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

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

The “Housing Market” - The Greatest Fraud of All

As the financial crisis has unfolded over the past few weeks, many high profile leaders have had their faith in a market driven economy shaken. Even Alan Greenspan had to admit in testimony before Congress that the assumptions behind his economic policies were wrong. He now says he made a mistake in believing that banks “operating in their own self-interest, would do what was necessary to protect their shareholders and institutions.”

Actually, I think markets work well when the conditions for them are allowed to exist. But we are seeing the unmasking of one of the greatest economic deceptions of all time—the claim that in the United States a market determined home prices. The “invisible hand” that Adam Smith envisioned setting prices in a marketplace is suppose to be just that—invisible. Smith’s economic model rested on the assumption that many buyers and sellers acting in their own self-interest and without government interference would negotiate fair prices for scare commodities.

But lets count the ways the so-called “housing market” has failed to meet these conditions.

Government subsidies for homeowners – For decades the federal government has taxed homeowners at a lower rate than renters. It accomplishes this by allowing payments for home mortgage interest to be deducted from income. Homeowners can borrow up to the entire equity in their house and spend the money on whatever they want—cars, vacations, college tuitions—and the interest paid on the loan is tax deductible. Renters are not allowed to deduct interest paid on loans. The effect of this policy is that homeowners are taxed less as long as they remain in debt. That makes owning a home intrinsically more valuable than just having a place to live.

Government-backed loans eliminate lenders’ risks-The point of Freddie Mac and Fannie Mae was to encourage banks to loan private money to purchase homes by promising public money if the loan went bad. This policy effectively privatized gains and socialized losses. The result is a moral hazard that subverts the functioning of the market. Banks can loan money under the most outlandish of circumstances because they have everything to gain and nothing to lose.

A single person sets interest rates – The Federal Reserve Chief dictates interest rates. It’s no accident that Alan Greenspan had the nickname “Maestro” when he ran the Federal Reserve. Rather than allow market processes to determine interest rates he orchestrated market movements by dictating the rates himself. Allowing the judgment of one person to determine something as fundamental as the cost of money on such a grand scale is the antithesis of a free market.

Of course the government had good reasons for these policies. Congress decided that communities benefited from widespread home ownership. In other words a social good resulted if more people owned homes rather than rented. But government manipulation of markets to achieve a social goal is the definition of socialism.

That is where the great fraud arises—the creation of a socialist system for home ownership but labeling it a “free market.” The claim that no regulation is needed for mortgages because the market will operate is absurd. Socialist systems need regulation; otherwise the moral hazards are too great. The government appears to have no plans for ending the mortgage interest deduction, ending bailouts of failed lenders, or ending Federal Reserve control of interest rates. If it continues to use these policies to manipulate home prices its needs to be intellectually honest. The government should admit that fact that the housing market has been socialist for decades and adopt appropriate regulations to protect the public.