[Senate Hearing 111-48]
[From the U.S. Government Publishing Office]



                                                         S. Hrg. 111-48

 
  MODERNIZING CONSUMER PROTECTION IN THE FINANCIAL REGULATORY SYSTEM: 
                 STRENGTHENING CREDIT CARD PROTECTIONS

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                                   ON

  REFORMING THE PRACTICES OF CREDIT CARD COMPANIES AND PROVIDING NEW 
                       PROTECTIONS FOR CONSUMERS

                               __________

                           FEBRUARY 12, 2009

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html



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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman

TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         JIM BUNNING, Kentucky
EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          MEL MARTINEZ, Florida
DANIEL K. AKAKA, Hawaii              BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  JIM DeMINT, South Carolina
JON TESTER, Montana                  DAVID VITTER, Louisiana
HERB KOHL, Wisconsin                 MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             KAY BAILEY HUTCHISON, Texas
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado

                 Colin McGinnis, Acting Staff Director

              William D. Duhnke, Republican Staff Director

                       Amy Friend, Chief Counsel

                       Lynsey Graham Rea, Counsel

                  Drew Colbert, Legislative Assistant

                       Deborah Katz, OCC Detailee

               Julie Chon, International Economic Adviser

                Mark Oesterle, Republican Chief Counsel

                    Andrew Olmem, Republican Counsel

                       Dawn Ratliff, Chief Clerk

                      Devin Hartley, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)



                            C O N T E N T S

                              ----------                              

                      THURSDAY, FEBRUARY 12, 2009

                                                                   Page

Opening statement of Senator Dodd................................     1
Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     4
    Senator Brown................................................     5
    Senator Akaka................................................     6
    Senator Menendez.............................................     7
    Senator Schumer..............................................     7
    Senator Reed.................................................     9
    Senator Tester...............................................     9

                               WITNESSES

Adam J. Levitin, Associate Professor of Law, Georgetown 
  University Law Center..........................................    10
    Prepared statement...........................................    44
    Response to written questions of Senator Shelby..............   215
Kenneth J. Clayton, Senior Vice President and General Counsel, 
  Card Policy Council, American Bankers Association..............    12
    Prepared statement...........................................    72
    Response to written questions of Senator Shelby..............   221
James C. Sturdevant, Principal, The Sturdevant Law Firm..........    13
    Prepared statement...........................................    96
    Response to written questions of Senator Shelby..............   224
Todd J. Zywicki, Professor of Law, Mercatus Center Senior 
  Scholar, George Mason University School of Law.................    15
    Prepared statement...........................................   115
    Response to written questions of Senator Shelby..............   226
Lawrence M. Ausubel, Professor of Economics, University of 
  Maryland, 
  Department of Economics........................................    18
    Prepared statement...........................................   154
    Response to written questions of Senator Shelby..............   230
Travis B. Plunkett, Legislative Director, Consumer Federation of 
  America........................................................    19
    Prepared statement...........................................   170
    Response to written questions of Senator Shelby..............   232

                                 (iii)


  MODERNIZING CONSUMER PROTECTION IN THE FINANCIAL REGULATORY SYSTEM: 
                 STRENGTHENING CREDIT CARD PROTECTIONS

                              ----------                              


                      THURSDAY, FEBRUARY 12, 2009

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:10 a.m., in room 538, Dirksen 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. The Committee will come to order. My 
apologies to our witnesses and my colleagues. Today is the 
200th anniversary of Abraham Lincoln's birthday and I took my 
daughter up to Lincoln's cottage this morning up at the Old 
Soldier's Home where there was a ceremony this morning to 
unveil a wonderful statue of Abraham Lincoln and his horse Old 
Boy that he used to ride every morning for about a quarter of 
his Presidency from the White House to the Old Soldiers Home 
where he lived for a quarter of that Presidency and he wrote 
the Emancipation Proclamation. So I thought I would take my 
daughter out of school this morning for a bit of history and I 
am sorry to be a few minutes late getting back here this 
morning, so apologies to everybody for being a few minutes late 
for enjoying a moment of history with a 7-year-old.
    Well, let me begin with some opening comments, if I can. I 
will turn to Senator Shelby. We are honored to have such a 
distinguished panel of witnesses with us this morning on an 
issue that many of my colleagues know has been a source of 
interest of mine for literally two decades, the issue of reform 
of the credit card industry. And so this hearing this morning 
will give us a chance to reengage in that debate and 
discussion, and I want my colleagues to know at some point, and 
I say this to my good friend, the former Chairman of the 
Committee, at some point, I would like to be able to mark up a 
bill in this area. I know he knows that, but I wanted to say so 
publicly.
    So good morning to everyone, and today the Committee meets 
to look into an issue of vital importance to American 
consumers, their families, and to the stability of our 
financial system, and that is the need to reform the practices 
of our nation's credit card companies and to provide some tough 
new protections for consumers.
    In my travels around my State, as I am sure it is true of 
my colleagues, as well, we frequently hear from constituents 
about the burden of abusive credit card practices. In fact, the 
average amount of household credit card debt in my State is 
over $7,100. Actually, the number is higher, I think, 
nationally. Non-business bankruptcy filings in the State are 
increasing. In the second quarter of last year, credit card 
delinquencies increased in seven of eight counties in my State.
    Across the country, cardholders are paying $12 billion in 
penalty fees annually, every year. It is a major problem 
throughout our nation. At a time when our economy is in crisis 
and consumers are struggling financially, credit card companies 
in too many cases are gouging, hiking interest rates on 
consumers who pay on time and consistently meet the terms of 
their credit card agreements. They impose penalty interest 
rates, some as high as 32 percent, and many contain clauses 
allowing them to change the terms of the agreement, including 
the interest rate, at any time, for any reason. These practices 
can leave mountains of debt for families and financial ruin in 
far too many cases.
    When I introduced Secretary Geithner earlier this week as 
he unveiled the framework of the President's plan to stabilize 
our financial system, I noted then for too long, our leading 
regulators had failed fully to realize that financial health 
and security of the consumers is inextricably linked to the 
success of the American economy. In fact, for too many years, I 
think people assumed that consumer protection and economic 
growth were antithetical to each other. Quite the opposite is 
true.
    I noted that unless we apply the same urgent focus to 
helping consumers that we apply to supporting our banks' 
efforts to restart lending, we will not be able to break the 
negative cycle of rising foreclosures and declining credit that 
is damaging our economy.
    In this hearing, the Committee examines abusive credit card 
practices that harm consumers and explores some very specific 
legislative ideas to end them. These kinds of consumer 
protections must be at the forefront of our efforts to 
modernize our financial regulatory system.
    Why is this both important and urgent? Well, today, far too 
many American families are forced to rely on short-term, high-
interest credit card debt to finance their most basic 
necessities. And as layoffs continue, home values plunge, and 
home equity lines of credit are cut or canceled, they are 
increasingly falling behind. This December, the number of 
credit card payments that were late by 60 days or more went up 
16.2 percent from last year.
    Banks increasingly worried about taking more debt, bad 
debt, into their balance sheets are monitoring their credit 
card portfolios very closely, slashing credit lines and 
increasing fees and interest rates even more for consumers who 
have held up their end of the bargain. That puts consumers, 
including many of my constituents and others around the 
country, in the worst possible position at the worst possible 
time.
    For too long, the use of confusing, misleading, and 
predatory practices have been standard operating procedures for 
many in the credit card industry. The list of troubling 
practices that credit card companies are engaged in is lengthy 
and it is disturbing: Predatory rates, fees, and charges; 
anytime, any reason interest rate increases and account 
charges; retroactive interest rate increases; deceptive 
marketing to young people; shortening the period consumers have 
to pay their bills with no warning. Even the Federal financial 
regulators, of whom I have been openly critical for a lack of 
appropriate oversight throughout this subprime mortgage market 
crisis, recognize the harm these sinister practices pose not 
only to credit card customers, but also to our economy.
    Last May, the Federal Reserve, the Office of Thrift 
Supervision, and the National Credit Union Administration 
proposed rules aimed at curbing some of these practices. These 
rules were a good step and I applaud them, but they are long 
overdue. But they fell far short of what is actually needed, in 
my view, to protect American families.
    Just as we have seen in this housing crisis, when companies 
lure people into financial arrangements that are deceptive, 
abusive, and predatory, it only means mountains of debt for 
families, bankruptcy, and financial ruin for far too many. It 
also proved catastrophic, of course, for our economy.
    Today as the Committee examines how best to modernize and 
reform our outdated and ineffective financial regulatory 
system, we have a clear message to send to the industry. Your 
days of bilking American families at the expense of our economy 
are over. Today, we will discuss proposals to reform abusive 
credit card practices that drag so many American families 
deeper and deeper and deeper into debt, including the Credit 
Card Accountability, Responsibility, and Disclosure Act, which 
I recently reintroduced.
    We must protect the rights of financially responsible 
credit card users so that if a credit card company delayed 
crediting your payment, you aren't charged for this mistake. We 
must prevent issuers from changing the terms of a credit card 
contract before the term is up. And perhaps most importantly, 
we must protect our young people who are faced with an 
onslaught of credit card offers, often years before they turn 
18, or as soon as they set foot onto a college campus. These 
practices are wrong and they are unfair. And mark my words, in 
the coming months, they are going to end.
    Of course, we must do all we can to encourage consumers to 
also act responsibly when it comes to using credit cards. But 
we should demand such responsible behavior when it comes to the 
companies that issue these cards, as well.
    The need to reform credit card practice has never been more 
important. It is not only the right thing to do for families 
and our consumers, it is the right thing to do for our economy, 
as well. I have been working on reforms in this area for many, 
many years and I am determined to move forward on these 
reforms.
    With that, let me turn to our former Chairman and Ranking 
Member, Richard Shelby.

