Why Credit Card Companies are so Mean

[Caliga]

I found this article amusing for some reason.  The strikethrough is from the original article, too.

http://business.theatlantic.com/2009/05/why_credit_card_companies_are_so_mean.php

Why Credit Card Companies Are So Mean
Tuesday, Ryan Avent wrote about credit cards, so I don't want to oversaturate people's interest, but I thought it might be helpful to understand just where credit card companies are coming from. And why those in Congress would really benefit from a class or two in basic economics. I'm talking to you Maxine Waters. Okay, she probably requires a brain transplant more than a class or two.

An example might help to better understand credit card companies.

Let's say you're a kid and have two brothers: Jake and Howard. Jake is unreliable and irresponsible. Howard is reliable and responsible. Each asks you to borrow money. What do you do?

If you understand economics, you'd know that the risk involved in loaning each money is different. There is significantly more risk in loaning Jake money than Howard. That means that if you charge Jake more interest, you are likely to have a lower loss based on that risk. So that's what you do. You charge Jake 20 percent interest, but only charge Howard 5 percent.

The following month, you decide that, for some external reason that has nothing to do with the loan - maybe Jake lost his lawn mowing job or crashed his bike - you are more worried about Jake paying you back than before. You now tell him if he wants to borrow more money, he needs to pay 25 percent interest.

Jake feels persecuted, so he complains to mom. Mom says you are mean and can't take advantage of Jake that way. She says you can't increase his interest rate.

How would you react?

If you said, "Easy, I would choose not to loan Jake any money because I can't be sure that I'll earn a high enough return to get my money back," then congratulations, you understand credit card companies and probably basic economics.

If you said, "Mom is right. He's my brother, so I should treat him more fairly," then congratulations, you might be a member of Congress someday.

The interest rate increases that Congress calls "arbitrary" are anything but. Credit card companies have complex models that include dozens of variables consisting of different customer characteristics. After everything is taken into account, a rigorous, highly tested credit recommendation pops out of their risk management engine. They literally have math and statistics PhDs who are in charge of this stuff. Congress seeks to prevent such complex analysis.

Ironically, denying credit to riskier customers is the only way that credit card companies really can respond. By increasing regulation on how they manage riskier borrowers, Congress is forcing the companies' hand, and they will be forced to tighten credit on the very people Congress intends to help. If they cannot be compensated for the risk they're taking, then they won't take the risk.

Ultimately, Congress must make peace with their presumably unintended proclamation that those with poor credit are better off without credit cards than with credit cards that have aggressive terms and conditions. Right now, those consumers have the freedom to choose, but instead, Congress' "credit card bill of rights," will take that right away when the credit card companies are forced to tighten or deny credit to many of them in the days to come.

[Berkut]

Christ, this shit is so fucking stupid - right up there with Congress, including the "smartest guy in the house" deciding that it would make good economic sense to pass laws encouraging banks to lend money to people who cannot pay it back in order for them to buy houses they cannot afford.

I simply do not understand the credit card problem being "solved". The bank offers you money at some interest rate. If you think the rate is unfuckingfair THEN DON"T BORROW THE MONEY FROM THEM!!!

They cannot raise you rates on the money you already owe them, barring some default on YOUR part (which you agreed to when you borrowed the money in the first place, btw), so what is the problem that needs this solution?

[ulmont]

They cannot raise you rates on the money you already owe them

Are you sure about that?

[Berkut]

They cannot raise you rates on the money you already owe them

Are you sure about that?

Yes.

The only way they can raise your rate on money you have already borrowed is if you have defaulted onteh terms of it being borrowed.

The only other way I could imagine is if you were stupid enough to sign up for a CC with a variable interest rate - but who would do that? I don't even know if they exist. And if they do, they are pegged to some standard rate, presumably.

[alfred russel]

They cannot raise you rates on the money you already owe them

Are you sure about that?

Yes.

The only way they can raise your rate on money you have already borrowed is if you have defaulted onteh terms of it being borrowed.

The only other way I could imagine is if you were stupid enough to sign up for a CC with a variable interest rate - but who would do that? I don't even know if they exist. And if they do, they are pegged to some standard rate, presumably.

Rather foolishly, I think I have open about 15 credit cards (though I only use a couple) and it seems recently I get letters every few weeks changing the terms and telling me that if I don't like the change I need to call them.

[Faeelin]

They cannot raise you rates on the money you already owe them, barring some default on YOUR part (which you agreed to when you borrowed the money in the first place, btw), so what is the problem that needs this solution?

Hmm. You're not concerned at all with the fact that credit card companies are basically an oligopoly?

[DontSayBanana]

Yes.

The only way they can raise your rate on money you have already borrowed is if you have defaulted onteh terms of it being borrowed.

The only other way I could imagine is if you were stupid enough to sign up for a CC with a variable interest rate - but who would do that? I don't even know if they exist. And if they do, they are pegged to some standard rate, presumably.

