Pew Urges Government Intrusion in Business Credit Cards

Apparently, the Pew Health Group wants to ride to the rescue of small business by urging Congress to expand the regulatory reach of the Credit CARD Act of 2009 to business credit cards. Is this a good idea?

On March 19, Pew released a brief on credit card offers to businesses. Nick Bourke, director of Pew's Safe Credit Cards Project, declared, "Every month more than 10 million business credit card offers are mailed to households at all income levels. The sheer number of offers that are sent to homes all across the nation represents a risk to millions of American families."

That's a strikingly odd statement. After all, are we really supposed to believe that more choices and competition somehow spell big trouble for business owners and households? Doesn't reality tell us the exact opposite?

Nonetheless, Bourke went on: "To better protect individuals, families and small business owners we urge that the safeguards found in the Credit CARD Act be extended to any card on which the cardholder is personally liable."

But this ignores the economic reality that when government steps in to regulate, there are always costs to be born in the private sector. In the case of credit card regulations, when banks are unable to price their services according to changes in risk in the economy and with particular customers, the result inevitably is reduced access to credit and increased costs of the credit available.

Just in case the Pew researchers don't understand, that's bad news for small business owners who face enormous obstacles in gaining the credit and/or capital needed to build their enterprises.

A May 19 BusinessWeek report pointed to a 2010 Federal Reserve study indicating that such an increase in regulation could spell trouble in terms of accessing credit. The Fed May 2010 report to Congress specifically observed the following regarding the Truth in Lending Act (TILA) as amended by the Credit CARD Act:

"However, if the Congress were to consider the application of TILA's substantive provisions to small business cards, it would be important to recognize the potential for adverse effects on the cost and availability of small business credit cards. For example, applying TILA's restrictions on the ability of creditors to adjust interest rates on small business credit cards could have negative consequences for small businesses. As noted earlier, credit card issuers have more difficulty assessing the creditworthiness of small businesses than consumers. Therefore, the willingness of issuers to extend the relatively large credit card lines that small businesses require may depend importantly on issuers' ability to adjust prices in the future, as they learn through experience about businesses' ability and willingness to pay. Restricting the ability of card issuers to adjust interest rates may lead to higher initial interest rates, which would harm those firms that borrow on small business credit cards. In addition, if credit card issuers were to reduce credit limits in response to the imposition of TILA's substantive requirements, even those businesses that use credit cards for transactions and cash management would be harmed."

In the end, small businesses should say "No thanks" to the Pew group's offer of more regulation, as it would only make credit tighter and more costly.

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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

More Economic Nonsense on Interchange in New York Times

More economic nonsense has appeared on the topic of interchange fees related to credit and debit cards. This time, it’s courtesy of Albert Foer, president of the American Antitrust Institute, writing on the opinion page of the April 21 New York Times (“Our $48 Billion Credit Card Bill”).

Foer begins: “These days, it’s hard to find anyone who doesn’t use credit and debit cards regularly — they’re convenient and compact and often come with small cash-back incentives. But what almost no one realizes is that those benefits are far outweighed by an implicit transaction fee, set by credit card companies and their issuing banks…”

How does Foer know that interchange fees outweigh the benefits of credit and debit cards? He offers no evidence. And considering the widespread use of such cards by both consumers and businesses, his assertion makes no sense. After all, if the costs truly did outweigh the benefits, then credit and debit cards simply would whither away and die in the marketplace. But since that obviously is not the case, Foer’s opening premise is dead wrong.

He goes on to talk about the share that MasterCard and Visa have of “the general purpose credit card market” in order to give the impression of some kind of noncompetitive, monopoly power at work. But that market definition seems a bit convenient, doesn’t it? After all, credit and debit cards – which by the way have thousands of banks offering such cards and competing to attract consumers – do not simply compete against each other. Consider the following points from “The 2008 Survey of Consumer Payment Choice” by Kevin Foster, Erik Meijer, Scott Schuh, and Michael A. Zabek, January 2010 version, Federal Reserve Bank of Boston, regarding U.S. consumers’ payment choices:

• “U.S. consumers have more payment instruments to choose from than ever before (nine). In 2008, the average consumer had 5.1 payment instruments and used 4.2 payment instruments in a typical month.”

