Monday, February 22, 2010

Distortionary Effects of Regulations and the Law of Unintended Consequences: Annual Fees Are Back

WASH POST -- "A law hailed as the most sweeping piece of consumer legislation in decades has helped make it more difficult for millions of Americans to get credit, and made that credit more expensive.

It wasn't supposed to be this way. The law that President Barack Obama signed last May shields card users from sudden interest rate hikes, excessive fees and other gimmicks that card companies have used to drive up profits. Consumers will save at least $10 billion a year from curbs on interest rate increases alone, according to the Pew Charitable Trust, which tracks credit card issues.

But there was a catch. Card companies had nine months to prepare while certain rules were clarified by the Federal Reserve. They used that time to take actions that ended up hurting the same customers who were supposed to be helped."


Exhibit A: "Annual fees, common until about 10 years ago, have made a comeback. During the final three months of last year, 43% of new offers for credit cards contained annual fees, versus 25% in the same period a year earlier, according to Mintel International, which tracks marketing data. Several banks also added these fees to existing accounts. One example: Many Citigroup customers will start paying a $60 annual fee on April 1."

MP: This story clearly illustrates the Law of Unintended Consequences ("Any intervention in a complex system may or may not have the intended result, but will inevitably create unanticipated and often undesirable outcomes.") and why regulations are distortionary - because companies can change their behavior to avoid or circumvent them.

Other examples include free food on airlines to circumvent ticket price-fixing by the government in the old days, employer-sponsored health insurance to circumvent price/wage controls during WWII, free "stuff" (toasters, etc.) at banks in the 1960s and 1970s to avoid interest rate controls on savings accounts, charging points on a mortgage to circumvent interest rate maximums on mortgage loans, or in this current case a resurrection of annual fees, etc.

HT: Lee Coppock


Update: Reason article on this topic (thanks to Colin).

21 Comments:

At 2/22/2010 10:03 AM, Blogger Colin said...

http://reason.com/blog/2010/02/22/today-is-the-first-day-of-the

 
At 2/22/2010 10:13 AM, Anonymous morganovich said...

this is what makes the new obama healthcare proposal out today so frightening.

he's seeking to both limit prices charged by private insurers and to mandate the coverage they provide. this puts them in a vice.

the "unintended" consequence (and i very much doubt it's unintended by the white house) will be the bankruptcy and failure of the private health system setting it up for massive government involvement.

this is the exact same play as using CRA to mandate that banks do unprofitable business, and look how that worked out...

 
At 2/22/2010 10:38 AM, Anonymous Anonymous said...

Annual fees you see upfront, making consumers more price sensitive and less likely to accumulate cards.

Hidden fees or fees which kick in when you least expect it or don't anticipate it, make you less price sensitive.

You pick.

I think upfront fees are good for the consumer and the economy, rather than hidden fees and fees which exploit the uninformed or careless.

Opinions may vary, but this is mine.

 
At 2/22/2010 10:40 AM, Anonymous Anonymous said...

C(Sh)itibank just tried to impose a $60 fee on me. They are presently extracting a plastic card shoved up their butt, sideways! If I want to pay a fee, why not give me a free round trip airfare?

 
At 2/22/2010 11:33 AM, Anonymous DrTorch said...

Why is it that some folks can't accept the fact that businesses are capable of bad/immoral/unethical practices?

Sure, if competition were perfect, maybe these would be rectified. But it's not!

Credit card fees may be a consequence, but what's the problem? Better to see those up front, and then look for a better card thru the competition...than be hit with fees in a dishonest manner.

Citi let me know (2 months in advance) that I will pay an annual fee if I keep their card. I have a choice! Furthermore, they will refund the fee if I use the card enough (which they quantified).

That's a straightforward proposal. What's to complain about?

 
At 2/22/2010 11:49 AM, Blogger OA said...

Anonymous said...
Annual fees you see upfront, making consumers more price sensitive and less likely to accumulate cards.

Hidden fees or fees which kick in when you least expect it or don't anticipate it, make you less price sensitive.

You pick.

I think upfront fees are good for the consumer and the economy, rather than hidden fees and fees which exploit the uninformed or careless.


