May 15, 2009

Check to See How Your Senators Voted on Credit Card Reform (Updated)

Here is the first vote to check:

A Yes vote supported a 15% cap on credit card interest rates, limiting usury. A No vote was against the 15% limit on credit card interest. (note that this vote was on whether to include amendment 1062 in HR 627)

Senate Vote on H.R.627: Motion to Waive CBA Sanders Amdt. No. 1062; To establish a national consumer credit usury rate.

People, let's hold them accountable. Let's pay attention. Let's know how they voted, and let's remember and tell our friends.

Somehow it doesn't occur to all our Senators that 20% or 25% interest is a bad thing.

Bad for the nation.

One can imagine the lobbying arguments they heard, probably carefully targeted to individual Senators, depending on their temperament and beliefs.

Here are a couple I can imagine:

For a Senator that is a "staunch" "free enterprise" "pro-market" person, but doesn't really understand the basic necessities of markets or enterprise (non-finance enterprise) -- the necessity of having enough potential customers with disposable income left over to buy your product(!) -- an effective pitch could go:
"We gave them a low introductory rate, and planned our business on the premise that the rate later would be higher. Now that defaults are up everywhere, we need higher rates."

For a Senator that is more realistic and down-to-earth, perhaps he'd hear:
"Senator, we'd really like to help you again during your next campaign, but we need your help now."

The 2nd hardly needs any further examination here, but the first pitch is worth batting down.

If a credit card issuer cannot make enough profit at 15% even with a background default rate rising towards 8%-11% for instance (some credit issuers are more careful than others), if that company cannot make it on a 4%-7% spread, then....that isn't a well run company. For issuers that fold at a 15% cap (if any would), we should pleased to let the free market run them out of business and replace them with a company that can live on a 5% or 7% spread of interest (more if the issuer is prudent), which the market would indeed quickly do, in only months. Prohibiting 20%+ interest credit card rates is similar to outlawing an addictive substance that is harmful to health.


Let's illustrate how 20% or 25% interest is ruinous.
Consider a typical family carrying a commonplace level of household credit card debt of about $7,000 who then suffer a few (commonplace) financial hits -- too many major expenses at one time, such as multiple large auto repairs in a few months, and some expensive dental work and all of this just after a major replacement expense for a quality refrigerator or money sent to help a kid or relative. (Of course some households could have a previous balance on their cards from items such as furniture before the new expenses...but less discretionary expenditures are also common in debt ramp-ups.) It could easily be the case that after some bad luck for a few months they could end up carrying a significant credit card balance, perhaps even as much as 40% of their annual income for instance.

Let's suppose a family with a household income of $50,000 ended up with a temporary balance on their credit cards of $20,000. Otherwise they are quite average, with a house costing $160,000 at purchase (just a bit over 3 times their annual income) which they bought with 10% down and a good prime mortgage at a nice low fixed 30-year rate of 5.25%.

In other words, a financially responsible family that pays their bills, with excellent credit, who just had some large bills all at once, and not really more than they could handle over time...

...given a normal, reasonable interest rate, such as they expected they would have, due to the advertising of the credit card issuers.

Normally, a credit-worthy family could expect to carry such a balance on a few cards and at an interest rate in the range of 11%-14%.

First, clearly the credit card companies are making a nice, fat profit on balances carried at 12% or 14% interest that are paid over time (account holders that pay on significant balances without defaulting are very profitable for card issuers). In fact, you'll see that shortly.

Do the credit card companies need a higher rate here? Can the family handle a significant rate hike on this existing balance, a practice that is now commonplace according to the news.

So, let's imagine the outcome for this family financially if the $20,000 is carried at 12% in one scenario, and at 22% (21.99%) in the alternative scenario.

What will happen?

Suppose our responsible family with excellent credit spends quite carefully during the next few years, and even gives up their previous plan for a ski trip, settling for a much less expensive trip to SeaWorld once a year.

So, the family is cutting back, paying what they can.

What will happen?

Let's see.

A plan that reduces financial risk is to aim to pay back a high balance like this in around 4 years, because it is likely there will eventually be further expenses, and the family needs to be making real progress reducing debt before those unpredictable future expenses hit.