• “Consumers have widely adopted some, but not all, payment instruments. Essentially all consumers have adopted cash. Checks have been adopted by 91.3 percent of consumers. A payment card has been adopted by 93.4 percent of all consumers: 80.2 percent have a debit card and 78.3 percent have a credit card, but only 17.2 percent have a prepaid card. Finally, 81.2 percent of consumers have adopted an electronic payment method. More than half of consumers (52.5 percent) have adopted online banking bill payment, and 73.4 percent of consumers have debited their bank account via an external website.”

Consider the following sample of payment options: Visa, MasterCard, Americans Express, Discover, PayPal, Google Checkout, STAR, NYCE, Accel, China UnionPay, JCB, NETS, the Euro Alliance of Payment Schemes, Revolution Money, Tempo, Amazon, Secure Vault, Tempo, Moneta, Click&Buy, eBillme, Noca, Danal, thousands of card issuers – and, yes, cash and checks.

Of course, Foer argues for the government to impose price controls. He proposes: “Congress should authorize the Federal Reserve to limit credit card interchange fees to their actual cost, fairly determined, plus a reasonable profit.”

Foer either forgets or fails to understand Economics 101, and the role that prices and profits play in the marketplace. Quite simply, prices and profits serve as signals. Credit card industry profits, for example, encourage the expansion of cardholders and merchants in the network, as well as investment and innovation, which benefit both consumers and businesses. Firms have every incentive to get the price right for their services so as to maximize profits. In the case of interchange fees, set them too high and businesses will not accept the cards; set them too low and fewer cards are issued. Perhaps most critically, price and profit signals spur competition.

The only things accomplished by price controls will be eroded card services, diminished investment and innovation, shifts in costs, less efficiency, and reduced access to credit.

Small businesses certainly want to reduce any and all costs possible. But having the government step in to impose price controls – i.e., set interchange fees – certainly is not the answer. Indeed, it would be another costly and dangerous expansion of governmental power.

Nonetheless, Foer calculates all kinds of savings resulting from price controls, and concludes: “Not only would such savings make our retail payment system more fair, but it would represent a significant economic stimulus at a time when consumers are just starting to spend again. And best of all, it wouldn’t cost Washington a thing.” Of course, to make such an assertion, one must ignore common sense economics, as well as lost investment, innovation and competition. Perhaps price controls would not cost politicians and regulators in Washington a thing, but they certainly would mean increased costs – in a variety of forms – for consumers and small businesses.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

Something for Nothing?

Something for nothing is a nice dream. But in the real world economy, it doesn’t happen too often. Instead, reality dictates in the marketplace that you get what you pay for.

Nonetheless, some retail businesses want a valuable service – that is, the ability for their customers to use credit and debit cards to make purchases – but they don’t like the price of this service. So, these businesses, who would fight tooth and nail to stop the government from dictating what prices they could charge, are looking for government, whether through the courts or legislation, to set the price paid for the enormous benefits that both consumers and these businesses derive from credit and debit card usage.

Consider a few points from July 16 New York Times report on the issue:

• “Merchants across the nation, from powerhouses like Wal-Mart and Home Depot, to gas stations, mom-and-pop restaurants and 7-Eleven, have spent years unsuccessfully fighting the biggest of these costs, known as an interchange fee, which generates an estimated $40 billion to $50 billion in income annually for banks that issue credit cards… Legislation is winding its way through Congress, a government audit has been ordered and petitions are surfacing in hundreds of convenience stores, including Ms. Orzano’s 7-Eleven, encouraging customers to voice their opposition to the fees.”

• “But retailers may have a tough time convincing Congress that consumers would benefit if the effective interchange rate, which has increased slightly in recent years, is dialed back. Many other countries, including Israel and Australia, have required banks that issue cards to reduce the fee. Yet there is little evidence that the savings were passed along. In Australia, where regulators required banks to cut the interchange rate for Visa and MasterCard purchases to 0.5 percent from 0.95 percent, the banks offset their loss by reducing rewards programs and raising annual fees, according to a 2008 report by the Government Accountability Office.”

• “Banks say they incur substantial risk when offering credit cards, and must make enough of a return to continue to extend credit. Reducing interchange fees would cut profit at both the largest and smallest financial institutions, including community banks and credit unions, Mr. Clayton said.”

