Credit Competition

by Don Boudreaux on January 21, 2007

in Politics, Prices, Regulation

Yesterday’s New York Times had a letter-to-the-editor from Mr. Morton Mintz who suspects that credit-card interest rates are too high — he even used the word usury.  Mr. Mintz calls upon Congress to investigate whether or not these interest rates really are usurious.

Overlook the ambiguity of such words as "usurious."  (Note: Mr. Mintz apparently believes that a clear dictionary definition of "usury" means that in reality usurious rates of interest are objectively distinguishable from non-usurious rates.  Such a belief is mistaken — as mistaken as would be, say, the belief that because the word "profound" has a clear dictionary definition that Congress (or anyone else, for that matter) could determine which books in a library are "profound" and which ones aren’t "profound.")

Overlook also the utter lack of expertise of politicians to assess the merits and terms of contracts between merchants and their customers.  And overlook Congress’ s unavoidable political nature: members of Congress are politicians who will behave as politicians rather than as objective finders of fact.

The germane fact is that many investigations into the appropriateness of credit-card interest rates and charges are continually underway.  They take place ruthlessly and constantly.  They are  done by competitive card issuers and by potential other suppliers of consumer credit seeking out, searching for, ways to expand their market shares.  They are also done by consumers themselves who can switch card issuers or refuse altogether to use credit cards.  If rates are too high, these investigations will discover this fact and correct it.

Am I naive?  Certainly no more naive that is Mr. Mintz and others who suppose that an investigation by Congress into credit-card rates will uncover trustworthy information and use this information as the basis for sound corrective actions.

Of course, I think that I am not naive (although I concede that, were I in fact naive, my naivete would itself hide its reality from my notice).  If there are government-imposed restrictions on the ability of banks and other firms to compete to offer consumer credit, then credit-card rates would then likely be too high.  But absent such restrictions — and I know of none — then our best guess is that rates are appropriate.  If rates were too high, then the greedy quest for profit would prompt one or several firms to lower rates or offer better terms to consumers.

I close by acknowledging that credit-card issuers sometimes resort to sneaky tactics.   Indeed, every time I write against the notion that such issuers should be hauled before Congress and "investigated," I receive a fair number of e-mails from people informing me of the tricks and snares that card issuers sometimes use to increase their profits.

The fact that such tactics are widely known reduces their effectiveness.  More to the point, fraud — if that’s what some of these tactics are — is an offense at common law and should be punished.  High interest-rate charges and late fees are themselves not fraudulent.

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{ 26 comments }

Matt C. January 21, 2007 at 7:40 am

It would be interesting to see Mr. Mintz's credit score. It's amazing the misunderstanding of many people when it comes to credit and especially credit cards. I would suspect that credit cards have a much higher degree of default than a normal credit with collateral backing it up.

There are certainly credit cards companies out there that offer, what I consider, reasonable rates. It would also be interesting to find what happened after laws regulating bankruptcy made it harder to claim bankruptcy, if it had any effect on the interest rates of credit cards overall.

If Mr. Mintz would also write the same about those mortgage companies that offer to consolidate all credit into a mortgage. They argue that all they have to do is beat what a person is paying monthly. So where a "normal" mortgage rate would be in the 5-7% range these mortgage's might be in the 12-15% range. Would those companies that offer these rates be called usurers?

GeorgeNYC January 21, 2007 at 10:06 am

Yiou guys sound like religious fundamentalists. As long as you believe in the god of the market why then everything will be fine.

Yes, that is the way that it is supposed to work. No givernment regulation and voila! the mgic f the market will make sure that the interest rates are corrrectly set!

Does any possibility ever exist in your minds of any type of market failure? Oh yes….that would be fraud!!!! Ha. Any thoughts to how someone who needs to get that kind of credit could afford a lawyer to even begi to figure that out.

You are the Taliban of econmists. Focusig on one issue (the regulation of the interest rates that can be charged) is not even good economics. What about the information asymetries? What about the fact that, even in "economics", it is not acceptable to allow someone to negotiate with a drowning man because of the clear power differential between the two. Of course, I am sure that you have your theolgical…I mean theoretical reasons why that should be so.

You are not talking economics, you are espousing religious belief in the mrket.

Adam January 21, 2007 at 10:30 am

George,

People always trot out example after example of how the market produces imperfect outcomes to "prove" that the market is bad (or, at the very least, deeply flawed) and that we need government to tame it.

No sane person argues that the market is perfect. The argument is simply that given the real-world interest politicians have in getting re-elected and the real-world interest bureaucrats have in expanding their powers and empire (i.e. the number of of people under them), the market is far more likely to reach a decent outcome than the political process.

