Overview of the New Report on Regulating Credit Cards

By Marcia Clemmitt, October 10, 2008

“As I was growing up, I always thought, ‘I don’t want a credit card; if I don’t have the money, I just won’t buy,’” says Edwin Lindo, a senior business major who is student body president at the University of the Pacific in Stockton, Calif. He’d seen his family struggle with some debt and didn’t want to repeat those experiences.

But early in his college career, he faced some big purchases – a laptop computer, for example, and about $500 for books each semester – that changed his mind. Quickly, Lindo found himself with three cards – only one of which he actually intended to apply for – and rising debts. “For a while, I was using all three, but when I got the bills and realized I was paying more for things than I would have paying cash, I didn’t like it at all and realized I was in a very bad position,” says Lindo.

“Right now,” working a part-time campus job that pays $9.50 an hour, “all the money I earn, I’m using to pay off my credit cards,” he says. But Lindo says he worries that his combined student loans and credit card debt will constrict his career dreams. He hopes to attend law school and would like to go into public service, but he fears he’ll have to take a job in a private firm, instead, just because of the better pay.

Consumer debt increasingly plagues Americans, and credit card debt makes up a large portion of that. Between 1980 and 2005, Americans’ annual credit card purchases jumped 25-fold – from $69 billion to $1.8 trillion. And along with the increase have come calls to regulate the credit card industry and end some industry practices that can transform moderate debt into a crushing burden for unwary consumers. Congressional bills introduced this year and in 2007 would ban, among other things, such bank practices as increasing credit card interest rates without notice. For its part, the banking industry argues that only a small percentage of people get into severe financial distress from credit card spending and that the benefits of cashless transactions outweigh the problems.

Overall personal debt – including credit card debt – has risen substantially in recent years. By 2006, says Robert M. Lawless, a professor of law at the University of Illinois, total annual personal income in the United States “was less than our total household debt,” including both mortgage debt and consumer debt such as credit cards. In other words, “if everybody in the country devoted their entire incomes to repayment of our personal debt, we still wouldn’t be able to retire it,” he says.

Moreover, while mortgages make up the biggest chunk of personal debt, in the past two years – as housing prices have dropped and home-equity-backed consumer loans have dried up – credit card debt rose four times as fast as it did between March 2001 and March 2006, says Tim Westrich, a research associate at the liberal think tank Center for American Progress.

Among the approximately 80 percent of U.S. households with at least one credit card, outstanding credit card debt now averages $10,000, says Ronald J. Mann, a professor at Columbia Law Schools in New York City. And only households earning more than $200,000 a year could comfortably pay off that amount of debt in the next billing cycle, he says. Thus, many are carrying so much credit card debt that their ability to respond to sudden needs is limited.

Americans’ median debt levels – the level at which half have more debt and half less – range from Mississippi’s low of $1,098 per individual borrower to Alaska’s whopping $3,384.

And many can’t keep up with those payments. At least 35 million U.S. households are either behind in payments or over the limit on at least one card, says Christopher Viale, president of the Cambridge Credit Counseling Corp. in Massachusetts.

Credit card debt is also instrumental in pushing more low- and moderate-income people into bankruptcy, says Lawless, who estimates 1.1 million American families will file for bankruptcy this year.

Filmmaker Danny Schecter, whose 2006 documentary “In Debt We Trust” traces the web of debt in American society, often asks college audiences how many are in credit card debt. Usually, no one raises a hand at first, he says. Eventually a student will admit to a few thousand in debt, and “suddenly there are topper stories all around the room,” he says. “ ‘I’ve got $10,000.’ ‘I’ve got $100,000.’ “

But many analysts point out that having readily available portable credit is a boon in many ways. “We could not have the kind of society we have” – with the ability to travel and engage in business everywhere and the “flexibility to make quick decisions and act on them financially” – without the current credit card system, says Jeffrey I. Langer, a partner at Chicago-based financial-services law firm Chapman and Cutler.

Credit cards are a big help to merchants, freeing them from the dangers of handling large amounts of cash, for example, he says. And a hotel will accept a credit card rather than a wad of cash for a room because “they can put a hold on your card for a significant amount more than the actual room charge to protect themselves from your unexpectedly using a lot of paid services that run the bill from $400 to $900,” he says.

Indeed, some analysts say, Congress risks mucking up the credit card market with ill-considered regulations.

Free competition, largely unfettered by prescriptive rules, has allowed the industry to develop cards that consumers want, says Langer. People who pay late, for example, have seen their penalties rise from around $10 a decade-and-a-half ago to $35 to $40 today, but raising those fees has allowed companies to reduce charges elsewhere, such as lowering interest rates for people who pay on time, he argues.

But others say current card practices allow or even encourage too many people to get into trouble. “Right now there is virtually no regulation of the substantive terms of credit cards,” says Adam Levitin, an associate professor of law at Georgetown University.

Industry practices that consumer advocates call troublesome include:

* charging customers with late fees for payments that arrive on the due date but after an arbitrary cutoff hour, which can be as early as 9 a.m.;
* raising interest rates suddenly and with no stated reason for customers in good standing;
* applying new higher interest rates to existing balances, not just future purchases; and
* requiring customers to bring disputes before professional arbitrators rather than the courts – even when the disputed debt may have resulted from identity theft.

“Arbitrators have a strong financial incentive to rule in favor of the companies . . . because they can make hundreds of thousands of dollars a year conducting arbitrations,” according to the consumer group Public Citizen.

Card issuers and free-market economists generally prefer greater disclosure of credit terms instead of more rules. But “the evidence [shows] disclosure is just not working,” says Lawless, who recommends “substantive” regulation. “We need to look seriously at some form of interest-rate cap,” he says, similar to the 36 percent cap on consumer-loan interest that Congress approved for the military in 2006.

The more vulnerable segments of the population – the poor and unsophisticated borrowers such as students – increasingly are offered credit cards.

The use of credit cards has steadily increased, with most of the recent jump occurring in lower-income households. “Credit card companies have become really good at exploiting people’s irrationality,” says Michelle J. White, a professor of economics at the University of California at San Diego. “They know that if they get the card into your pocket, you’ll use it, even if you think you won’t.” Then, “once you do something like pay late, you get put into a riskier group,” your interest rate and fees rise, and the debt becomes much more difficult to repay, she says.

Extending more credit to poorer people has gone hand in hand with another troubling trend, says White. “People filing for bankruptcy have become poorer and poorer,” she says. “The average person filing for bankruptcy now is well below median income,” a significant change from 20 years ago. “And that’s not surprising, with more credit available. Once you’ve built up a big balance, you can’t pay it off.”

But others dispute that expansion of credit card use has harmed low-income groups. If credit cards weren’t easily accessible, many would borrow anyway, using far riskier loan sources, such as payday lenders, said Todd Zywicki, a professor at George Mason University School of Law, in Fairfax, Va. The percentage of the lowest-income households “in financial distress” has been largely constant since 1989, he said.

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