Perpetual Debt, Predatory Plastic

Last year John, a 55-year-old African American living on public assistance in Takoma Park, Maryland, a Washington, D.C., suburb, received an invitation in the mail promising him a chance to join millions of other Americans who enjoy the convenience and status of credit-card membership. In its direct mail solicitation, United Credit National Bank Visa declared, “ACE VISA GUARANTEED ISSUE or we’ll send you $100.00! (See inside for details.)” For the unsuspecting, it might have sounded like a terrific opportunity to enter the credit mainstream. But a closer look inside showed that the primary beneficiary was the credit-card company:

Initial credit line will be at least $400.00. By accepting this offer, you agree to subscribe to the American Credit Educator Financial and Credit Education Program. The ACE program costs $289.00 plus $11.95 for shipping and handling plus $19.00 Processing Fee, a small price to pay compared to the high cost of bad credit! The Annual Card Fee [is] $49.00 For your convenience, we will charge these costs to your new ACE Affinity VISA card.

In other words, getting the card would cost John $369, leaving a net credit line of as little as $31—all financed at an annual percentage rate (APR) of 19.8 percent. As a poor, minority consumer, John’s been gouged often enough to recognize a come-on: “Man, they just want to rip me off.” He didn’t go for the offer.

The credit card industry tries to whitewash such usurious and predatory practices by arguing that it is “democratizing” access to credit through its offers to households previously limited to “second-tier” lenders such as pawnshops and rent-to-own stores.

But not everyone has John’s hard-earned savvy. Many impoverished consumers are blinded by financial desperation, low literacy skills, and a desire to part of what the TV commercials tell them is an exclusive club: the fellowship of consumers lucky enough to have earned bank credit cards. After all, exclaim the well-dressed actors, “You work hard for your money. Don’t you deserve some credit?”

Not surprisingly, they sign up and become willing subjects of America’s new credit economy, a brave new world where technology, marketing innovations, and deregulation have transformed old ways of lending and borrowing. The only thing that hasn’t changed is this time-honored principle: The most profitable way to make money off the vulnerable is to keep them in debt at the highest rates for as long as possible.

In the 1940s, when folksinger Merle Travis was memorializing the harsh fife of Southern coal miners in his famous ballad “Sixteen Tons,” consumer debt served as an effective management tool for lowering both wages and worker turnover. Coal miners became indebted to the company store through high prices and excessive finance charges in an era when “saving for a rainy day” reflected the vagaries of the business cycle (unemployment) and the physical risks of the job (accidents). As a result, company scrip often replaced government currency, and miners’ household debts bound them to their employers in a form of debt servitude.

You load sixteen tons what do you get

Another day older and deeper in debt

Saint Peter don’t you call me ’cause I can’t go

I owe my soul to the company store

As mail order retailers like Sears Roebuck expanded into the hamlets of the American South in the early 20th century, the growth of working class consumer markets became intertwined with access to credit. Unlike the company stores of Appalachia, where extending credit was a profitable business practice, the “open book” credit policies of local merchants (usually interest free), as well as credit lines at retail chains, were designed primarily to promote sales volume and customer loyalty. Although household incomes rose throughout the 1950s and 60s, the popular Sears credit card—the largest proprietary consumer credit system in the post-World War II era—featured an onerous finance charge of 1.5 percent per month on outstanding balances. Even so, the high costs of administering these low volume “revolving” accounts typically resulted in annual losses to the company; retail profits were made from selling rather than financing consumption in the golden age of U.S. manufacturing.

The recent revolution in consumer financial services dates to the 1970s and the increasingly successful assaults against Depression-era banking regulations. For example, the 1933 McFadden Act limited national banks from crossing state boundaries and competing with state-chartered banks. Until the 1980s, these restrictions protected the community banking system and its conservative installment lending policies. Significantly, the best customers of these local banks were those with the lowest outstanding debts—the borrowers who were most likely to repay their loans within an agreed period.

By the late 1970s, high inflation and declining real wages encouraged families to embrace debt as a strategy for coping with financial hardship. State usury laws and interstate banking restrictions, however, limited the growth of the “all-purpose” or “universal” national bank credit card until 1978, when the U.S. Supreme Court ruled that nationally chartered banks could charge the highest interest rate permitted by their “home” states and export these rates to their out-of-state credit card clients. Banks quickly relocated their “brick and mortar” offices to states without usury ceilings—Citibank, for example, moved from New York to South Dakota. In this way, the universal credit card (led by Visa and MasterCard) was transformed into a high profit product that could hurdle state banking regulatory barriers.

The universal bank credit card played a major role in the deregulation of the U.S. banking industry in the 1980s. National “money center” banks faced mounting losses on Third World, residential, and commercial real estate loans following the 1981-82 recession. Credit cards became the banks’ means of profit salvation. Although Citibank’s credit card division bled over $500 million in red ink between 1979 and 1981, the sharp reduction in inflation and advances in computer technology sparked a dramatic shift toward consumer financial services over the next two decades.

