Big (Credit Card) Bills on the Sidewalk

The New York Times' Andrew Martin has a big story today on how credit card companies are worried that Congress is going to put the kibosh on their big money making center -- big borrowers and balance carriers -- leading them to try and squeeze more out of the folks who pay off their bills every month. Ezra Klein remarks:

The credit card industry, in recent years, has developed something of a tiered model. Good customers are treated extremely well. There are rewards programs, favorable terms, and high limits. But those who don't prove as assiduous about their bills, or slip up amidst their payments, fall into a second tier that's as punishing and deceptive as the first tier is serene and straightforward. Hidden fees, unexpected rate increases, universal default, and all the rest. The result is that low income credit card holders effectively subsidize high income credit card holders. The financially illiterate are gamed so the financially literate can pay very low fees. Flattening that business model out a bit would make a lot of sense. It's a feature of the new legislation, not a bug.

This seems off to me.



First point: there's nothing particularly shady about companies earning different size margins on different types of customers. The practice goes by the negative sounding phrase "price discrimination," but it's standard and wholly unremarkable. That's what coach, business class, and first class tickets are all about, for instance -- varying pricing and terms in order to earn as much as possible from different kinds of passengers.

Earning different margins on different groups is also vastly different from cross-subsidization. To say that low income borrowers are subsidizing high income borrowers implies that credit card companies take a loss on loans to their high income borrowers, but are able to continue offering them credit thanks to the money they make on everyone else. That would be a peculiar business model indeed; firms would be better off offering high income borrowers terrible terms so that they wouldn't sign up in the first place.

What about the claim that regulation would reduce margins on poorer borrowers, forcing credit card companies to make up the difference by sticking it to quality borrowers? Well, the first half of the statement is likely true, and it also doesn't bother me much. I strongly suspect that the benefit to low income borrowers of not getting routinely screwed by credit card companies will outweigh whatever negative effect there is on the supply of credit to low income borrowers. But the second half of the statement is problematic.

Here's why -- if credit card companies could have been making more money on quality borrowers all along, why didn't they? That's what this claim amounts to -- the suggestion that the business could have been sticking it to quality borrowers -- raising rates and charging fees -- but chose not to. That doesn't make a great deal of sense. What seems more probable is that high quality borrowers used to have more credit options available to them, and so credit card companies had to work harder to get their business. Now, in the midst of recession with many borrowing options -- including home equity lines -- no longer available, credit card lenders can squeeze more out their customers. They're the only game in town and can price accordingly.

In this story, fees and higher rates will be coming in any case. But given the threat of regulation in Congress, a harder line with quality borrowers seems like a nice little stick to brandish in front of legislators.