WHY ARE CREDIT CARD INTEREST RATES SO HIGH?

I read an interesting article recently written by Ben Carlson  regarding credit card interest rates in the United States, but what is mentioned in this article is valid for Canada as well

US bond bull market ends after 40 years. That’s 40 years of declining government bond yields. As of this writing, treasury bills have a maximum yield of less than 1.5% (30-year maturity) and a minimum yield of less than 0.2% (3-month treasury bills).

The Fed (US Federal Reserve) has already promised to keep short-term interest rates at 0% until at least 2022.

Treasury yields serve as a benchmark and impact consumer borrowing rates.

Mortgage yields continue to reach historic lows for this reason:

Auto loan rates are a bit higher, but much lower than they have been historically:

Basically, every interest rate you can think of has gone down, except for credit cards:

There have been some slight declines over time, but credit card borrowing rates remain firmly entrenched at elevated levels. And as interest rates have fallen around the world in recent years, credit card borrowing rates have risen.

– Lending standards are much lower for credit cards.

– Loans are unsecured.

– Consumers have full control over when and how to use the credit given to them.

– The default risk of credit cards is higher than that of other loans.

I understand all of these reasons and the fact that the debt is unsecured makes the most sense. But that doesn’t say it all. For one thing, credit card loan default rates have actually come down a lot in recent years as consumers repaired their balance sheets in the wake of the financial crisis:

On the other hand, credit card rates remain so high due to entrenched inertia. Banks have always offered high rates on credit cards, so that is what they have continued to do. Because that’s how we’ve always done it, it’s as good a reason as any when it comes to entrenched ideas.

Surprisingly, in the early days of banking, banks were reluctant to offer much consumer credit because they knew it could be dangerous and wanted to protect people from financial peril.

The rise of the middle class in the 1950s caused this notion to disappear quite quickly when people decided to spend money they did not yet have. From 1958 to 1990, there was not a single year when the stock of consumer debt was not higher than that of the previous year.

The growth in the use of credit cards is the main reason for this.

Bank of America was the first major bank to understand this shift in consumer spending habits. After seeing a 700% increase in consumer lending after World War II, she began experimenting with BankAmericard.

The BankAmericard initiative was started by a man named Joseph Williams, who came up with the idea of ​​setting credit card interest rates by looking at previous versions from different companies. Joe Nocera explains how it worked in his book “A Piece of the Action

Williams had friends at Sears and Mobil Oil, and these friends secretly allowed his team to observe their credit operations. From this latest research came a number of standard credit card features, features that have remained remarkably unchanged to this day. The idea of ​​a one-month grace period, a period during which customers could pay off their balances without incurring interest charges, grew out of this research, as did the idea of ​​charging 18% per year on credit card loans — a figure that would seemingly be set in stone for the next thirty years, even if all other forms of interest rates fluctuated wildly. There was no black magic involved:

This card was mailed to people across the country representing what was essentially the first mass-produced consumer credit card. And Bank of America set its rate based on credit terms Sears had applied in the past.

One of the reasons these high rates have remained unchanged is that Mr. Williams underestimated consumers’ willingness or ability to pay off their balances each month. He first assumed that only 4% of card users would fall behind on their payments.

The actual delinquency rate in this first batch of cards was 22%. The bank didn’t bother to set up a collections department because it was convinced that it wouldn’t have to worry about collecting its loans. Nor did it provide for measures in the event of fraud, which immediately multiplied.

By doing so, Bank of America lost nearly $20 million in the first year or so of widespread credit card use, which was real money in the 1950s. Williams, the architect of BankAmericard, resigned soon after those losses materialized.

But then a funny thing happened.

The use of credit cards has exploded. Consumers became increasingly comfortable with taking on debt, and Bank of America’s credit card division quickly became profitable, raking in nearly $13 million 10 years later.

Total outstanding credit card debt in the United States is now close to $1 trillion. In this new season of Against the Rules , Michael Lewis estimates that credit card companies earn around $100 billion a year from late fees and interest.

It’s a pretty good deal. And business is so good with other fees paid by vendors that credit cards can offer incentives to those who don’t even pay interest charges in the form of reward points like amounts of cash. , travel, shopping, etc.

Many policy makers are trying to find ways to make people’s lives easier financially as we navigate this crisis.

One way to ease the financial pressure on a number of consumers might be to find a way to lower credit card interest rates to more reasonable levels.

Does it make sense that these rates are higher than those of other forms of borrowing?

Absolutely.

Does it make sense that these rates haven’t moved at all, even in the face of falling rates elsewhere?