Lower Fees Without Higher Rates

What consumer financial protection advocates can learn from the CARD Act

Neale Mahoney

Market regulations aimed at protecting consumers–especially the kind seemingly designed to make political hay for policymakers–tend to draw a skeptical eye from economists. Neale Mahoney, one such economist and an assistant professor of economics at Chicago Booth, has studied results of such legislation. He shared his findings at a Becker Brown Bag talk Oct. 16.

He analyzed 10 terabytes of credit card account data covering 180 million credit card accounts active during the time frame when the CARD Act, a consumer financial regulation reform bill, was signed into law in 2009. The intentions behind the law became clear immediately. "Average low FICO score consumers, borrowing maybe $1000 a year, were paying $200 in fees," said Mahoney. But he and his team still initially questioned the law's efficacy. 

The bill limited the ability of credit card companies to levy fees when consumers exceed their credit limits and make late payments. Mahoney assumed that would simply mean higher interest rates for consumers, not a better deal. In a perfectly competitive market, every price change has to be offset, so fee cuts would result in higher costs of borrowing. Moreover, if we assume a market where consumers integrate all pertinent information into their decisionmaking, consumers will know that the difference is being passed from one price to another, and the regulatory change won't affect their day-to-day decisions. In short, it seems unlikely that the CARD Act could be all that effective at improving the economic well being of consumers.

As it turns out, the actual credit card market isn't so perfect. "Looking at the data changed how I thought about the world," said Mahoney.

Mahoney and his collaborators observed a 2.8 percent overall decline in fee revenue, particularly in the case of over-limit fees. These became an opt-in alternative to simply declining a maxed out credit card and fell to nearly zero following the CARD Act's implementation. But the data shows no evidence that consumers were simply charged more to borrow or for other services offered by credit card companies, or that retailers or smaller banks were  forced to absorb the lost revenue. And since the data came from one of the worst time frames for credit card defaults in the history of the industry, it seemed unlikely that costs of operation were in decline.

Mahoney said his analysis lead them to believe that the $20.8 billion saved on credit card fees as a result of the law was simply a surplus, transferred to consumers from banks. Given the high costs of searching for and switching to new credits cards, it appeared that the credit card industry exhibited all the signs of a market with low fee salience and limited competition, a shortcoming the law helps address.

A second component of the lawa requirement to tell consumers how much they would save in order to nudge them toward paying off balances fasterwas less successful, in Mahoney's analysis. Those who altered their payment behavior had midlevel credit scores, and had been making small payments previously; seeing the potential savings in paying off their cards faster definitely lead them to increase their payments. "That's exactly what the writers of this law wanted," said Mahoney. "The thing they might be less happy about is the fact that that effect is quite small." Only about 0.5 percent of account holders actually changed their behavior.

Mahoney said that there remains plenty of work left  to understand how these sorts of consumer financial regulations will ultimately affect the targeted marketplace, but at least in the case of this industry and dataset, there's an indication that such laws can be designed to benefit the consumer as intended.