I recently had the chance to catch a preview of "The Card Game," a Frontline special on credit cards, which airs tonight at 9pm ET (check local listings). Lowell Bergman talks with a wide range of financial insiders and regulators and describes the changing nature of the credit card industry over the past 30 years.
During the hour, Bergman speaks with Tim Geithner, former Providian CEO Shailesh Mehta, Elizabeth Warren, Christopher Dodd, and many others. He traces a narrative of the changing nature of credit and debit cards, where services and goods became free because they explicitly took on hidden fees and charges, hoping to net enough from a large body of consumers to make profits. Mehta is quite explicit about this, as are other insiders.
There's been a lot of fascinating research in behavioral applied microeconomics along these lines recently; it seems that the credit card industry already figured it out a long time ago. Mehta points out that the most affluent consumers pay the least, while the poorest pay the most. Another way to phrase that is struggling working class families pay a little extra so the comfortable can fly for free, or as a risk modeler told Felix Salmon: "The industry is just a giant wealth transfer mechanism from poor people to wealthly people. The profits from below (subprime) serve to subsidize the interest rate and rewards cost of people in the 'super prime' category."
It's one thing to hear it from a commenter on a blog; it's another thing to hear a former major credit card company CEO say it. The show ends with a discussion of creating a Consumer Financial Protection Agency. If you follow financial blogs obsessively you may have heard a lot of these debates already; however it is good to step back from the esoteric world of capital reserving models and over-the-counter derivatives and realize how the financial crisis is playing out for hundreds of millions of everyday Americans, and this special covers the creation, evolution and current precarious state of the credit card industry well.
And it does have a quote that consumer advocates and financial literacy experts will need to hurdle, during the discussion of free checking that isn't necessarily free: "The two best marketing words in the United States are 'free' and 'all you can eat.'"
The Card Game will be available for streaming here after it airs tonight.
"The industry is just a giant wealth transfer mechanism from poor people to wealthly people.
Seems more a transfer from the ignorant and foolish to the informed and prudent - certainly something I feel should be incouraged.
It's "Encouraged" and it's clear on which side of the "to" you belong. The entire economic system in the US encourages wealth to travel from the poor to the rich. While this may be satisfying to the increasingly rich it results in an underfunded government that as we have seen, can be had at bargain prices.
It's not the US system "encourages" the transfer, it's that this transfer is "permitted." There's a difference and this difference should not be overlooked.
The entire economic system in the US encourages wealth to travel from the poor to the rich.
So, in your world the system would be set up to encourage wealth to travel from the informed and prudent to the ignorant and foolish?
More specifically, a transfer from those who pay their bills on time to those who don't.
Just want to mention that the merchant side of this is a near 3%* shave off teh purchase price. So the merchant takes a 3% hit up front for accepting cards. *The rate varies, but that is the average upper end when you combine the various fees.
So the merchant takes a 3% hit up front for accepting cards.
Merchants will take a hit no matter what form of payment they accept. Cash has significant costs as well in terms of theft both by robbery or embezzlement, accounting, transporting, depositing, insurance, etc.
You can pull a report from the register and reconcile it with the credit card machine in 2 min. Counting out a cash draw can take 10 min on a busy day and then if it doesn't balance, you need to count it again.
3%
For monthly sales of say $50,000, that's $1500. I think I can count cash for that savings. Heck, I can even buy a money counter. And that'as a one-time purchase.
That $4 latte mocha grande costs the retailer maybe 37 cents in per-swipe fees and the discount fee. So the retailer has to build the costs of the discount into the price of his goods or go slowly broke.
For monthly sales of say $50,000, that's $1500. I think I can count cash for that savings.
And if you're not on the floor during all business hours how do you prevent your employees from robbing you blind in an all cash business?
How much do you end up paying in workers compensation premiums when your employee gets robbed and ends up going out with PTSD?
I'm not even arguing that cash isn't cheaper, just that is has its own substantial costs.
I just don't understand this theory. If poorer customers are subsidizing the wealthier customers - that means that the credit card companies are losing money on the wealthier customers, right? And if they were, then wouldn't a company be able to out-compete its competitors by dropping those customers? And yet credit-card companies are competing to invite wealthy customers - which leads me to believe that those customers do create a profit. It may be the case that the companies make a larger profit off lower-income customers, but that doesn't imply any sort of subsidy.
The wealthy customers certainly generate a profit as part of that 3% Paul notes above. And, in reality, they are just sharing a part of that 3% with their highest volume customers, since taking 2% off a $5000 monthly expense is a lot nicer than 3% off a $500 monthly expense. Then factor in that the guy who charges $5000 per month and pays it all off in full like clockwork probably has a lot of payment options. But the bottom line is that this isn't where banks are making their money -- they're making it on the 18% interest charges on those people who don't pay it off in full.
So I'm still not clear, though, on why this translates into a poor subsidizing the rich situation? The only way I see this as a subsidy is if the banks are suggesting that the risk they face of a rich guy defaulting costs more than the 1% kickback they are paying their best customers on the 3% they make charging vendors, and they are absorbing this risk at no charge because they are just so wealthy from the interest rates the poor pay. Because otherwise they are still making 2% on whatever the richer customers charge.
