A lot has already been written citing Alan Greenspan, ex-head of the Federal Reserve, as one of the people most accountable for the country’s current economic problems. Reportage on the tech bubble, the housing bubble, the systemic risk of unregulated Credit Default Swaps (CDS), and the extremely relaxed underwriting standards to mortgages habitually mention Greenspan’s policies as a primary contributor to these problems. The fact that the U.S. government has had to step in to fix the credit card industry suggests that regulators under Greenspan were asleep at the wheel. As head regulator, the Federal Reserve was in a position to regulate the excesses of the credit card industry for years. Now that disaster has struck, the Federal Reserve finally came up with a new set of rules in December 2008 which would take effect in July 2010, but obviously, their regulation has come too late, as the United States Congress and President have already had to step in and do their jobs for them.
For fifteen years, credit card regulators have had it in their power to prohibit the excesses of the credit card industry. 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, law will force credit card companies to change their practices, but the government wouldn’t have had to take this kind of action if credit card regulators had been doing their job over the last decade and a half. America is now, in essence, forced to make laws to regulate the credit card industry because our regulators completely failed to do so.
Relying on legislators to step in for regulators is bad for a number of reasons. The first and most obvious is that by the time legislators are called in, it is 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 that consumers and the credit card industry will be forced to learn and deal with changed rules while already in the middle of the crisis.
This is not to say that we do not 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 and not necessarily for the common good. When the regulators don’t do their jobs, they open the door for politicians to make regulatory laws based on their concerns which are, by definition, political and not necessarily 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 did not make it into the final law, one did.
According to the new law, people under 21 will need parent or guardian co-signers in order to get credit cards or will have to show proof that they can successfully make payments. Thus, the new law makes the strange claim that people who we trust to defend the country and vote in national elections, are not trustworthy enough to have a credit card. This is preposterous.
The nation dodged potential disaster when Congress, in debating the new law, turned down a proposal which would have capped interest rates at 15%. This is solid evidence that these kinds of decisions, when put in the hands of legislators, can lead to dire consequences. While politicians and intellectuals might think that capping an interest rate 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 (i.e. anyone whose credit history recommended an interest rate of over 15%). They wouldn’t simply choose to make bad business decisions just because those were the only decisions they were allowed to make. For the consumer, this problem would have meant catastrophe. Without a credit card, even a credit card with a high interest rate, many people can not meet unexpected financial obligations such as car repairs or surprise medical bills. Without a credit card, an emergency might wipe them out, cost them their jobs, or force them to give up necessities.
Finally, the debate over the 15% interest rate cap shows just how unclear we still are about the role of regulation. On one hand, people like Alan Greenspan are willing to let free market principles decide what kind of market place 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 choices by stepping in and telling them how to manage their finances (for example, restricting credit cards to people under 21 or capping interest rates at 15%). The answer lies somewhere between these two extremes. 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 who is best suited to make financial decisions for you is you. The regulator’s job is not to make those decisions, but to make sure the decision is as easy as possible for you to make.