Credit Card industry explains our obligations

[hotShot]

What percentage does the Federal Reserve Bank take from a bank for the money, this bank takes as a credit?

I think it's 0.25%. If the credit card company charges you with 18%, they intend to make a profit of 17.75%.

Do you think that is fair?

profit 17% after tax cool..pls provide proof so I can invest

 

based on your stats i see negative.

Based on this source the rate was more than 5% 2 years ago.

Did the credit card companies take 23% from you than, or did they optimize their profit.

 

Obviously the banks could reduce their costs. My question is, did the free market forces work resulting in better conditions for the customers or did the banks just keep the extra profit.

[cherdanno]

Credit card companies optimized their profits??? I AM SHOCKED!!!!!!!

[barmar]

We have never had debit cards because I have read that they are very dangerous (suseptible to fraud), and we have two credit cards that we pay off every month.

This must apply to off-line debit cards which can be used like credit cards. I don't see why they would be more fraud-prone than credit cards but maybe in case of fraud you have less coverage than you have with a credit card.

I believe the difference has to do with disputing a charge.

 

With a debit card, the money is deducted from your account immediately. It's gone, and at least in the US, I don't think banks are required to recoup your loss if you claim it was fraudulent, unless you've notified them already that your card was lost or stolen.

 

With a credit card, you're not out any money until you pay your bill. Until then, you can dispute the charge. And if the credit card issuer believes you, they have to eat the charge. They have insurance to cover this, so they usually believe the cardholder's claim.

[blackshoe]

Some years ago, back when I was still working, somebody hijacked my boss' Platinum Visa card number. He found out about it when his attempt to charge something or other was denied. Called Visa, found out that somebody had charged $7500 worth of computer on the card - in Zurich, Switzerland. He told 'em he'd never been to Zurich, and certainly not on the date in question. They took the charge off the card. A couple months later, they put it back. It took him a year to finally get them to quit doing that.

[kenberg]

This sense of entitlement which the financial industry exudes is repugnant to me.  I say let the beggars try to get by by issuing nothing but credit cards to sub-prime holders.

If they want me to pay my part by fee, I'll cancel their card and get another.

Isn't that a "sense of entitlement" on your part? Why do you think you're entitled to use a credit card for free?

No one claims an entitlement to use a credit card for free, or at least I don't. The credit card company offers me a credit card under whatever conditions it chooses and I do or do not accept. If I accept the offered conditions, I get pissed if they then suggest that I am some sort of deadbeat (I heard they have a specialized pejorative name that they use in house but I don't recall it) if I use the card in accordance with the terms offered.

 

They offer the terms that they offer because they believe them to be advantageous to them. Partly they get some cash from the retailer when I use it, partly they hope I'll lose my mind and run up debts that require me to carry a balance at a substantial interest rate. Even better they hoe that I will do something, almost anything qualifies, that will allow them to charge a truly impressive interest rate.

 

I'll cope of course. I am not on the edge and I am not expecting to lose my mind. I am retired so I cannot lose my job. I am not shocked that the card companies hope to make a buck, as do producers of cigarettes and Twinkies. I do think that the economics of credit cards is such that once again the poor and the dumb get the shaft, and I think as a large scale enterprise it is a threat to financial stability. The portion of society most likely to be in over their heads even with their job intact is largely the portion most in danger of job loss during the recession. A large number of people with large debt and absolutely no means of paying it off is ominous. I am sure the bankers will do fine. The taxpayers will bail them out.

[barmar]

From what I've heard, the credit card bill is designed to help the "poor and dumb". Usurious interest rates and surprise charges are going to be curtailed, but to make up for this the credit card companies are probably going to do away with no-fee cards.

[barmar]

Some years ago, back when I was still working, somebody hijacked my boss' Platinum Visa card number. He found out about it when his attempt to charge something or other was denied. Called Visa, found out that somebody had charged $7500 worth of computer on the card - in Zurich, Switzerland. He told 'em he'd never been to Zurich, and certainly not on the date in question. They took the charge off the card. A couple months later, they put it back. It took him a year to finally get them to quit doing that.