                  STATEMENT OF SENATOR SHELBY

    Senator Shelby. Thank you, Chairman Dodd.
    Although problems with mortgage-related assets have taken 
center stage in our ongoing financial crisis, credit card 
lending has also rapidly declined as our economy has 
deteriorated. The securitization market, a key vehicle for 
financing credit card transactions, remains severely 
constrained, at its best. The absence of a robust secondary 
market has deprived many financial institutions of the 
financing needed to support credit card-based lending. Unable 
to securitize their credit card portfolios, many banks have 
been forced to cut back their customers' credit limits or even 
terminate their customers' credit cards altogether.
    In the midst of these challenging market conditions, the 
Federal Reserve, along with the Office of Thrift Supervision 
and the National Credit Union Administration, finalized new 
rules last December that will drastically alter the credit card 
industry. The rules prohibit a variety of business practices 
and impose a new layer of complex regulation. They also update 
and enhance certain consumer protections.
    The new rules will be implemented over the next year and a 
half, but already, financial institutions are drastically 
altering their credit card practices, as they should. Recent 
reports suggest that the new rules will cause a substantial 
contraction in consumer credit.
    While I believe that there are many credit card practices 
that need reforming, as Senator Dodd mentioned, I also believe 
that regulators need to be especially careful in this time of 
financial stress not to take actions that unduly restrict the 
availability of credit. Limiting the ability of consumers of 
low and moderate means to obtain credit could have unfortunate 
consequences. If they can't get credit from regulated banks, 
they may seek it outside the banking system. Regulators must 
exercise caution to ensure that the appropriate balance is 
struck between adequately safeguarding consumers, which is 
important to all of us, while not eliminating access to credit 
for millions of American families.
    Regulators also need to make sure that they do not stifle 
innovation or unduly restrict consumer choice. Many innovative 
products that have been demanded by and have benefited 
consumers, including zero percent financing, may be eliminated 
or severely curtailed because of the recent regulatory rule 
changes.
    We can all agree that abusive products should be addressed, 
and soon, but we should also be careful not to eliminate 
legitimate products in doing that. An overly broad approach 
risks giving consumers a false sense of security. Too often, 
consumers fail to consider whether a particular financial 
product is right for them because they believe that Federal 
regulators have already determined which products are safe and 
which are dangerous. Yet in many cases, whether a financial 
product is appropriate for a consumer depends on the consumer's 
own financial position. If the financial crisis has taught us 
anything, it is that all sectors of our economy, from big 
commercial banks to retail consumers, need to do more due 
diligence before they enter into financial transactions. No 
regulator can protect a consumer as much as they can protect 
themselves if they have the necessary information, which is why 
clear, complete, and understandable disclosure, as Senator Dodd 
has pushed for years, is so critical.
    Several bills have been introduced that seek to codify the 
recent rule changes, and in several instances would go beyond 
those rules to enact even more severe regulations. I believe 
before we legislate in this area, I think we should be careful. 
I would prefer that we give regulators the necessary time to 
implement the rule changes and then we can evaluate how those 
rules have worked and what changes are needed.
    In this time of economic turmoil, we need to proceed 
carefully, but we do need to proceed. We need to be especially 
careful not to undermine the ability of our financial system to 
accurately price risk. The advent of risk-based pricing has 
helped our financial institutions expand the availability of 
credit. Undermining the ability of banks to employ risk-based 
pricing could reverse this very positive development.
    As this Committee begins to consider regulatory reform, I 
believe it is important to keep in mind the need to balance 
carefully our strong desire to protect consumers and the 
absolute necessity of preserving an innovative and diverse 
marketplace. These are not mutually exclusive concepts and it 
is our job--our obligation--to craft a regulatory structure 
that can accommodate them both, and I hope we will.
    Senator Johnson.
    [Presiding.] The Chairman has stepped out momentarily to 
confer with Secretary Geithner and Mr. Summers. Does anyone 
want to comment briefly before we get to the panelists? Senator 
Reed?
    Senator Reed. I will pass, Mr. Chairman, and defer to my 
colleagues if they would like to speak.
    Senator Johnson. Anybody?

                   STATEMENT OF SENATOR BROWN

    Senator Brown. Mr. Chairman, I would like to make a couple 
of comments. Thank you, Mr. Chairman, Senator Johnson.
    I think a lot of us--I appreciate the comments both of 
Senator Shelby and the Chairman. A lot of us are particularly 
concerned about credit card targeting of young people. Go to 
any college campus across this country, in my State, Ohio 
State, the largest university in the country, you will see that 
college students are inundated with credit card applications. 
Ohio State's own Web site counsels students to, quote, ``avoid 
credit card debt while you are a college student.'' We know 
what kind of debt students face anyway and I think that just 
paints the picture of how serious this is.
    There are other examples of what has happened with small 
business and it is so important. I just underscore how 
important this issue is and that we move forward on more 
consumer protections.
    I yield my time back.
    Senator Johnson. Senator Akaka, you have a comment to make?

                   STATEMENT OF SENATOR AKAKA

    Senator Akaka. Yes. Thank you very much. I appreciate the 
Chairman holding this hearing.
    Too many in our country are burdened by significant credit 
card debt. Not enough has been done to protect consumers and 
ensure they are able to properly manage their credit burden. We 
must do more to educate, protect, and empower consumers.
    Three Congresses ago, or the 108th Congress, I advocated 
for enactment of my Credit Card Minimum Payment Warning Act. I 
developed the legislation with Senators at that time, Senators 
Sarbanes, Durbin, Schumer, and Leahy. We attempted to attach 
the bill as an amendment to improve the flawed minimum payment 
warning in the Bankruptcy Abuse Prevention and Consumer 
Protection Act. Unfortunately, our amendment was defeated.
    My legislation, which I will be reintroducing shortly, 
requires companies to inform consumers how many years and 
months it will take to repay their entire balance if they make 
only minimum payments. The total cost of interest and principal 
if the consumer pays only the minimum payment would also have 
to be disclosed. These provisions will make individuals much 
more aware of the true costs of credit card debt.
    The bill also requires that credit card companies provide 
useful information so that people can develop strategies to 
free themselves of credit card debt. Consumers would have to be 
provided with the amount they need to pay to eliminate their 
outstanding balance within 36 months.
    My legislation also addresses the related issue of credit 
counseling. We must ensure that people who seek help in dealing 
with complex financial issues, such as debt management, are 
able to locate the assistance they need. Credit card billing 
statements should include contact information for reputable 
credit counseling services. More working families are trying to 
survive financially and meet their financial obligations. They 
often seek out help from credit counselors to better manage 
their debt burdens. It is extremely troubling that unscrupulous 
credit counselors exploit for their own personal profit 
individuals who are trying to locate the assistance they need.
    My legislation establishes quality standards for credit 
counseling agencies and ensures that consumers would be 
referred to trustworthy credit counselors. As financial 
pressures increase for working families, credit counseling 
becomes even more important. As we work to reform the 
regulatory structure of financial services, it is essential 
that we establish credit counseling standards and increase 
regulatory oversight over this industry.
    Mr. Chairman, I appreciate your inclusion of this in your 
bill, of a provision that mirrors the minimum payment warning 
provisions in my bill. Thank you very much, Mr. Chairman.
    Senator Johnson. Thank you, Senator Akaka.
    Senator Menendez, do you have a very brief statement to 
make?