There's no such thing as interest rates that are "correctly set." There are rates that are appealing to lenders and others that are appealing to borrowers. The market will find something in between. Yes, you don't have any power to negotiate with a bank, but the collective power of consumers to go to another institution (or in this case of a non-necessity, decline to use the product) is enormous. Do you really think that if not for government, we'd be paying 10,000% interest on loans? I like to ask people who believe that government is the only thing protecting us from the capitalist monsters whether they make more than minimum wage. Why does any employer pay more than the legal floor if they're so evil and in need of regulation?

On another note, name-calling isn't very polite.

James Pyrich January 21, 2007 at 10:36 am

George,

It's really hard to take you seriously when you pepper your replies with insults and attacks. Perhaps you're upset at the post and it feels appropriate, but, seriously, dude, you need to chill and think things through before you post.

You have to consider that the plight of the average consumer when it comes to credit is, by and large, a problem created *by* the consumer. That is, a consumer that does not pay attention to his overuse of credit reaps what he sows. I happen to be one of those people and am currently beginning to suffer the consequences.

I have absolutely no love for "corporatism," which I am going to loosely define as "business entities seeking special favors from the state." It is as reprehensible as any special favor sought from the entity of coercion we presently call "government." The recent changes in the credit regulations heavily favor those who offer credit at the expense of those who currently owe credit.

What does this mean to me? Well, duh, I shouldn't have gotten myself into this mess, but now that I'm in it, I have to find a way out. It would be "nice" if the state forced the credit companies to lower their rates and default fees, made it easier to declare bankruptcy, made the effects of bankruptcy not nearly as painful, etc., etc., but that makes me no better than the credit companies themselves.

Ryan Fuller January 21, 2007 at 10:40 am

"I would suspect that credit cards have a much higher degree of default than a normal credit with collateral backing it up."

Of course they do, that's why they charge higher interest rates. It's a riskier loan in the first place.

"You are the Taliban of econmists."

George, you're talking like an idiot. Taliban of economists? Please.

The fact remains that nobody, *nobody* uses a credit card who doesn't think they benefit from it, otherwise they wouldn't use them in the first place. Let those who believe they benefit from them use credit cards, and let everyone else use other forms of payment.

Lets talk about your drowning man scenario. In reality, people in the private sector negotiate to save others who are drowning all the time. They're called "lifeguards". They negotiate their pay in advance, and credit card companies do the same. If someone were to somehow start off with tens of thousands of dollars in debt to their credit card company *before* they signed the contract, maybe your babble about power differentials would mean something.

Flash Gordon January 21, 2007 at 10:57 am

I believe that an imperfect free market will deliver better results for more people than any politician or bureaucrat ever will. But I had a situation recently which shows that for some problems there is no free market solution.

I disputed a debt and offered a compromise amount to the creditor. The creditor accepted the compromise offer, I paid it and thought that was the end of it.

But then the creditor filed a negative report with all three credit reporting agencies. I spent a lot of time trying, unsuccessfully, to get it corrected. The credit reporting agencies will "investigate" a negative report if you ask them, but their "investigation" amounts to no more than asking the creditor if it wants to stick by its negative report. When the creditor affirms its original negative report, that is the end of the matter. It remains on your credit and affects your credit score.

I cannot think of any way the free market can address this situation. I probably have a claim for defamation against this creditor, but realistically that is not much of a remedy because the cost of vindication so outweighs the potential benefit.

Flash Gordon January 21, 2007 at 11:04 am

By the way, when a credit agency "investigates" a dispute only the creditor is allowed to present evidence. The credit agency will not consider anything that the debtor sends them. They say they do not want to be an arbiter between the parties, and will only ask the creditor to investigate itself to see if it thinks it might have made an error. If the creditor "investigates" itself and finds itself to be pure, that is the end of it.

I'm in favor of a law that holds credit reporting agencies liable for false credit reports that it accepts from its members.

JT January 21, 2007 at 11:58 am

>>>Any thoughts to how someone who needs to get that kind of credit could afford a lawyer to even begi to figure that out.

Contingency fees come to mind.

GeorgeNYC January 21, 2007 at 12:01 pm

I apologize if you took offense. I did not mean Taliiban as a personal affront but merely to highlight the dangers of fundamentalism. In this case, you are giving intelectual "cover" to an economic activty that could cause serious harm to people.

"The fact remains that nobody, *nobody* uses a credit card who doesn't think they benefit from it, otherwise they wouldn't use them in the first place. Let those who believe they benefit from them use credit cards, and let everyone else use other forms of payment."

Where does this fact come from other than in your assumption that all individuals act out of self-interest. "Benefit" is somewhat problematic statement. My only "benefit" may the fact that I can feed my kids or pay the rent. I know "on average" these things are not true but you need to consider the margins when dealing with these types of things. Have you ever been in a deperate situation? Do you now whether you would act rationally? No. You would do whatever you could "right at that moment" without regard for the future.