A few years ago, a couple of my credit cards were stolen. I found out about this a few days later when one of the credit card companies called me to ask about some unusual charges they received. They took the charges off, cancelled the card, and sent me a replacement. I called the other credit card issuer, told them the card had been stolen, and had them check for recent charges, which I told them to cancel as well.

 

About 20 years ago I was working for Thinking Machines Corp., a supercomputer company that was targeting AI applications. One of our biggest customers was American Express, which was developing the first generation of software that tried to recognize customers' purchase patterns and detect when they deviated, to catch possible fraud.

[y66]

From How credit card companies want to debit you, by Dean Baker

 

One of the provisions of the Dodd-Frank bill passed last year instructed the Federal Reserve Board to determine the actual cost of carrying through a debit card transfer and to regulate fees accordingly. The Fed determined that a fee of 10-12 cents per transaction should be sufficient to cover the industry's costs and provide a normal profit. The Fed plans to limit the amount that the credit card companies can charge retailers to this level.

 

This would save retailers approximately $12bn a year... The prospect of losing $12bn in annual profits has sent the industry lobbyists into high gear. They have developed a range of bad things that will happen...

 

The credit card industry and the banks really don't have a case here; they are just hoping that they can rely on their enormous political power to overturn this part of the financial reform bill. ... Brushing away their rationalizations, their argument here is that they want larger profits and they have political power to get them. That may turn out to be true.

[kenberg]

Some of this, no doubt, falls into the "A fool and his money are soon parted" category. It's perhaps impossible to stop a willing lamb from being fleeced but some effort to slow down the process might be helpful.

 

Here is a case I am close enough to so that I know some of the details. A middle class couple have a perpetual credit card balance that runs somewhere between 10K and 20K. I suppose a conservative estimate of the yearly interest is around a thousand dollars. The wife tries to pay it down, the husband runs it up. Recently the wife's father (no, not me) gave her $1,300 to pay off one of the cards, which she did. This upset the husband who felt he would have been consulted, he wanted to use the cash to buy a new TV. They have three TVs now, I believe.

 

Absolutely nuts, of course. From what I have seen, not so rare as you might think/hope.

 

It is sometimes said that there should be a class in high school teaching youngsters how to handle money. A short class, imo. Lesson one: If you don't have the cash, don't buy it. Lesson two: See lesson one. You can run up a debt, as small as possible, for education. You can have a mortgage, but not a second mortgage, for a house. Possibly you can buy a car on payments but that's less clear. Starting from when I was very young and very broke, I have avoided this. And of course there can be a true crisis, but a crisis is something you get past as soon as you can and then return to normalcy, meaning no debt.

 

 

People of my generation almost universally regard the above paragraph as totally obvious, like 2+2=4. Somehow this is no longer the case. A pity. Maybe nothing can be done but we should try. Partly we should try because people are ruining their lives, partly it is because sooner or later there will be massive default and guess who will get stuck with the bail-out tab.

[Winstonm]

It is sometimes said that there should be a class in high school teaching youngsters how to handle money. A short class, imo. Lesson one: If you don't have the cash, don't buy it. Lesson two: See lesson one.

 

The problem with your idea, Ken, is that it flies in the face of modern economic theory. Just look at what Ben Bernanke and the Fed are doing now with QE I and QE II. The entire purpose of quantitative easing, i.e., buying bonds, i.e., printing money is to foster inflation to fight deflation and spur the economy by encouraging more borrowing and making holding dollars in savings a losing proposition.

 

When the economy is based primarily on consumption and inflation it is difficult to sell a depression-era idea like saving for a rainy day when tomorrow it may cost twice as much to buy that t.v.

 

And of course the banks should keep their extra 12 billion in profit - we can't afford to bail them out again if they lose that, too. B-)

[kenberg]

Whether it makes sense to put money in a savings account is another issue, but it can't be good personal economics to run a revolving cc debt. A friend recently bought a new car (one of these hybrids). He could very well afford to pay cash but he has very good (very very good, actually) credit scores and is buying the car on payments at low rates. He believes, probably correctly, he can do better investing the money. This approach isn't for me because I find the whole investment thing boring. But for him it works. However this is a completely different ballgame. A sophisticated investor makes a business decision on where to place his cash, that's one thing. A couple supports the cc industry by buying crap they don't need, paying 8% or more on a loan they cannot pay off, that's quite another.

