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Credit Card Industry Takes Its Licks

Congress Shines a Light on Abusive Practices

By Martin H. Bosworth
ConsumerAffairs.com

March 12, 2007
After years of docilely taking orders from banking interests, Congress is at least trying to assert a bit of independence, as evidenced by recent Congressional hearings that have spotlighted the abusive, predatory and usurious practices that have come to characterize the credit card industry.

Just last week, a Senate committee called executives from Bank of America, Chase, and Citigroup on the carpet to grill them about practices that seem specifically designed to punish consumers simply for doing what the credit industry encourages them to do -- not paying off their balances in full, paying only the minimum balances, and so on.

• Credit Tips And Tricks • Get Control of What You Owe • No Easy Way Out Of Credit Card Debt • Penalty Fees, Interest Rate Hikes, and Misleading Contracts Await Credit Card Shoppers • "Convenience Checks" Carry a Heavy Price Tag • New Forms of Credit Scoring • Understanding Credit • Credit Bureaus: Who You're Dealing With • Reading Your Credit Report • Credit Scoring: The Fickleness of FICO • Credit Knowledge: A Long, Hard, Struggle --- News • Retailers Applaud GAO Report On Interchange Fees • Schumer Moves to Clean Up Credit Reporting Ads • Report: Deceptive Credit Card Practices Remain Widespread • Dodd Bill Would Freeze Credit Card Rates • Annual Credit Card Fee Makes a Comeback • Credit Card Holders Angrily Abandon Their Cards • Fed Proposes New Credit Card Rules • Lawmakers Propose Faster Adoption Of New Credit Card Rules • Acid Test: Prepaid Debit Card vs. Big Bank • J.D. Power: Customer Satisfaction With Credit Cards Falls • How To Survive The New Credit Card Rules • New Credit Card Law Not A Cure-All • Consumer Credit Continues To Shrink • Consumers Using Credit Cards To Stay Afloat, Survey Finds • Credit Cards Giving Consumers Heartburn • Obama Signs Credit Card Bill • Olive Garden Settles Credit Card Data Exposure Suit • Video — Credit Card Law May Produce Unintended Consequences --- • More about credit cards

So what are some of the most egregious jabs a bank or creditor can take at a customer who doesn't pay on time or clear off their whole balance? Here's a sample:

• Universal Default This simply means that if you fall behind on payments to any lender, your bank will raise the interest rate on your credit card, due to what they perceive as a higher level of risk. So if you forget to pay your phone bill one month, and your phone company reports that to creditors, your bank will suddenly judge you a poorer credit recipient, and your card's interest rate will increase.

As lenders generally only report negative lending information to creditors, months or years of diligently paying on time can be wiped away with a single mistake, from which it takes many more months to recover. Citigroup execs agreed to end this practice after being grilled by senators over its potential for damage, but many other lenders continue to employ it.

• Trailing Interest Paying your credit card bill in full doesn't let you off the hook for charges anymore. Some banks apply a technique called "trailing interest," meaning that they charge interest through multiple billing cycles for an unpaid balance, even if the balance is completely paid in full in the first cycle.

Unless you pay your bill in an exact, specific timeframe, you end up incurring more interest on the charges, which somewhat defeats the purpose of credit cards as a flexible payment tool for use when times are hard. All of the bank execs brought before Congress defended "trailing interest" as a common lending practice, but declined to offer specifics.

• Penalty Fees Want to pay your balance over the phone? It'll cost you $15. Miss one payment date? Add $40 to your bill. Go over your balance? That's another $40 for each month your balance isn't paid in full. Penalty fees, late fees, and overlimit fees are a huge source of revenue for banks and credit card companies, which now charge fees for practically every transaction beyond simply paying a bill.

Penalty fees for late payments have nearly tripled in the last ten years, from $13 in 1995 to $34 in 2005, according to a Government Accountability Office report studying credit card business practices.

• Complex Statements The same GAO report confirmed what most cardholders have known for years -- that the average credit card statement and disclosure agreement might as well be written in Klingon. Although most Americans read at an eighth-grade level or below, the average credit card statement is written at a twelfth-grade level, full of confusing verbiage and written in such tiny print that it's often impossible to decipher what you owe, what you need to pay, and what changes are made to your agreement.

Sen. Carl Levin (D-MI), who authorized the GAO report and chaired the latest credit industry hearing, opined that you need to read at a "27th-grade level" to understand a credit card statement.

And speaking of changes, most lenders state upfront that they can change their agreements any time, for any reason, and your only form of redress is mandatory binding arbitration, which is nearly always hopelessly biased towards the bank. Binding arbitration not only takes away your right to sue as an individual, it also blocks your right to be a party to class-action lawsuits, which in practice are just about the only defense most consumers have against giant financial corporations.

Citigroup promised to end its policy of unilateral changes in contract language, but many lenders will continue to use it for as long as they can get away with it. No one has yet promised to get rid of binding arbitration clauses. Can't let citizens have access to the courts, now can we?

Hidden Costs

Upfront fees aren't the only costs we face when paying with plastic. Chief among the others is the "interchange fee," the cost merchants and retailers incur for processing transactions made with credit and debit cards. Interchange fees are complex and even more difficult to understand than penalty fees; simply put, they increase the cost a merchant incurs in selling to a customer who uses a credit or debit card.

Interchange fees are often so high that merchants lose money on plastic transactions, particularly for "micropayment" purchases such as food. Because retailers are barred from offering discounts for buying with cash, the end result is that prices go up for all the goods they sell, and consumers never know why.

Merchants also claim it's impossible to negotiate a more favorable fee, as Visa and MasterCard have colluded to use their market strength to set the bar at a level they prefer.