I am not talking about a "nanny state" mentality, but rather to try to recognize when companies are truly acting in a market-driven environment and when they are simply utilizing a market inefficiency (here the dire starights of the individuals) to exploit those without any marlket power. Some government regulation is appropriate to help a market act efficiently in the manner in which you believe it should.

This is difficult to achieve. What I am really asking when I challnge you here is what are the conditions that need to be in plae for there to be a true "free" market. Does there have to be full information sharing? That is, does do all of the market participants need to know what the otehrs are doing? (e.g. the New York stick exchange). Does there need to be fungible commodities? (how can the market distinguish between slightly different products? Does there need to be forced information flows or post-sale enforcement in order to allow for a true market equilibrium. That is, are there incentives to lie about qulity that could result in market inefficiencies.) I am NOT talking about abandoning the market or proposing that government crush competition. These are legitimte economic issues that require thought. I too beleve in the market but I do not beleive that it exists in every context The goal is to try to get it there which MAY require government intevention.

The "lifeguard" situation is not what I am talking about. The hypothetical is that I see a drowning man and say to him "I will save you for $1 million"and he agrees. Is that contract enforceable? It was made freely without any government intervention.

beeper January 21, 2007 at 12:38 pm

Calling for gov't action sounds like a prayer to me.

Who is the religous fundamentalist?

Sparky January 21, 2007 at 1:40 pm

Would not a usurious rate of interest fly in the face of Stiglitzian credit rationing?

David Z January 21, 2007 at 2:27 pm

"Where does this fact come from other than in your assumption that all individuals act out of self-interest"

It's called the "Action Axiom"

see: http://www.mises.org/story/2097

Cam January 21, 2007 at 3:15 pm

What's sad is that if forced to lower their interest rates, credit firms will be more discriminating when it comes to accepting clients. This would theoretically force those with bad credit into the loan shark market, where they are unable to seek the protection of the police.

Needless to say, this is another policy that hurts those it is trying to help.

ben January 21, 2007 at 5:39 pm

Missing from most discussions on credit cards is a mention of the tremendous convenience a credit card provides. The ability to go outside your budget at short notice with no (additional) contracts to write is valuable, though hard to quantify. I do not accept that the value of this convenience to me should be weighed against costs on my behalf by politicians or GeorgeNYC.

quadrupole January 21, 2007 at 6:41 pm

Cam starts to hit on a central point.

All usury laws do is place a ceiling on how risky a borrower a lender can lend to.

Interest rates basically consist of:

1) Cost of money
2) Anticipated inflation
3) Anticipated risk
4) Profit

In general the difference between paying 6% in interest and 27% in interest is the anticipated risk. So if cost of money plus anticipated inflation plus profit is x%, and I charge you y%, it is because I need to charge a premium of (y-x)% to cover the risk of default you represent.

So what I am really doing when I pass a law saying it is usurous to lend at a rate above z% is saying that it is illegal to borrow money if the risk of you defaulting produces a risk premium of greater than (z-x)%. Usury laws restrict the availability of credit to risky parties.

Now it may be that as a matter of public policy we feel that some people just shouldn't be allowed to borrow money. But we should never loose sight of the fact that that is what we are doing: banning some people from the credit market.

True_Liberal January 21, 2007 at 9:13 pm

Flash Gordon: If credit agencies are immune from judgement under civil law, then clearly justice is not served, and I'll submit that is a problem of one-sided government, and can only be solved by releveling the scales of justice. I'll bet if a few such suits are brought and won, the credit agencies may be herded into a fairer way of dispute resolution.

Ryan Fuller January 21, 2007 at 11:43 pm

"Where does this fact come from other than in your assumption that all individuals act out of self-interest. "Benefit" is somewhat problematic statement. My only "benefit" may the fact that I can feed my kids or pay the rent."

That seems like a pretty significant benefit, wouldn't you say?

A benefit is anything that someone considers as such. It only becomes problematic when you adopt the paternalistic attitude that you or someone else is in a better position to dictate what is beneficial, rather than letting everyone decide for themselves. Now, a lot of people make decisions that others will disagree with. I, for one, think it's pretty stupid that anyone would ever do drugs, stay up all night at a party, or buy lottery tickets. However, I realize that other people's values are not the same as mine, so when they balance the short term benefits against the long term costs, the only "right" answer for them is the one they come up with.

"Have you ever been in a deperate situation? Do you now whether you would act rationally? No."

That's assuming an awful lot. The strange thing here is that you're claiming not to be advocating a paternalistic stance, while at the same time trying to conjure up cases where some enlightened bureaucrat (I'm trying not to laugh here) decides what decisions people should be allowed to make for themselves.