[blackshoe]

I was taught that one should never buy a depreciating asset (such as a car, or a TV) on credit. Of course, it took me a long time to realize that just knowing that isn't enough, you have to put it into practice.

[Chas_P]

A couple supports the cc industry by buying crap they don't need, paying 8% or more on a loan they cannot pay off, that's quite another.

 

And apparently neither member of this couple ever made a passing grade in arithmetic. I can't see condemning the credit card companies for the financial illiteracy of a large portion of the American people. The "BUY NOW - PAY LATER" pitch has been around for at least 50 years and consumers have succumbed to it more and more. Look at the furniture retailers. They don't advertise furniture; they advertise the DEAL..."No payments for two years, No interest for three years" etc. Same with the automobile retailers. They do advertise features to some degree, but a lot of it is stuff like, "$0 down, sign and drive, no payments for 6 months." The credit card issuers are no different. "Transfer balances. Only 4.9% for the first 60 days." In other words, "Pay off your Visa with your new Mastercard." And people fall for it. I don't blame it on the credit card companies. I blame it on a lack of education.

[Echognome]

I always thought people were just misapplying the Permanent Income Hypothesis and had grand notions of their "permanent income."

 

It's not just some crackpot economic theory. It was developed by Milton Friedman.

[kenberg]

Even as a mathematician I find that reference a tough slog, but I will give it some attention. However I think the answer is not to be found in rational economic theory. There needs to be an economic theory based on the irrational man.

 

Probably most people want their lives to go well, I do, and most people can be a bit lazy, I am. The trick for lazy people is to keep things simple, and this is getting harder all the time. When I was young and financially strapped, it was easy to see what I could afford. I looked in my wallet. If I bought a this, I couldn't buy a that. Now you can buy both, and then go out for dinner. You shouldn't, but you can. We all fall short on occasion and use bad judgment. It's just a lot easier now, and it is epidemic.

 

It's of course best if people take responsibility for themselves and so yes, the people who run up their cards need to take a lesson from Pogo; we have met the enemy and he is us. But

society makes efforts to protect the foolish and gullible. At least somewhat, sometime. I think that many could use a little help with the cc industry.

[Winstonm]

There needs to be an economic theory based on the irrational man.

 

You mean the theory of reality?

[luke warm]

A friend recently bought a new car (one of these hybrids). He could very well afford to pay cash but he has very good (very very good, actually) credit scores and is buying the car on payments at low rates. He believes, probably correctly, he can do better investing the money.

 

"low" rates now are 0% (in a lot of cases), so it's hard to see how buying on "credit" in that circumstance is a mistake... if your friend simply put the cost of the car in a simple savings account he'd come out ahead... if he's a successful investor he'd come out *way* ahead

[helene_t]

There needs to be an economic theory based on the irrational man.

Disclaimer: I haven't that much training in economics, probably much of the below is nonsense. Anyway, I can't resist.

 

I have never come across macroeconomic models based on the assumption that consumers are rational in the sense that they always make the optimal choice. Rather, the assumption of rationality comes into play when relations between changes in stimulus and changes in behaviour is modeled. For example, it is generally assumed that when the price for something increases, then demand decreases. Unless their is a snop effect or some other strange exception to the general rule.

 

Maybe economists tend to overestimate consumers' knowledge and/or their ability to optimize behaviour given the limited knowledge that they have. But for the most part, the "rational man" assumption isn't really an assumption. It is more like an axiom.

 

But to the extent that the "rational man" assumption is really an assumption, it has political implications.

 

Liberalist: Ordinary people are rational. It follows that aggregated utility is maximized by giving individuals freedom to make choices as long as they don't harm others.

Socialist: I take exception to your assumptions. Most people are not rational at all.

Liberalist: Well they may make choices that look stupid in the eyes of the Central Planning Committee. But that is largely because they have other goals for themselves than the CPC thinks they ought to have. And who is to decide where in Mr. Jones' opportunity space Mr. Jones is better off? Mr. Jones or some bureaucrat?

