Montana Viewpoint
January 7, 2008

It’s just a little piece of plastic but it has overturned the principles of sound borrowing, driven major bank profits to record highs, and changed the economy of the United States. Borrowing to pay living expenses, which was once held to be a financially irresponsible thing to do, is now accepted and encouraged. While banks used to rely on interest on loans and earnings on savings accounts for income, they now rely on fees—including credit card fees—which have replaced interest income as the primary source of revenue; and the American economy is now driven by people buying “stuff.”

Money used to be loaned only for acquiring assets or for financing a business venture. Loans for day to day living expenses didn’t happen; it was bad financial policy for banks and customers alike. But times change, and now borrowing money for living expenses is encouraged, and that’s putting it mildly. When we charge something on a credit card, we are borrowing money. We may not think of it as borrowing, but that’s exactly what it is.

Beside this different way of looking at debt two other important events that changed the credit card economy were a 1978 Supreme Court decision and the abolition of state usury statutes in the 1980s.

Usury laws prohibit lenders from charging borrowers unconscionable rates of interest. When the double-digit inflation of the early 1980s hit, most states relaxed their usury laws significantly and Delaware and South Dakota did away with them. Previous to the change in usury laws a 1978 US Supreme Court ruling (Marquette v. First Omaha Services) held that no matter where the borrower lived, if the lender was a National Bank, the laws in the state where the loan originated governed the terms of the loan. If there is no limit to the amount of interest banks can charge in South Dakota, there is no limit in any other state if the loan originates in South Dakota. Not surprisingly, banks issuing major credit cards began to migrate to states without usury laws where they were able to raise the interest rate on their cards.

Even though nationwide credit card interest rates are typically high, they must not be high enough, because the credit card banks play games with their customers to make sure the banks get a little more. Allowing for artificially low minimum payments, for instance, makes it difficult for customers to pay off their debt and causes them to pay more in interest.

I’ll use the rates on my card for an example. I have a card with a 14% interest rate that requires a $15 minimum payment on a balance of $1000. If I make nothing but the minimum payment every month it will take me 10 years to pay it off, and that’s only if I don’t charge anything else to the card. I will also be paying some $980 in interest. [You can find nifty information like this by going to creditcards.com and using their rate calculator. This site has a lot of other information you might find helpful.]

Interest rates are only one of many fees used to earn revenue; there are late fees, overlimit fees, balance transfer fees, check fees, and fees ad nauseum. As if they weren’t high enough, banks follow practices that make incurring them unavoidable, like manipulating the grace period—the interest free time between the statement date and date the bank gets your money—by sending the statements out later than usual. That shortens the grace period, the payment arrives late, and a late fee is charged to the account.

Overlimit fees are assessed for charging more than the amount of credit the card allows. While the banks certainly have the ability to deny approval of a purchase if you go over the limit, they prefer to let you exceed your limit and incur the overlimit charge. And by the way, you may get to pay interest on that charge, and every other fee.

The fee costs charged to credit card users do not relate to the actual cost of the transaction in any meaningful way. They are simply a way of making money by encouraging people to make bad decisions.

The rules of sound financial planning are the same as they have always been and are as valid as they have always been. Finding an easy way to make money by flaunting them doesn’t change that, and financial giants like Bank of America and Citigroup have an obligation to promote responsible borrowing policies instead of making money by encouraging people to make bad financial decisions.

It would be nice, but I won’t hold my breath.

Jim Elliott