Truly there were some really shady business practices highlighted the last year. But they could have been fixed with disclosure regulations, or prohibition on just those activities.

Instead we get some ridiculous overkill regulations in the name of "consumer protection."

What's happened is that fees which were rightly imposed upon the worst credit risks are now being spread among the rest of the cardholders. Just as all the homeowner bailouts are rewarding those who have defaulted on their contracts at the expense of others.

If you read the link that Colin posted, it's not just annual fees that are making up the difference.

I noticed that balance transfer fees jacked way up right after the bill passed. A typical fee that I used to see was something like 2% of the balance with a $50 or $75 cap. Now it's normally a 4% uncapped fee. For a $10,000 balance transfer the fee which would have been $50 or $75, would now be $400. Easy fee to avoid, yet many will incur it.

Also a sneaky fee that I never used to see but almost all my VISA and Mastercards have now is a foreign transaction fee. This is where 1% or more is charged if a biller is overseas even if the amount is in dollars. So buying an airline ticket from a foreign airline or hotel booking site incurs a fee even if it they charge in dollars.

 
At 2/22/2010 12:02 PM, Anonymous norman said...

To circumvent the credit card companies' (and really all financial services like banks, mutual funds, mortgages, etc) wiggling by the use of the Law of Unintended Consequences all we have to do is pass a law that obligates these companies to give their customers, on a quarterly basis, a report that shows what the fees were that the customers paid. Disclosure beats almost any 'law'.

 
At 2/22/2010 12:05 PM, Anonymous Benny The Man said...

Really.
Let's wipe out FDIC insurance, as Milton Friedman wanted to do.
It means depositors willy-nilly put money into banks, instead of first determining that banks lend prudently.

 
At 2/22/2010 12:29 PM, Anonymous Anonymous said...

@OA,

per my previous post favoring upfront fees, and actually welcoming these changes, the balance transfer fee is upfront and known when you decide to get a new card and transfer. That is an upfront and you see it fee so you can decide whether to take the new card or not. No problem with me.

The foreign fee--firms compete on that and you should look for a card that doesn't. If you are a good credit risk, good. Otherwise, I use a foreign ATM or bring cash.

Actually, what you may be seeing is competition for good accounts, and less competition for bad credit risks given these changes. And, as a result of having less bad credit risks, your costs may decline over time.

As for up front ala carte pricing, unbundling actually makes the market work better. You are not paying for something you do not want or use.

I have been utterly amazed at how the credit card industry has tried to paint these reforms as hurting consumers. These guys--the credit card industry--have been the purveyors of this bs. Do you think they have your interest at heart? Or, do you think they were better off under the old regime?

 
At 2/22/2010 12:39 PM, Blogger Earl said...

Being recently RIF'd by State lack of tax revenues (sales tax state) and retiring from the mad race to acquire everything thing free sexy hot and have to have - I am paying off the credit card bills and last auto loan - downsizing to existence mode, no longer consumption champion of the world. But they won't miss me when I send back the cards - and I have never ever worried about my credit score.

 
At 2/22/2010 3:02 PM, Blogger OA said...

Anonymous said...
@OA,

per my previous post favoring upfront fees, and actually welcoming these changes, the balance transfer fee is upfront and known when you decide to get a new card and transfer. That is an upfront and you see it fee so you can decide whether to take the new card or not. No problem with me.

The foreign fee--firms compete on that and you should look for a card that doesn't. If you are a good credit risk, good. Otherwise, I use a foreign ATM or bring cash.



You miss the whole point that the fees are higher, and they're being imposed on people who didn't previously have to face them. All in order to reduce fees on those who are generally more deserving of them.

I have a credit score over 800 in 2 of the 3 bureaus, and I think 780 on the third. So no issuer has yet announced an annual fee on my accounts and all my cards have rates below 10%. But potential fees spiked the last year oh all my cards. AMEX being an exception.

