Proposed Credit Card Rules May Complicate Economic Turndown

When the Federal Reserve asked for comments on a proposed rule that would protect credit card customers from questionable lending practices regarding interest rates and payment cycles, over 56,000 outraged responses flooded in, most of them from card holders with horrendous personal stories and a variety of common but very troubling complaints.

Worst Practices Much Too Commonplace
A few of the most frequently cited (and most commonly hated) lending practices included:

• hiking credit card rates when a customer pays an unrelated bill late even once (such as a monthly utility bill paid with a check)
• using a “two cycle” billing method which allows the credit card company to charge interest on the billing cycle preceding the one in which the bill is mailed (thus greatly increasing the interest charged before it is ever billed out)
• changing the due date without warning or shortening the billing cycle unrealistically thus making timely payment nearly impossible
• offering multiple promotional rates but only applying payment to the lowest rate purchases first, neglecting the highest rate purchases entirely until the low rate purchases are paid off

In an election year, credit card reform might seem like a political no-brainer, and in fact Representative Carol Maloney, Democrat of New York is already sponsoring a “Cardholder’s Bill of Rights” that would enforce limits very similar to the ones already proposed by the Fed in May. Democratic Senator Christopher Dodd, Chairman of the Senate Banking Committee, will soon be sponsoring similar legislation in the Senate. Politically, the legislation is a slam-dunk.

The Downside of Credit Card Reform for Customers
But it’s not all good news.

In the wake of the sub-prime mortgage meltdown, not only have banks been losing enormous sums of money, consumers have found themselves without any ready source of cash or credit just when they need it most. As home values plummet, home equity lines nationwide are being frozen. Many customers now find themselves ‘upside down’ with regard to their secured debt. However, the cost of gas and food keeps rising anyway, jobs keep disappearing, and more and more customers have been leaning on their unsecured credit cards to fill the gap.

Banks and lending institutions are naturally becoming skittish about a projected wave of credit card defaults that could rival the sub-prime meltdown in scope and toxicity. To head off losses that will surely come when the new Federal Reserve fair practices guidelines kick in, banks are starting to quietly lower credit limits on cards held by even their best customers. This immediately impacts credit scores: A major part of a customer’s credit score is calculated on how close to the credit limit the credit card debt has climbed. So, a good customer with $7,000 in credit card debt and a $20,000 limit will instantly see a lowered FICO score when his or her credit limit is reduced to $7500, thus making it even harder to get any other kind of loan.

Taking such preemptive measures may afford a degree of protection to banks, but it also tightens up credit in an already tight credit market and takes away yet another (admittedly bad) tool left to consumers for coping with serious financial crises. So what is understandably popular on a surface level is already having a negative impact on consumers by tightening up the availability of credit and downgrading credit scores even for responsible borrowers.

Clamping Down Hard on Predatory Secured Cards
However, a few practices the Fed hopes to eliminate are so predatory it’s hard to see how they can have anything but a positive effect. For example, many secured credit cards charge exorbitant application fees, card issuing fees, and so many other fees that by the time the card is actually sent out the customer almost no credit is left for that person to use, and what’s more, interest is then charged on the fees for opening and issuing the nearly worthless card. While companies who issue these cards assert that these tactics are necessary due to the risky nature of the customers who apply, the new rules proposed by the Fed will make it much harder for such companies to engage in this kind of predatory unsecured lending.

Credit card lending guidelines do need to be tightened. The Federal Reserve, Congress, and customers all agree easily on that single point. What is much less clear right now is how these tighter rules and standards will affect consumers, banks, and the economy as the current slowdown (some would even say ‘the current crisis’) unpredictably plays itself out over the coming months.