In the 1980s, an average of one million blue-collar workers lost their jobs each year, swelling the pool of families struggling to make ends meet and increasing the demand for quick, unsecured consumers loans. The consumer services revolution shifted into high gear. Soaring bank profits fueled unprecedented consolidation. In 1977, the top 50 banks accounted for about half of the credit card market. Twenty-five years later, the top ten banks controlled over 80 percent of the market. In the process, “net” revolving credit card debt climbed from about $51 billion in 1980 to over $610 billion in 2002. At the same time, more than half of all outstanding credit card debt is resold in the secondary financial markets as securitized bonds, at a typical premium of 15 to 18 percent in 2001. Many institutional investors such as pension funds purchase these bonds for their portfolios.

Today, the ascendance of credit cards marks the shift from installment lending to revolving loans, where the “best” bank customers will never repay their high interest credit card balances. In this new world of consumer finance, the most disadvantaged (debtors) subsidize the low cost of credit for the most advantaged (convenience users). It is this moral divide that leads banks to refer to those clients who pay their charges in fall each month (39 percent of all customers in 2002) as “deadbeats.”

The other 61 percent are the ones who fuel the banks’ profits, and for them the price is growing ever higher. The true cost of borrowing on bank credit cards has more than doubled since the advent of banking deregulation in 1980, thanks to painful interest rates and escalating penalty and user fees. The upward spiral began in 1996, when the U.S. Supreme Court invalidated state limits on credit card fees by ruling that fees are part of the cost of borrowing. This decision produced a striking change in the way card issuers do business, along with some striking numbers:

■ The average late fee jumped from $13 in 1996 to $30 in 2002.

■ Penalty fee revenue climbed from $1.7 billion in 1996 to $7.3 billion in 2001.

■ Total fee income rose more than five times faster than overall credit card profits between 1995 and 2001.

■ Together penalty ($7.3 billion) and cash advance ($3.8 billion) fees equaled the after-tax profits of the entire credit card industry ($11.1 billion) in 2001.

■ Three out of five families (61%) now carry a balance on their credit cards each month. Their average card debt has risen from over $10,000 in 1998 to over $12,000 in 2002.

In response, banks argue that they provide an efficient service to consumers in urgent need of cash or a necessary purchase. Also, they emphasize the payment flexibility credit cards give their clients, many of whom face increasing financial demands and prefer to carry balances from month to month.

As profits have climbed, corporate retailers have become increasingly dependent on finance revenues to make up for shrinking margins on consumer sales. In 2001, for instance, Sears and Circuit City reported that more than half of their profits were due to finance-related revenues. This is not surprising since credit cards are the most profitable product of the financial services industry. Even during the current recession, pre-tax profits of the credit card industry (measured by Return on Assets) jumped 20 percent from 2000 to 2001. The industry pulled in record pre-tax profits of nearly $18 billion in 2001, or a whopping 4 percent of assets—three times greater than the average of the banking industry.

Not incidentally, the growing burden of high-cost credit card debt is borne by middle-income and working poor families. The current recession, which elicited President Bush’s patriotic exhortations to spend more time and money in the malls, has highlighted the critical role of consumer spending to the vitality of the corporate economy. Although government policy-makers have encouraged household spending by reducing interest rates (the Federal Funds rate was cut from 6.5 percent in 2000 to 1.75 percent at end of 2001), the sharp decline in the cost of borrowing by banks has not been passed on to consumers. For the major credit card companies, the Federal Reserve’s low-interest rate policy has produced a windfall, given that they had reduced their rates only modestly—from an average of 18 percent in 2000 to about 16 percent in 2001.

The industry, meanwhile, has fought to stop or hinder any state regulation of credit card interest rate ceilings and fees—or requirements that consumers be given meaningful notice of rate hikes or other changes in their contract provisions. For example, Maryland-based Chevy Chase Bank promised its credit card clients not to raise the top interest rate above 24 percent. In 1996, however, it moved its credit card headquarters to Virginia and raised its interest rate to a high of 28.8 percent. It also changed the terms of its contract to include higher late fees, a new overlimit fee, and a more costly “daily” calculation of finance charges—all without the sort of effective notification that would give customers a chance to reject these unfavorable amendments to their existing contracts.

Real disclosure would cut into profits, so the industry has fought to keep customers in the dark. If credit card clients understood the long-term cost of their accounts, they might make higher monthly payments—something banks don’t want. The American Bankers Association has sued to prevent the enactment of a 2002 California law that requires banks to use clients’ monthly statements to inform them of the number of years necessary to pay off the outstanding balance, assuming there are no additional charges and only the minimum payment is remitted.