I don't incur balance transfer fees, as I don't transfer balances.
But note there was no back end or hidden fee previously that is now in a transparent up front fee. It has always been an up front fee, but now is much higher. And it is all the time, whereas the fees/interest at issue last year only came up during "the worst financial crisis since the Great Depression." I don't mean a change in credit card offers I've been getting, I mean an increase in the balance transfer fees on existing accounts.

Paying cash or using an ATM card is an option only when you're physically in a foreign country.

I'm referring to paying for a US dollar priced ticket or hotel on the internet with a foreign based company. For that matter I had it pop up on some electronics purchase where I had no idea it was a foreign company. That's how I found out there was such a thing. I use a 1.5% cash back card to still net 0.5%, but previously that full 1.5% was coming back to me.

I find it amazing that people who seemingly were against higher fees are now trumpeting higher fees as being a good thing.

 
At 2/22/2010 4:00 PM, Anonymous Anonymous said...

"You miss the whole point that the fees are higher, and they're being imposed on people who didn't previously have to face them."

Horse shit. There are - according the article posted by MP - still 57% of credit cards issued WITHOUT such fees.

So if you insist on deciding on a card with fees, it's your own stupidity you have to blame and not the government.

 
At 2/22/2010 4:22 PM, Anonymous Anonymous said...

@OA,
I think you are missing the point. Up front fees are good because they form a focal point for competition.

I teach from time to time graduate level marketing course on pricing in business school (I also teach antitrust). We teach people to hide fees, to make them less price sensitive, to price discriminate.

And, unbundling will work for both consumers and credit card companies. If you pay a price for the cost and risk of currency risk the credit card company pays, I don't pay it. And, there are companies who compete by bundling.

The old system worked well in fleecing everyone--you included--and I for one, am glad to see the change.

Unless I represented a credit card company.

 
At 2/22/2010 6:16 PM, Anonymous Lyle said...

As has been stated all the change to up front fees means is that one now has it easier to shop. As many commentators have said, a credit union is a better place to put money and get a credit card than a bank. Coops are better in general just like mutual insurance companies as any profits go back to the consumer. Unfortunatly due to the need of executives to be paid a boat load of money a lot of the insurance industry de-mutualized. A mutual company is more stable and is not subject to bear raids because it does not have stock. But it can't pay the greedy executive class as much so companies had to de-mutualize

 
At 2/22/2010 7:49 PM, Blogger OA said...

Anonymous said...

"You miss the whole point that the fees are higher, and they're being imposed on people who didn't previously have to face them."

Horse shit. There are - according the article posted by MP - still 57% of credit cards issued WITHOUT such fees.

So if you insist on deciding on a card with fees, it's your own stupidity you have to blame and not the government.



And any people who went over balance, missed payments, and were subjected to fees previously have only themselves to blame and not the credit card companies. Yet somehow their plight is everyone's problem now.

If anyone can show me a credit card that has decreased fees this year, I'm all ears. I don't mean a card that is lower than other cards, I mean a card where fees have gone down from last year.

If I said there were people facing new taxes under the Obama administration, would you say horse shit, 95% of people get a tax cut? That doesn't mean 5% aren't facing increased taxes, just as saying 57% don't have annual fees doesn't mean there are people facing those annual fees who never faced them before. That it's not 100% the case is irrelevant.

And from the article: "During the past nine months, credit card companies jacked up interest rates, created new fees and cut credit lines."

So you can ignore the reality of millions of people facing new fees, but they are there. And I haven't "chosen" a new credit card in over 5 years, so it's not stupidity in choosing a card with fees, it's having a card where potential fees have been jacked up.

 
At 2/22/2010 8:12 PM, Blogger OA said...

...If you pay a price for the cost and risk of currency risk the credit card company pays, I don't pay it...

This is not a currency risk fee. The vendor is charging US dollars so if it's US$40, that's the charge. No foreign currency price converted, the bank just has to pay US$40 no matter when they actually pay the vendor.

All they are doing is charging a fee for the vendor being a foreign vendor. Basically pretending there's a foreign currency transaction fee, but for US dollars.

Here's how it slipped into one agreement " "Foreign Transaction" means any transaction made in a foreign currency, and any transaction made in U.S. dollars if the transaction is made or processed outside of the United States. Foreign transactions include, for example, online purchases from
foreign merchants. "

Previously the part about "and any transaction made in U.S. dollars if the transaction is made or processed outside of the United States." was different.


