to go out to dinner every
once in a while. Many students use credit responsibly
and maturely and can have a happier student life
experience if they have access to a credit card.
(3) LMany students need access to credit. Although under the
age of 21, many students essentially live on their own
in off-campus apartments and the like. They need credit
cards to pay for food, transportation, and the like.
Thus, the rule sweeps far too broadly.
(4) LSince the early 1990s, the fastest-rising debt on
household balance sheets has been student loan debt.
Students routinely graduate with tens of thousands of
dollars in student loan debt. By contrast, very few
students have more than a few thousand dollars in
credit card debt. If Congress wants to seriously help
indebted students, it should investigate the
extraordinary level of student loan debt being
accumulated. While credit cards can be a problem in
some cases, the scope of the problem is dwarfed by the
deluge of student loan debt.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM LAWRENCE
M. AUSUBEL
Q.1. Access to Credit: A potential outcome of the new rules
could be that consumers with less than a 620 FICO score could
be denied access to a credit card. Such an exclusion could
affect 45.5 million individuals or over 20 percent of the U.S.
population.
Without access to traditional credit, where do you believe
that individuals would turn to finance their consumer needs?
A.1. There is no reason to expect that the new rules will
result in the wholesale denial of access to credit cards for
any group of consumers that currently has access to credit
cards. As such, individuals who currently have access to credit
cards are likely to continue to rely primarily on credit cards
for their consumer finance needs.
Q.2. Risk-Based Pricing: Banks need to make judgments about
the credit-worthiness of consumers and then price the risk
accordingly. Credit cards differ from closed-end consumer
transactions, such as mortgages or car loans, because the
relationship is ongoing. I am concerned by the Federal
Reserve's new rules on risk-based repricing for a couple of
reasons. First, without the ability to price for risks, banks
will be forced to treat everyone with equally stringent terms,
even though many of these individuals perform quite differently
over time. Second, without a mechanism to reprice according to
risk as a consumer's risk profile changes, many lenders will
simply refuse to extend credit to a large portion of the
population.
Do you believe that consumers will have access to less
credit and fewer choices because of the Fed's new rule? If so,
is this a desirable outcome?
A.2. There is no reason to expect that consumers will have
significantly less access to credit or fewer choices because of
the Fed's new rule. The principal effect of the new rule will
be to limit penalty pricing of credit card consumers, not to
limit access to credit or consumer choices.
Q.3. Safety and Soundness and Consumer Protection: I
believe firmly that safety and soundness and consumer
protection go hand-in-hand. One needs only to look at the
disaster in our mortgage markets, for clear evidence of what
happens when regulators and lenders divorce these two concepts.
A prudent loan is one where the financial institution fully
believes that the consumer has a reasonable ability to repay.
Do you agree that prudential regulation and consumer
protection should both be rigorously pursued together by
regulators?
A.3. It should be observed that consumer protection, as
furthered by the Dodd bill, will help to contribute to the
prudency of loans. Consumers will better understand whether
they will be able to repay loans, and they will be more likely
to avoid loans that they understand they do not have the
reasonable ability to repay. Lenders will be unable to rely on
penalty interest rates following delinquency, so they will be
more likely to avoid making loans that are destined to go
delinquent. It is difficult to state an opinion on prudential
regulation more generally, without being provided some
specificity about the form of prudential regulation being
proposed.
Q.4. Subsidization of High-Risk Customers: I have been
receiving letters and calls from constituents of mine who have
seen the interest rates on their credit cards rise sharply in
recent weeks. Many of these people have not missed payments.
Mr. Clayton, in your testimony you note that credit card
lenders have increased interest rates across the board and
lowered credit lines for many consumers, including low-risk
customers who have never missed a payment.
Why are banks raising interest rates and limiting credit
apparently so arbitrarily?
Does this result in low-risk customers subsidizing people
who are high-risk due to a track record of high-risk behavior?
A.4. If it is the case that banks are raising interest
rates and limiting credit arbitrarily, this is probably due
primarily to the financial crisis and the economic downturn.
Under normal circumstances, credit card lending is highly
profitable and there is little reason for banks to reduce
credit lines. Banks do raise interest rates, but usually not
across the board, as this would result in the loss of some
profitable customers. There is no reason to expect that the new
rules will lead to cross-subsidization of any particular group
of customers.
Q.5. Effects on Low-income Consumers: I want to put forward
a scenario for the witnesses. Suppose a credit card customer
has a low income and a low credit limit, but a strong credit
history. They use their credit card for unexpected expenses and
pay it off as soon as possible, never incurring late fees. With
the new regulations approved by the Federal Reserve, banks will
be restricted in their use of risk-based pricing. This means
our cardholder could see his or her interest rates and fees
increased to pay for the actions of other card holders, many of
whom have higher incomes.
Do any of the witnesses have concerns that moving away from
risk-based pricing could result in the subsidization of credit
to wealthy yet riskier borrowers, by poorer but lower-risk
borrowers?
