WASHINGTON – An expert Thursday criticized a credit card market with high late fees, arbitrary interest rate increases and vicious cycles of revolving debt even though the “free market” should create affordable, easy-to-use products.
Lawrence Ausubel, an economics professor at the University of Maryland, College Park, told Congress today he blamed market failures for these consumer problems.
Ausubel, who has studied the economics of credit cards for more than 15 years, testified in favor of a bill to improve the transparency and fairness of credit terms. The “Credit Cardholders’ Bill of Rights Act of 2008” introduced by Rep. Carolyn Maloney, R-N.Y., restricts rate increases and requires a clear explanation of terms and pricing changes.
“Federal limitations on repricing and penalty terms could be expected to improve the competitive process,” Ausubel said.
His remarks came before the House Financial Services Subcommittee on Financial Institutions and Consumer Credit. The panel of experts that testified included Harvard Law School professor Elizabeth Warren, the expert featured in last year’s documentary on credit cards, “Maxed Out.”
There’s incentive for credit card companies to create high penalty rates, said Ausubel. Financially distressed consumers would tend to first pay cards with higher rates. Lenders with high rates are rewarded even when consumers can’t pay because they get greater returns in bankruptcy proceedings, he said.
“Since every credit card issuer has this unilateral incentive to charge a high penalty rate, the likely outcome is inefficiently high penalty rates,” said Ausubel.
And, said Ausubel, credit card issuers are unlikely to fix them.
“(T)his . . . problem may be viewed as a market failure, yielding scope for Congress to intervene in useful ways,” his written statement said.
The bill could be improved, said Ausubel, if it took effect sooner than a year after enactment, given the current economic crisis; and if it were extended to limit “junk fees,” including other late payment fees, surcharges for foreign currency purchases and overlimit fees.
Ausubel also discussed universal default, a phenomenon that hurts consumers, but its use has skyrocketed to include half of banks that issue credit cards in the 10 years since its introduction.
Universal default — where a lender worsens loan terms for borrowers when they miss payments to a different lender — also results from market failures, said Ausubel.
“The prisoner-dilemma-like game has the result that all issuers impose universal default and no issuer is any better off than without it. Indeed they may all be worse off; an overextended consumer suffering a setback is often best dealt with by relaxing the terms of the loan and giving the consumer an opportunity to get back on his feet.”
“Instead, penalty pricing and universal default create an explosion of interest rates from which it is difficult for the consumer to emerge.”
Finally, he said, “any time, any reason” repricing appears to be “detrimental to competition.”
“How can a consumer comparison shop,” he asked, “if all he is told about future pricing is: ‘We may change your (annual percentage rate) and fees'” and then he quoted from a Bank of America document, “based on information in your credit report, market conditions, business strategies, or for any reason?'”