'Help' that hurts

A high-school student recently emailed me to ask my assessment of the Credit Card Accountability, Responsibility and Disclosure Act of 2009 (CARD). With this legislation, Uncle Sam regulates the terms that may be legally agreed upon between credit-card issuers and their customers.

In particular, CARD strictly regulates late fees and interest-rate hikes on delinquent debtors.

Congress, the White House and most of the news media describe CARD as "pro-consumer." At first glance this description seems accurate. After all, don't consumers benefit when the fees and interest rates they must pay are reduced?

Although the answer to this question is "yes," this isn't the correct question.
The correct question is, "Don't consumers prefer to have the option of paying higher fees and interest rates if the alternative is having no access to credit at all?"

Not everyone is financially careful or responsible. Traditionally, credit-card issuers dealt with this fact not by refusing to lend to consumers with poor credit scores but, instead, by using an ingenious approach that helps both those consumers with poor credit scores as well as the banks that lend to them. That approach is to charge delinquent customers significant fees for late payments and to raise interest rates on delinquent balances.

These fees and higher interest rates might seem harsh, but they do two things to keep banks lending to people who would otherwise lose access to credit.
First, the prospect of penalty fees and higher interest rates gives borrowers stronger incentives to pay on time. So some people who might otherwise slip into financial irresponsibility are motivated to behave responsibly to avoid these extra charges.
Second, these penalty charges compensate lenders for the greater risks of lending to consumers with poor credit histories. Chances of default for borrowers with histories of late payments are higher than for borrowers who regularly pay on time. So it's more costly to lend to late payers than to on-time payers.
By restricting lenders' abilities to charge late fees and to raise interest rates, CARD denies lenders a chief means of encouraging customers to pay on time.
Like so many other statutes sold as being "pro-consumer," CARD hurts consumers, especially low-income consumers.
As obvious as this truth is, many politicians don't get it. They cling to their faith that regulations never create incentives for people to do what politicians don't want people to do. Politicians don't want lenders to cut back on lending to high-risk customers, so politicians exercise blind faith that their legislation will not prompt lenders to act in this way.
Curiously, though, politicians aren't so naive when it comes to taxes.
If politicians were as naive about taxes as they are about the consumer-credit industry, Congress and the White House would demand that the IRS treat delinquent taxpayers with much greater kindness -- say, by reducing fees and interest charges for late payment of taxes, and by eliminating jail time as a punishment for tax evasion.
If regulations create no incentives for people to act in ways that politicians dislike, restricting the IRS's ability to penalize delinquent taxpayers would cause no rise in tax evasion and delinquencies. Revenue collected by the IRS would be unaffected.
So the fact that the IRS continues to punish delinquent taxpayers with fines and penalties far greater than any ever dreamed of by credit-card issuers suggests that when it comes to revenues that hit close to home -- taxes -- politicians do, in fact, understand something about economics.