                 STATEMENT OF SENATOR MENENDEZ

    Senator Menendez. I will make a brief statement. I don't 
know about very brief, Mr. Chairman. I will make a brief 
statement.
    Senator Schumer. Moderately brief.
    [Laughter.]
    Senator Menendez. Moderately brief. Let me thank the 
Chairman for holding this hearing. Credit card reform has been 
one of the top priorities that I have had both in the House and 
in the Senate since I arrived here, and I think this hearing 
couldn't come at a more important time, when millions of 
Americans are increasingly using their credit cards to float 
their basic necessities from month to month. As a result, 
Americans have almost $1 trillion of credit card debt 
outstanding. It seems to me that it is a dangerous cycle that 
is piling up.
    And while that debt is piling up, people in our State and 
across the country are discovering that their credit card 
agreements often conceal all kinds of trap doors behind a layer 
of fine print. If you take one false step, then your credit 
rating plummets and your interest rate shoots through the roof.
    Many of my constituents have contacted me after facing sky-
high interest rates they never expected after accepting one 
offer, only to learn later that the terms seem to have been 
written in erasable ink, or after watching in horror as their 
children in college get swallowed in debt.
    So for far too many people, credit card is already a 
personal financial crisis and I believe it is a national 
crisis. Our economy will not recover if debt ties down 
consumers tighter and tighter, and making credit card lending 
practices fairer would be the right thing to do under any 
circumstances, but under these economic conditions, it is an 
absolute necessity.
    Mr. Chairman, I have legislation, as well. Some of it has 
been incorporated in what I think Chairman Dodd is going to 
include. I appreciate those efforts and I hope that the Federal 
Reserve's guidelines, which are a good step, could actually be 
accelerated, because waiting a year and a half to get those 
guidelines into place at a critical time in our economy is only 
buying us more and more challenges.
    With that, Mr. Chairman, I ask that the rest of my 
statement be included in the record.
    Senator Johnson. Senator Schumer, do you have a very brief 
statement?

                  STATEMENT OF SENATOR SCHUMER

    Senator Schumer. I also have a moderately brief statement, 
like my colleague from across the Hudson River, but I thank you 
for calling on me. It is an issue that I have been involved 
with and care about for a long time.
    We know how important this is. Average credit card debt for 
the average--the average American family has $8,500 in credit 
card debt on a yearly income of $52,000. That ought to make you 
stop and think right then and there.
    I have been working on this issue for a long time. When I 
started in the 1980s, there were two schools. Some said 
disclosure is enough and competition would take hold. Others 
said, let us put limits. I was in the former school. I said, 
free market, let disclosure work. I worked long and hard on 
legislation and the Fed and the result was something that 
became known as the ``Schumer Box,'' clear, concise disclosures 
of important credit card terms in an easy-to-read table, and it 
worked.
    Before the Schumer Box, credit card interest rates were at 
19.8 percent. Every company somehow came up with the conclusion 
that was the exact right rate. There was no competition. The 
box came in and rates came down. Good old fashioned American 
competition did the job. So it worked. Disclosures at that 
point seemed to be a good balance between consumer protection 
and fostering business and innovation.
    But now, credit card companies have become so clever at 
inducing consumers to buy and use cards and trapping them with 
high interest rates and fees that I believe disclosure is no 
longer enough. Over the past few years, we have seen explosion 
of debt. The card industry began using many of the same sales 
tactics as mortgage brokers, below-market fees or interest 
rates that shoot up for the most minor of infractions, and fine 
print, as Senator Menendez mentioned, containing dozens of fees 
that a consumer has to pay.
    Now, recently, the Federal Reserve updated the Schumer Box. 
I was glad to see that. But more has to be done. Consumers are 
trapped in a business model that is designed to induce mistakes 
and jack up fees. That sums it up. And then the fees go from 7 
percent to 19 percent for some minor infraction on all the 
debt, something is very wrong and disclosure is not enough.
    The type of trip-wire pricing is predatory. It has to end. 
One issuer went so far as to provide its customers with 
incorrectly addressed return envelopes to ensure that consumer 
payments wouldn't arrive on time and allowed the company then 
to charge late payment fees. That is outrageous. Other 
companies charge fees so often, so many fees so often, 
borrowers end up paying over the limit fees because their 
credit has been maxed out by the previous round of fees, a 
vicious treadmill cycle.
    So as I said, the Fed has made a good step, but the rule, 
which doesn't go into effect until July 2010, that is too far 
from now. Too many families are struggling to make their 
minimum payment. And while the Fed's intentions are now good, 
we cannot be too shortsighted. There is going to come another 
time when credit will be loose and issuers will seek to roll 
back some of the important protections the Fed has implemented. 
That is why we must legislate.
    I have introduced the bill on the Senate side along with my 
friend, Senator Udall, that Congresswoman Maloney, my 
colleague, has introduced and successfully passed on the House 
side. And I know that Senator Dodd is considering many of the 
points in that legislation, as many of my other colleagues' 
legislation, when he puts together a bill, and I hope we will 
move one quickly, Mr. Chairman.
    Senator Johnson. Does anyone else feel absolutely compelled 
to make a comment?
    Senator Reed. Can I make a very, very, very brief comment?
    Senator Johnson. Senator Reed.

                   STATEMENT OF SENATOR REED

    Senator Reed. I think what my colleagues have said is that 
despite the first step by the Federal Reserve, we have to be 
very, very sensitive to the capacity and willingness of the 
Federal Reserve to actually protect consumers when it comes to 
credit cards, and I think that issue has to be before our panel 
and I am glad the Chairman has brought the issue to us and to 
this panel of witnesses.
    Thank you, Mr. Chairman.
    Senator Johnson. Senator Tester?

                  STATEMENT OF SENATOR TESTER

    Senator Tester. I will be brief, Mr. Chairman.
    In the good old days, you used to take a loan and you used 
to pay it back. Under the current scheme that goes on with 
credit card companies, you take out a loan and then they start 
attaching fees and increasing interest rates, and by the time 
you get done, you are paying it back, but none of it is going 
to the principal.
    There are a lot of issues out here. My friend, Senator 
Brown, talked about how the college kids are being roped into 
this kind of thing. I just think it puts everybody in a bad 
boat. I think the Federal Reserve did take a first step, but it 
was only a first step. I look forward to working on this bill.
    Senator Johnson. Anyone else? If not, I am pleased to 
welcome Mr. Adam Levitin to the Committee. Mr. Levitin is an 
Associate Professor at Georgetown University's Law Center 
specializing in bankruptcy and commercial law. Before joining 
the Georgetown faculty, Professor Levitin was in private 
practice at Weil, Gotshal and Manges, LLP, in New York and 
served as a law clerk at the United States Credit Appeals for 
the Third Circuit.
    Our next witness will be Mr. Ken Clayton. Mr. Clayton has 
been with the American Bankers Association since 1990 and is 
currently the Senior Vice President and General Counsel of the 
ABA Card Policy Council, the group responsible for recommending 
policy within the ABA on all card-related issues. Mr. Clayton, 
we welcome you to the Committee.
    Mr. Jim Sturdevant is founder and partner of the Sturdevant 
Law Firm in California and is an experienced litigator who has 
represented consumers in a number of significant consumer 
justice cases. In addition to his active litigation practice, 
Mr. Sturdevant is the Past President of the Consumer Attorneys 
of California and a member of the Board of Directors of the 
National Association of Consumer Advocates. We welcome you to 
the Committee.
    We welcome Professor Todd Zywicki. Professor Zywicki 
teaches at the George Mason University School of Law in the 
area of bankruptcy and contracts. From 2003 to 2004, Professor 
Zywicki served as Director of the Office of Policy and Planning 
at the FTC.
    Next will be Professor Lawrence Ausubel. Mr. Ausubel is a 
Professor of Economics at the University of Maryland and he has 
written extensively on the credit card market and other aspects 
of financial markets. Professor Ausubel, we welcome you to the 
Committee.
    Last will be Mr. Travis Plunkett. Mr. Plunkett is the 
Legislative Director of the Consumer Federation of America, a 
nonprofit association of 300 organizations. He is a regular 
witness in this Committee and we welcome him back.
    I welcome you all to the Committee and look forward to your 
testimony.
    Mr. Levitin, why don't we proceed with you.

