Bernanke: Damage From Crisis 'Likely to be Long-Lasting'
Speaking to the Fed Reserve's Community Affairs Research Conference in Washington today, Fed Chairman Ben Bernanke said "the damage from this turn in the credit cycle -- in terms of lost wealth, lost homes and blemished credit histories -- is likely to be long-lasting."
The topic of Bernanke's speech is "Financial Innovation and Consumer Protection," two concepts that Bernanke admitted are hard to imagine going together.
Indeed, the subprime mortgage was considered a financial innovation that ended up being bad news for a lot of homeowners.
Bernanke gave a quick history of three major forms of financial innovation -- mortgages, credit cards and overdraft protection -- and listed fixes the Fed has made to each and promises to make going forward.
Bernanke noted that broad deregulation starting in the 1970s made financial innovation possible to good effect, such as limits on how many branches a bank could own and how much interest it could pay on accounts.
But they got too complex, Bernanke said, and a key element was overlooked: When the new financial instruments were invented, it was not taken into consideration how they would perform when the economy went into crisis.
"I don't think anyone wants to go back to the 1970s," Bernanke said. "That said, the recent experience has shown some ways in which financial innovation can misfire. Regulation should not prevent innovation, rather it should ensure that innovations are sufficiently transparent and understandable to allow consumer choice to drive good market outcomes."
Bernanke highlighted the way credit card companies allocate payments consumers make on their cards.
For instance, a credit card may charge 12 percent interest on purchases and 20 percent on cash advances.
If the cardholder made a payment greater than the monthly minimum, "most" credit card companies, Bernanke said, chose to apply the payment to the 12 percent part of bill but not the 20 percent part.
That meant that, until all the purchases -- the 12 percent part -- of the credit card bill were paid off, cardholders were prevented from paying off the balance that was being compounded at a 20 percent rate.
In other words, let's say you bought $200 worth of clothes from the Gap with your credit card, which is charged at 12 percent interest. Then, you got a $300 cash advance on your credit card, which is being charged at 20 percent interest. Until you pay off the $200 worth of clothes -- plus the 12 percent interest on that -- the credit card company would maintain the $300 charge plus the 20 percent interest on that.
The Fed did market-testing of proposed disclosures explaining the two different credit card balances, but they were still too complicated for most to understand. Which is why, last year, the Fed put rules in place that will "limit the discretion of creditors to allocate consumers' payments made above the minimum amount required," Bernanke said in the speech.
(The first general use credit card was introduced in 1952, Bernanke said.)
Bernanke said that technology allowed banks to extend overdraft charges beyond checks to retail transactions.
"As a result, consumers who used their debit cards at point-of-sale terminals to make retail purchases, for instance, could inadvertently incur hundreds of dollars in overdraft fees for small purchases," Bernanke said.
You can read the entire speech here.
April 17, 2009; 1:56 PM ET
Categories: The Ticker | Tags: Ben Bernanke, Fed, Federal Reserve, credit cards
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