Invasion of the Credit Cards
It is pretty easy to find dire statistics about credit cards in America. Frankly, the financial puritan in me likes it when I see another news story denouncing over-leveraged American consumers and the sad erosion of thrift and delayed gratification. Bring on the jeremiads! On the other hand, I realize that there is an important sense in which these statistics are misleading.
This week in my Article 9 class we went over the rules governing security interests in consumer purchases. The interesting thing about this material is that the standard hypothetical — I buy a refrigerator on credit from the department store — is an anachronism. Today, if I am going to finance the purchase of a big-ticket consumer good, I don’t get a loan from the J.C.Penny finance department. I charge it. Indeed, even if Target or Home Depot wants to finance my purchase I don’t go to the lending office at the back of the store. I get a Target credit card. Of course, some of these charge cards — I am told — claim a security interest in the goods purchased with them. On the other hand, I suspect that the Walker-Thomas days of a retailer who repos the cross-collateralized big stereo sets are as obsolete as, well, big stereo sets. In other words, we now have more credit card debt in part because credit cards have replaced virtually all other forms of consumer finance.
This, of course, makes economic sense as well. The biggest benefit of secured credit does not come from the reduction of risk. Miller and Modigliani long ago taught us to be skeptical of this story. The unsecured creditors ought adjust their interest rates to accommodate the risk created by secured creditors and the over all effect on the cost of capital will be a wash. Of course, this is far from entirely true — there are non-adjusting creditors like tort victims and trade creditors. On the other hand, I’m skeptical that secured credit exists mainly as a vehicle for lowering financing costs through increases in risky behavior.
Rather, the story on secured credit is that it reduces monitoring costs by providing a legal technology that reduces the need for creditors to constantly watch their debtors’ every move. Credit cards are also based on monitoring technology, but in their case the technology is . . . well . . . technology, in particular, computers, low-cost credit reporting, and the law of large numbers. In other words, the information technology of credit cards is a substitution for the legal technology of secured credit, and on many fronts it seems that legal technology is losing the race. Hence — at least in part — the rise in credit card debt.
It would seem, however, that credit cards may be moving in to replace not only the old consumer finance departments, but now ordinary commercial lending as well. According to the NYT:
Just as the slowing economy has made access to cash a higher priority for a lot of small businesses, banks have become more reluctant to extend traditional lines of credit to those businesses, experts say. But banks have been offering “small business” credit cards.
Bank cards and lines of credit both offer money when it is needed, but there is a fundamental difference: lines of credit have low, fixed interest rates or slow-moving, variable ones, while interest rates on credit cards can jump unpredictably.
Hardly an encouraging trend, although I suspect that the unpredictability of credit cards can be overstated. To be sure, if you miss your payments regularlly the combination of changing interest rates, penalty fees, and the like gets very bewildering very fast. On the other hand, if you are a good credit risk that subprime-spooked banks just won’t lend to, then credit cards may not be a horrible way of providing short term liquidity. Longer term credit card loans, however, get my inner puritan fired up.