• “Still, while legislation on interchange fees would not have stood a chance a few years ago when the economy was buoyant and banks were not under the political spotlight, the winds on Capitol Hill have shifted as public anger at banks — and credit card companies — has grown.”

Businesses understandably want to cut costs, but perhaps they need to look at the bigger picture, including the negative consequences when government in effect sets prices. It means less innovation, less investment, and reduced availability of credit.

Checking out SBE Council’s recent report titled “Credit Cards and Small Business” would help.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

House Votes for More Credit Card Regulation

The costly regulation train continues to pick up speed in our nation’s capital.

While touting it as a pro-consumer measure, the U.S. House of Representatives passed a credit card regulation bill on April 30 that would have the government involved in dictating pricing for the industry. Price controls, of course, never work out well, taking a heavy toll in terms of investment, innovation and service. When it comes to credit cards specifically, this government intervention threatens to reduce access to credit for consumers and small businesses.

Not a good idea, especially in a bad economy with tight credit.

Take a look at how your representative voted, as reported by the Associated Press. The overall vote was 357-70, with the Democrats coming in at 252-1, and the Republicans at 105-69.

Special kudos to Stephanie Herseth Sandlin from South Dakota, who was the lone Democrat to vote “no.”

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

The Credit Card Crunch?

Meredith Whitney – CEO of Meredith Whitney Advisory Group, LLC – has an important and sobering opinion piece in today’s (March 10) Wall Street Journal.

In “Credit Cards Are the Next Credit Crunch,” Whitney notes, “Currently, there are roughly $5 trillion in credit-card lines outstanding in the U.S., and a little more than $800 billion are currently drawn upon.” She projected six months ago that some $2 trillion in credit card lines would be reeled in by the close of 2010, but now projects that to reach $2.7 trillion.

Whitney discusses various factors in play here, including FICO score issues and home prices.

On the policy front, she observes:

Along with many important and necessary mandates regarding fairness to consumers, impending changes to Unfair and Deceptive Acts or Practices (UDAP) regulations risk the very real unintended consequence of cutting off vast amounts of credit to consumers. Specifically, the new UDAP provisions would restrict repricing of risk, which could in turn restrict the availability of credit. If a lender cannot reprice for changing risk on an unsecured loan, the lender simply will not make the loan. This proposal is set to be effective by mid-2010, but talk now is of accelerating its adoption date. Politicians and regulators need to seriously consider what unintended consequences could occur from the implementation of this proposal in current form. Short of the U.S. government becoming a direct credit-card lender, invariably credit will come out of the system.

How often have we seen so-called good intentions on the part of lawmakers turn into ugly realities for the economy? That will be the case here once again.

Also, keep in mind how important credit cards are to financing startups and small businesses. Another fact to consider the fallout of misguided government interventions in the credit card market.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

Congress and Credit Card Regulations

All government regulation comes with costs. The businesses being regulated have to deal with those costs one way or another, and eventually, consumers pay, such as through increased prices, reduced service, fewer choices and/or less innovation.

That goes for credit cards as well.

In December, the Federal Reserve, along with the Office of Thrift Supervision and the National Credit Union Administration, proposed various rules and regulations on the credit card industry. Those restrictions might sound good or even boost consumer protections, but again, it must be understood that any new rules and regulations come with costs. On the credit front, that can mean that an already tight credit market just grows tighter, with consequences for consumers, small businesses and the overall economy.

The Federal Reserve’s rules would take effect in mid-2010. But that’s just not quick enough for many members of Congress. That came through in a congressional hearing last week. Many are pushing an accelerated implementation of these rules and regulations on the credit card industry.

But that would just make a bad situation even worse. At least by giving the industry some time to adjust to new rules, the negative impact might be softened to some degree. Rushing through new regulations – and the commensurate costs – can only be a negative for credit markets, consumers, and the economy in general.

It also would mean higher costs and reduced access to credit for many small business owners who have become dependent on credit cards to help start up and run their businesses.

Is that what the economy needs, especially now?

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

Regulation and Credit Woes

Representatives and appointees in the federal government – including the Federal Reserve – supposedly are quite concerned about a credit crunch and the negative implications for the economy in general.

If that is the case, then why has the Federal Reserve just put forth various regulations on credit card issuers that look destined to raise credit costs and reduce access to credit?

