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10/11/2005 Archived Entry: "Source of the new credit card minimum payment"

THE INCREASE IN CREDIT CARD MINIMUM PAYMENTS is a complex issue. I blogged about this, relying on reports of highly trustworthy economics writers for my statements that the new minimum payment requirements originated in the now infamous bankruptcy law.

Claire asked me to check into the source after her own reading of the law found no such provision.

She is right, I was wrong, and I offer my apologies for misleading any readers. The bottom line is that minimum payments are indeed going up, and in many cases will roughly double, but the reasons are not as I originally stated. There are lots of great lessons here on the multiplying problems of government interventions in the free market, but chastened by my inaccurate reporting, I'll stick to the facts for now.

The tale is a complex one, and while I haven't yet followed it to the bitter end, it goes something like this. Don't read any more unless you have a high tolerance for TLAs and gov-speak.

The federal Office of the Comptroller of the Currency and Administrator of National Banks (OCC) regulates much of the banking industry. Credit cards are issued by banks and are an extremely profitable part of their business. The OCC began growing concerned about bank credit card lending practices near the turn of the century, or perhaps even earlier. Typical minimum payments resulted in loans that took 20 to as much as 50 years to pay off, assuming the debtor didn't make any additional charges. (Yeah, right.) Agressive banks were extending even more credit to consumers who were clearly having trouble making even these token payments. If a large number of consumers defaulted on credit card debt, it could threaten the banking system. The OCC began formulating "guidelines" for banks.

They didn't do this alone. There is an entity called the Federal Financial Institutions Examination Council (FFIEC). Apparently it includes representatives from OCC, the Federal Reserve, FDIC, and OTS. I haven't been able to track down a lot of information about this group, but they clearly played a role in forming the new regulations.

The OCC issued the "guidance" in January, 2003. It took some digging, but I think the relevant documents is Credit Card Lending: Account Management and Loss Allowance Guidance (Word file.) To get a stomach-turning feeling of the degree to which banks are regulated, take a glance at current list of OCC issuances.

Reading the "guidance" is tough sledding, even without jet lag. It appears that even some bankers were not sure what they were being ordered, I mean guided, to do. So OCC's Julie L. Williams, First Senior Deputy Comptroller of the Currency and Chief Counsel (got to respect anyone with a 7-word title) gave a speech to a risk management conference. "We expect financial institutions to require minimum payments that will amortize the current balance over a reasonable period of time. "

But what is "reasonable," particularly to a fedgov bureacrat? Banks didn't know, so the OCC clarified the guidance. I haven't been able to find the OCC clarification document, but Michelle Singletary wrote a good article for the Washington Post, found in the Boston Globe Credit card minimum payments going up. In it, she quotes OCC spokesthing Dean DeBuck, who tells us that OCC "issued a clarification that the minimum payment must cover interest, fees, and at least 1 percent of the outstanding balance each month."

Got that? But its still not that simple. ''Because banks were having trouble deciding what was reasonable, we have gravitated toward 1 percent of the principal," DeBuck said. ''This is not a hard and fast rule and banks may establish other payment amounts." I can find more or less credible references to payment schedules that amortize the credit card loan in 10 years, others to more complex formulas that include other card balances, and so on. I need to find the "clarification" document to get to the bottom of this.

To summarize:

The new minimum payment guidance seems to be interest plus fees plus 1% of the outstanding balance, or something close to that figure. Some existing minimum payments are a flat 2% of outstanding balance. With a big balance, high interest rate, and/or fees tacked on, a 2% payment might not pay any loan principal at all, leading to negative amortization. Other former payment plans called for interest plus fees plus $15, meaning it could take forever to pay off a large balance. The OCC caught banks extending still more credit to consumers in trouble, and came up with these regulations in an attempt to stop it. They released the rules in January 2003, and have put banks on notice that they will begin enforcing the new rules after December 2005. That means that most banks will raise minimum payments soon, if they haven't done so already.

Paying 1% of the principal each month, with typical 18-27% annual rates plus various fees, could require payments approaching 4% of the overall balance. Some banks seem to be going to a straight 4% minimum from the present 2%. In some cases, a bank's minimum payment might go down, if they were formally requiring more than 1% principal payment every month, but I don't think this is very likely in the present regulatory climate. So credit card minimum payments are generally going up, but not simply doubling, and not because of the new bankruptcy law.

Phew.

Silver

Posted by Silver @ 05:43 AM CST
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