Thursday, November 19, 2009

Consumer Reports Lectures Me on Credit Card Regulation

I have a subscription to the Consumer Reports website because of the wealth of product information it contains. Occasionally, however, Consumer Reports takes positions on policies, and I nearly always disagree with them (another example: Consumers Union supports higher CAFE standards; I do not, as a higher gasoline tax would be far more effective). I received an email from Consumer Reports today regarding credit card legislation. I was encouraged to go here and support immediate regulation of credit card fees by Congress. I responded with the following.

Dear Consumer Reports,

I have a better idea. Rather than relying on government regulation to set prices, interest rates, and fees, let's lower barriers to entry into the credit card market to encourage competition. I trust a competitive market process to protect consumers much more than I trust a government to do so.

Consumer Reports's naive view of regulation and wrongheaded policy advocacy is almost annoying enough to make me want to cancel my subscription, but your valuable product information is sufficient to change my mind. If only I could get one without supporting the other.
Mike Hammock
Two things may deserve more explanation.
1) Why does competition protect consumers?
Because firms that are afraid of losing customers to competitors have an incentive to keep those customers happy. If that means keeping fees low, that's what they'll do. DVD players didn't go from $200 to $30 because Sony and Philips and Samsung like their customers; they got cheaper because these companies are trying to beat the hell out of each other in a competitive market. There are only five credit cards in common use: Mastercard, Visa, American Express, Discover, and Visa. Discover was the last new major card, and it was introduced back in 1985! Before the government starts trying to set prices and fees, it would make more sense to eliminate whatever barriers to entry exist in this market. I'm guessing they are primarily regulatory. There are probably some network effect problems (getting retailers to accept a new card may be difficult), but those shouldn't be insurmountable--especially if the new card charges lower fees to retailers than existing cards.
2) Why not just let government set all fees and prices?
Because it won't get them right. Prices can be too high, in the case of insufficient competition, but they can also be too low, resulting in shortages. In the credit card market, this would mean denial of credit to some consumers.

This has implications for other policy debates, too. If we want to make something cheaper--like, say, health care--we should look first to the way the market is structured, and look for a market mechanism that can push prices down.


Asghar said...

"I'm guessing they are primarily regulatory".. well that settles it then!

There are over 6000 independent credit card companies that issue credit cards through the visa and mastercard network. Each of these sets its own pricing, conducts its own advertising, offers its own terms. However, 12 of these companies presently control 90% of the credit card market. And the concentration of market share has grown in recent years.

I think a strong argument can be made that government oversight will dampen profitability and that this will in turn create a disincentive for new entrants and new products. But the credit card industry presently exhibits profits higher than any other banking activity, has plenty of independent players and has no shortage of innovation.

Just so you know I'm not making up these facts:

My view: Credit card industry profits are directly tied to market failure. Low income consumers provide credit card companies with the highest profit margins. Unfair and Deceptive practices should not be the basis for profitability. Period. That's what the CFPA is being proposed to stop.

Mike Hammock said...

This just raises the question of why there isn't more competition. I guess there could be network effects, but you don't really present an argument for why more competition wouldn't protect consumers. An economist would tell you that competition at the retail level wouldn't matter much if monopoly rents are being extracted at the wholesale level--we need more than just Visa, Mastercard, Amex, and Discover.

Furthermore, I do not think low income consumers paying more represents a market failure. Low income consumers present the biggest risk of default, and they pay extra for the privilege of borrowing. Charging a higher risk premium, in interest, fees, or whatever, is not unfair, so long as consumers agreed to pay it.

If there are deceptive practices, that's what contract law is for.