Plastic fantastic

So I’ve belabored the distinction between transactional and revolving credit quite enough, I think. And I’m pleased, reading around the intertubes, that people seem comfortable with that distinction, and with the idea that it might be good public policy to treat these two forms of credit differently, despite attempts by credit card issuers to blur the lines. Yay!

But my previous piece seems to have left readers with two pretty big WTFs:

  1. Don’t we already have a ubiquitous and perfectly good transactional credit product called debit cards?
  2. What would be the point of having the government provide a charge card?

Let’s take those in turn.

1. Are debit cards good enough?

Debit cards are indeed a transactional credit product. Specifically, they offer overnight transactional credit which is automatically repaid from a designated bank account. Problem solved, right? Everyone should just use debit cards.

Debit card use is on the rise in the United States (and in other countries use of debit cards is often the norm). But very many of us — possibly even you, dear reader — have both debit and credit cards, but prefer the credit card, even though we pay our balances monthly. Why might that be?

Here’s a minibarrage of reasons. Using a credit card…

  1. is more convenient, since you needn’t keep track of an account balance unless you are very near your credit limit;
  2. is cheaper because it doesn’t require keeping a substantial buffer of funds in a zero or low interest checking account;
  3. is cheaper because you can get some of the interchange fee refunded via rewards programs;
  4. is safer, because it offers the opportunity to review and occasionally repudiate transactions prior to transferring funds;
  5. is safer, because stronger consumer protections are offered in the event of theft or fraud;
  6. is safer, because if the cardholder faces an unexpected liquidity crisis, she can shift from transactional to revolving credit. Cardholders have the option of making partial payments with little penalty.

If we want a purely transactional product, we’ll have to do without that last, the option to revolve. A competitive market for transactional credit might or might not offer kickbacks on transaction fees (American Express does). But to be conservative, let’s suppose not. That still leaves four pretty good reasons why an American-Express-style, pay-at-the-end-of-the-month “charge cards” are superior to debit cards. Banks have tried to address the consumer safety and dispute resolution issues that disadvantage debit cards, but there is still a big gap in perceived and I think actual safety. But the first two issues are the zingers. To get the same payment flexibility with a debit card that you would get with a charge card, you need to maintain a large checking account balance, which costs you in interest foregone. If you keep your buffer savings in an investment account, then you have to track your account balance carefully and transfer funds between accounts frequently. Even with a $95 annual fee (the going rate for a basic American Express card), most families would be better off earning interest on their savings and paying the fee than keeping substantial savings in a no interest account. (Right now this may not be true, because interest rates are so low that you don’t lose much by holding funds in a checking account. But it has usually been true when we’ve not been in ZIRP mode.)

There are arguably behavioral disadvantages to the buffered debit card strategy. If you spend unusually much in a month, there is nothing that forces you to replenish your buffer. But if your savings are held in a separate investment portfolio, transferring funds to cover a shortfall may feel like raiding the piggy bank. Avoiding that might encourage people to not spend more than current income. If you keep substantial savings in a debitable checking account, the mechanics of dissaving are indistinguishable from the mechanics of ordinary spending, and there is no third party demanding that you make yourself whole at the end of the month. With a charge card and a separate investment account, spending beyond income compels painful, explicit transfers from what you thought was savings, which might motivate you to replenish the overdraft quickly. (This entire paragraph is bullshit if you don’t believe in things like “mental accounting” — money in an investment account is viewed differently than ordinary spending money — or “anchoring” — once you reach a level of “savings”, it comes to define where you “ought to be”, and you will strive to maintain or recoup that level. Do you believe?)