They're out there. I used to process a lot of variable rate card apps for Juniper Bank that tried to catch people with "introductory APR" offers. You end up paying back about 170% of what you borrowed under a lot of those cards, though; we used to pick a project and amuse ourselves in the office by actually sifting through the terms and conditions and figuring out what the actual obligation was.

This whole thing is pretty ridiculous, though. Congress has managed to completely ignore what happened the last time they "lobbied" for lower-income/higher-risk borrowers (oh yeah, it's a large part of what got us into this mess!).

[KRonn]

The more I'm hearing about these new credit card plans by Congress, the more doubts I have. Changes/fixes are needed though, just depends what else goes along with it too.

Follow the money trail. I wonder how many pork items will have to get tacked onto this legislation in order to get it passed?

[KRonn]

I realized a while ago, since last Autumn, that I haven't received any new solicitations to apply for credit cards. About the time the financial sector melted down. I used to get them every week, all the time.

[Berkut]

They cannot raise you rates on the money you already owe them

Are you sure about that?

Yes.

The only way they can raise your rate on money you have already borrowed is if you have defaulted onteh terms of it being borrowed.

The only other way I could imagine is if you were stupid enough to sign up for a CC with a variable interest rate - but who would do that? I don't even know if they exist. And if they do, they are pegged to some standard rate, presumably.

Rather foolishly, I think I have open about 15 credit cards (though I only use a couple) and it seems recently I get letters every few weeks changing the terms and telling me that if I don't like the change I need to call them.

Of course - they can change the terms all they like. And you can elect not to borrow form them under the new terms.

Just because someone made a deal with you at some point does not obligate them to never make any deal with you again. Hell, send them a letter back saying you are changing the terms, and if they want to loan you money it will have to be on yours, rather than theirs.

I imagine they will choose not to loan you money. The same choice you have.

[alfred russel]

They cannot raise you rates on the money you already owe them, barring some default on YOUR part (which you agreed to when you borrowed the money in the first place, btw), so what is the problem that needs this solution?

Hmm. You're not concerned at all with the fact that credit card companies are basically an oligopoly?

They really aren't. There are a lot of institutions offering credit cards.

[Valmy]

Christ, this shit is so fucking stupid - right up there with Congress, including the "smartest guy in the house" deciding that it would make good economic sense to pass laws encouraging banks to lend money to people who cannot pay it back in order for them to buy houses they cannot afford.

I simply do not understand the credit card problem being "solved". The bank offers you money at some interest rate. If you think the rate is unfuckingfair THEN DON"T BORROW THE MONEY FROM THEM!!!

They cannot raise you rates on the money you already owe them, barring some default on YOUR part (which you agreed to when you borrowed the money in the first place, btw), so what is the problem that needs this solution?

The problem is that so many people did this it threatens the stability of the entire international financial market.

Obviously if a few fools did something stupid nobody would care.

[DontSayBanana]

Hmm. You're not concerned at all with the fact that credit card companies are basically an oligopoly?

They're not. All VISA, Mastercard, etc. really do is provide the networks for processing transactions. It's up to the financial institutions to decide whether or not to extend you the credit.

It's a bit like Cisco networking. You have a LinkSys router set up along Cisco lines, but you don't call Cicsco if you have trouble with it- you call LinkSys. Same with computers. You don't call Microsoft for every hardware issue with your Dell, HP, or eMachines computer, even though they all run Windows out of the box.

[Malthus]

Actually, from what I've read the big problem with the credit card business model is that it relies for its profit margins on those who do not pay it off promptly - essentially, on bad credit risks.

From what I've seen, Credit cards perform really two functions: first, as a handy substitute to carrying around large amounts of cash, and a way to make purchases and security deposits; and second, as a way of borrowing money. The first is a real convenience, modern life is annoying without access to credit cards for car rentals and hotels - the second is a really foolish way to borrow money, given the high interest rates charged.

Ideally, one would only use the card in the first sense, instantly paying off any balance oustanding. Card companies offer all sorts of points and perks for using them, so you can actually make money doing this (or at least, the card company doesn't get much profit).

Way it seems to work is that, in order to make a profit, the card companies rely on consumers attempting to use the card in the first sense, failing or forgetting to pay, and running up interest charges (that is, using the card in the second sense).  In short, in the above little parable about Jake and Howard, the card companies LOVE unreliable Jake and hate Howard - Jake earns them money (assuming he doesn't default totally - he has to be unreliable but not too unreliable) and Howard isn't earning them anything much.

Thing is, this business model seems to rely on foolish financial behaviour. Dunno what the import of this is, but I can see why this can cause problems.

[Berkut]

Well, I think there is some happy medium in there.

I have a 821 credit rating - mainly because we are a credit card companies nemesis. We use our card often, but *always* pay it off every month, and never, ever pay interest.

Between this extreme and the guy defaulting all the time is the people who are a perfectly safe risk, but do pay interest. They are the target audience, of course.

No doubt that the credit card industry is largely a shit deal for the consumer - but so is McDonalds. I don't think the solution is to tell McDonalds they aren't allowed to sell cheap, high quality, incredibly unhealthy food though.