Putting our balance of $20,000 into the calculator for a 4-year payoff at 12% and 22% yields the following monthly payments:

12% -- $527/month
22% -- $630/month

So, only a difference in our scenario of $103/month more. Is that enough to matter?

Let's see, over 4 years, the roughly $103/month extra adds up to about $4,944 in extra payments (all interest).

Leaving aside for a moment what that $4,944 could have bought, such as two years of $2,470 contributions to an IRA, or $4,944 put into a 529 plan for college for the kids, while the years until college are still enough to earn some returns on the contribution, or....say a replacement used car when the old wagon goes.

Well....the last isn't a trivial example (though neither are the first). Because, in our example this frugal and responsible family has already chosen to repair their old car instead of buying a replacement, because the repair was still cheaper than buying another used-car as replacement....but, in several years, that old car is going to need some more repair, or replacement finally with a newer used car.


So, there is already a danger this budget difference could put the family on a "crash" course.

But, let's go ahead and look at the budget numbers carefully.

For their monthly mortgage payment on the house described above with $2000 in annual property taxes and a quality $700/year homeowners insurance policy, and PMI (loan to value is 90%) of about $60/month, we arrive at a monthly house payment of $1,080/month.

Let's suppose our family has 1 child, 2 cars, one with a payment of $420/month for another 2 years, and the other older car paid off.

While both parents work, they pay $500/month for daycare for their 3 year-old.

While neither employer provides health insurance, the family has a good quality blue cross policy with a $3500 deductible for which they pay $750/month. To cover their deductible in case of a major medical expense (their regular office visits are covered at a $25 co-pay and no deductible), they funded an traditional IRA last year with $2500, as an emergency fund for medical care (IRA withdrawals are allowed for medical expenses).

For comparison note that the national average health insurance cost for a family is $12,000/year. This family is carefully aiming at a lower cost, but using a significant deductible, for which they have saved up money to help cover.

This is a frugal, money-careful family.

Normally, they contribute $2000/year to a Roth IRA, and this is the only retirement savings they have.

Being an old hand at Turbotax, I ran through all of this family's 2008 tax year. They were able to itemize deductions, due to the costs of medical insurance and home mortgage interest.

With only 5 $25 office visits during 2008, the family had no major medical expenses other than just the basic cost of health insurance. They are healthy and lucky, and don't have significant health costs other than the braces they just had to get for their kid's teeth.

Turbotax revealed they received $600 for their child tax credit, and also a significant child-care tax credit of $1,000, which was a major help, reducing their family federal taxes from about $2800 down to under $1200.

We'd like to list the federal income taxes in our budget, so to figure the family take home pay, we'll subtract only FICA taxes (social security and medicare taxes), and nothing else. All other expenses -- income taxes, health insurance, and retirement will not be withheld, but paid in our budget below.

Take home pay after FICA for our family is then $46,175 or $3848/month.

Also, our lucky family lives in a state with no income tax.

Nice. So this careful, prudent family, who are in many ways lucky and who Uncle Sam has treated very well in 2008, how will things turn out for them financially?

So, with all these advantages, with all these favorable basic facts, but with a few typical large expenses all at once of $20,000, will our family make it financially???

Let's suppose the family doesn't mind sweating some in the summer and is lucky enough to choose a low-cost electricity plan at only 10 cents/KwH. Nice. Their electric bill will average out over a year to only $120/month.

This is a careful, conservative, prudent family, remember?

So here are the budget results (on a few items like gasoline I just use some commonplace amounts):

Monthly Expenses before Credit Card Payments:
Housing Payment: $1080
Health Insurance: $750
Roth IRA Savings: $167
Auto Payment: $420 (5-yr, 6% auto loan for a car just under $22K)
Auto Insurance: $80 (they have good $100K/$300K insurance but comprehensive on 1 car).
Auto tags/inspections: $12 (about $140/year)
Child Care: $500
Federal Taxes: $100
Electric Utility: $120 (average over year)
Gas Utility: $35 (average over year)
Trash/sewer/water: $65
Grocery Budget: $600
Eating Out: $80 (yes, that's only $80 for a whole month -- they cook a lot at home)
Gasoline: $110
Phone and Internet: $75 (our frugal family forgoes cable TV and uses an antenna)
HOA fees: $20
Cell Phones: $65 (this may seem low, but these people are frugal)
Movie Rentals: $15 (cheap entertainment)
Clothing: $35 (some work clothes, some GoodWill clothes)
Dog food: $30 (most families have a pet)
Haircuts, cosmetics, toiletries: $45
Life Insurance: $50 (both parents, prudent, are insured with term life insurance)
Health Club: $20 (they have a deal!)
Babysitter: $25 (obviously, this is about 1 night's worth, again: think frugal)
Ok....let's see where we are at with this very basic, frugal family budget
Basic Frugal Budget $4499



