Credit Card Charges

The credit card bill is headed for the President's desk, where it is sure to be signed.

Among the more significant items are: teaser rates must last at least six months; payments get applied to the lowest interest rate balance first; and consumers cannot be charged for overlimit fees unless they have asked for permission to go overlimit.

These are significant changes, and there are other ones as well. Some of them I find not entirely disagreeable. Disclosure of terms has not been wonderful, and I think there is the capability of banks to exercise market power on the basis of locked-in consumers: once your credit record gets scarred, you effectively cannot switch banks and your existing lender has you at their mercy.

This said, there will be negative consequences -- many consumers will not get offers of credit that they otherwise would have. That will mean that folks who get into trouble and use credit cards to weather the storm (how many of us have not been there) will have to forego more purchases. Let's not immediately think of alcohol and cigarettes, but how about food and medicine??

What bothers me most about the discussion is the naivety that commentators display in talking about the ramifications of the changes. The view that some people have of business is just amazing. Read this New York Time story,especially this quote:

And to make up for lost income, the card companies are going after those people with sterling credit.

So the thinking is that a business basically has these various faucets, out of which profits flow. If one faucet slows down -- in this case because of regulation -- well, you just turn up the other one. After all, business has to maintain its profitability, right?

If only it were so easy.

If some set of credit card users are currently unprofitable, why are they not already eliminated? Or if the banks could increase profits by changing terms on the "sterling" users, why wouldn't they already have done that?

The answer is, of course, that those free lunches simply do not exist. All faucets are already optimized, producing as much profit as they can. If one slows down, turning the other ones will only reduce profit.

There are some more complicated theories of how some deals will be cut back. Basically the idea is that I might offer things like frequent flyer miles to all users even if I do not make money from charges per se. What I am hoping is that some consumers will take the card for the miles and then end up paying me interest. If the interest rate gets capped by regulation, the whole scheme gets less profitable so I might stop offering the deal.

Understanding the why of things is rather critical.

How Does Closing Dealers Help the Auto Companies?

Can someone explain this one to me? The dealers are independent, and buy cars from the manufacturers at a wholesale price. Yes, there are some volume-based rebates and so on, but nothing that would seem to change my basic view of things.

For any given wholesale price, the manufacturers want to sell as many cars as possible. Or, to put it differently, for any wholesale price, the manufacturers want the final retail price to the customer as low as possible.

This calls for as much competition among the dealers as possible.

Closing dealers reduces competition among dealers and for a given wholesale price causes a larger wedge between that wholesale price and the final retail price.

If there were things that the dealers were doing such as providing information or extra services, then there is a valid reason for the manufacturer to want to limit price competition -- to avoid some dealers from free-riding on other dealers' provision of services.

But in the modern auto world, I don't know what services are being free-ridden on. Consumers can find most information online. All that dealers need to do is to have some cars on the lot for people to drive. The manufacturers can easily require that and even pay for the cost.

Many people get the basic economics here wrong, even people who are pretty smart. They somehow think that competition between dealers on price reduces the price that the manufacturer gets. This is clearly wrong. Or they think that the manufacturers are paying for the dealers' costs. That also is not right.

I cannot believe that the manufacturers and their consultants are getting this wrong. There must be some other contractual obligation that I am unaware of, or there is some freeriding issue that is not obvious to me.