   STATEMENT OF ADAM J. LEVITIN, ASSOCIATE PROFESSOR OF LAW, 
                GEORGETOWN UNIVERSITY LAW CENTER

    Mr. Levitin. Good morning, Mr. Chairman, Ranking Member 
Shelby, and members of the Committee. I am pleased to testify 
today in support of the Chairman's Credit Card Accountability, 
Responsibility, and Disclosure Act and other legislation that 
would create a more efficient and fair credit card market and 
would encourage greater consumer responsibility in the use of 
credit.
    Credit cards are an important financial product. They offer 
many benefits and conveniences to consumers. But credit cards 
are also much more complicated than any other consumer 
financial product, and unnecessarily so. Auto loans, student 
loans, closed-end bank loans, and all but the most exotic 
mortgages are relatively simple. They have one or two price 
terms that are fixed or vary according to an index. Not so with 
credit cards. Credit cards have annual fees, merchant fees, 
teaser interest rates, purchase interest rates, balance 
transfer interest rates, cash advance interest rates, overdraft 
advance interest rates, default or penalty interest rates, late 
fees, over-limit fees, balance transfer fees, cash advance 
fees, international transaction fees, telephone payment fees, 
and probably several other fees of which I am unaware.
    In addition to these explicit price points, there are also 
numerous hidden fees in the form of credit card billing 
practices. The card industry has been ingenious in creating 
tricks and traps to squeeze extra revenue out of unsuspecting 
consumers. These billing tricks cost American families over $12 
billion a year.
    Credit card billing tricks make cards appear to be much 
cheaper than they actually are, and that leads consumers to use 
cards too much and to use the wrong cards. By disguising the 
cost of using cards through billing practices, card issuers are 
able to maintain uncompetitively high interest rates and to 
generate greater use of cards. That produces additional revenue 
from interchange fees for the issuers as well as over-limit 
fees, late fees, and penalty fee revenue.
    The complexity of credit card pricing makes it impossible 
for consumers to accurately gauge the price of any particular 
credit card, and unless consumers can gauge the cost of using a 
card, they cannot use it efficiently and responsibly. Markets 
cannot function without transparent pricing because demand is a 
function of price. The lack of transparency in credit card 
pricing has resulted in inefficient and irresponsible use of 
credit, and that has resulted in dangerously over-leveraged 
consumers, who are paying too much for what should be a 
commodity product with razor-thin profit margins rather than 
one with a return on assets that is several multiples of other 
banking activities.
    Consumer over-leverage is a factor that should concern all 
of us, especially today. There is nearly a trillion dollars of 
credit card debt outstanding. The average carded household owed 
almost $11,000 in credit card debt last year. That is a drop in 
the bucket compared with household mortgage debt, but even the 
most exorbitant subprime mortgage rate is rarely over 10 
percent annually, whereas the effective APR on many credit 
cards--the effective APR--can easily be five times as high. And 
the harm to families is palpable. A single repricing due to a 
billing trick can cost a family between an eighth and a quarter 
of its discretionary income.
    These levels of credit card debt are not sustainable. 
Dollar for dollar, a consumer with credit card debt is more 
likely to file for bankruptcy than a consumer with any other 
type of debt. And to the extent that consumers are servicing 
high-interest-rate credit card debt, that is money they cannot 
use to purchase new goods and services from merchants. The 
money siphoned off by credit card billing practices does not 
create value. It cannot be spent in the real economy.
    The card industry's arguments that Congress should not 
interfere with their finely calibrated risk-based pricing are 
malarkey. Only a very small component of credit card pricing 
reflects risk. Almost all credit card pricing is a function of 
the cost of funds, the cost of operations, and the ability-to-
opportunity price, not the function of risk.
    Moreover, to the extent that credit card prices reflect a 
risk premium, it is a pool-based premium. It is not an 
individualized risk premium. The card industry is not capable 
of pricing for risk on an individual basis. The technology is 
not there. This means that there is inevitably subsidization of 
riskier consumers by more creditworthy ones.
    Nor is there any evidence that connects the so-called risk-
based pricing to lower costs of credit for creditworthy 
consumers. While it is true that base interest rates have 
fallen, that is almost entirely a function of the lower cost of 
funds, and the decline in base interest rates has been offset 
by increases in other credit card prices. According to the GAO, 
for 1990 to 2005, late fees have risen an average of 160 
percent, and over-limit fees have risen an average of 115 
percent.
    Since the 1990s, credit card pricing has been a game of 
three-card monte. Pricing has been shifted away from the up-
front, attention grabbing price points, like annual fees and 
base interest rates, and shifted to back-end fees that 
consumers are likely to ignore or underestimate.
    The card industry's risk-based pricing story simply doesn't 
hold up on the evidence and is not a reason to refrain from 
much-needed regulation of unfair and abusive credit card 
billing and pricing practices that have had a deleterious 
impact on the economy and society. Legislation like the Credit 
Card Accountability, Responsibility, and Disclosure Act is a 
crucial step in restoring transparency and fairness to the 
credit card market and to letting American consumers 
responsibly enjoy the benefits of credit cards. Thank you.
    Senator Johnson. Thank you, Mr. Levitin.
    The panel should know that we will limit your remarks to 5 
minutes in order to have a proper question and answer period.
    Mr. Clayton?

  STATEMENT OF KENNETH J. CLAYTON, SENIOR VICE PRESIDENT AND 
    GENERAL COUNSEL, CARD POLICY COUNCIL, AMERICAN BANKERS 
                          ASSOCIATION

    Mr. Clayton. Thank you, Senator, members of the Committee. 
My name is Kenneth J. Clayton, Senior Vice President and 
General Counsel of the ABA Card Policy Council. I appreciate 
the opportunity to testify today.
    Credit cards are responsible for more than $2.5 trillion in 
transactions a year and are accepted in more than 24 million 
locations worldwide. It is mind boggling to consider the 
systems needed to handle 10,000 card transactions every second 
around the world. It is an enormous, complicated, and expensive 
structure, all dedicated to delivering the efficient, safe, and 
easy payment vehicle we have all come to enjoy.
    As the credit card market has evolved to provide greater 
benefits and broader access, it has become more complex. As a 
result, legitimate concerns have been raised about the adequacy 
of disclosures and other regulations. In response to these 
concerns, the Federal Reserve and two other regulators released 
comprehensive rules that fundamentally change the protections 
offered to cardholders. In many respects, these rules reflect 
the input from those on this Committee and others. They have 
heard you.
    Federal Reserve Chairman Ben Bernanke noted that the new 
rules were, and I quote, ``the most comprehensive and sweeping 
reforms ever adopted by the Board for credit card accounts.'' 
These changes have forced the complete reworking of the credit 
card industry's internal operations, pricing models, and 
funding mechanisms.
    As this Committee considers new restrictions on credit 
cards, it is important to understand the sweeping nature of the 
Fed's rule and the extent to which it has already addressed the 
core concerns of cardholders. The rule essentially eliminates 
many controversial card practices. For example, it eliminates 
the repricing of existing balances, including the use of 
universal default. It eliminates changes to interest rates for 
new balances for the first year that the card is in existence. 
It eliminates double-cycle billing. It eliminates payment 
allocation methods perceived to disadvantage customers. And it 
eliminates high up-front fees on subprime cards that confuse 
consumers over the amount of credit actually available.
    The rule likewise ensures that customers will have adequate 
time to pay their bills and adequate notice of any interest 
rate increase on future balances so they can act appropriately.
    Perhaps most importantly, the rule provides significant 
enhancements to credit card billing statements, applications, 
solicitations, and disclosures that ensure that consumers will 
have the information they want in a manner they will understand 
and in a format they will notice so they can take informed 
actions in their best interests.
    These new rules will have even broader implications for 
consumers, card issuers, and the general economy. The rules 
affect every aspect of the credit card business, from how cards 
are funded to how they are priced to how they are marketed and 
to how credit is allocated among customers with different 
credit histories and risk.
    For example, because of the limitations on the repricing of 
risk, the rules will reduce credit availability and increase 
the price of credit. The rule will also impact the ability of 
card lenders to fund consumer loans in the secondary market as 
pricing restrictions coupled with increased delinquencies in 
this recession make investors very wary of buying asset-backed 
securities backed by card receivables. These securities fund 
about half of all card loans, to the tune of $450 billion. This 
can have enormous implications for the U.S. economy going 
forward and it is why the Fed and Treasury are currently 
working hard to unlock this market.
    Finally, the rules will impose enormous operational 
challenges for card issuers. Card lenders must completely 
overhaul internal processes, software, billing, product lines, 
advertising, customer service, and a host of other internal 
workings. Risk management models must be completely revised.
    The Fed understood the enormity of this challenge and 
stressed that adequate time to implement it is critical to 
avoid significant harm to consumers, and I want to stress that 
last point about the harm to consumers because there is a real 
concern that moving the date up on some of these rules will 
actually end up harming the consumers more than it benefits 
them.
    In closing, we would urge that any discussion over further 
legislation in this area be viewed in the context of the recent 
Federal Reserve rule, recognizing its sweeping nature, 
protection to consumers, impact on operations, and most 
importantly, its potential impact on our broader economy and 
the provision of credit to consumers and small businesses.
    Thank you. I would be happy to answer any questions you 
have.
    Chairman Dodd.
    [Presiding.] Thank you very much. I appreciate your 
testimony and your presence here.
    Did you introduce all the witnesses?
    Senator Johnson. Yes.
    Chairman Dodd. You did? Well, then Mr. Sturdevant, we 
welcome you, as well.
    Mr. Sturdevant. Thank you, Mr. Chairman.
    Chairman Dodd. I read your testimony last evening, as I 
read all of yours, and it is very, very helpful.