Considering I carry no balances except the business card, get cash back on the main card I use and points on others, and have no annual fees, it's interesting that I've been fleeced. I get float, convenience, and cash back and somehow I should be glad there's new fees now.

 
At 2/22/2010 8:22 PM, Anonymous Anonymous said...

It seems to me that the credit card companies were abusing people who lacked the ability to manage credit, which to me is analogous to a psychological disorder like compulsive gambling. They were taking advantage of such people in order to provide competitive benefits to people who could manage credit. I feel this is amoral and it is something I don't mind the government regulating.

I see "predatory" lending as a vice that humans are susciptible to, like drug pushing to school children, and which should be illegal.

Also, it seems resaonable to me in principle to make people pay, via an annual fee, for the credit card services they use.

However it does seem like credit cards companies are now, through new fees, making people who can manage credit pay for the credit card companies losses to people who can't manage credit, when what you'd like to have is credit card companies managing their losses to poor credit risks by simply not lending to such individuals. I would hope that the regulatory environment and competition would tend to push credit card companines in that direction.

Another problem I see with credit card companies is that they prevent stores from instituting a minimum purchase of, say $10, before accepting payment with credit cards. Accepting payments with a credit card costs the store money and in order to make up the cost the store has to have higher prices than otherwise. In effect non-credit card users are paying higher prices to subsidize the service used by credit card useres. I suspect non-credit card users are more often poor and so it seems like poor people are forced to pay higher rices to subsidize the ability of rich people to use credit cards.

 
At 2/22/2010 8:27 PM, Anonymous Anonymous said...

"Distortionary Effects of Regulations and the Law of Unintended Consequences: Annual Fees Are Back"

How is paying for the services you use "distortionary"?

 
At 2/23/2010 8:37 AM, Blogger OBloodyHell said...

> Annual fees you see upfront, making consumers more price sensitive and less likely to accumulate cards.

There are already systems in place to make "accumulating cards" impractical (the credit reporting agencies record even when you apply for credit, whether you take/get the credit or not), meaning that the CC producers can spot someone "hunting" for excess credit.

This, by the way, is to the benefit of both the CC people AND the CC holders.

 
At 2/23/2010 8:54 AM, Blogger OBloodyHell said...

> Why is it that some folks can't accept the fact that businesses are capable of bad/immoral/unethical practices?

Because there's no such thing as "immoral" to a corporate entity, which is a legal figment, not a living, thinking organism?

There are actions we deem societally unacceptable, which is not the same thing at all.

Why is it that some folks can't accept the fact that governments are capable of societally unacceptable practices? Especially among the ones who are often found caterwauling about the "immoral" practices of business entities?

> than be hit with fees in a dishonest manner.

How are you getting "hit with fees in a dishonest manner"?

You're getting notified ahead of time with two or more months to clear off the debt if you don't want to continue it. Where are these "dishonest fees" you're talking about?

You read the contract, and you either understand it, or you don't. The first time you get hit by a fee, unless it's pretty damned obvious, most CCs will refund you the charge -- that first time. After that, it's not a "dishonest" fee by any stretch of the imagination. In either case, it's up to you to understand what you're signing. If you don't understand it, you shouldn't have signed it. If you don't like it, you can take your business elsewhere. Or you can take the one-shot from the fee as a learning experience, and not make that mistake ever again.

it's called "personal responsibility".

What a concept!!!!

I don't think well of "annual fees" because they're already collecting the interest on any money I leave on the card. Why should I pay them a fee as well?

Now, solely thanks to Obama's idiotic laws "protecting me", I might have to pay extra for my sole credit card, which I've made timely payments on for several years now? How, please, am I being "protected"?

 
At 2/23/2010 3:12 PM, Blogger juandos said...

"I see "predatory" lending as a vice that humans are susciptible to, like drug pushing to school children, and which should be illegal"...

You must be a progressive, right?

What I find astounding is the ages old lesson that isn't being learned: caveat emptor

 

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