A.5. No. There is no reason to expect that the new rules
will lead to cross-subsidization of any particular group of
customers. The principal effect of the new rules will be to
limit increases in credit card interest rates following late
payments. As documented in my written testimony, the typical
increases in interest rates bear no reasonable relation to
default risk. The penalties imposed on consumers are typically
at least double or triple the enhanced credit losses
attributable to these consumers. The terminology of ``risk-
based pricing'' for the regulated practices is a misnomer; it
is more accurately viewed as ``penalty pricing.'' Under the new
rules, banks will still be able to charge higher interest rates
(upfront) to riskier customers. That is, true risk-based
pricing will still be possible within the rules.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM TRAVIS
PLUNKETT
Q.1. Without access to traditional credit, where do you
believe that individuals would turn to finance their consumer
needs?
A.1. As I mentioned in my testimony before the Committee,
it is important to note that the lack of regulation can also
lead to detrimental market conditions that ultimately limit
access to credit for those with less-than-perfect credit
histories. Credit card issuers have recently reduced the amount
of credit they offer to both existing and new cardholders, for
reasons that have virtually nothing to do with pending
regulation of the market. Issuers losses have been increasing
sharply, in part because of unsustainable lending practices.
(Please see my written testimony for more information.) Had
Congress stepped in earlier to require issuers to exercise more
responsible lending, they might not be cutting back on
available credit as sharply right now.
Regarding access to affordable credit for individuals with
an impaired or limited credit history, CFA has urged mainstream
financial institutions to offer responsible small loan products
to their depositors. We applaud FDIC Chairman Sheila Bair's
leadership in proposing guidelines for responsible small loans
and her call for military banks to develop products that meet
the test of the Military Lending Act predatory lending
protections. Banks and credit unions should extend their line
of credit overdraft protection to more account holders. The
FDIC has a pilot project with 31 participating banks making
loans under the FDIC guidelines for responsible small-dollar
lending.
Offering affordable credit products is not the only
strategy needed to help households more effectively deal with a
financial shortfall. Borrower surveys reveal that many
households are not using high-cost credit because of a single
financial emergency, but instead have expenses that regularly
exceed their income. For these households who may not be able
to financially handle additional debt burdens at any interest
rate, non-credit strategies may be more appropriate. These may
include budget and financial counseling; getting help from
friends, family, or an employer; negotiating with a creditor;
setting up different bill payment dates that better align with
the person's pay cycle; and putting off a purchase for a few
days.
Toward this end, it is very important that banks and credit
unions encourage make emergency savings easy and attractive for
their low- and moderate-income customers. Emergency savings are
essential to keep low-income consumers out of the clutches of
high-cost lenders. CFA's analysis based on Federal Reserve
Board and other survey data found that families earning $25,000
per year with no emergency savings were eight times as likely
to use payday loans as families in the same income bracket who
had more than $500 in emergency savings. We urge banks and
credit unions to make emergency savings easy and attractive for
their customers.
Q.2. Do you agree that prudential regulation and consumer
protection should both be rigorously pursued together by
regulators?
A.2. Absolutely. Credit card issuers must do a better job
of ensuring that borrowers truly have the ability to repay the
loans they are offered. As I mention in my testimony, card
issuers and card holders would not be in as much financial
trouble right now if issuers had done a better job of assessing
ability to repay. This is why CFA has supported legislation
that would require issuers to more carefully assess the
repayment capacity of young borrowers and potential cardholders
of all ages.
Q.3. Do any of the witnesses have concerns that moving
away from risk-based pricing could result in the subsidization
of credit to wealthy yet riskier borrowers, by poorer but
lower-risk borrowers?
A.3. Under the Federal Reserve rules, card issuers will
certainly have to be more careful about who they extend credit
to and how much credit they offer. Given the current levels of
indebtedness of many card holders--and the financial problems
this indebtedness has caused these borrowers and card issuers--
it is hard to argue that this is a bad thing. However, the
Federal Reserve rules still preserve the ability of card
issuers to price for risk in many circumstances, if they wish.
They can set the initial rate a cardholder is offered based on
perceived financial risk, reprice on a cardholder's existing
balance if the borrower is late in paying a bill by more than
30 days, and change the borrower's prospective interest rate
for virtually any reason, including a minor drop in the
borrower's credit score or a problem the borrower has in paying
off another debt. In addition, issuers can manage credit risk
in more responsible ways by reducing borrowers' credit lines
and limiting new offers of credit.
Q.4. Do you believe that borrowers' rates and fees should
be determined based on their own actions and not on those of
others?
A.4. It is certainly reasonable to base offers of credit
on legitimate assessments of borrowers' credit worthiness. As I
mention in my testimony, however, many of the pricing methods
that card issuers have used to arbitrarily increase borrowers'
interest rates and fees do not appear to be based on true
credit risk, but rather on the judgment of issuers that they
can get away with charging what the market will bear.
Q.5. Do you think that credit card offerings from the
past, which had high APR's and annual fees for all customers
were more consumer friendly than recent offerings that use
other tools to determine fees and interest rates.
A.5. As I mention in my response above, the Federal
Reserve rules leave plenty of room for card issuers to price
according to borrower's risk, so I do not think it is likely
that we will see a return to the uniform, undifferentiated
pricing policies of the past.