Wed, 20 May 2009 20:56:53 +0000 – By Horace CooperLegal Commentator, Adjunct Fellow, Institute for Liberty
Proving Dick Armey's axiom that "the market is rational and the government is dumb", the Congress of the United States is racing to get credit card legislation to President Obama's desk for signing before the Memorial Day weekend begins. -- Billed as a way to keep credit card companies from "ripping off working Americans" President Obama will instead punish responsible credit card users and provide a great boon to credit card abusers.
The credit card reform bill would place new limits on the fees that companies can charge for being late or going over your limit; mandate restrictions for rate hikes as well as place new limits for borrowers under age 21. Getting even with the credit card companies might seem like just the kind of feel good legislation we need in the midst of the most significant economic downturn in the generation but we should be wary of falling into a populist trap.
Why? Because credit card fees and rates are the means that credit card companies use to offset the risks associated with credit card use. Credit cards are simply unsecured pre-approved loans. Instead of having a banker approve each and every request for a loan, the card holder gets to makes the decision himself. This ability is the key feature that has lead to the widespread use and popularity of the credit card. But this feature is also the reason that many people get over their head. They charge when they shouldn't.
Instead his bill limits the only real mechanism that companies have to get the money back that credit card users have charged - fees and interest rates.
Because the individual makes the choice and the credit card companies can't legally seize the items that you've bought with the card or even take your car or your home if you default, the companies use a variety of techniques to measure risk including determining creditworthiness before and during credit card use and assessing interest rates and fees afterwards.
This leads to different households receiving different credit card benefits. Responsible persons will get lower rates and no annual fee credit card accounts. Irresponsible credit card holders see higher rates and more fees. Those in the middle will see a mix of rates and fees. This system encourages irresponsible card holders to become responsible and rewards responsible card holders for fulfilling their commitments.
Unfortunately the new rules change the reward risk matrix by placing limits on the tools needed to recover loans. It is a fundamental rule of lending that an increase in risk means that less credit will be available and that the credit that is available will likely come at a higher interest rate. Because the bill makes no distinction between those whose credit card debt was run up because of an illness or family death and those who were simply irresponsible, anyone today with a high rate and who has missed a few payments will get a reward - new limits on the fees they can be charged and restrictions on the interest rate hikes they face. But in order to subsidize this windfall, the rest of us will get higher average interest rates and mandatory annual fees.
Say good bye to teaser rates of 0% to 5% and so long to complimentary credit card checks or balance transfers. Instead of getting cards authorized for use for two to four years, expect activation periods to drop to months or weeks in order to limit risk exposure. This might not seem like that big of a deal, but what happens when you're stranded on the road with a flat tire and the tow truck driver lets you know that your card expired yesterday?
As night follows day, a reform that rewards misuse, punishes commitment and forces even responsible lower income groups out of the credit market is a terrible idea. And it is even more destructive during an economic downturn when Americans might need access to credit most.
Horace Cooper is a legal commentator and an adjunct fellow with the Institute for Liberty (www.horacecooper.com)