A lot of debit card enthusiasts will find all this comparing of “buffered” debit cards and charge cards artificial: Debit cards, they will claim, are good because you can’t ever spend more than the cash you have. It’s as simple as that, right? But we keep wealth we may wish to spend in a variety of different forms, and many of us even have multiple bank accounts. Debit cards without a cash buffer don’t really do the job of transactional credit, that is letting you spend what you can near-term afford without having to much worry about how your (liquid) wealth is held. One might argue that extra friction is good. Perhaps people are so undisciplined that we should have to track balances and arrange transfers prior to even routine spending. That’s an argument for an electronic “cash only” economy, and I think it’s farther than we need to go. It’s a judgment call, but my sense is that people handle short-term transactional credit pretty well, and benefit from the convenience of it, while indefinite-term, low monthly minimum revolving credit frequently becomes a trap.

2. What would be the point of government provided transactional credit?

In the previous post, I suggested that the government could offer a “Treasury Express” card, supplying access to transactional credit as a public good. To my surprise, some people seemed to actually like the idea (e.g. Ezra Klein, Matt Yglesias, Doug Singsen). Others understandably dislike the idea of more state involvement in a sphere that has been traditionally left to the private sector. Kevin Drum just doesn’t see the point:

We already have “Treasury Express” cards: this is basically what debit cards are, and they provide the same benefits of transactional credit that regular Visas or Mastercards do. Why do we need the government for that?

That leaves us with the problem of limiting revolving credit, which is the same problem we have now. Do we need firmer rules on interest rates, fees, and penalties? Better bankruptcy protection? Bans on things like universal default? An end to tricks and gimmicks and fine-print-laden marketing come-ons? More sensible ways of setting credit limits? Maybe. Probably. But unless Steve is suggesting that we essentially ban credit cards entirely — and then create some kind of federal mega-authority to limit every other kind of consumer credit too — those are all the same issues we have now. I’m not really sure what his proposal would accomplish.

If it’s true that the differences between a pay-at-the-end-of-month charge card and a debit card aren’t very important, then Kevin’s right, and there wouldn’t be much point. But suppose that I am right, and people really value the efficiency, convenience, and safety of a charge card, even if they do not intend to run a balance. As things stand now, they have two choices: they can pay $95 per year for an American Express card, or they can get the same product for free with a credit card, as long as they accept a dangerous option not to pay in full at the end of the month. (If having to pay more for fewer options strikes you as odd, you are not alone. In two posts, the amazing Rortybomb tries to make sense of credit-card-pricing mysteries, including this one, using ideas we learned in finance class. Only his training in critical theory prevents a Scanners-style head explosion.)

A free basic transactional credit product would let people avoid signing on to temptation when all they want is a charge card.

A public option would also create political space for better regulating revolving credit. The obvious way to limit revolving credit to those most likely to use it well is to force rationing via price controls. In English, that means we should bring back usury laws. Credit card companies won’t offer cards to financially insecure customers if interest rates, penalties, and transaction fees are capped. Under the present terms of debate, that would be a bad thing, “limiting access to credit”. But the meaning of that phrase is very slippery. “Access to credit” is let to stand for participation in the modern economy, i.e. the ability to rent a car or hotel room, to make purchases or pay bills on-line, etc. If we unbundle those good things from credit cards, what usury laws would limit is “access to high-interest, high-fee unsecured revolving credit”. Put that way, it doesn’t sound so bad.

The existence of universal charge card accounts would offer some side benefits. Such accounts would provide uniform and convenient means for the government to make payments to citizens, rather than mailing out stimulus or social security checks. It would make it easier to implement flat transfers, which I consider a better form of fiscal policy than tax cuts or aggressive government spending.