STATEMENT OF JAMES C. STURDEVANT, PRINCIPAL, THE STURDEVANT LAW 
                              FIRM

    Mr. Sturdevant. Thank you very much, Mr. Chairman. I am 
pleased to be here. I was here 2 years ago, in January of 2007, 
when you last convened a hearing on this subject. By way of 
background and simply to address the Federal Reserve's efforts 
in this regard, it began a quest in 2007, as well, with 
Solicitor comments. They finally came up with a set of rules 
late last year, but those rules won't take effect until 2010, 
which is why we need legislation this year and why I strongly 
support your legislation, Mr. Chairman.
    By way of background----
    Chairman Dodd. Who is the next witness here?
    [Laughter.]
    Mr. Sturdevant. By way of background and to put the fees 
that have been identified both in numbers and names and amounts 
into some perspective, I tried two cases, one in the late 1980s 
and one in the early 1990s, one against Wells Fargo Bank and 
another against First Interstate Bank, which now no longer 
exists, and the issues in the case were whether or not $5 late 
fees and $10 over-limit fees were excessive damage amounts for 
a simple breach of contract by the customer. We proved to a 
jury in the Wells Fargo case and to an experienced judge in the 
First Interstate case that $5 exceeded the damages resulting 
from breach of contract for late payments and that $10 was $9 
too much for someone who exceeded the authorized credit limit.
    As the Committee knows, beginning in 1996 with the U.S. 
Supreme Court's decision in the Smiley case, which allowed 
credit card companies to export anything they could charge in 
the home State where the credit card company was based, they 
could export interest rates and then, according to the 
Comptroller of the Currency, interest rates included late 
payment fees, advance fees, over-limit fees, membership fees, 
quick-look fees, whatever, all of these penalty fees then went 
from $10 or $15 to the present average level of $39. If they 
couldn't justify $5 or $10 in the late 1980s or early 1990s, 
they couldn't come close to justifying anything approximating 
$39 today.
    I was also co-lead counsel in a nationwide case against 
Providian Bank in the late 1990s and early years of this 
century. Providian's challenges were practiced from A to Z. Its 
entire credit card operation was abusive, predatory, and 
designed to lure low-income customers into situations where 
instead of a regular loan, they weren't paying off any of the 
principal. They were simply paying penalty fees, higher 
interest fees, balance transfer fees, et cetera. In order to 
stay in business, the Comptroller of the Currency required 
Providian to pay $300 million. The company was sued in private 
litigation and also by the City and County of San Francisco.
    And while Senator Schumer was here, he remarked on two of 
the then-shocking practices of Providian. One was to do a 
nationwide search to see where to locate its credit processing 
office, and they found that New Hampshire was the place where, 
on average, it took the longest amount of time for a letter to 
be mailed from any point in the country. But still, that wasn't 
enough to trigger enough late fee revenue at $39 a payment. 
They then issued bar code payment envelopes that would never 
reach the payment processing center in New Hampshire and were 
investigated on three separate occasions by the United States 
Postal Service for that. One can only imagine what would have 
appeared at trial had we not settled the case several years 
ago.
    And finally, two cases, Badie v. Bank of America, which I 
tried in the mid-1990s and won on appeal, and Ting v. AT&T 
challenged the attempts by Bank of America, on the one hand, 
and AT&T to impose mandatory pre-dispute arbitration clauses on 
their customers. In the Bank of America case, it was an attempt 
through a bill stuffer sent with statements which are multi-
page documents and other marketing materials to alert its 
customers that it was replacing the civil justice system with a 
private system of arbitration.
    And then in the Ting case, we challenged AT&T's attempt to 
impose not only mandatory arbitration, but several different 
unconscionable provisions, as well, unconscionable under 
California law because they prohibited class-wide adjudication, 
they imposed a secrecy gap on the consumer, they limited 
remedies otherwise available in litigation.
    The latest abuse, revealed last week by Chase, was to send 
out a bill stuffer which required many of its customers to 
increase the minimum payment from the standard in the industry, 
which had been 2 percent of the balance, to 5 percent. For low-
income people, an increase of 250 percent per month is more 
than significant and absolutely almost universally triggers 
default. For people at higher-income brackets, making a payment 
that usually was $99 a month and then trying to pay $250 a 
month is difficult in these financial times, as well.
    Chase also thought it appropriate to impose a $10 
administrative fee because I think the industry had simply run 
out of names for the fees that it charges. I have included in 
my written testimony a list of the fees that Professor Levitin 
mentioned.
    Mr. Chairman, I support your bill. I support provisions of 
the bill introduced a year ago by Senators Levin and McCaskill. 
I support Congressman Maloney's bill. Consumers in this country 
need legislation and they need a combination of enforcement by 
Federal officials, by State officials, and by private 
litigation, where necessary, to enforce the prohibitions that I 
hope this Congress will enact and President Obama will sign.
    In closing, let me say this. Professor Elizabeth Warren 
from Harvard, who chairs the TARP Committee, has written a 
paper and advocated something akin to the Consumer Product 
Safety Commission for financial services, which I know you are 
aware of and hopefully other members. This will elevate for 
education purposes to consumers and to students, who Senators 
Brown and Tester talked about, the serious traps for the unwary 
that the credit card industry in its current form presents.
    Thank you for inviting me to testify. I would be happy to 
answer any questions.
    Chairman Dodd. Well, I thank you very, very much. The 
complexity of it all for consumers is not accidental, in my 
view.
    Mr. Zywicki, thank you.