A coalition of retailers and merchants filed a class action lawsuit against Visa, MasterCard, and their partner banks to end interchange fees, saying they amounted to a "hidden tax" on consumers and wrought heavy costs on the retail industry. As a result, both Visa and MasterCard have published their interchange fee rates, but the Merchants' Payment Coalition, retailers like 30 Minute Photos' Mitch Goldstone, and others continue the fight to expose practices they have called "anticompetitive and collusive."

Passing The Buck On Identity Theft

Another new cost of credit cards that cardholders didn't anticipate was the ease with which credit transactions facilitate identity theft.

With the billions of credit transactions that go on around the globe on a daily basis, and the ease with which purchases can be made over the Internet, credit has enabled hackers and cybercriminals to root through bank records, retailer payment databases, and use "phisher" sites to steal buyers' personal data and hit them with fraudulent transactions.

The Federal Trade Commission (FTC) received 250,000 complaints about identity theft for 2006, far more than any other form of fraud it tracked. In that category, credit card fraud accounted for the highest percentage of identity fraud-related complaints. The FTC's estimates for reported fraud losses topped $1 billion. Industry insiders estimated that the amount of actual fraud was many times more than the number of complaints actually received.

Federal law limits the liability of a cardholder to no more than $50 in the case of a fraudulent transaction, and many banks will often reduce that liability to zero. However, when a consumer reverses a fraudulent charge (called a "chargeback"), the retailer from whom goods were purchased bears the cost of the refund, even when the sale was made in good faith. (Banks are like gambling casinos; the house never loses).

Further, debit cards do not have the same level of liability protection as credit cards, and debit card fraud can lead to thousands of dollars being lost from your checking account before you even realize it. As shoppers switch from credit to debit cards to avoid going into debt, they're unknowingly opening themselves up to financial vulnerability of a different kind.

Although the banking and retail industries have each suffered their share of high-profile data breaches in recent years, each side is keen to pass the buck to the other rather than implement real reforms.

Writing for the New York Times Magazine, "Freakonomics" authors Stephen Levitt and Stephen Dubner found that banks were not "sufficiently incentivized" to pay for heavier security measures for the data they process, considering it the cost of doing business. Retailers, meanwhile, are blaming banks for trying to saddle them with even more fees and costs while they reap astronomical profits.

In the end, the real loser is, once again, the consumer, who gets stuck with higher prices retailers must charge to cover the losses from chargebacks.

Killing the Golden Goose

In principle, credit makes sense -- it's intended to give buyers a chance to buy goods and services and reap the benefit of the purchase while paying for it over time. Without credit, after all, most of us would never be able to afford houses, cars, mammoth TV sets, college educations or other mileposts of contemporary life.

But the ubiquity of easy credit and the astounding barrage of usurious interest rates and ludicrously high fees and charges have combined to pull most consumers so deeply beneath the surface that they will spend their lives paying, paying and paying yet again for their purchases. Americans' total household debt level reached $830 billion in 2005, an astounding figure that should indicate to any observer that something is out of whack.

As a now-legendary "Frontline" documentary showed in late 2004, the banking industry doesn't make any money off cardholders who pay their credit card bills in full each month, except for interchange fees. In fact, the common term for responsible payers in the credit industry is "deadbeats," because there's no profit to be made from them.

The credit card industry won an exceptional coup in 2005 when it finally romanced Congress into passing strict new bankruptcy laws that make it virtually impossible to discharge high credit card debt through Chapter 7 bankruptcy.

Under the new laws, most consumers will be shunted to Chapter 13 bankruptcy through a "means test," which usually mandates a payment plan for their debts if the consumer is only inches above the poverty line. Although the stated goal of the law was to reduce "frivolous" bankruptcies, the quite obvious motivation was to ensure that banks are able to wring the last drop of blood from consumers buried in debt, even those whose financial ruination was the result of serious illness, natural disaster or job loss.

What's Needed

A cold splash of reality is needed here. While it's possible that Congress may clamp down on banks' more odious practices, it's by no means a sure bet. Beyond that, it's doubtful President Bush would go along, so don't look for bold new regulations anytime soon.

But Congress has at least helped call attention to the problem through its recent round of hearings. That and the carping of consumer advocates and the occasional lurid stories in the press are gradually raising Americans' appreciation of how credit cards really work.

As consumers come to realize how huge their debt problem really is, they're beginning to look for ways to get out of debt and to moderate their buying habits.

So, assuming for a moment that Congress and the White House will be deadlocked for at least the next few years, what are some of the steps enlightened banks might take to be more consumer-friendly?

Here are a few modest suggestions:

• End punitive practices. Cardholders should pay the money they owe, no more, no less. Ending practices such as universal default and trailing interest would help cardholders with high balances get their debt under control and bring them closer to paying their balances off in full. That would, in turn, give them more money to put aside for beneficial purchases, such as a house or car, or saving for their childrens' education and make them more creditworthy in the long run.

• Clearly disclose the terms. Cardholders should be able to know upfront, in plain English, exactly what their credit card agreement entails. Payment schedules should clearly state how long it will take to pay a balance off, how much interest is owed, and what payment levels are necessary to clear the balance.

• Reduce reliance on the credit score. Too many lenders rely solely on credit scores to decide if a borrower is a safe bet. Banks should employ much greater flexibility and give their branch managers more latitude to use their personal judgment. Lenders should also report positive payment information regularly to credit agencies, in order to develop a more complete picture of a person's financial history.

• Better financial education. Consumers need to know a lot more about how to manage their personal finances. More schools should offer classes devoted specifically to teaching students how investing works, how debt can be accrued, and how credit is not a blank check.

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