Finally, it’s worth thinking generally about when public sector competition helps to keep the private sector honest. Critical industries that are prone to concentration due to network effects or economies of scale, that are informationally opaque, or that have high barriers to entry may benefit from the implicit threat presented by even inferior public sector competition. I am a huge fan of UPS and Fedex, and generally prefer their services to those offered by the post office. But I wouldn’t be at all comfortable disbanding the postal service, even though as a taxpayer I am forced to fund its losses. Perhaps I underestimate the magic of the marketplace, but if USPS weren’t there to put under a floor under the quality and price of service offered by the private couriers, the degree of concentration and barriers to entry in that industry would make me nervous. There are other examples: State schools offer useful competition to private colleges and universities. A “universal Medicare” option in health care would serve as a low bar that private sector providers would have to overleap. Consumer banking services may be an industry where public sector competition would be useful. We don’t want the government making fine-grained decisions about the allocation of business capital. There are good reasons to think that capital markets and profit-motivated relationship lenders do a better job of that than the state. But there’s little reason why the public sector shouldn’t provide basic transactional credit and checking account services. (Other countries have state-affiliated banks that compete with fully private institutions. A public/private banking ecosystem is not a radical idea.)

All that said, there are good reasons to oppose a “Treasury Express” card. I share the cynicism of libertarian critics. The only thing I trust less or want less involved in my life than the government are cartelized private corporations. To the degree that people choose to make payments with publicly provided cards rather than with cash or private credit products, the government would obtain detailed individual payment histories. This may (or may not be) worse than Chase or Citigroup having access to the intimate details of our lives. Universal access to transactional credit might do harm by altering the incentives of people on the margins of the economy. For example, someone who currently lives in the cash economy might max out, and not repay, their “Treasury Express” card. Even though the penalties they’d face for nonpayment would be mild, they would have created a new hurdle they’d have to overcome if they wish to reintegrate themselves into the mainstream. Dispute resolution might be a nightmare for a public program. Disputed credit card transactions leave either a customer or a merchant feeling screwed. What is now private cause to switch banks would suddenly become a contentious matter of public policy. The government might meddle in what people can buy and sell with the card, creating a nanny-state non-neutral form of money. Government entry into the banking sector with a limited, basic product could lead by increments of mission creep to a state-subsidized monopoly taking over financial services and credit allocation. These are all real concerns that would have to be addressed, if we were to give public sector transactional credit a try.

Neither this post nor the previous one has been intended as full-throated advocacy. A state-provided universal charge card is a speculative idea that merits further consideration. It might be worth doing. It might not be. But as we negotiate with the banking sector going forward, we will no doubt hear dire warnings about how this or that regulation will force thousands of widows and orphans into bartering chickens for shelter. We should keep in mind that if banks won’t provide the simple, consumer-friendly financial products we require, we can create other options.

By the way, if you haven’t read Felix Salmon’s candid correspondence with former industry insiders about credit card business models, do that now. It is remarkable. For more of the weekend’s credit card links, try Conor Clark on credit cards for college kids (and Richard Serlin’s response), Michelle Singletary, and all the other brilliant writers I’m sure I’ve missed.


14 Responses to “Plastic fantastic”

  1. Bill Mill writes:

    I would add as a benefit of credit cards that you avoid the outrageous overage fees that the bank charges you for overdrawing your debit account.

  2. a writes:

    There are debit cards which:

    1/ debit the transactions once a month;

    2/ provide advance notice of the debiting lines, so that:

    a/ one can review the lines before the debit, and

    b/ allow the transfer of funds to the account in order to meet the debit.

  3. babar writes:

    @a: what are these debit cards called– where can i get one?

    sometimes i would prefer to use a debit card, but the lack of fraud protection has stopped me from doing this. (i have an ATM card, but it isn’t a debit card.)

  4. SW:

    I oppose anyissuance of Treasury cards. Look at Fannie and Freddie. Barney Frank will scream about “underserved” minorities. If you haven’t, familarize yourself with Steve Sailer’s work on minorities and mortgage defaults. I now do something I rarely do, make a comment you may consrute to be an ad hominem attack. Here goes and I’m not asking for forgiveness. You wrote, “Finally, it’s worth thinking generally about when public sector competition helps to keep the private sector honest”. Like when the private planitiffs’ bar has to keep an eye on the politically controlled and Wall Street-friendly SEC? Or the OCC which closes down small banks but lets Citigrpup operate? Surely you haven’t forgotten about “regulatory capture”?

    SW, you should be ashamed of yourself. Go sit in the corner for three hours and face the wall!

