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There was a twitter debate on Trumps plan to limit credit card interest rates to 10%.
In my view this is an interesting exchange between bad academia (fed paper), expert (Patrick Mckenzie), MBA logic, populists (Trump).
Trump proposed a policy of capping credit card interests rates at 10%. That set up a twitter folly of the high rate people are subsidizing low rate people with rewards backed by a fed paper.
https://www.elibrary.imf.org/view/journals/001/2023/054/article-A001-en.xml
Ackman backing it: https://x.com/billackman/status/2009976076559077844?s=46
Personally being a dumb MBA I feel like I can perfectly segment pnl between subprime borrowers and rich people. If I make money on subprime and lose money on rich people I can just shutdown the rich people business and deploy more money to poor people. So the academia people are most likely wrong based on simple logic?
I can’t find it now but somewhere he did a longer post on how all cc are segmented https://x.com/patio11/status/2010185232159518904?s=46
I think for culture war attributes there are: Academia can do bad research. Ignore basic (or a price) and find a conclusion that seems smart but does not pass a logic text.
Honest experts can give full market breakdown.
MBA and idiots can give a logic that makes sense and is more correct than an academic trying to make a paper.
And then there is the Trump 10% interest rate cap. Maybe most borrowing above 10% interest is bad? I might compare this to online gambling where the people doing it and are profitable it’s bad for them. Or legalized weed.
If I didn’t make it clear above. Most of the rich people rewards are paid for by the high interchange fees of 3%. It’s not credit risks. It’s not subsidized by poor people.
Edit: as a high income high fico. I would prefer we limit credit card fees. And rewards go to zero. Then the store I go to doesn’t pay a processing fee. So they cut prices. And it probably saves me more money than getting 2% cash back.
It should be obvious from basic efficient market processes that every measurable category of people the credit card companies can subdivide people into is internally profitable without needing subsidization, otherwise they wouldn't serve those people at those interest rates. The only subsidization occurring is
People that don't use credit cards subsidize rewards for people with credit cards since stores are charging higher average prices than they would if credit cards weren't so prolific.
People who have different actual repayment within the same legibility category. Ie, someone with a bad score who ends up in debt, paying a lot of interest, and working their way out of bad credit ends up subsidizing the people with bad scores who end up defaulting on their loans. If the credit card company doesn't know ahead of time which is which, they have to offer interest rates that will enable them to recoup their costs on average across the group. The former ends up paying a lot of interest because the credit card company gave them the same risk profile as the latter.
Now, you could make a claim that XYZ piece of information should be priced in but isn't and thus the market isn't truly efficient. But it's not going to be something as obvious as "rich people" vs "poor people".
Tagging @Opt-out and @magicalkittycat to continue their inclusion in the discussion.
You got it half right. I practiced bankruptcy law for a couple years, and I've seen the credit card industry a little closer-up than I would have liked. The first thing that should be noted is that all credit cards charge interchange fees ranging from around 1%–3% to cover the cost of processing the transaction. From there we can put cards into four rough categories:
Secured Cards: These are the lowest level, and aren't advertised. I dealt with them a lot, though, because they exist more or less to help people who just filed for bankruptcy build credit. The way they work is the borrower puts a small amount of money down (I usually recommended around $500) that acts as their credit limit and collateral for the "loan". Then they use it like any other card, except I usually recommended they only charge a small amount on it each month and just pay it off to build a consistent payment history. There are still interest rates and late fees, but I honestly never looked at them because they aren't designed for people who are going to be paying interest.
Cards for People with Terrible Credit: These are just what they sound like. They have no rewards and the highest interest rates, and are only given people with the worst credit scores. People with recent bankruptcy discharges would often get applications for these in the mail; I would tell them to put them in the garbage and go the secured route. These were people trying to reset their financial lives, and the last thing they needed was access to easy cash whenever things got tough. With secured cards the loss is limited to the amount of the deposit, while with these things can quickly spiral out of control. I gave this advice even to responsible bankrupts who filed due to e.g. medical debt or because of an atypical rough patch (divorce, unemployment, disability) where they were forced to rely on credit cards; these people didn't need my lecturing and were quite different than people who just overspent. Most of the overspenders, though, were so chastened by the experience that they never wanted to look at a credit card again, and I had to talk them into the safety of the secured route since it was worth it for them to build their credit if they wanted to get a car loan or mortgage in the future.
Credit Cards for People Who Use Them For Credit: These last two categories are available to anyone with a halfway decent credit score, but they're targeted at people who pay interest. It's really easy to target this market—advertise low rates. No one would be enticed by a low interest rate if they didn't have any intention of paying interest. These predictably have the lowest interchange fees, since the banks are making money from the interest payments. They don't offer any rewards, because the reward is the lower monthly payment. They're marketed through their interest rates, credit limits, and introductory 0% periods.
Reward Cards: These cards are specifically marketed towards people who don't run balances. After people realized that getting a credit card and paying the balance off every month was a convenient way to build credit and not deal with the inconvenience of cash, banks realized that that they were ignoring an important market segment. The ubiquity of credit card use allowed the companies to charge higher interchange fees, and since the fees were accounting for a share of revenue on par with interest payments, it made sense to try to attract these no-balance customers through reward enticements, which are paid for out of the fees. The interest rates are relatively high because the people who apply for these cards aren't concerned about the rate, and if they end up paying it it's just a bonus for the issuer.
The point I'm trying to make here is that outside of the absolute bottom of the market, credit worthiness doesn't really play into how these cards make their money, because the cards' users are differentiated by what marketing segment they belong to. There's nobody out there who would qualify for a low-interest card that wouldn't qualify for a rewards card, or vice-versa. The reason the interest rates are so high on credit cards (the lowest I've seen a client have was around 15%) is because of the ease of use. I may be able to get a better rate from a bank, but I have to go to the branch and submit paperwork and wait and then get a fixed amount of money with fixed repayment terms. With a credit card I get a limit and I can borrow money pretty much on the spot. Regardless of credit worthiness, this is an inherently riskier form of lending.
That is a good matrix for cards. I have a writing problem where I fail to structure my thoughts correctly. And probably something the Fed paper that kicked off the debate on twitter should have started with.
My gut is most people here started out getting category (3) card offers during college and later and eventually saw a lot of ads for category (4) cards. Category (3) you get a lot of offers for 0% balance transfers and (4) airlines and hotels. In (3) you have good enough credit you get offered interest rate buy downs while (4) you get basically a few free flights.
The populist take which I’ve used the term MBA logic for why it fails is that poor people subsidize free flights for rich people. Now more than a few smart people backed this idea (it had a fed paper saying it was true) but I think MBA logic prevails and you can just market segment. Besides AMEX only offers rich people cards and has the best rewards before mid 2010’s when Chase tried to challenge them.
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