Paper: Rules should focus on credit cardholders' behavior
Allow consumers to "opt out" of paying credit card interest
Credit card industry regulation should focus more attention on how consumers actually behave when given credit cards, according to a new paper that recommends radical changes in the way the industry operates.
Under the plan released Friday by the New America Foundation, a Washington, D.C., think tank, consumers would have to pay off credit card balances quickly rather than stretch them out over long periods of time making only minimum monthly payments. Credit cardholders would be able to "opt out" of paying high interest charges and avoid some of the financial traps that go along with easy credit, according to the authors of "Behaviorally Informed Financial Services Regulation."
During a panel discussion on the paper Friday in Washington, Michael Barr, the paper's co-author, said the financial services market currently exploits the human failings of many consumers who do not understand the principles of compounding interest and therefore "undersave and overborrow."
Barr is a University of Michigan Law School professor. His fellow authors were Princeton University psychology professor Eldar Shafir and Harvard University economics professor Sendhil Mullainathan.
They contend that current lending regulations, including the amendements proposed by the Federal Reserve -- which focus on providing disclosure of terms of credit card agreements and mortgage contracts or on curbing issuer practices -- assume that consumers are rational people who make intelligent choices about borrowing money. Credit card issuers, the authors say, take advantage of consumers' behavior and "prey on common psychological biases -- biases that limit consumer ability to make rational choices regarding credit card borrowing," according to the paper.
"The current regulatory system is broken," said Ellen Seidman, financial services policy director for New America, a nonpartisan public policy institute. According to the foundation, "A new approach to the way we write the rules for buying homes, getting credit cards and managing our finances is needed, one based on real-world human behavior, not just economic theory."
Credit cards are the focus of four of 10 recommendations put forth in the paper. The other recommendations target home mortgages and savings accounts. The credit card measures are:
- Improving credit card disclosures.
- Allowing credit card users to "opt out" of payment plans.(Update: On Aug. 20, 2009, provisions of the Credit Card Act of 2009 went into effect that mandated consumers be given the right to opt out of increases in interest rates, fees, finance charges and certain other changes in credit card agreements. See story.)
- Giving users the option of having an "opt out" credit card (a "clean" credit card offering simple terms that are fully disclosed).
- Regulating credit card late fees by requiring issuers put a portion of the late fee proceeds into a public trust that would sponsor financial education for consumers and assistance for troubled borrowers.
Said Barr: "You're going to make it a lot less likely that fees will be focused on assuming the human failing that we all have."
An "opt out payment plan" would require consumers to "make the payment necessary to pay off their existing balance over a relatively short period of time unless the customer affirmatively opted out of such a payment plan and chose an alternative payment plan with a longer (or shorter) payment term."
"Increasing such behavior would mean lower rates of interest and fees paid, and lower incidence of financial failure," according to the paper. "Confronting an optimal payment plan may force cardholders to confront the reality of their borrowing, and this may help to alter their borrowing behavior, or their payoff plans."
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