(it seems paying the full cost of health insurance has shot this family's budget)


It seems our family can't basic budget on $50,000/year.

OK, let's suppose the parents have been working quite hard at their jobs, and are great at them, and they just got BIG raises....(perhaps in part due to their employers canceling health insurance benefits).

Let's revise the family income upwards to a very average family level of $60,000

$10,000 is a nice raise, yes?

But...we'll keep that credit card debt unchanged at $20,000, now about 1/3 annual income.

Federal taxes increase (TurboTax says) to about $232/month.

Take home pay after FICA withholding only is now increased to $55,410 or $4618/month.

The basic budget though is increased by only the new income tax increase, or another $132/month:
Basic Frugal Budget $4631

whew....not so good...

It seems $60,000 is not enough for our "frugal budget" above.

Notice that some or several of the items are *less* than your own family spends?

Ok, let's cut costs to the bone, and put on a 2nd job for dad.

Of course, some families don't have a $420/month auto payment.

Let's give them a cheaper car there.

Let's cut that car payment to $350/month -- they bought a cheaper car to begin with, say. This cuts the basic Budget by $70/month.

Dad is now working 55/hours week (40hrs + 15 hours on the 2nd job at $9/hour) and brings in an extra $6750/year now in 50 weeks.

The little boy sees less of dad now, is sometimes hard (and sometime made harder by decisions of other people though), and that's a reality.

Of course, another job will require a little more gasoline, and probably the family will need fast food a few times also, being too exhausted to cook sometimes. Let's suppose $20 more for gasoline, and $25 more for fast food.

This brings home another 6233/year after FICA, or $520/month, for a total of $5,137/month. Federal taxes increase by another $91 to $323/month now. Against the increase of $91/month in taxes we decrease the car payment by $70, then add $45 for more fast food and gasoline for a net increase of $66 in the budget:

Basic Frugal Budget $4697/month

Ok, now with 3 jobs and a cheaper car the family is bringing in enough for their basic frugal budget and will have

$440/month left to pay on... credit cards.


remember this payment amount on the $20,000?:

12% -- $527/month
22% -- $630/month

We are still not making it here...

ok, we have to be somehow more favorable, less desperate. Let's say that that credit card balance for those unexpected expenses all at once was only $15,000.

We are now under 1/4th of family income from that expensive, unlucky 4 months.
The new 4-year payment amounts (on $15,000) are:
12% -- $395/month
22% -- $473/month

Ok, now we've made it. The family can pay the credit cards. Sort of.

They can pay about $400/month at 12% interest. Or with the help of Congress, they can pay more, about $470/month, lining the pockets of bank executives and investors. Perhaps they can save somewhere else in the budget to close that $33 a month gap needed to make the $473 payment when the interest rate is 22%.

Is one scenario better for the economy than the other?

I'm not just being rhetorical with that question. The $78 more each month the family has available under the lower interest rate is sustainable (non-credit) money that will be spent, sooner or later (more later if saved first), in the
ordinary economy -- giving a waitress an extra tip, or buying a little iPod. It's discretionary money like this that ultimately provides you and I with our jobs. If that is sent off instead as extra interest, it can go to investors overseas, or into an U.S. high-wealth portfolio of securities somewhere, and be socked away for decades.

Update: A helpful reader pointed out that the example of buying a couch (in addition to medical and repair bills) suggested the example family wasn't prudent enough, so I substituted an equally realistic example without a couch. But ultimately the issue wasn't what a family chose to buy in piling up debt, so much as just simple usury, and worse usury after the fact.

