My Two Cents - "CARD Law: Benefits and Fallout"

12/23/2009

It is probably very appropriate as we close in on the traditional climax of consumer largesse to discuss the backdrop of this year’s consumption binge (or lack thereof). So lavish has spending historically been between the day after Thanksgiving and the end of the year that it has become a month that retailers cannot do without. They’ve even gone as far as to name the days, coining the terms ‘Black Friday’ and more recently ‘Cyber Monday’.

However, there is a new twist this year. Retailers are crying the blues for some different reasons. First and foremost, according to many industry groups is the fact that credit card companies are cutting limits and turning down applications as they prepare for provisions of the new CARD Law regarding their conduct to take effect next year. According to America’s Research Group, nearly $9 Billion in holiday sales are in jeopardy because of these actions.

Consumer Credit Contraction

In fact, the availability of consumer credit has dried up significantly in the past year, down to $3.6 Trillion from $4.7 Trillion; a decline of over 23%. During this same period, consumer credit outstanding (the amount of the aforementioned credit actually deployed) has dropped over $92 Billion. This has been the first such drop in the history of the series, dating back to 1943.

In fact, so much of a threat is any curtailing of consumer borrowing to the overall economy that the government has taken some unprecedented steps to get banks lending and consumers borrowing. So far it hasn’t really worked, with the notable exception being housing, but there are signs that the housing rally is starting to run out of steam as well.

What the CARD law does (and doesn’t do)

One of the biggest impacts of the new credit card law will be to stop the concept of universal default. If you have a card from bank A and miss a payment on bank B’s card in the past, bank A would raise your rate because they now categorized you as a default risk even though your late payment had nothing whatsoever to do with them. The same went for car, mortgage, and even utility payments. One little mistake anywhere in your financial life and you paid dearly on the credit card front.

The new law also limits the scope of changes that can occur to cardholder agreements without significant notice time given. Just as a personal note, I recently received a booklet, and I do believe that is the correct term, filled with changes to my cardholder’s agreement. At the end, it said I could refuse the changes by cancelling my card. Fair enough. The changes didn’t affect me, but I read the pamphlet anyway. In essence, this particular bank, which shall remain nameless, is paving the way for a bevy of new fees and credit limit cuts. It is my understanding this is going on throughout the entire industry.

Also put in check are random and capricious interest rate hikes not only for new purchases, but on existing balances as well. Perhaps most importantly, when a consumer has multiple interest rates in affect across their outstanding balances, payments will be applied to the highest rate portion first, then downward. This will help prevent a small balance from essentially becoming a perverse annuity for the card issuer.

It is pretty much a no-brainer that many of the consumer-friendly changes listed above will cut bank revenues because they address ways in which banks have scalped consumers for easy cash in the past. What is pretty much left unsaid and completely unaddressed is what the banks might do to maintain their profit levels on consumer credit cards. Unfortunately, the banks and card companies are going to respond in general by making it harder and more expensive for people to get and use credit cards, including even the most responsible borrowers. Rewards programs are likely to be cut or eliminated, and the 30-day grace period may become a thing of the past. Credit is likely to dry up at the margin where people have lower FICO scores and maybe a bankruptcy or two. Deadbeats are liable to lose their 1-3% cash back incentives for using the cards. What also might see an ugly return is the annual fee. Annual fees pretty much disappeared during the orgy of consumption because banks could make money in so many other ways.

If nothing else, the CARD law and the fallout will present a unique opportunity and hopefully some solid incentive for people to dump credit cards in general. It would certainly be better for our savings patterns if we did. It has been demonstrated time and time again that when people use cash, they’re more mindful of the money they spend.

Solutions

Sometimes, however, dumping the cards totally isn’t a viable option. There is a definitely a convenience factor in place with credit cards and much of our economy has shifted in this regard. So unloading your wallet of those plastic shackles might not be something you want to do.

One solution I always give people is to purchase pre-loaded cards. You can get them at most retailers in denominations generally up to $500. You pay the retailer $500 in cash plus a small activation fee and you have yourself a credit card. You can go shopping online or in a store and use it just like a credit card with one limitation: when the funds are used up, you’re done shopping. The card is indexed to what you can afford unlike most credit cards. Another benefit, especially if you shop online, is that if your number is swiped, much less damage can be done. Unfortunately, in the case of the prepaid card, whatever money was on the card is likely gone if someone does get the number.

Another related solution is to use your ATM card for purchases since it is linked directly to your bank account and you can’t overspend. However, there have been countless cases where people have cleaned out their bank accounts to make impulse purchases only to reap the whirlwind when the mortgage comes due.

Another solution, and this is one that has vexed retailers is that people actually SHOULD be cutting back on discretionary purchases. Retailers are mad at Congress for imposing limits on the card industry because it’ll keep people from using cards for purchases they wouldn’t make otherwise. Here’s a news flash. If you need a loan at 20% to buy something then you shouldn’t be buying it! The people on the margin that will be most likely to lose access to credit cards are the ones that will probably benefit the MOST from the CARD act since they’ll be less able to get themselves into credit card trouble.

As we approach the time of year when people celebrate the birth of Christ, it is probably not a bad idea to take a lesson from the Bible as it relates to debt. Romans 13:8 states: Owe no man any thing, but to love one another: for he that loveth another hath fulfilled the law. Maybe this year and forward we could set down the credit cards, live within our means and continue to repair our balance sheets regardless of what Congress, retailers, or banks say. After all, they’ve demonstrated a complete inability do be financially responsible. Perhaps we could lead the way this time.

I’d like to take this opportunity as I put the cap on my pen for the last time in 2009 to wish everyone a safe and relaxing Holiday Season and to thank you for reading My Two Cents; I’ve enjoyed being here.

Graham Mehl is a pseudonym. He is not an ‘insider’. He is required to use a pseudonym by the policies of his firm when releasing written work for public consumption. Although not an insider, he is astonishingly bright, having received an MBA with highest honors from the Wharton Business School at the University of Pennsylvania. He has also worked as an analyst for hedge funds and one G7 level central bank.

Andy Sutton is a research and freelance Economist. He received international honors for his work in economics at the graduate level and currently teaches high school business. Among his current research work is identifying the line in the sand where economies crumble due to extraneous debt through the use of economic modelling. His focus is also educating young people about the science of Economics using an evidence-based approach.