May 19, 2009

Congress Hates Me (and the Poor)

Damn. It has been a long time since I last posted. This has been a rough nine months (more on this later) for this blog, but as the school year winds down, I thought I would ease back into writing, with the goal of resuming my normal productivity levels soon. While the meaninglessness of life is certainly a topic to which I will return, I thought that today I would focus on something a little less cerebral: credit-card legislation making its way through Congress this month.

Defenders of this legislation have couched their rhetoric in fiery imagery of abuse and exploitation, invoking again the equivalent of mustachioed subprime mortgage banker of yesteryear (by that, I mean 2007, when the apocalypse was not visible on the horizon). Greedy corporate executives working at evil banks, it seems, have been tricking honest, hard-workin' 'Merican folks into taking out credit they could not afford and then charging them unfair fees and penalties. And since we generally believe that abuse and exploitation are a Bad Thing™, why shouldn't our saviors in Congress step in and impose blanket restrictions on the evil credit card companies?

Plainly speaking, because it will screw me over. True, there is abuse and exploitation in credit cards, and certainly, no one can credibly deny that those with less education or less capital bear the brunt of that exploitation and abuse. And to the extent we can, we should stop the trickery and deceit that (apparently) runs rampant.

Stopping trickery and deceit, however, is a far cry from capping interest rates (as many have proposed). Higher interest rates for riskier borrowers is not an abusive lending practice; it is a fundamental tenet of capital markets. If there is less chance that you will recover the money you lend, you charge a higher interest rate to compensate for that risk.

So, when credit card companies are restricted from charging the interest rate that would compensate for a particular borrower's risk profile, they are left with only two options: (1) not lend at all to that borrower; or (2) charge less risky borrowers (like me) more to compensate for the risk they cannot offload due to the cap on interest rates. In practice, credit card companies will probably do both, as the Times (bastion of conservatism that it is) noted yesterday.

Neither of those results, in my mind, is desirable, but the latter is leaps and bounds more offensive than the former. The problem with the first option, of course, is that the riskiest borrowers tend to be the poorest, so when credit card companies start denying credit (because they are unwilling to take on a risk without adequate compensation), the poorest will be disproportionately affected. No one is going to offer risky borrowers a rate the market will not bear absent a subsidy. And, that is exactly what the second option is—a subsidy from the middle class, who have a low risk of defaulting on their debt, to the poor, who have a high risk.

Ultimately, the inescapable truth, terrible though it may be, is this: really risky borrowers should not be getting credit at all. The only way they can is (1) if they are charged higher interest rates, or (2) if someone less risky subsidizes that risk. When you take away first option via legislation, only the second option is left. And if we are limiting options, we should be certain that the ones left are superior to the ones limited. Responsible people subsidizing irresponsible people does not sound like the better option here. Isn't that what the subprime mess was about fundamentally? People buying stuff that they could not afford and others subsidizing them.

This is my true frustration with economic populism. Demagogues always win points for it with the (much loathed) unwashed masses, but in the end, it is those unwashed masses along with the middle class that get reamed while the rich escape unscathed (in this case, for example, the rich will be unaffected because they have enough assets such that they do not need credit). Something to think about the next time some asshole gets in front of the cameras and starts babbling on about corporate greed and the like.