STATEMENT OF TODD J. ZYWICKI, PROFESSOR OF LAW, MERCATUS CENTER 
     SENIOR SCHOLAR, GEORGE MASON UNIVERSITY SCHOOL OF LAW

    Mr. Zywicki. Mr. Chairman and members of the Committee, it 
is a pleasure to appear before you today. Let me make clear at 
the outset, I have no relationship with the credit card 
industry. I fight with them just like everybody else does. I 
disagree with them, just like any other company from which I 
buy goods and services, and you may find this hard to believe, 
but sometimes I even disagree with my elected representatives 
on various issues.
    And I am really quite ruthless and not the slightest bit 
sentimental about leaving one card and switching to another if 
a better deal comes along. I don't care whether the industry 
makes a lot of money or a little bit of money. What I care 
about is maximizing consumer choice and maximizing competition 
in a manner that will be consumer welfare-enhancing, and I fear 
there are many provisions in this legislation that may have 
unintended consequences that will lead to higher interest rates 
for consumers, will stifle market and regulatory innovation, 
and will restrict consumer access to credit at a particularly 
inopportune time.
    Unlike almost any other good or service, credit card 
issuers are forced to compete for my loyalty every time I pull 
out my wallet to make a payment. I have got four credit cards. 
I decide at any given time which one is the best one for me to 
use, whether I am buying gasoline or shopping online. In such a 
competitive environment, credit card issuers face relentless 
competition to retain my loyalty, and as I said, I am not the 
slightest bit sentimental about switching if a better deal 
comes along.
    Federal Reserve surveys indicate that 90 percent of credit 
card owners report that they are very or somewhat satisfied 
with their credit cards, versus 5 percent who are somewhat 
dissatisfied and only 1 percent, that is one out of 100, who 
say that they are very dissatisfied with their credit cards. 
Moreover, two-thirds of respondents in a Federal Reserve survey 
also reported that credit card companies usually provide enough 
information to enable them to use credit cards wisely, and 73 
percent stated that the option to revolve balances on their 
credit cards made it easier to manage their finances, versus 10 
percent who said this made it more difficult. So let us not 
throw out the baby with the bath water.
    Nonetheless, the myriad uses of credit cards and the 
increasing heterogeneity of credit card owners has spawned 
increasingly complexity in credit card terms and concerns about 
confusion that may reduce consumer welfare. Nonetheless, we 
should not sacrifice just for the sake of making credit card 
simpler some of the benefits that we have generated from credit 
cards. Consider some of the more troubling provisions in the 
legislation to my mind.
    First, there are some provisions that will likely lead to 
higher interest rates and other costs for consumers. For 
instance, and many of these are in the Federal Reserve rules 
but I still am troubled by them, and to the extent that they 
are phased in rather than posed immediately, I believe that 
will be better for consumers. First, for instance, it prohibits 
the application of any rate increases on an outstanding balance 
on credit cards, often called retroactive rate increases. The 
way credit cards operate is they are revolving credit. They are 
month-to-month loans. That means at any given time, I can 
cancel my card and go to a lower interest rate card. To the 
extent that issuers are unable to raise the interest rate when 
situations change but I am allowed to switch to a lower 
interest rate when situations change, the end result of that is 
that issuers are going to be less likely to offer lower 
interest rates on the front end. If I can lower my interest 
rate but it can't be raised if circumstances change, they are 
going to be less likely to offer lower rate interest cards.
    Second, the provision that has to do with application on 
outstanding balances suffers from the same sort of problem.
    Second, I am concerned that some of the things in this 
legislation will stifle innovation. For instance, the provision 
that requires an ongoing payoff, a timing disclosure that 
includes, for instance, a statement to the consumers how long 
it would take to pay off the card balance by only making the 
minimum payment. This would go on every billing statement. 
According to research by Federal Reserve economist Thomas 
Durkin, this provision would be of interest to approximately 4 
percent of credit card users, being those who intend to pay off 
their balance by making the minimum payment and intend to stop 
using the card.
    It is an open question whether or not it is worth mandating 
a brand new disclosure for 4 percent of consumers, much less 
one that would be conspicuously disclosed. Why is that a 
problem? Because the more things that you require to be 
disclosed and the bigger you require it to be disclosed, the 
more distracting and more difficult it becomes for consumers to 
find out what they actually want.
    More fundamentally, I think this illustrates a one-size-
fits-all strategy to consumer protection that is not accurate 
in the context of credit cards. The reason why credit cards are 
so complicated today is because consumer use of credit cards is 
so multi-faceted. Consumer cards offer an endless array of 
terms that respond to the endless array of demands of different 
consumers. Some consumers never revolve. Some consumers revolve 
sometimes. Some consumers revolve all the time. I never 
revolve. I have no idea what my credit card interest rate is. I 
don't care. I don't shop for a card on those terms. I care 
about what my annual fee is and what my benefits are.
    To the extent that we mandate certain disclosures, it makes 
it more difficult for consumers to shop on the terms that they 
actually want, and the empirical evidence on this is clear. 
Consumers do shop on the terms that they want. Those who 
revolve, unlike me, do know what their interest rate is, by and 
large, and they shop very aggressively on that. The best 
evidence we have is that those who revolve balances actually 
have a lower interest rate on their credit card than those like 
me who don't pay interest and so don't shop on that particular 
term.
    To the extent, then, that we also place limits on penalty 
fees and that sort of thing, we are going to reduce risk-based 
pricing by requiring interest rate raises for everybody else.
    The final thing I would like to close on is the concern 
that this might reduce credit access. We know what has happened 
during this past year as credit card access has dried up and 
credit limits have declined. Reports indicate that middle-
class--some people have been forced to go without things they 
wanted. Other reports indicate that those who are unable to get 
credit cards have been, for instance, forced to turn to layaway 
plans. They brought back layaway this fall because people 
couldn't get credit cards. Other people have had to turn to 
payday lenders. Other middle-class people have turned to pawn 
shops.
    To the extent that the impact of this law is to reduce 
access to credit, it will harm those who we intend to help, and 
in particular, I would urge caution, although it is obvious 
college students often misuse credit cards, I would urge 
caution at this particular time at doing things that might 
limit access to credit for college students. We know that the 
student loan markets are not performing very well right now 
either, and we know that a lot of college students drop out 
when they can't get access to credit. So it may be that on net, 
some of those are appropriate, so let us not be overzealous in 
a way that might lead to reduced access to credit.
    Thank you.
    Chairman Dodd. Thank you very much.
    Dr. Ausubel.

   STATEMENT OF LAWRENCE M. AUSUBEL, PROFESSOR OF ECONOMICS, 
                     UNIVERSITY OF MARYLAND

    Mr. Ausubel. Good morning, Chairman Dodd, Ranking Member 
Shelby, and members of the Committee, and thank you for 
inviting me here. My name is Lawrence Ausubel. I am a professor 
of economics at the University of Maryland and the author of 
perhaps the most cited article on credit cards in the scholarly 
literature.
    Penalty interest rates or risk-based pricing, this is the 
question of the day. Consumer advocates assert that when the 
typical issuer raises the credit card interest rate by 12 to 15 
percent following a late payment, this is penalty pricing 
intended to take revenues from their most vulnerable customers. 
However, industry representatives respond that consumers who 
miss payments are the most likely to eventually default and all 
they are doing is requiring the riskiest consumers to shoulder 
their true cost.
    My testimony will seek to address which characterization is 
more accurate. The consumer view would justify legislation, 
such as the Dodd bill, while the industry view would suggest 
that such rules are misplaced.
    Unfortunately, the data necessary to answer this question 
are typically confidential and out of reach. However, in 2008, 
Morrison and Foerster issued a data study on behalf of lenders 
which tracks various delinquency events such as going 16 to 30 
days past due or going three or more days past due on two 
separate occasions, and it reports the percentage of consumers 
who ultimately default. Using their reported numbers, one can 
perform simple back-of-the-envelope calculations that answer 
the question of the day.
    The data enable me to reach the conclusion that the 
increases in interest rates bear no reasonable relation to 
default risk, i.e., these are penalty interest rates that 
demand regulation. Here is a simple calculation. Accounts that 
were 16 to 30 days past due in May 2006 experienced higher 
defaults than accounts that were current. Twenty-point-seven 
percent of these balances went into default, as defined by the 
study, over the following 22 months as compared to 9.3 percent 
for accounts that were current.
    Converting these percentages into annual rates of net 
credit losses gives an increased economic loss per year of 4.5 
percent. However, the standard repricing in the marketplace is 
a 12 percent to 15 percent increase. Let me repeat that. 
Economic loss of 4.5 percent versus standard repricing of 12 to 
15 percent. This is three times greater. By any standard, this 
is penalty pricing, not risk-based pricing.
    Moreover, this calculation is overly generous to the 
industry in several respects. For example, the data study omits 
late fees, typically $39, which are imposed above and beyond 
the interest rate increases. Further, to be more than fair, I 
selected 16 to 30 days late as my selection criterion. Using a 
trigger of just two to 5 days late, as some banks do, one can 
get the economic loss down below 2.5 percent per year. And 
again, the standard increase is 12 to 15 percent.
    At the end of the day, the economic conclusion is 
inescapable that these are penalties based not on cost, but on 
demand factors, and observe that the demand of consumers facing 
penalty rates is rather inelastic. They are often borrowed up, 
distressed, and have diminished alternative borrowing 
opportunities.
    I should also emphasize that a retroactive penalty rate 
increase for distressed consumers is precisely the opposite 
policy prescription that we apply in other areas of lending. 
For example, there is a growing consensus today that in the 
mortgage area, loan modification, i.e., reductions as opposed 
to penalties, are needed.
    To summarize, economic analysis of recent data supports 
stricter regulation of the credit card industry, particularly 
with respect to penalty interest rates imposed on existing 
balances. The Fed has taken some action in this area, but 
regrettably, the regulations are weak and the effective date is 
not until July 1, 2010. The current economic crisis makes it 
all the more urgent that Congress adopt the Dodd bill sooner.
    So to close, Chairman Dodd, I support the bill you 
introduced yesterday.
    Chairman Dodd. Thank you very much, Doctor. I appreciate 
that very much.
    Travis Plunkett has been before the Committee on numerous 
occasions with the Consumer Federation of America. We thank you 
for being here.

