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Adverse selection in the credit card market?

cardcolumn.JPGIt's been a bad year for the credit card business. A sharp recession means consumers aren't paying back their loans. New regulations mean old avenues for profit are blocked off. The result, as the New York Times reports today, is that rates are spiking, new customers are paying higher fees and fewer applicants are being approved for credit cards. Indeed, between September 2008 and September 2009, the number of Visa, Mastercard and Discover card accounts actually fell by 12 million.

Put together, credit cards are becoming harder to get and less valuable to hold. And that probably means we're going to be seeing fewer of them. Debit cards, along with prepaid credit cards, break the convenience of plastic away from the dangers of debt. That doesn't work for everybody -- some people need short-term credit -- but it works for a lot more people than are using it now, and we're likely to see a greater percentage of the market realizing that.

The problem is that the people who migrate toward debit cards are the people who have enough money not to need much credit and are responsible enough to not want it. The good risks, in other words. The people left in the credit card market will be disproportionately bad risks, which means rates will go up and standards will tighten, which will in turn drive more people out of the market, starting the cycle over again.

Photo credit: Mark Lennihan/AP.

By Ezra Klein  |  November 10, 2009; 1:09 PM ET
Categories:  Economy  
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That's why you'd have other benefits that keep people in the credit segment - such as rewards or miles, and greater purchaser protections. Also, for people like business travelers who wouldn't want to finance their company's cash flow, being able to wait until a reimbursement comes in to pay off expenses is useful. Similarly, those who travel and might have unexpected expenses pop up, for which most people wouldn't keep funds in cash, credit cards can be useful. Obviously, this is a small part of credit card users.

Posted by: GrandArch | November 10, 2009 1:14 PM | Report abuse

You're not just writing this because you have never in your life ever had a credit card, right?

Posted by: constans | November 10, 2009 4:02 PM | Report abuse

constans, you're confusing journalism for day labor.

Ezra, that would make sense in a world without Fair Isaac. In the real world, people will continue to use revolving credit instead of debit cards to establish and maintain credit scores.

Posted by: wcwhiner | November 10, 2009 4:10 PM | Report abuse

A credit union credit card may be a good option.

The average interchange fee in the U.S. is seven times the interchange fee set by Visa and MasterCard in countries throughout the rest of the world. Using 2008 figures, if the interchange fee charged by credit card issuers was decreased (via comprehensive credit card reform legislation) from the current 2.10% to 0.60%, the result would be an annual savings of approximately $34.3 billion for U.S. merchants and consumers.

Let's be clear. The interchange fee is a hidden tax, just not a tax subject to political control or for which there is any discernible social benefit.

The following article discusses the need for comprehensive, standardized, simplified, and transparent credit card reform legislation.

Posted by: brianjdonovan | November 11, 2009 7:03 AM | Report abuse

Isn't this pretty much what the fee-and-penalty business model would be expected to produce? Of course, V/MC could make their product more attractive to sane people, as they used to be, but I guess that's way too silly an idea to implement.

Posted by: paul314 | November 11, 2009 11:38 AM | Report abuse

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