Summary
Highlights
The credit card industry's modern era began in Sioux Falls, South Dakota, a town transformed into a credit card processing hub. In the late 1970s, facing a recession and high interest rates, South Dakota lifted its usury laws. This attracted Citibank, which was struggling with New York's interest rate caps, to move its credit card operations to the state. This move was cemented by the Marquette Supreme Court decision, which allowed banks to export their interest rates to other states, making South Dakota and later Delaware credit card capitals.
The deregulation of interest rates led to a massive expansion of the credit card industry, making it the most profitable sector of banking. While credit cards offer convenience, they are also a significant source of debt for many Americans, with the average family carrying around $8,000. Consumers are often attracted to credit cards for their ease of use and perceived benefits, but the industry strategically targets 'revolvers'—those who carry a balance and pay interest—as their most profitable customers.
Ben Stein, a frequent credit card user who pays his bills in full each month, is ironically labeled a 'deadbeat' by the industry because he doesn't generate interest. The real profit lies with 'revolvers,' the 90 million Americans who carry a balance. This segment explains how high interest rates (25-30% for some customers) and innovative strategies like lower minimum payments, spearheaded by consultant Andrew Carr, encourage borrowing and increase profitability for banks.
Andrew Carr's insight to reduce minimum payments from 5% to 2% significantly increased consumer borrowing and bank profits. This strategy, combined with tempting 0% introductory offers that can change with a single missed payment, keeps consumers in debt. The industry relies on gathering extensive data on consumer behavior through FICO scores, a number determining creditworthiness, which influences interest rates without most consumers understanding how it works or what their score is.
Credit card contracts contain clauses, like 'universal default,' that allow companies to raise interest rates on existing balances if a customer misses a payment with any other creditor, or even if their creditworthiness changes. This practice, considered unfair by many, can drastically increase debt, as seen in Andrew Guile's case where his interest rate more than doubled due to a past missed payment with another company. Critics argue this allows companies to change the price of a deal after the fact, making it difficult for consumers to manage their finances.
The 1996 Supreme Court decision, Smiley v. Citibank, deregulated fees, leading to a significant increase in late fees, over-the-limit fees, and returned check fees. These fees have become a major profit stream for credit card companies, often far exceeding the actual cost of processing. Critics, including former City Bank counsel Duncan McDonald, express concern that these practices exploit vulnerable consumers and create a 'Frankenstein' of an industry.
The Office of the Comptroller of the Currency (OCC), a federal agency, is responsible for regulating national banks, including major credit card issuers. However, the OCC has been criticized for not adequately protecting consumers. The case of Providian Financial, a company that engaged in deceptive practices, highlighted the OCC's initial reluctance to intervene until local authorities, like the San Francisco District Attorney, stepped in, eventually resulting in a large settlement. The OCC's assertions of exclusive regulatory authority have led to conflicts with State Attorneys General who argue for stronger state-level consumer protection.
Despite criticisms regarding practices like 0% introductory rates and universal default, the OCC has not banned them. Consumer advocates like Elizabeth Warren argue that greater transparency, such as disclosing how long it would take to pay off a balance with minimum payments, is crucial for consumers to make informed decisions. However, the credit card industry and its lobbyists have successfully blocked legislative attempts at reform, claiming such regulations are 'bad bills' and that consumers don't want such disclosures. Senator Dodd emphasizes that the industry's political power has stifled past reform efforts, but he predicts a future 'tipping point' where consumer frustration will force changes.
Former South Dakota Governor Bill Janklow, instrumental in attracting credit card companies to his state, expresses mixed feelings about the industry's evolution. While acknowledging the economic benefits for South Dakota, he admits that the 'plastic society' and the high-interest rates, sometimes exceeding 20%, are not a 'healthy thing for human beings.'