STATEMENT OF TRAVIS B. PLUNKETT, LEGISLATIVE DIRECTOR, CONSUMER 
                     FEDERATION OF AMERICA

    Mr. Plunkett. Thank you, Chairman Dodd, members of the 
Committee. I am Travis Plunkett, the Legislative Director at 
the Consumer Federation of America. I am testifying today on 
behalf of CFA and five other national consumer organizations. I 
appreciate the opportunity to offer our analysis of the very 
serious national consequences that unfair and deceptive credit 
card practices are having on many families in this recession as 
well as what this Committee can do to stop these traps and 
tricks. American families cannot become the engine of economic 
recovery if they are burdened by high credit card debt that can 
further escalate at a creditor's whim.
    I would like to summarize five points that I will leave 
with the Committee and then come back at the end of my 
testimony and provide a little detail on each point.
    First, the number of families in trouble with their credit 
card loans is approaching historic highs, as Senator Dodd said. 
Based on loss trends the card issuers are reporting, 2009 could 
be one of the worst years on record for credit card consumers.
    Second point, credit card issuers share a great deal of 
responsibility for putting so many Americans in such a 
vulnerable financial position through their reckless extension 
of credit over a number of years and use of abusive and 
unjustified pricing practices, which seem to be accelerating at 
this time when consumers can least afford it.
    Third, the need for quick action to end abusive lending 
practices is more urgent than ever now because taxpayers are 
propping up major credit card issuers through several 
enormously expensive programs. If the government is going to 
attempt to spur credit card issuers to offer more credit, it 
must ensure that the loans they are offering now are fair and 
sustainable.
    Fourth, the recent credit card rule finalized by the 
Federal regulators is a good first step in curbing abusive 
practices. It does have significant gaps, though, and as we 
have heard, it doesn't take effect until July of 2010.
    Fifth, Senator Dodd's comprehensive Credit Card Act fills 
in many of these gaps, as do a number of other legislative 
proposals that have been offered by members of this Committee. 
It will make the credit card marketplace fairer, more 
competitive, and more transparent.
    So let us talk a little detail here. On loss trends, 
Senator Dodd went through some of the most worrisome factors. 
One thing to watch is something industry insiders look at a 
lot. It is called the payoff rate. This is the amount of money 
that credit card consumers pay on their credit card bill every 
month and it has just dropped at the end of last year 
precipitously for credit cards. It is now at one of the lowest 
levels ever reported, showing that cardholders are having a 
harder time affording their bills and that the amount of money 
they can pay every month is dropping.
    Charge-offs and delinquencies--charge-offs is the amount of 
money proportionate to how much is loaned that credit card 
issuers write off as uncollectible--it is looking like they may 
approach the highest levels ever by the end of this year, and 
they are already quite high and have shot up very fast. 
Personal bankruptcy is up by about a third.
    On the responsibility that issuers have for this problem, 
just so you don't think this is last year's news or old news, 
let me just cite a few recent problems with some of the pricing 
practices you have heard about. They involve issuers adding new 
fees, increasing the amount of fees that they are charging, 
using harmful rather than responsible methods to lower credit 
lines, and a number of other abusive practices.
    Citigroup last fall back-pedaled on its promise to note 
increase interest rates any-time for any-reason, and then 
increased interest rates on a large part of their portfolio. 
Chase, as we have heard, has suddenly started charging people 
$120 a year for their accounts. These are cardholders who were 
promised a fixed rate for the life of their balance. Bank of 
America has used a variety of questionable methods for 
cardholders who appear to have done nothing wrong to violate 
their agreement, citing risk-based pricing and not providing 
clear information to these cardholders about the problem. 
Capital One and a number of other issuers over the last year, 
year and a half, have used very vague clauses in the cardholder 
agreements that allow them to increase interest rates for large 
parts of their portfolio for so-called market conditions.
    Let me be clear. Issuers do have the right to try and limit 
their losses in a recession, but these kinds of arbitrary and 
unjustified practices for cardholders who thought they were 
playing by the rules are very, very harmful.
    On the need for quick action because of government support, 
a couple of days ago, Treasury Secretary Geithner announced the 
expansion of a program that is supposed to provide taxpayer 
dollars to support securitization of credit card loans. They 
want more credit card lending. We have urged the Secretary to 
establish minimum fair practices standards for credit cards now 
so that our tax money isn't supporting unfair loans.
    On the Federal Reserve and regulator credit card rule, 
several positive aspects that we have heard about to the rule 
related to double-cycle billing, restrictions on increasing 
interest rates on existing balances, payment allocation. There 
are gaps, though. Fees are not addressed at all. Credit 
extension is not addressed at all. Bringing down rates if 
cardholders say they have a problem, then they pay on time for, 
say, 6 months, not addressed. And as we have heard, it doesn't 
take effect for a long time.
    The Credit Card Act and a number of other bills introduced 
in the Senate address many of these gaps. No any-time, any-
reason repricing. That is the excuse Chase used. Limiting 
unjustified penalty fees by requiring that fees be reasonably 
related to the cost issuers incur, a very important part of the 
Credit Card Act. Limiting aggressive marketing and 
irresponsible lending to young consumers and lowering rates if 
consumers perform well after a problem occurs.
    Let me just close by saying that we have heard a lot about 
fears that fair regulation of the credit card market will lead 
to less credit, will lead to people who need it not having 
access to credit, especially lower-income or minority 
consumers. I always get a little worried because this context, 
or the context for this discussion is to ignore what has 
happened through essentially self-regulation of the market. I 
mean, where are we now? Issuers have been able to write their 
own rules for a very long time and they are cutting back on 
credit, especially to more vulnerable borrowers, especially to 
lower-income and minority borrowers. Plus, we have to deal with 
the kind of uncompetitive, not transparent marketplace we have 
heard about.
    So it sounds like the worst of all possible worlds to me, 
and that is why we support Senator Dodd's bill and fair 
regulation of the marketplace.
    Chairman Dodd. Thank you very much, and I appreciate your 
comments, and all of you here this morning for your counsel on 
this issue, which is, again, a complex one and one that 
deserves our attention.
    I want to also make two points. One is credit cards are a 
tremendously valuable and worthwhile tool for consumers. I 
think it is very important. This is not a Committee, or at 
least an individual here that is hostile to the notion of 
credit cards at all. Quite the contrary.
    Second, I respect immensely that Ben Bernanke and the 
Federal Reserve moved on the issue of regulation, and while 
there are gaps and problems I have with what they have done, he 
is the first Chairman of the Fed that has actually moved in 
this area, despite the issue having been raised for a long 
time, and I certainly want to reflect my appreciation for the 
steps they have taken. I am disappointed that you have got to 
wait until July of 2010 for them to become effective, but 
nonetheless I want the record to reflect it.
    I was very impressed, Mr. Levitin, with this study and I 
highly recommend to my colleagues. It is lengthy in some ways. 
It is a number of pages long, some 20 pages long, this analysis 
of the credit card industry and how it works. But one thing 
that struck me at the outset of the report is something I think 
we kind of blow through, and that is the credit instruments 
that we use as Americans are tremendously valuable--the home 
mortgage, the car loan, the student loan. And the point that 
you make, or that this report makes is, of course, the pricing 
points, and I think it is a very worthwhile point to make.
    In almost every one of these other transactions, pricing 
points are rather clear. They are one or two or three, maybe 
four, but you have a pretty clear idea. You know with almost 
certainty what your mortgage is going to be, what your car 
payments are going to be, what your other payments are 
regardless if you take credit.
    When you get into this area, it is exactly the opposite, 
and I was stunned at the pricing points and why, in terms of 
taking on this responsibility, knowing what your 
responsibilities are going to be, you are faced with the 
following, just on pricing points, an astounding array of 
points--annual fees, merchant fees, teaser interest rates, base 