I think it's more the suggestion that the rich guy who has always paid it off on time might at some point fail to pay it off, whether because of forgetting or losing a job or whatever.
If you believe, as some do, that missing a payment or not being able to pay it off in full is mostly about luck, the people that never end up owing interest are slightly subsidized by those who do because the card company gives them the card in the hopes that one day the customers will mess up and get hit with fees.
Yes, paying everything off in full is related to being richer. It's easier to do the more money you have But some people live within their means at any income, and some people would burn through all their money no matter how much they had. Some people would always save 10%, some people would always run up debt.
The real world has both a combination of the inherent random unfairness (stressed by liberals) and results of moral choices (stressed by conservatives and libertarians.)
The real world has both a combination of the inherent random unfairness (stressed by liberals) and results of moral choices (stressed by conservatives and libertarians.)
If you asked a liberal - Should someone be forgiven for being racist, sexist and homophobic because they grew up in a family that espoused such views? The vast majority would say no, you can't be excused from a belief just because your parents, your church, or the government indoctrinated you.
But ask them - Should transfer payment be made to support someone because they were raised in an anti-intellectual environment that felt that education and delayed gratification was a waste of time? The vast majority would say no, you can't hold someone to account for beliefs that were exposed by both popular culture and their own parents.
I don't see such beliefs as internally consistent.
And to Kennyboy I mean "espoused" not "exposed".
Well, if I get to buy today, with Visas money, and I pay Visa in full when the bil comesw in in say, three weeks, I just scammed myself an interest free loan. That "cost of money" has to be recouped in interest and late fees, cash advance fees, etc from people at all income strata, but as has been mentioned, probably from those without the means to pay in full each month or who otherwise use the expensive services of the credit card company. Call them "poor" if you like, it's either cash poor, or poor financial management skills.
The comments here reflect that the article doesn't do a particularly good job of reproducing the original story, which I read elsewhere.
Here's how it works: Leave aside the person paying credit card interest for a moment. The real victims (so runs the argument) are those who are so poor they can't even get a credit card in the first place (possibly they don't even have bank accounts). Because the law generally (not universally, but generally) prohibits merchants for charging consumers extra for paying with credit card, those merchant fees are simply factored into the price that all consumers pay.
This means that the rich-- who get the convenience of the credit card, presumably pay no interest or annual fees, and enjoy all kinds of valuable perks (such as the 2% cash back I get on every single transaction)-- pay only a portion of the very real fee that the credit card provider charges. The rest is paid, involuntarily, by the poor who do not benefit from the service at all. This is a subsidy, or a wealth transfer.
Anyway, that's the argument.
And again - we'd have to get an idea of how much it costs a business to process cash transactions. It may be lower than for credit cards but it's certainly not zero.
Yes, processing cash has some costs associated with it, but a good portion of these costs will be present if your business chooses to accept cash at all. I assume the marginal cost of taking another dollar in cash as payment is close to zero, but the marginal cost for accepting the credit card is always 3% (or whatever that card charges the merchant). Since most businesses aren't planning on getting rid of cash completely, I think it is fair to focus on the marginal cost.
As prima facie evidence I'll take the fact that many small businesses that can get away with it will still charge you less for cash than for credit (at least if you ask). If the cost of processing cash was more than credit it seems unlikely that they would do this.
To clarify my point-- the cards aren't robbing the poor to spoil the rich. I'm going to assume that the credit card companies are extremely greedy, not Dennis Moores going around stealing from the poor to give to the rich because they love the rich. They'd like to maximize profit from everyone.
The card issuers can pretty easily distinguish the poor from the rich. If the rich were actually unprofitable or less profitable than they could be, then the card issuers would change their terms (or deny them cards) fairly easily. Since we have a lack of major credit card companies who specialize in denying cards to the rich in order to concentrate on that profitable poor person market, I'm dubious that the margins are so much smaller on the rich as a class. (As opposed to the rich being less likely to default.)
However, part of the rich and middle class, made up of the people who run balances regularly, or who forget and incur a fee, or who get in financial trouble and have to carry a balance, probably does subsidize those who never have a problem. Card companies do envision those penalty fees as part of their expected take, and if you never fall in that category, you do win out a bit. Of course, card companies could just cancel the cards of people who refuse to run a balance, but it seems that doing that is more trouble than it's generally worth-- you hear more rumors of that happening than you actually experience it. A customer who pays her balance in full each month is still generally profitable, just not as profitable as she could be.
OTOH, some cards have no annual fee and 5% on some purchases. Cardholders who only use those cards for the 5% items, using another card for everything else may well be unprofitable. But then those cards should disappear, and indeed Chase and Citi stopped offering some cards with so generous rewards a couple years ago, before this legislation.
Now the card issuers may be robbing the poor who lie on their applications and overstate their income in order to get a card. And I suppose one could argue that somehow that's also the issuer's responsibility to do more due diligence, but I wouldn't be happy about losing instant approval and having to provide more evidence of income in order to get a card, when I'm trustworthy and responsible. In addition, if the poor are so desperate to get a card, then perhaps the current alternatives to using credit cards are even worse.