 

All this said, I think it could be really interesting to try to develop a macroeconomic model that builds on more subtle psychological models than simply utility maximization. Take cognitive dissonance as an example. People may have an aversion against making decisions that would imply that they admitted to themselves that an earlier decision was wrong. Maybe this can explain why house sales are so slow when prices are going down. Would-be vendors "know" that they should just accept that bygones are bygones and realize their loss. But in doing so they would admit to themselves that they made a wrong decision when they bought at the peak of the market. So they hold on to their property.

[Echognome]

A couple of things.

 

I do think that we all exhibit some "consumption smoothing." We overspend some when we are young and save when we are old. Do we do it somehow "optimally"? I don't think so. There are many reasons for this, in particular that we do not have a really great view into our future to do so. There are also "time inconsistencies" with ourselves. We may expect our future selves to act in a certain way, but then have a completely different mindset when we get there.

 

As for the rational/irrational discussion, I will add the following points.

 

1. I think most economists believe that humans exhibit constrained rationality. The constraint coming from the fact that they do not have perfect foresight, perfect memory, or complete information.

2. There are models, that do not assume full rationality. Several macro models have a certain percentage of consumer make decisions based on a "rule of thumb" rather than rational expectations. There are micro models that utilize limited memory or limited information.

3. How does an irrational agent act? Irrationality is not the same as random. As such, there are an infinite number of ways to model irrationality. There is only one way to model full rationality. Of course there are varying degrees of rationality.*

 

* In game theory it is pointed out that assuming that all agents are rational does not often get you very far. Instead you need to assume all agents are rational; all agents know that the other agents are rational; all agents know that the other agents know that they are rational; ad infitum. This term is called "hyper rationality" or that strategies are "rationalizable".

[cherdano]

I don't understand the aversion to credit cards expressed in this thread. There are now several major credit cards that offer 1% (or slightly more) payback for every credit card purchase. No catch if you pay your bill on time. You can set up automatic payment from your checking account if you are worried about every missing a payment.

 

Also, while I have never taken a loan, but everyone seems to recommend a credit card with good rates as the best resort when you unexpectedly need a short-term loan. (Say your car breaks down and you would really prefer to buy this used car from a private owner immediately, your washing machine needs a repair and your cat an urgent and expensive cosmetic surgery.)

[helene_t]

I don't understand the aversion to credit cards expressed in this thread.

I am sure that credit cards are useful for some in the sense that some people are smart enough to screw the credit card companies and/or harvest a part of the revenue that credit card companies make from screwing less smart people.

 

I believe credit cards are bad for the overall economy at least if sensible alternatives (such as a competitive market for online transactions for debit cards) exist.

 

Credit cards are very insecure. Now this could be resolved by using online verification etc. and obviously credit card companies are moving in that direction. But a more fundamental issue is that credit card companies rely on unethical business practices, such as tempting stupid/lazy people build up credit cards debts for which they pay high interests, customers who forget to pay for their purchases on time, and blackmailing shops by not allowing them to charge extra for credit card payments.

 

I suppose credit cards had a raison d'etre back in the days before widespread availability of online verification. But today it is not a technical problem to take the money from the buyer's account at the time of payment.

[kenberg]

I am not exactly anti-credit card. It's the same way in which I am not exactly anti-gambling. In both cases there are people making big bucks by reeling in the suckers. Well, there's a sucker born every minute, so what's the problem? No one is putting a gun to their heads.

 

I lack data, of course. But we keep reading stories, and hearing more directly, of people who get in way over their heads. There is this line from the song Sixteen Tons: St. Peter don't you call me 'cause I can't go, I owe my soul to the company store.

 

To what extent should society interfere with the individual's right to do something that is brain dead stupid? And who decides? Using a credit card for convenience is fine, temporarily running up a balance to pay special expenses is fine, running a perpetual balance of 20 or 30 K, or more, as a way of life is pretty damn dumb. Or so I say. Dumb yes, rare no.

 

 

Sometime back there was this great story in the Post. A guy explained to his clients that there were ways to hide their assets from the IRS. The trick was to give the money to him and he would put it into off-shore accounts. And he did! His off-shore account. Now they showed a picture of the guy and that alone should have been enough. But consider: Here is a guy advertising that he is a shady financial schemer, asking people to give him their money. How dumb can you get? Still, we make such schemes illegal and try to protect the hopelessly naive.