"This is difficult to achieve. What I am really asking when I challnge you here is what are the conditions that need to be in plae for there to be a true "free" market. Does there have to be full information sharing? That is, does do all of the market participants need to know what the otehrs are doing? (e.g. the New York stick exchange). Does there need to be fungible commodities? (how can the market distinguish between slightly different products? Does there need to be forced information flows or post-sale enforcement in order to allow for a true market equilibrium."

No, on all counts. A free market requires the lack of coercion, and that's it. From there you can add all the fantasies about perfect information or horizontal demand curves at the competitive price point that you want, but they have abosolutely nothing whatsoever to do with a free market. A free market is free because it is unregulated, not because it matches somebody's models.

"The "lifeguard" situation is not what I am talking about. The hypothetical is that I see a drowning man and say to him "I will save you for $1 million"and he agrees. Is that contract enforceable? It was made freely without any government intervention."

It should be. The sort of person who would let someone else drown unless they get paid to save them is the sort of person who certainly wouldn't do it for free, which is what banning that sort of contract would force.

The "lifeguard" example is a whole lot closer to the way that credit card companies operate than your $1 million drowning man scenario. We have a contract formed in advance by a professional party vs an ad hoc offer by a random bystander.

quadrupole January 22, 2007 at 2:21 am

True Liberal

Under the Fair Credit Reporting Act (FCRA) credit agencies are required to perform a 'a reasonable reinvestigation to determine whether the disputed information is inaccurate'. If you feel they have not done that, you may sue them for violation of the FCRA and recover damages.

Tory Anarchist January 22, 2007 at 4:51 am

Is it that hard to understand that (forced) lower credit rates lead to more discriminatory measures? For all talks about facilitating people's lives with easier access to credit, you'd think that those who advocate such measures would think the whole thing through.

As for 'information asymetries' [sic], I think it's quite fair to assume that if there was 'perfect information' in the market place then there'd be no need for competition; only one provider/producer would be needed, others being superfluous.

lowcountryjoe January 22, 2007 at 6:26 am

If George wants his "life perserver" in a time on need then just who/why in the heck does he think will there will be someone there to throw him the darned thing to begin with?

George, listen to the "Munger" Podcast, please!

jp January 22, 2007 at 10:10 am

George said: "The hypothetical is that I see a drowning man and say to him 'I will save you for $1 million' and he agrees. Is that contract enforceable? It was made freely without any government intervention."

Under well-established principles of Anglo-American common law, a contract made under those circumstances would not be enforceable. (Or, more accurately, the promise given by the drowning man would not be sufficient to form a contract.) The drowning man in the hypothetical made his promise under "duress," as legally defined.

Adam Malone January 22, 2007 at 1:13 pm

JP-

You are correct, that contract would be not be enforcable. But this is not the appropriate analogy for a credit card use situation.

That actual situation would be if someone contacted (or was contactd by) a life saving agency and entered into a contract that stated if there was an emergency situation the agency would save the person's life for a fee.

This is how credit cards actually work. Consumers contact (or are contacted by) credit cards companies. The consumer and the credit company enters into a contract that states that at some point, if a monetary emergency arises the company would help them (save them) for a fee.

When the person enters into the contract they are completely sane and under no form of duress. When the credit card honors the contract by loaning x dollars on demand for y% interest.

Instead of thinking about interest as something creditors use to "stick it" to consumers, interest rates should be thought of as the price paid as a fee for the use of someone else's money.

The argument of "usurious" fees is the same argument as "price gouging". Because some people think it is too much to pay $12 per bag of ice in the aftermath of hurricane they believe that no one should have the opportunity to purchase that bag of ice either.

jp January 22, 2007 at 2:02 pm

Adam Malone — I agree completely with your analysis. My post was just intended to deal with George's argument (which is often trotted out) that the drowning-man hypothetical somehow demolishes libertarianism.

Russell Nelson January 23, 2007 at 8:27 am

GeorgeNYC is frustrated that we don't immediately abandon our religion in favor of his religion: worship of the state. It's obvious to him who the real God is, and he can't understand why we worship a false god.

Russell Nelson January 23, 2007 at 8:34 am

GeorgeNYC says "Some government regulation is appropriate to help a market act efficiently in the manner in which you believe it should."

The trouble, George, is that government regulation is like a stronghold. It is a concentration of resources. The trouble is that any time you concentrate resources, you create a target for attack. What happens when your government regulation is captured and used against you?

A simple call for market intervention is naive without acknowledgement that market intervention has, is, and will be used against the interests of the less powerful.

tv bracket April 14, 2008 at 3:21 am

I can accept George saying "High interest-rate charges and late fees are themselves not fraudulent.", but that doesn't change the fact that there are not enough regulation done by the government to protect the consumers itself. There is nothing wrong for card issuers to profit more, but when it is getting out of control and jeopardizing the nation like it is right now, I believe this is no time for the government to act slowly.

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