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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.

-- Frank Ahrens
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By Frank Ahrens  |  April 17, 2009; 1:56 PM ET
Categories:  The Ticker  | Tags: Ben Bernanke, Fed, Federal Reserve, credit cards  
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About Bernakes' speech on long lasting damage from the crisis.

Consumers have been complaining for years about credit card and overdraft abuses in the charges the banks have realized. Why has it taken a crisis for the government and the federal reserve to acknowledge these abuses and maybe attempt to do something about them?

Posted by: rgoldwing | April 17, 2009 4:01 PM | Report abuse

Financial innovation. That's about as big a fraud as Greenspan's productivity miracle. Please show Bernanke the door in '10. He neeeds to go back to pushing chalk.

Posted by: wesatch | April 17, 2009 4:31 PM | Report abuse

Irresponsible borrowers were a cash cow for the banks !! And hardly anybody keeps a checkbook anymore....especially the kids.... so it's easy to overdraft on a debit.

Take the abuses away. Then see how much bank earnings will be hit. Find banking's true value when the fix is "off". that's gonna' happen !!

Any reform of credit will chop millions of people out of the borrowing pool for regulated banks. That's on top of the lost former borrowers with tainted credit due to foreclosure, job loss, etc.

It would mean layaway and pawn shops for a lot of Americans.

I'll start holding my breath.

Posted by: bandcyuk | April 17, 2009 6:08 PM | Report abuse

The usurious interest charges on credit card balances are destroying all other sectors of our economy by sucking up every dollar of disposable income to pay interest into the financial sector.

Who has money for retail goods, cars, tuition, or a down payment on a home when the credit card company requires 30% interest on their balances?

These credit card companies are using bogus formulas and credit scoring mechanisms to justify these usurious interest rates of 15, 20 even 30 percent on old balances.

These interest rates are charged, even on accounts with perfect, or near perfect past payment histories.

The banks/credit card companies justification for these outrageous rates, is that they need to collect these amounts to cover late payments or defaults.

But if this is truly the justification, then a simple formula charging a total of 10% percent interest with 5% of that, earned and retained by the bank, and the second 5% refundable, when the balance is timely paid in full, would be more fair and effective.

One can only wonder about the inefficiencies in management and lending practices that necessitate the charging of 15, 20, 30 percent or more, plus fees, in order to earn a profit when the money being lent can be borrowed from the fed at near 0%, and as well the encompassing institution is subsidized with billions of dollars of TARP Funds.

Posted by: secretscribe | April 17, 2009 7:21 PM | Report abuse


The banks must be run by relatives of the casino bosses. I'm sure of it. But they sure run the vig pretty high. That 30% vig would make even the loan sharks blush.

Oh well......just blame it on the gamblers.

Posted by: bandcyuk | April 17, 2009 7:55 PM | Report abuse

As someone who's not part of the banking industry, I have to say I like Bernake and given the tough situation we're in I think he's done a good job.

The banking industry however has none of my sympathy and considering the ineptitude and flat out greed they've displayed recently, I'm convinced that we need to regulate the banking industry alot more than we've done in the past ... this is a perfect example of the kind of thing that needs to be addressed.

The banking industry should be about 'greasing the wheels of commerce at a reasonable profit' not about flat out usury and lining their pockets simply because they give us products that are too difficult to understand because each bank does them so differently. The border between the two can be mighty fine but clearly there is something wrong with the situation that Bernake is calling out here.

My suggestion to the banking industry is ... clean up your act or EXPECT that Uncle Sam is going to rain on your parade. Based on past experience, I expect the banking industry to botch this and we'll have new laws to straighten out the banking industry.

Posted by: fjt123 | April 20, 2009 8:31 PM | Report abuse

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