The Fed has put forth a set of requirements that dictate how credit card issuers operate and price their services. Some of these measures sound quite appealing. But, in general, this government intervention into the marketplace comes with potentially serious costs.

Consider several points made in a November 30 report by Meredith Whitney, Joseph Mack and Kaimon Chang titled “Consolidated Lending Market Poses Risk to Overall Consumer Liquidity” from Oppenheimer:

• The authors are “beginning to see evidence of broad-based declines in overall consumer liquidity.”

• Part of this story is increased regulation: “We believe that by restricting a lender’s ability to price for risk and significantly altering the economics of the credit card industry, lenders will ultimately choose to provide fewer credit lines to fewer customers. In fact, … we expect over $2 trillion in outstanding lines to be reduced over the next 18 months.”

• The authors are concerned about an unprecedented combination hitting the economy: “We view the credit card as the second key source of consumer liquidity, the first being their jobs. Pulling credit at a time when job losses are increasing by over 50% year on year in most key states is a dangerous and unprecedented combination.”

• With the Unfair and Deceptive Acts or Practices proposals, the authors note “that the regulators believe they are actually doing what is best for the consumer, but we argue that the ‘unintended consequences’ of such actions will at least do a commensurate amount of harm to the economy by stifling consumer spending… Due to an inability to maintain pricing flexibility on unsecured loans, we believe there will be a dramatic reduction of risk taking and therefore credit lines outstanding. This line reduction will strain credit quality not just for credit card loans, but, in our opinion, for all consumer loans.”

• The authors compare this regulatory scenario to what recently happened in Japan: “We believe what happened in Japan related to the change in Grey Zone laws provide an informative proxy of what to expect in the US if our regulatory timetable remains ‘as is.’ In December 2006, Japan passed a series of laws setting the maximum interest rate lenders can charge to a range of 15% to 20%, down from what had been over 29%. In addition to these restrictions, moneylenders could face criminal sanctions if they charge rates over 29.2%. What happened as a result of the reduction in lenders’ ability to set their own prices (however unfair they may or may not have been) was a dramatic contraction in lending by those lenders.” The fallout included lenders going bankrupt and some firms exiting the business, with a reduction in liquidity for Japanese consumers.

No one should be surprised when government regulation generates unintended, sizeable costs.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

SBE Council Hopes New Regulation of Credit Cards Will Not Lead to Less, or More Expensive, Credit

The Small Business & Entrepreneurship Council (SBE Council) is concerned that new regulations from the Federal Reserve on credit card issuers may serve to raise costs and diminish credit for consumers and small business owners.

SBE Council President & CEO Karen Kerrigan said, "Whatever your opinion may be of the new rules governing the practices of credit card issuers, the bottom line is that they will likely have an effect on consumers and small businesses regarding costs and credit access. Our hope is that the Congress and regulators see what the impacts of these new regulations are before acting further on initiatives that may do more harm than good."

A report issued by Oppenheimer in November 2008, estimated that the credit card industry will pull more than $2 trillion in lines of credit over the next year or so. Driving that move, of course, are economic conditions creating greater risks. However, the report also noted regulatory and accounting changes will add to this extraordinary credit contraction.

Kerrigan added: "It is important to keep in mind how central credit card financing has become for small business owners - both in terms of expanding the number of customers, getting paid on a timely basis and, for many entrepreneurs, being able to use credit cards when starting up or financing their businesses."

The Oppenheimer report noted above views "the credit card as the second key source of consumer liquidity, the first being jobs."

Raymond J. Keating, chief economist for SBE Council, noted: "In essence, the Fed is dictating the way issuers can price their products and services. Price controls are never a good idea. The consequences are shifted costs and reduced supply or service. In this case, by not being able to adjust prices based on credit worthiness, credit costs will increase for responsible users of credit cards (such as higher interest rates and fewer rewards), and credit access will be reduced for others."

In addition, Keating said, "It's particularly strange that the Fed would be coming forth with regulations that will diminish access to and raise the costs of credit at a time when there is a credit crunch for many."

According to SBE Council, it is critical that the next Congress and incoming leaders of federal agencies take a measured approach, and not make matters worse by adding even more regulations and mandates. Such a regulatory frenzy would restrict credit access even further, and raise costs.