The Credit Model
The Atlantic's Conor Clarke slaps down a credit card skeptic with a defense of the very concept of credit. And he's right! Credit is a good thing. And credit cards can, and should, be a good thing. But they're a more complicated thing than simple credit. And you see it in the example Conor chooses. "It's pretty obvious the widespread extension of credit can increase social welfare," he writes. "This is easy to see if you think about a college student paying her way with credit in anticipation of a higher future income, or a small business owner making an investment in his business in an anticipation of higher future sales."
Which is, again, true. But not the point of a credit card. A business owner making an investment generally goes and gets approved for a loan. He has to present evidence that the investment is wise and the loan likely to be repaid. We tend to think this due diligence a good thing. Indeed, the breakdown of similar mechanisms in the mortgage market is considered partially responsible for the current crisis. And there's been, of course, a similar deterioration in the credit card market. You don't go to a credit officer to present your plans for using the loan wisely. The credit officer mails you a letter to assure you that you've been pre-approved to use the money however you please.
Another way to put this is that credit cards look a lot better from a neoclassical standpoint than a behavioral economics standpoint. Rational and wise economic actors can do a lot with an easy line of credit. But we're not rational and wise economic actors. The main finding of behavioral economics, arguably, is that we're short-term actors who tend to discount long-term consequences. And credit cards exist, in part, to tempt that bit of irrationality.
Other credit markets -- like, in theory, the mortgage market or the small business loan market -- have developed systems to enforce long-term planning among credit users. Their business model relies on the loan being paid back. The credit card market, however, has done the opposite. And that's because its business model isn't really built on people using credit responsibly. It was built -- as the credit companies are admitting in this debate -- on penalizing people who use credit irresponsibly. The fact that easy credit is bad for some people, in other words, was a key part of the industry's strategy. They weren't simply looking to extend credit that would be responsibly paid back. They were looking, in part, to extend credit that would not be paid back. That's a very different approach.
(Photo credit: AP Photo/Chuck Burton)
May 22, 2009; 3:00 PM ET
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