Monday, December 29, 2008

Debit or Credit?

As I finished my Christmas shopping this past week, the “debit or credit” question at checkout is annoying me more than the longer-running “paper or plastic” inquiry. While I miss paper bags when it comes to carrying goods, I do not miss writing checks for payment at the cash register. Swiping my plastic check card is quicker and easier. But for some bizarre reason two alternative methods for processing the same transaction have evolved. In each case money is deducted from my checking account to pay the merchant. However, whether I say credit or debit, or more precisely whether I choose to identify myself with my signature or my PIN number makes a big difference on who pays the cost of the transaction and the risks I take as a consumer.

If I choose debit, the transaction proceeds much like taking cash from an ATM machine. A PIN number is required and after entry funds for the purchase are debited from my checking account along with an additional fee to pay for the transaction. It is not as costly as using a remote ATM, but it is not free. My bank charges me $0.50 for each transaction and that adds up quickly. If I make purchases at three or four different stores it would be cheaper for me to just go to the ATM and get the cash. It would all come out of the same checking account. After all, I’m not using actual credit.

If I choose “credit” the money also comes out of the same checking account, but a different set of rules apply. This is what I find so weird. I no longer pay the transaction fee because no electronic funds transfer takes place. Instead the Visa credit card network takes over and the merchant is hit up for the usual 2% to 3% of the purchase price even though no credit is extended. However, I have the protection of using a credit card meaning I can dispute charges and there are limits on my liability for fraud. In contrast, I have no protection for unauthorized PIN transactions. If someone obtains my PIN and check card numbers that person could drain my entire checking account and I would have little leverage for recovering the loss.

There is little reason for me to ever make a debit transaction at checkout. It is costly and risky to use my card in that mode. Naturally the store wants me to use debit because it is cheaper and safer for them. As a result all the machines are set up to prompt for a PIN number. To use credit I need to hit the nonsensical “cancel” button to move on to the credit option. No matter how many times I do this I still get confused by this step. The concept of “canceling” my purchase so that I can complete it just doesn’t sink in.

So are there ever any reasons to choose debit? Actually consumers who choose credit for gas, hotel, or rental car purchases could be in for a nasty surprise if their checking account balance is too low. The reason is that merchants selling open-ended purchases such as these typically place “holds” on the account for much more than the purchase price and these holds can last for days.

For example, suppose you intend to buy $25 of gas and swipe your visa check card. The computer doesn’t know your intention so it might automatically request an authorization for $50 to make sure you have the funds to fill up a large tank. In your checking account $50 is immediately set aside. You drive away with your $25 purchase, but the $50 set aside stays for several days. Over that time you could easily be writing bad checks because you keep account of your actual balance. Your bank has a different number—the “available balance”—that is less because of the funds set aside for the credit authorization.

You the consumer have no idea what number represents the “available balance” but you will be paying hefty bounced check fees if you overdraw on it. It’s all perfectly legal and just another excuse banks have for soaking consumers.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Monday, December 22, 2008

Good News/Bad News for Credit Card Holders

It has been a good news/bad news week for consumers who use credit cards. Labeling current credit card practices “deceptive” and “unfair,” the Federal Reserve proposed new rules for credit card issuers. What is most striking about reading the list of practices the Fed now intends to abolish is that these tactics were ever legal in the first place.

First the good news–if adopted the new rules will prohibit such practices as:

• Assessing hefty late fees if a payment arrives one or two days late. Borrowers will have a reasonable grace period of 21 days before a payment is deemed “late.”

• An interest computing practice known as “double-cycle billing.” As it stands now, a balance that is not paid in full is assessed interest beginning from the date of purchase rather than from the end of the grace period.

• Charging high fees for exceeding the credit limit solely because of a hold placed on the account. Consumers often don’t know the amount of holds when they check into hotel rooms or rent cars. I’ve had $1000 holds placed on my account just for checking into a $200 hotel room.

• Applying payments to the part of the balance with the lowest interest rate. Under the new rules, any payment above the minimum will have to be applied to the balance with the highest interest rate. It is not uncommon for consumers to have balances with multiple interest rates because cash advances and balances transfers often have different interest rates than purchases. Currently banks apply payments to balances in ways that maximize finances charges by applying all money paid to the part of the balance with the lowest interest rate.

Now the bad news: These are “proposed” regulations, not laws and they will not take effect until July 2010. As Bob Sullivan noted in his blog: “A 300-page report by the Office of Thrift Supervision described bank misbehavior in great detail, at times using stinging language.” Federal regulators “then invited card issuers to continue those unfair tactics for the next 18 months.”

A December 18 report on the NBC Nightly News stated that the rationale for allowing these practices to continue was to give banks time to adjust. A spokesperson for the American Bankers Association, Nessa Feddis, stated on camera: “The regulations, in effect, require the credit card industry in effect to completely dismantle and rebuild their credit card business model.”

This is a bizarre defense of an indefensible delay. Maybe in the future the Feds should give organized crime syndicates time to dismantle and rebuild their “business model” instead of busting them.

In the mean time, while the banks retool, all of the practices listed above are still in use. I’m not optimistic that a “rebuilt” credit card business model is going to be any better for consumers. The Federal Reserve is taking steps that should have been taken many years ago in response to the current economic crisis. I think the banks are creative enough to put together a different set of deceptive practices that will still gouge consumers. And, once the crisis is past, federal regulators and Congress will go back to looking the other way.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Tuesday, December 16, 2008

Gaming the Inflation Numbers

Is inflation good or bad? Most consumers and businesses would say inflation is bad. By distorting prices, inflation makes financial planning for the future difficult, it squeezes family budgets, wrecks business plans, and destroys savings. The government, at least in principle, agrees that inflation is bad and one of the duties of the Federal Reserve is to “fight inflation” by tinkering with interest rates.