Although banks emphasize the availability of low-interest balance transfers, the most indebted rarely qualify for these promotional programs or benefit for only a short period of time (two to six months). More frequently, heavily indebted households encounter “bait and switch” offers, where low-interest promises are quickly replaced with high-interest realities. Furthermore, credit card companies have adopted a stringent policy of imposing penalties on promotional interest rates for minor payment infractions or simply due to high outstanding balances on other consumer loan accounts.

In Houston, Texas, for example, Doug received an enticing six-month, 1.9 percent balance transfer offer from Chase MasterCard and shifted $5,000 from his MBNA credit card account. Unfortunately, Doug’s wife mistakenly sent $80 instead of the required $97 for the first month’s minimum payment. Even though it was received two weeks before the due date, his next statement reported $17 past due plus a $35 late fee. More striking was the increase in the interest rate, from 1.9 percent to 22.99 percent, even though he had not had a late payment in over two years. A Chase customer service representative informed Doug he would have to document six months of on-time payments before the bank would consider his request for a lower interest rate. This followed a previous “bait and switch” from Chase on the same card in 2001, where the 4.9 percent promotional rate was raised without warning—simply because the bank had decided that the balances on his other credit cards were “too high.”

The passage of the Financial Services Modernization Act of 1997, which authorized the Citibank and Traveler’s Group merger, marks the end of Depression-era regulation of retail banking as separate from commercial banking/insurance services. Moreover, the ability to acquire companies across financial services sectors and share client information with corporate subsidiaries underlies the rise of “cross-selling” financial products such as investment services to credit card clients. This explains Citibank’s 1997 purchase, at a substantial premium, of AT&T’s unprofitable credit card company (eighth largest), with its disproportionate number of high-income customers. For Citigroup, this corporate synergy produces multiple revenue flows by originating high interest loans through credit card and subprime lending, which are then resold through its Salomon Smith Barney division to individual and institutional investors.

Not incidentally, access to personal consumer credit information enables predatory lenders to identify highly indebted households that are susceptible to slippery solicitations for “debt consolidation.” According to a 2002 California lawsuit, Household Finance obtained lists of prospective clients from Best Buy, K-Mart, Costco, and other retailers. Homeowners with high debts were identified from these lists and contacted by account executives at nearby branches. Household promised these potential customers that their debt consolidation loans would save them money after the refinancing of their credit card, consumer loan, and mortgage debts into a single monthly payment. In the process, the lawsuit alleged, Household deliberately sought to “upsell,” or persuade their clients to accept consolidated loans in amounts so high in relation to the value of their homes that it would be nearly impossible to sell or refinance in the future.

By misrepresenting the total cost of these debt consolidation loans (origination fees, mandatory insurance, high interest rates), the suit claims, Household Finance Corporation generates high profits from the initiation of these loans as well as from their resale in secondary mortgage and securitized bond markets.

Today, high credit card interest rates are no longer sufficient to satisfy the financial services industry’s voracious appetite for profits. Penalty and transaction fees continue to rise while new fees are imposed, such as overdraft transactions, foreign currency conversion, and “double billing” cycles which reduce the payment “grace” period. In addition, banks have begun aggressively marketing financial-related services that offer little practical benefits for their clients. These include credit protection programs ($9.99 per month from Citibank) that cannot prevent identity fraud, and unemployment and injury insurance (typically 0.5 percent of outstanding monthly balance) with premium costs that usually exceed the minimum credit card payments provided by the insurance. The proliferation of these products yields big profits for the banks and only modest benefits for consumers.

For American families and consumer advocates, fighting back isn’t easy. The industry has thwarted state and local attempts to create better consumer protections by invoking the principle of federal preemption—the U.S. Constitution’s provision that public efforts to regulate the national banking system can be legislated only by Congress. The influence of the banking industry on both the U.S. Congress and the executive branch (MBNA was the largest contributor to George Bush’s Presidential campaign) seemingly ensures that no significant pro-consumer bills will see the light of day in the next couple of years. At the same time, the industry has reduced its vulnerability to class-action lawsuits by specifying arbitration agreements in their credit card contracts that deny consumers their right to a day in court.

Now, with the threat of regulation and litigation diminished, the credit card industry is focusing its efforts on passing the Bankruptcy Reform Act. President Clinton vetoed the measure at the end of 2000, but other versions of this industry-written bill were passed by both houses of Congress in 2002, and again by the U.S. House of Representatives in April 2003. The aim of the bill is to increase the amount of unsecured consumer loans (especially credit card debts) that must be repaid before the approval of a bankruptcy petition. If this bill is enacted into law, it will expand the U.S. government’s role as a de facto debt collector and increase the costs assumed by the public in extending consumer credit to the most risky credit card clients. In doing so, it will provide banks even greater incentive to push high-cost credit to their most marginal clients. For an industry whose motto is “Greed is Good,” this legislative distortion of the free market system could enable it to top even its current record profits and spiraling executive bonuses.