01 Jan 2009 New Visions Commentary: Real Stimulus: Reform How Banks Shop Credit Cards, by Bishop Council Nedd II

Real Stimulus: Reform How Banks Shop Credit Cards by Bishop Council Nedd II (bio)

Americans are justifiably distraught over the home foreclosure crisis and the glut of delinquent debt.  They are also upset and perplexed by the capricious nature of the government’s rush to rescue the financial institutions central to the problem.

It’s not a luxury afforded to the average American.  Why are banks being treated differently?  Among businesses, why are banks being treated differently from automakers?

As the comedian and social commentator Jon Stewart said about the U.S. Congress:  “[They] won’t bail out the people who make cars.  You’ll only bail out the people who make car loans.  Not even car loans!  The people [the Congress] bailed out make derivative paper transfers speculating on the future value of enormous groupings of said loans to China.”

A lot of this is rooted in our economy being lured away from its free-market roots.

Another upheaval is brewing in the credit card industry, where reform is necessary.  Specifically, there needs to be a reform of the “interchange fee.”  Since four of the top five credit card companies took a slice of the bailout pie, demanding change should be relatively easy.

The interchange fee is untethered from market forces.

Some may remember a time when U.S. banks lent money and then profited when their customers repaid the loan with interest.  Of late, some bankers have moved away from that sound business model to making money on fees when a credit card is used.

There’s no more waiting for something as trivial as repayment of a loan.  Bankers get their money immediately.  But now that bankers no longer worry the way they used to about loans getting repaid, we are all feeling the pain. 

As Professor Adam J. Levitin of Georgetown University School of Law pointed out in a New York Daily News commentary last December:

Card issuers make money on every credit card transaction, regardless of whether the consumer pays interest. The bank that has its name on the card receives around two percent of every transaction in a fee paid by the merchant (and passed on to all consumers in the form of higher prices).  This is called the interchange fee.  The banks will collect about $48 billion in interchange fees this year.

Because interchange is based on transaction volume, it creates an incentive for banks to issue as many cards as possible, regardless of the creditworthiness of the borrower.  So, by creating a huge revenue stream unrelated to interest, interchange encourages banks to engage in reckless lending – and virtually every credit card loan is a “liar loan” with no income verification.

It creates a perverse but lucrative incentive to issue more credit cards.  In fact, the structure of the business and the story of loans going bad mirrors what happened with mortgages.

Perhaps this shouldn’t be a surprise in light of the fact that the same banks that gave people mortgages they couldn’t afford also send pre-approved credit card offers to people who can’t afford them! 

We still have a lesson to be learned.  When a market is devoid of competitive market forces, problems always follow.

We need a vibrant and competitive marketplace for our economy to thrive, and we need a financial system that can handle our credit needs in order to get there.  Perhaps that means we should re-think the banks’ current business model.

A return to the traditional system of making money when customers repay their loans – rather than making money on fees – may be just what the doctor ordered.

If we did that, then banks would do well when their customers do well, and vice versa.  

Barack Obama and his allies got a “stimulus” bill passed, but making sure that the interests of people giving out credit and the interests of the economy as a whole are aligned may be the real stimulus that everyone needs.

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