But there’s a problem with this good versus evil story line. Inflation actually has beneficiaries with a vested financial stake in seeing it continue. For example, debtors benefit from inflation. People who borrow money during periods of inflation get to pay back cheaper dollars than the ones they spent. Homeowners benefit from inflation because no landlord raises the rent. That means as a homeowner’s income increases, the fraction of income needed for housing decreases. Most people who own homes are also in debt because of the home, so they get duals benefits from inflation.

But, the biggest beneficiary from inflation is the federal government itself. The same institution that controls the money supply and purports to fight inflation benefits from it. Actually, the government benefits most from stealth inflation. If the real rate of inflation can be hidden, the government realizes all the benefits from inflation without having to bear the same costs that everyone else does.

The federal government benefits from inflation because it is the largest debtor on the planet. No other institution measures its debt in trillions of dollars. Not only is the debt enormous, it is projected to go on forever. Vague proposals to balance the budget are lame attempts to end the growth of debt, not the debt itself. Inflation makes the national debt manageable. Without inflation it would be mathematically impossible for the federal government to meet its financial obligations.

In fact inflation is an ideal two-headed quarter for the government. Devaluing the currency is a means of taxation without the need to pass a law raising taxes. The government cheapens the dollars it owes and collects more money through the effect of tax bracket creep. At the same time, rising prices create an illusion of wealth while purchasing power falls. But much of the mathematical magic of inflation would go away if the government were honest about reporting inflation rates.

For example, the government issues inflation-indexed bonds that pay a variable interest tied to the inflation rate. Increases in entitlement spending on such a programs as Social Security are based on the inflation rate. The idea that the government can “stimulate” the economy by lowering interest rates only works if you can convince lenders that the inflation rate is low so they don’t need a high rate of return just to break even.

So how does the government pull off this deception? The problem is no one agrees upon a definition of inflation. CEOs of large corporations will say that their ever increasing, stratospheric compensation packages are necessary for a prosperous company. Of course these same executives will fight raising the minimum wage on the grounds that such an action is “inflationary.” It is rather convenient to label your rise in income as deserved and label someone else’s as delusory.

So it is with the federal government. It can tinker with economic data to underreport inflation so that it reaps the benefits but doesn’t have to pay the costs. In Jim Jubaks December 5, 2008 column: “Fake Inflation Numbers Mask Crisis” he explains some of the techniques the government has used in recent decades to disguise inflation.

For example the government started using “hedonics,” a technique that reported a $100 increase in the price of a car as $0 if in the judgment of the government the “usefulness” of the car increased by $100. An increase in the power, safety, or other features would qualify as increasing its “usefulness.” Never mind that the car does essentially the same thing—take its driver from point A to point B.

The government also started to make “substitution” adjustments to its inflation numbers. If the price of steak goes up, the government assumes consumers will substitute chicken and not pay more for food. Therefore food prices are not actually rising. Got the logic on that one? Of course some government official has to decide what substitutions consumers will make and those decisions are subject to a later change.

According to Jubak the result of fudging the inflation numbers is that the Fed should have been raising interest rates to fight inflation instead of lowering them and allowing the housing bubble to develop. Of course the Fed could accurately report the money supply figures that would give a much better insight into real inflation. While there are disagreements on what inflation is, there is common agreement that printing money to circulate without a corresponding increase in economic activity will cause inflation. But in 2006 the Fed stop publishing broad measures of the money supply focusing on more narrow measures instead.

According to the Fed, the cost of collecting the additional data outweighed the benefits the data provided–a rather convenient cost/benefit analysis to make.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Monday, December 8, 2008

Shopping our way to prosperity?

Individuals who wish to accumulate wealth and become financially secure are told to work hard, be productive, save, and invest. The advice is old fashioned and trite. Recent events have shown it doesn’t always work, but, it’s difficult to suggest a better alternative. Work hard, don’t produce, spend every dollar you make and then some will certainly not lead to financial security.

However, as the holiday season approaches and with it the annual nationwide orgy of shopping, we are told that the way out of the economic crisis is to keep up the behavior that made the mess. Black Friday sales figures are headline news. The media, politicians, and corporate executives spread a gospel of salvation through consumption. Robust consumer spending will lead us out of the financial wilderness and avert a reenactment of the 1930s great depression.

On my local NBC affiliate in Baltimore— WBAL— the general manager broadcast an editorial Saturday night pleading with people to shop. While he urged responsible use of credit, he stated: “If you can shop you should. We must each do our part to get the economy jumpstarted. The message from Washington is clear—happy shopping.”

I’m sorry but if consumption without production is not a recipe for individual success, how can it lead to prosperity for all? If Americans saved, invested and then produced what they consume the argument might have some validity. But, as a nation Americans accomplish none of the above.

Americans buy lots of stuff that people in other countries make. For the first time since the great depression our national savings rate is quantified with negative numbers. And for all the trillions of dollars our federal government and large corporations have burned through recently, there appears to be nothing with future value to show for it. Our public infrastructure is crumbling along with our manufacturing base.

Consider Dan Rodricks' column Sunday where he observed: “Look at us: We've become a nation that thrives when people spend money they don't have. This is completely upside down from the society baby boomers recall, when the economy was robust, when people made a decent wage and benefits from manufacturing jobs, and the only things they had to finance were their homes and cars.”

The lesson from the economic crash of 2008 is that unchecked consumption and debt accumulation without production and investment in the future is unsustainable. All bills come due and all debt must be paid back. Shopping is not the magic elixir that will lead us to economic salvation; it’s an ingredient in the poisonous brew that’s killing our prosperity.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy