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Credit Card Roundup: Penalize Borrowers More, Not Lenders

Of all the different areas of consumer finance, to many none is more emotive than credit cards.

New legislation introduced last week to curb credit card issuers from "abusive" practices such as slapping late-paying customers with ultra-high fees was therefore, received with much fanfare.

Basically, the new laws will prevent credit card issuers from jacking up fees at the last minute to "late payers," issuing credit cards to those under the age of 21, and increase fees to those who have been timely interest payers for around two months.

The biggest opposition to the new laws comes, as you might expect, from the credit card companies themselves. Already besieged with big earnings declines last year from credit card defaults, lenders such as American Express and Capital One Finance claim that the legislation will force them to disadvantage their best customers in order to remain profitable.

Jim Randel over at the Huffington Post complains about the absurdity of limiting credit card issuances to over-21's, while David Lazarus, writing in the Los Angeles Times, takes further issue with the lenders:

Leave it to the banks to try to turn passage of credit card reform legislation Tuesday into bad news for many cardholders.

Here's the deal: Banks are basically saying that because they're going to have to change some lending practices to comply with the bill, they'll be facing greater risk.

To cope with that risk, they say, they'll have to turn the screws on their best customers -- the ones who manage their finances prudently and pay off their bills on time -- by possibly raising interest rates, scaling back rewards and imposing annual fees.

In a very detailed analysis of the effects of the new rules, Reuters' Felix Salmon ebbs on the side of the policymakers:
Yes, those of us who pay our credit-card bills off in full each month might be worse off as a result of this legislation, but probably only by a few dollars a year. On the other hand, all of us will be better off in that we will no longer run the risk, however small, of being egregiously shafted by the credit-card companies.

Think of the credit card legislation as an insurance premium: it might cost a few bucks a year, but it might end up saving you a huge amount of money and hassle. Meanwhile, it'll certainly help out millions of cardholders who are less assiduous in paying their cards off in full each month.

But others are less sure about how the new changes will affect them. Writes one Los Angeles Times reader:
I'm one of those credit card users who has never missed a payment in my life, and I never use a credit card that charges an annual fee. I'm concerned that if credit card companies start to assess even prompt payers like me an annual fee and I cancel their card, it is not going to look good on my credit report.
I'd go broke just paying annual fees with all the cards I have collected over the years.

Indeed, the biggest problem with the way credit card companies affect household finances seems not be with what the credit card companies are doing, but with how borrowers are acting. In other words, people are taking on too much debt proportionate to their income (or income growth).

The issue is with our current definition of a "good" credit card customer. Contrary to popular belief, a "responsible" borrower is not someone who takes out ten credit cards and pays the balance off in full on each every month. A responsible borrower is a person who uses a credit card for small, extraneous unforeseen payments every now and then, and otherwise, locks the card away in the bottom drawer.

The problem with the new legislation is that it penalizes the credit card companies' ability to respond to changing prices in debt. Debt doesn't have a constant value: it fluctuates according to supply and demand, and constraining the card companies' ability to tweak rates accordingly is nonsensical.

In fact, legislation should be penalizing that large proportion of borrowers who use credit cards as ATM cards (even if they do pay off the balance). An effective legislation would therefore prevent consumers from borrowing above a certain percentage of their annual income minus a certain percentage to account for unforeseen events.

This is the same sort of criticism which current fiscal policy has come under in recent months. While the Federal Reserve is printing money to subsidize banks and automakers, it's merely sweeping the problems under the table for a few more years, goes the argument. The companies should just declare bankruptcy, and we should all suffer a "quick cleansing of the system," since that's what Chapter 11 is for.

As it stands now, borrowers can still take out as many credit cards as they want, and certainly way more debt than their income can reasonably sustain in the event of another downturn. That will eventually put us back in the same situation as we're in now. Blocking them from doing so would yield longer-lasting results.

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