  5. a writes:

    babar: I should add, I guess, that I don’t live in the U.S. But I don’t see any any legal reason why American banks couldn’t offer such cards (for a yearly fee) as part of a checking or some other account.

  6. Bill Mill — in a (typical, private) charge card product, the outrageous fees for overdrawing you balance get replaced by outrageous fees for not paying on time.

    but it is arguably easier to keep track of a fixed, regular payment deadline than a variable, often automatically drawn-upon account balance…

    a / babar — sounds like an interesting product. it would be great if there were more and better private alternatives to the tempt-and-squeeze credit card model. but that’s a hard sell on both sides of the competitive divide: issuers love high interest revolvers, so why should they provide products that create barriers, and consumers don’t anticipate becoming long-term revolvers and don’t consider the option to revolve a drawback. an advantage of a public plan is because it could be available by default: laziness would then be the barrier to getting a revolvable credit line, since less affluent people who never intend to revolve would have little reason to trade “up”.

    IA — i wear a dunce cap 24/7. no need to banish me to the corner. i’m painfully aware of regulatory capture and the likelihood that public programs become subverted. unfortunately, we often have no good alternatives to a flawed public sector in attempting to remedy problems created by concentration and market failure. of course, the government is itself a concentrated bad actor. it has in the past and continues to encourage the overuse and misuse of credit. my metaphor is king kong vs godzilla… i dislike and mistrust the government, and i dislike and misutrust concentrated, cartelized industries, but neither are going away, so the best we can do is to turn the monsters against one another when we can. banks will capture a significant part of state action regardless of what we do, but the state is also amenable to populist incentives, and sometimes we can use those to force the state to meaningfully check concentrated private power.

  7. I was just now looking for information about this when I found your post. I’m only stopping by to say that I definitely enjoyed seeing this post, it is very well written. Are you considering posting more on this? It looks like there is more depth here for later posts.

  8. SA writes:

    Definitely a great idea… one thing that debit cards do not provide ( and u missed ) is credit history…. I have experienced this first hand since I thought paying with debit card would make my bank happy and prove that I can be trusted with a high score. But the response I got from the bank was : ‘Since u have not used the credit card we cannot determine your credit history and hence u are unworthy of credit’. This will then hamper your mortgage rates as well as other utility facilities… do yes debit cards atleast in current state are no substitute for credit cards even for transactional credit.

  9. Phillip Huggan writes:

    Rather than giving money to banks, why not give it to all citizens in the form of a debit card within which $500 annually is lent out by an individual to the needy businesses; supplementing banking activities that are too big to fail. When bank execs get too greedy, instead of giving them more money and further reinforcing their corruption, you could increase the free money to individuals and cut off the rich people welfare (better uses for a reserve currency).

    I’m thinking people take these cards that are issued out of whatever money ($4 trillion USA every 15 years or so is enough to give $1000/yr to every American to invest so $500/person is only half existing finance coddling) is traditionally used to publicly bail out finance companies. You take your card to a Crown ATM. You select what area or what sectors or what risk tolerance you want your portfolio invested in (after passing brief personal finance questionnaire when opening account)…

    The idea is over the long-term the bailouts go to individuals who over years withdraw from the account like an annuity. As finance industry keeps screwing up more bailouts go to indivudal minibankers and an inefficient industry contracts or it grows up. The knowledge gained by individuals might even to help shrink needlessly large finance industry. To beat millionaire portfolio managers over the long-term, I think it is simple as offering simple investment instruments. In a boom banker investment ROI goes down so giving the money to individuals achieves poverty reduction, maybe personal finances education, finance lobby shrinkage, and would introduce a novelty into isolating just what finance activities are too big to fail (obviously no one in finance now is cutting this macro-pork). The average Joe without credit is a better credit risk than a USA banker in a boom with credit, is the thesis giving a slice of the too-big-too-fail industry mantra to individuals, would test.

