I wrote before about a Dick Morris' economic errors, but this time he is much farther off base. In a repeat of the foolish errors uttered by Debra Saunders, Mr. Morris, in his most recent article, argues that credit card companies need to be more strictly regulated. Sadly, many people seem to believe this, but, if you look at all the facts, they simply don't support that conclusion.

First, let me address the most basic argument. If credit card rates are too high, then credit card companies would be making excessive profits. Whenever profits rise too high above the prevailing rate of return, what happens? Why investment money flows into that field, competitors show up, and prices drop. Unless there is some restraint on trade, usually in the form of government restrictions, history has shown an excess profit cannot remain, as it is just too attractive to investors and, inevitably, new investment brings profits in line with the prevailing rate of return.

In terms of credit cards this is easy to see. Let us suppose credit card companies are making a killing charging 20% interest. Let us imagine at that rate they make a profit of 20 cents on the dollar. As most investments return about, let us say 5%, it would be obvious that money would flow into the credit card companies. Even if you had to borrow money, with the prevailing rate being 5%, it would be easy to borrow from venture capitalists at 7% or 8% and make a 12-13% profit without risking your own money. Or, you could do even better, by dropping your rate to, say, 15%, accepting profits of only 7-8% and taking away almost all of the business from the existing companies.

And that, in reality, is just what would happen. If credit card companies were making such exorbitant profits*, then one smart company, or a new company, would reduce their rates 1%, or 0.5%, get a huge share of the market, and still make a killing. Until, that is, another thought of undercutting the first, and then another, and so on, until the profits fall in line with the prevailing rate of return on the market**. As this has not happened, we must assume that the "usurious" rates are actually needed to keep profits in line with other industries.

So, why are credit card rates so high?

Well, there are three reasons.

First, people in general are less frightened of bad credit than they once were. Whether it is because of the government making credit easier to get even with bad credit, or because it has become easier to "clean" one's credit record, or some other reason entirely, people are less frightened than in the past of simply refusing to pay a debt. Which means that some significant portion of credit card debt will simply be uncollectable, no matter what is tried. That places a pretty high risk premium on any consumer credit. If the same conditions prevailed in home mortgages or car loans, doubtless their rates would be just as high or higher. So it is absurd to blame the credit card companies for the behavior of their borrowers.

Second, thanks to "borrower" friendly bankruptcy laws, it si easier to discharge debts to credit card companies than it once was. Just as with the first point, this means that such companies have to deal with more losses than in the past, meaning they have to charge everyone higher rates or fees to compensate for the losses they incur when others either default or discharge debts in bankruptcy. The more they lose, the more they have to make up form their paying customers. Which means those "borrower friendly" bankruptcy laws, allowing those who default to have some partial "debt forgiveness" (that is, to fail to pay off some debts),are not friendly to other borrowers who now have to shoulder higher debts. (I discussed the harm "borrower friendly" policies inflict on many borrowers in "To Correct Debra Saunders" and "When Help Hurts". The latter also discusses other banking and lending regulations, including usury laws, so it quite apropos to this discussion)

Finally, the government has done to consumer lending what it has done to home mortgage lending, introduced politicized criteria. Just as with EHOC and other regulatory bodies, the government has the tools to bully credit card companies it thinks are giving too little credit to minorities, the poor, or any other group. As a result, credit card companies often defensively grant cards to many poor credit risks just to avoid government headaches. This, obviously, also results in a higher rate fo default, as these cards are rarely given to those who would normally qualify. And, as I said earlier, when faced with more defaults, rate rise.

All of whichs hould make it obvious that, no matte rhow high the rates and fees, credit card companies ar ehardly raking in massive sums of money, despite Mr. Morris' claims.

Then again, they are easy political targets, just like "Big Oil" and "greedy Wall Street tycoons". So it is likely the government will meddle still more with consumer lenders. Though the resutls, less credit, fewer people qualifying, maybe a complete disappearance of many varieties of credit, will probably not please those who think they are fighting "corporate greed".

---------------------------------------------------------------------

* As I said of the oil companies in "When Did We Become Liberals?", if you think credit card companies make "unconscionable" profits, then buy their stocks. Citigroup is publicly traded, as is BOA. Sadly, both are doing pretty badly. But, if you truly think credit cards are "gouging", then you can join in the profits by buying their stocks. (As they are not soaring right now, I think the market does not share the belief in their exorbitant profits from credit cards.)

** This is identical to the behavior of businesses I described in "Saving Us From Lower Prices" and "Cheap Lighters, Overseas Dumping and Monopolies" with regard to prices, and in "Seeing People As Stupid", "Exploited Labor", "Capital Investment", "Pay Disparities" and "Just Asking For It" with regard to salaries. It is a topic I discuss at length in "Planning For Imperfection" and "Fairness and the Free Market" as well.

----------------------------------------------------

POSTSCRIPT

In the interest of disclosure, I should reveal I once did work for Citigroup, back when they were Citicorp, though not in their credit card or loan divisions. I also held Citigroup stock until recently, though I sold it when I became worried that more government intervention was going to bring about a drop in value (or that other people's worries about future intervention might make the stock more volatile than I would desire). Though I should not need to say so, I will add that neither of these facts influenced my thinking on this matter in any way.