Credit card annual fees and the self-appointed consumer protectors
Adam Levitin has a blog post up responding to Todd Zywicki’s recent WSJ editorial on credit card interchange fees. As most readers know, this is a topic of significant interest around here, and Josh blogged about Todd’s op-ed just yesterday. I’m on vacation so I’ll be brief, but I thought Adam’s post was so wrong it necessitated my getting off the beach for a reply. Adam writes:
Todd is right that consumers are happy to see annual fees go away, but the disappearance of annual fees wasn’t a freebie for consumers. It came about as part of a shift in the credit card business model whereby upfront fees were replaced with backend fees that have lesser salience to consumers when the consumers decide which cards to carry and use. This was a move that was made to increase revenue for card issuers (or put another way, to siphon off more consumer surplus); it was not a charitable act. The disappearance of annual fees is an important innovation, but I think it is a stretch to call it a pro-consumer innovation, when it is viewed contextually.
The disappearance of annual fees was a step in the democratization of credit (or put another way, the decline in underwriting standards). Whether this was a good thing is unclear. It certainly increased consumer’s borrowing ability and choices, and might have led to a substitution from secured installment credit to unsecured revolving credit. But greater ability to borrow and more borrowing choices are not necessarily good. They are only good to the extent that a consumer is capable of repaying the increased credit line and making informed choices among credit options. Both of those are questionable for many consumers.
Adam’s incessant claims that consumers are idiots, fooled time and again by rapacious capitalists, is tiresome. The behavioral econ/behavioral law and econ literature just doesn’t support these strong claims. Yes, there are some interesting theories. No, there is no empirical proof, and there are plenty of counter-explanations. There are some experiments that support these claims. And they have been called in to question (sorry I can’t take the time to link right now, but we’ve discussed the behavioral literature quite a bit on this blog). Todd’s competition story is the Occam’s Razor argument here and unsupported claims to the contrary should be scoffed at.
The “contextual” reality is that the “backend” fees that have replaced annual fees are born by a small fraction of cardholders and are avoidable, as opposed to unavoidable annual fees born by all cardholders. These backend fees have likewise been falling in magnitude and incidence over recent years. And meanwhile, they act to make borrowing more expensive for the helpless people Adam and other self-appointed consumer advocates claim to want to protect from themselves and less expensive for those who don’t “need” Adam’s protection (scare quotes because I’d say no one “needs” Adam’s help). On Adam’s own terms this should be a feature, not a bug, and it is arguably more efficient, lowering consumer credit costs for everyone.
Adam’s view that these backend fees make credit seem cheap to profligate spenders in a way that annual fees do not is absurd. Maybe the first time, but I’d have to say that fees imposed directly when repayment is not forthcoming, for example, and showing up on a statement at the very moment they are incurred should have much more “salience” than annual fees imposed once a year with no relationship in time or magnitude to any behavior on the part of consumers. Meanwhile, there is a whole industry of protectors warning consumers of the dangers of over-extending, and very few daytime talk shows warning of the perils of annual fees. I’d wager the behavioral fee is much more “salient” than the annual fee.
This is the problem with the behavioral literature on which Adam relies: It is a set of non-rigorous, just-so stories that can be tortured to support any a priori policy view. The bottom line is that credit card markets have seen falling fees, increasing benefits (rental car insurance, airline miles, purchase protection, etc., etc.) and structural changes that respond to consumer preferences. The just-so story that would turn this into a story of corporations preying on ignorant consumers is insulting and unsupported.