Credit Card Law Reveals State of Confusion

Alan Greenspan, former chairman of the Federal Reserve, has been vilified for all but singlehandedly causing the country's current economic problems.

Media coverage on the tech bubble, housing bubble, risk of unregulated credit default swaps (CDS) and relaxed mortgage standards cite Greenspan's policies as primary contributors. The fact that the U.S. government has had to step in to fix the credit card industry is further evidence of another Greenspan failure.

The Federal Reserve was in a position to regulate the excesses of the credit card industry for years. However, it wasn't until December, after disaster had struck American households, that the Fed came up with a new set of rules, which will take effect in July 2010. Those regulations were too little, too late, as Congress and the president had already set their eyes on the need for comprehensive credit card reform.

For 15 years, credit card regulators have had the power to prohibit the excesses of the credit card industry, dominated by
American Express (AXP) , Bank of America (BAC) , Capital One (COF) and JPMorgan Chase (JPM) . At any time, they could have put rules in place that would have prevented arbitrary interest hikes or the creation of additional fees without rhyme or reason. Now, laws will force credit card companies to change their practices, but the government wouldn't have had to take this kind of action if regulators had been doing their job. Congress was forced to pass laws to regulate the credit card industry because our regulators failed to do so.

Relying on legislators to step in for regulators is bad for a number of reasons. First, by the time legislation is called for, it's already too late to avert disaster; we are already suffering the effects of lax regulation. The best we can hope for now is damage control. Unfortunately, this means consumers and the credit card industry will be forced to learn and deal with changed rules in the middle of a crisis.

That isn't to say we don't like the new credit card law. We do. However, we have to acknowledge that politicians, who don't necessarily understand what is needed to keep the economy healthy, are likely to vote in ways that are popular. When regulators don't do their jobs, they open the door for politicians to make regulatory laws that may be more politically than economically advantageous. As Congress debated the bill that was to become the new credit card law, two ideas were bandied about that were essentially bad, and while one didn't make it, one did.

According to the new law, people under 21 will need parent or guardian co-signers to get credit cards or will have to show proof they can successfully make payments. Thus, the new law makes the claim that people whom we trust to defend the country in the military and vote in national elections aren't trustworthy enough to use a credit card. That's preposterous.

Secondly, the nation dodged another potential disaster when Congress, in debating the new law, turned down a proposal that would have capped interest rates at 15%. This is solid evidence that these kinds of decisions, when put into the hands of legislators, can lead to dire consequences. While politicians and intellectuals might think capping rates will suddenly extend cheap credit to all, the truth is that the credit card industry would have simply responded by refusing credit cards to a significant portion of the population. For the consumer, this problem would have meant catastrophe. Without credit cards, even a card with a high interest rate, many people wouldn't be able to meet unexpected financial obligations such as car repairs or medical bills. Without a credit card, an emergency might wipe out a person financially.

Finally, the debate over the 15% interest-rate cap shows just how unclear we are about the role of regulation. On one hand, people like Greenspan are willing to let free-market principles decide what kind of marketplace the consumer will enter, and if those principles create unfair and deceptive practices, so be it. On the other hand, some politicians think it's a good idea to restrict individual choice by stepping in and telling consumers how to manage their finances -- for example, restricting credit cards to people under 21 or capping interest rates at 15%.

The answer lies somewhere in between. The role of the regulator should be to create an open and fair marketplace that fosters innovation and competition. At the end of the day, the person best-suited to make financial decisions for you is you. The regulator's job is to make sure those decisions are as easy as possible for you to make.

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