 

If one guy wants to jump off a cliff, I suppose we let him. If an industry grows up making huge profits from mass marketing the idea of cliff jumping, it may be time to step in.

[y66]

I'm not credit card adverse. I use one all the time because it's extremely convenient, especially when traveling, and I don't pay less if I pay cash. In fact, I pay more because my credit card earns a decent rebate.

 

For me, the main problems are the net increase in the cost of stuff I buy due to merchant pass through of credit card costs and the de facto monopoly in the credit card industry, which causes those pass through costs to be out of whack with actual processing costs as well as other problems, including what seems to me to be an increasingly incestuous, anti-democratic relationship between the banking industry and the lawmaking industry.

 

Also, I don't like the predatory marketing practices of the credit card industry and the way they take advantage of consumers who don't pay off their balance each month, for example, by burying details of extra fees and rate changes in 30+ page credit card contracts.

[hrothgar]

There needs to be an economic theory based on the irrational man.

 

http://en.wikipedia.org/wiki/Behavioral_economics

[y66]

From Why we do what we do By Tim Harford

 

Behavioural economics has never been hotter. It’s not just the success of books such as Nudge, Predictably Irrational and Basic Instincts, but the political influence of the field: one of Nudge’s authors, Cass Sunstein, runs the Office of Information and Regulatory Affairs for Barack Obama, and his co-author Richard Thaler has been advising David Cameron’s new Behavioural Insight Team, based in the Cabinet Office.

 

A simple summary of behavioural economics – I’ve borrowed this one from The Guardian – is that it is the study of “how people actually make decisions rather than how the classic economic models say they make them”. But this approach is now under attack, from Gerd Gigerenzer, a psychologist, and Nathan Berg, an economist, and they argue that behavioural economics is not nearly as realistic as its boosters claim. While it does study what decisions we make, the very last thing it does is study how we make them – and as a result it is even more wedded to silly accounts of the way human beings think than its neoclassical rival.

 

Neoclassical economics has often relied on the “as if” defence, published in 1953 by Milton Friedman, who argued that while people don’t actually solve complex neoclassical optimisation problems in real time, they still behave as if they do, somehow making rational decisions thanks to a combination of experience and cognitive short-cuts. But economists have been strikingly incurious about what those cognitive short-cuts actually are. Gigerenzer is not.

 

Behavioural economists point out cases in which our decisions don’t match neoclassical theory, and thus the “as if” defence fails. But Gigerenzer and Berg complain that behavioural economists have retained the neoclassical incuriosity about why we act as we do. Instead, they have modified the neoclassical model until its predictions fit our observed choices, and then fallen back on the same “as if” story.

 

Consider the human response to risk. Neoclassical economics says that we act as if considering all possible outcomes, figuring out the probability and utility of each outcome, multiplying the probabilities with the utilities, and maximising expected utility. Clearly we do not in fact do this – nor do we act as if we do.

 

Behavioural economics offers prospect theory instead, which gives more weight to losses than gains and provides a better fit for the choices observed in the laboratory. But, say Berg and Gigerenzer, it is even more unrealistic as a description of the decision-making progress, because it still requires weighing up every possible outcome, but then deploys even harder sums to produce a decision. It may describe what we choose, but not how we choose.

 

Gigerenzer prefers to look for actual decision processes. Take the simple act of catching a ball in flight. The spirit of neoclassical economics would say that people act “as if” swiftly calculating the parabolic arc of the ball. The spirit of behavioural economics would explain dropped catches with references to some systematic errors in the way we perform that calculation. But in fact, ball-catchers use a cognitive shortcut called the “gaze heuristic”, running forward and back while keeping constant the angle of sight up to the ball as it descends. No amount of “nudging” towards faster differential calculus will help prevent dropped catches.

 

This is tough on behavioural economists, because in order to be taken seriously by other economists they have had to play the optimising game. Switching to Gigerenzer’s rules would mean the end of economics as we know it.

 

Yet the critique is sobering. If behavioural economists do not really understand why we do what we do, there are surely limits and dangers to the project of nudging us to do it better.