  10. Phillip Huggan writes:

    ….perhaps a flag to low banker ROI in a boom is high compensation becoming the exec norm. When CEO stock options redemptions become the newspaper headlines, maybe that’s when banker ethics switces to hiding in the corrupt crowd rather than providing businesses with capital. At that point my preferred bailout recipients would be those not profiting most from expanding bubble. The pay of individuals capable of passing a one day personal finance exam give them temporal grounding that those on the knife’s edge of a bubble don’t have. Even a good bubble, maybe the networking part of was good, if it devours a large enough share of GDP you might want this micro-banker function as a brake for reflection. Probably maintaining one’s microbank portfolio help one’s small business prowess so maybe it even reinforces total finance industry workforce (more portfolio managers), albeit without crazy USA compensation.

  11. Thanks for posting, I really enjoyed reading your newest post. I think you should post more frequently, you clearly have natural ability for blogging!

  12. It strikes me that i and ii are both easy to replicate with a high interest savings account back end to a checking account – $1000 costs $15/year in lost interest at current rates. Such a setup also negates your “mental accounting” advantage.

    I want to challenge your central assertion: high interest credit is bad for poor people on two counts.

    First, in order for this scheme to work, you will have to do a lot more than just create a government charge card. There are plenty of easy revolving credit options available to people with low capital and a poor credit rating – payday loans and over drafting bank accounts are the two most common. Both of those options, by the way, carry much higher effective interest rates than the highest of high credit cards.

    Secondly, it seems like there is significant evidence that in the third world that access to credit, even at high rates, is immensely helpful to people – particularly the poor. I believe that Grameen charges 20%, and no one is accusing them of usery.

    “Even though the penalties they’d face for nonpayment would be mild, they would have created a new hurdle they’d have to overcome if they wish to reintegrate themselves into the mainstream.”

    This doesn’t really make sense. If people can get by without ‘Treasury Express’ cards today without being excluded from society (because they don’t exist), I see no reason why they wouldn’t be able to in the future. You aren’t talking about outlawing cash are you?

  13. JA — Grameen is different from payday loans or 24% credit card balances. Loans are made for purposes, not on demand, not to cover old loans. They are made within an organizational and social infrastructure designed to encourage both productive use and repayment.

    I did not, and would not, say high interest credit is bad for poor people. That is much too broad brush. I will say that on-demand high interest credit is prone to abuse, in the same way that morphine is prone to abuse. That quality is not income based. There are lots of reasonably affluent people who get caught up in credit card debt.

    High interest credit is actually a fine thing if it is used in the way financial theory says it would be used: to help fund productive high risk, high return projects. In practice, that is not what on-demand credit is used for. I’m all for high interest small business credit, when the creditor has made a rational evaluation of the project and accepts the risk of nonpayment should the project fail (although I’d prefer personal bankruptcy not be the means of enforcement, as it certainly isn’t in the third world). An independent evaluation, commitment to a project, and social incentives to use the funds in the manner intended and carry the project forward make a big difference.

    I think that payday loans and other forms of ad hoc credit should be subject to usury laws as well. To the degree we’ve depended on desperation credit as a crutch to keep people going, we need to find a better way. (Hint: transfers.)

    By mainstream, I mean the able-to-rent-a-car economy. People could go back to cash, but by my sloppy usage, the cash economy is “not mainstream”. The point is that people with no access to private credit can’t screw up their access to credit arguably until they are “ready to handle it”. With universal access, people would have access to credit by default from day 1 (or their 18th b-day or whatever), and could dig themselves into a credit hole, leaving them less able to escape the cash economy than they would have been had “Treasury Express” not been so accessible.

  14. Rhys writes:

    I like the sentiment and the reasoning behind the Treasury-issued cards – your thinking seems related “the power of small” school of thought – but I’m not sure I agree with the conclusion, simply because these cards would be at the whim of changing political winds. I have a feeling that you proposed this more as an interesting idea rather than something you feel would actually work.