I liked this metaphor from Austan Goolsbee in a NYTimes article on the credit card reform bill to describe the practice of raising rates exorbitantly on existing balances:

Austan Goolsbee, an economic adviser to President Obama, said that while the credit card industry had the right to make a reasonable profit as long as its contracts were in plain language and rule-breakers were held accountable, its current practices were akin to “a series of carjackings.”
“The card industry is giving the argument that if you didn’t want to be carjacked, why weren’t you locking your doors or taking a different road?” Mr. Goolsbee said.


  1. I am NOT pleased to find that both of my senators (Feinstein and Boxer) voted NO on HR 627. Time for some angry emails; maybe even a phone call to the local office. Thanks for the heads up, I've been so busy lately I haven't been following this (see my blog!).

  2. That's California, right? I was surprised, so I checked the graphic again. The solid color signifies a Yes vote, so they voted sensibly after all.

    Good to hear from you again.

  3. There are 2 problems here:
    First, these responsible people who actually work and pay their bills are paying off the largess of every poorly issued credit card for people who charged it through the roof and defaulted.

    But are they entirely innocent? No. If they'd saved up to buy the couch (you can live with a substandard couch for a while) and had a cushion for auto maintenance which is a basic reality of owning a car, they wouldn't be over the edge.

    Responsible people don't live on the edge. They follow common wisdom of holding an emergency fund with 3-6 months worth of expenses.

  4. SK, I agree that a couch seems a frivolous expenditure if they are already carrying $7000, even if the couch is broken and sagging, etc. Sit on the floor a few months. Yes, I agree.

    But the broad point remains: "too many major expenses at one time, such as multiple large auto repairs in a few months, and some expensive dental work and all of this just after a major replacement expense for a quality refrigerator...[but no couch] It could easily be the case that after some bad luck for a few months..."

    Now, obviously if you have a well-planned $1100 auto maintenance savings account, but *both* cars needed major repairs and one set of new tires (a possible "all-at-once" scenario) then your prudent savings are not enough. That's no big deal often, unless, there are also some other sudden expenses that also exceed the emergency savings.

    If you prefer more hard headed expenses and less of an initial debt, that's fine. It's quite easy in the U.S. for a careful, prudent family to get in significant debt fast.

    Commonplace, according to research (Elizabeth Warren, etc.).

    Suppose, you've saved $4000 for medical expenses and have only a $3500 deductible. In fact, that's very good savings and you are quite prudent and careful. Good work, but...

    Oh uh, you have some genuinely unlucky events: you have a major medical situation, and your $3500 deductible kicks in full, and after that there's still your co-insurance up to the "out of pocket" max, another $3000 (Blue Cross invdividual policy). Not so bad, right? You are only $1500 in the hole for the moment, also have office visit co-pays, drug co-pays, and uh oh, it's the turn of the year already, Jan 1rst, so the deductible is set back to $0, and it's time to start paying up to that out of pocket max again.

    ...Its all too easy for a careful and prudent family to get $5000 or $8000 deeper in the hole in just a few months, with some "bad luck", as I suggested.

    Still, this is somewhat beside the point. We are less concerned with whether a family on the edge needs bankruptcy relief (protection from creditors, which is actually a good thing for their financial future), than with the broader issue of interest rates alone.

    The central question here is after advertising that strongly suggests moderate interest rates, regardless of pages of fine print (do you know precisely what your fine print sasys?) -- should an card issuer have the legal right to raise the rate on a on-time account from 12% to 25%?

    We're talking here about folks who "actually work and pay their bills" -- you can read about this.

    It's a bigger issue really. The "old fashioned" idea of "usury". Why is it that so many nations throughout history have made usury a crime?

  5. That is, the rate on an existing balance. Suppose you bought some tools for your business, and planned reasonably to pay them off over a year at 12%, which your card seemed it would stay near, and without much lead time (perhaps even only 45 days), your rate is changed to 29% but also other alternative credit drys up also.

    We don't need a high-risk individual to get a gouging interest rate.

    It's a different situation if going in your already knew clearly that the rate was likely to be over 25% to begin with.

  6. This comment has been removed by a blog administrator.

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