interest rates, balance transfer interest rates, cash advance 
interest rates, overdraft interest rates, default interest 
rates, late fees, over-limit fees, balance transfer fees, cash 
advance fees, international transaction fees, telephone payment 
fees. These are all the pricing points in credit card 
negotiations.
    To expect a consumer to appreciate and absorb that many 
pricing points when you are trying to determine whether or not 
taking on that financial responsibility--now, again, we are not 
going to eliminate all of these, but the idea that a consumer 
is able to juggle and understand that many different pricing 
points when you are making a determination as to whether or not 
you ought to engage in a service or a product purchase.
    I was stunned, as well, on the issues of bankruptcy and the 
like in terms of driving these costs up and the complexity of 
dealing with it.
    Again, I draw my colleagues' attention to this report. I 
think it is extremely useful. It gets into the issue of the 
risk-based pricing issue, as well, that Dr. Ausubel referenced, 
but I think it is an important point, as well.
    It is an industry that started out making its money on 
interest rates, and that was where the money was made. It has 
transferred itself from interest rates to fees, and that is the 
$12 billion increase in fees that have occurred that have added 
so much cost and confusion.
    Mr. Clayton, thank you for being here. One of the issues 
that is obviously of concern to many of us is the universal 
default. I think most people understand it, but the idea that 
if you are current on your credit card responsibilities, but if 
you are late on an electrical bill or a phone bill or the like, 
that we have seen examples where the issuers will then raise 
fees or rates as a result of your late payments on unrelated 
responsibilities, financial responsibilities.
    Now, it is true that, in a sense, the new rule to some 
degree eliminates the universal default. But under the rule, as 
well, and having conversations with the Fed about this, issuers 
can still look to off-comp behavior to increase interest rates. 
And so while it talks about banning it on one hand, it still 
tolerates the issue of actually accounting for off-balance 
behavior to increase rates that consumers pay. I would still 
call that universal default. If, in fact, the issuer can raise 
rates by considering these late payments in unrelated matters 
to the credit card, then it still seems to me that universal 
default exists. How do you respond to that?
    Mr. Clayton. Well, Senator, I know there has always been 
this discussion about how universal default is defined and I 
understand respect the fact that people take different 
perspectives. But it is our understanding that the Fed permits 
the changing of interest rates on existing balances under four 
conditions and four conditions alone.
    The first condition is if it is a promotional rate card, 
essentially, and it is disclosed ahead of time and that 
promotional rate expires.
    The second one is if it is a variable rate card tied to 
some kind of index.
    The third one is if there is a delinquency in excess of 30 
days.
    And the fourth one is if it is a violation of a work-out 
agreement.
    I am unaware of any other circumstance where, when this 
rule becomes effective, that institutions can consider off-
account information in determining the interest rate on that 
existing balance.
    Chairman Dodd. Mr. Sturdevant, do you have any comment on 
this, or any of you who are familiar with it?
    Mr. Sturdevant. I am concerned about the Federal Reserve's 
rule, particularly in light of your comments, not simply today, 
but 2 years ago about this very issue, and in terms of consumer 
expectations under agreements that now exceed 30 pages in 
length about what they are getting when they get a credit card. 
I mean, I think Senator Tester is right, and you were right, 
Mr. Chairman, on auto loans. You know what you are getting. You 
know what you are paying. In the old days of banking, they 
loaned the money out and they took deposits in. We don't do 
that anymore.
    And the problem with universal default is consumers do not 
understand that if they have a problem with a utility bill or 
some other relationship, that the interest rate is going to 
skyrocket, that the penalty fees are going to be imposed. That 
is what universal default does. It is a complete trap for the 
unwary and it needs to be prohibited, not regulated.
    Mr. Plunkett. Senator, to answer your question, universal 
default would be allowed prospectively. The Federal Reserve 
rule deals with increases on existing balances.
    Chairman Dodd. But not going forward?
    Mr. Plunkett. But not going forward. So they could decide 
that they didn't like my library fines or my utility payment 
and increase my--you know, send me a notice saying that going 
forward, as long as they met other requirements of the law----
    Chairman Dodd. Despite the fact that you are absolutely 
current. What I am suggesting, if you are late and various 
things, under reasonable rules, having fees and penalties and 
so forth. We are not talking about that. We are assuming that 
that consumer is absolutely current in their payments on their 
credit card responsibility, and then still because they are 
late on some other charges, that then justifies increasing the 
rates on that consumer going forward.
    Mr. Plunkett. Our reading of the rule is that that would be 
allowed going forward.
    Chairman Dodd. Can you imagine the effect it would have if 
you were late on your credit card and the phone company or the 
electrical company decided, we are going to increase your rates 
because you didn't pay your credit card on time? What would be 
the reaction? Do you have a comment?
    Mr. Clayton. Senator, can I jump in for a second? First of 
all, card companies don't consider whether you are late on a 
telephone bill or utility bill as part of what is in their 
credit records.
    The other thing is that consumers have absolute control 
here. This is about future balances. And I would note, by the 
way, that the Fed said that you cannot increase future balances 
for the first year of the card. That is the first thing. Plus 
they gave you notice of that effect. And it gives you the 
choice of walking. If you don't like what the card company is 
doing, there is a lot of competition out there and choice for 
people, and that is the ultimate controlling mechanism here. 
Consumers can just say no. And it is not that hard and we 
need----
    Chairman Dodd. Why do you have to--why all these fees and 
rates and so forth? Is that really the answer to consumers? If 
you don't like this, what we are loading you up with and 
charging these fees, just take a walk?
    Mr. Clayton. Well, but that is what you do every time when 
you walk by and decide whether you are going to buy a sweater 
in a store or not. But the other thing that is important to 
note that gets lost in this, credit cards, while they are 
loans, are fundamentally different. They are not secured. They 
are completely used with incredible flexibility for consumers 
at any time. You can use it 24/7 virtually anywhere in the 
globe. There is a huge amount of risk in making those loans 
available.
    What we worry about, and we understand are sympathetic to 
the concerns being raised, the Fed has acted and we will 
obviously enforce that with all the strength we can. But the 
point is----
    Chairman Dodd. So the comments are coming then in favor of 
the Fed rules?
    Mr. Clayton. We didn't necessarily agree with everything 
the Fed said, but it is the rule of law today and it is what we 
will have to comply with going forward and we will do our best 
to----
    Chairman Dodd. Are you in favor of them?
    Mr. Clayton. There are concerns that people have raised 
about the impact it will have on availability of credit.
    Chairman Dodd. My time is up. Let me turn to Senator 
Corker. I have extended my time.
    Senator Corker. Mr. Chairman, thank you for having the 
hearing. I am going to be very brief. I have got something 
starting in about 3 minutes.
    But let me just, Mr. Clayton, I just recently met with a 
number of folks that are in the credit card business and I got 
the sense that it wasn't a particularly rosy time. Could you 
give us a sense as to how the industry itself right now is 
performing from the standpoint of making profits, losing money, 
just generally the state of the credit card issuers' business 
today?
    Mr. Clayton. Sure. Credit card issuers are subject to the 
same economic influences that are out there affecting everyday 
consumers and every other lender in the country. Card companies 
are under particular stress right now. A number of them are 
losing money and have indicated in recent reports significant 
losses on their card portfolios, which actually reflects the 
underlying risk of this product. I mean, people talk about how 
much consumers are getting in debt or can't pay it back. Well, 
lenders who make loans to those people are the ones at risk 
here of not getting paid. So there is a significant amount of 
stress right now.
    Senator Corker. Mr. Chairman, I have got two daughters that 
are in college and every time we have a hearing or some 
discussion about credit cards, I literally call them that day--
the credit card industry won't like this--to make sure they do 
not have a credit card, OK, that they have only a debit card or 
a check card. So I actually appreciate many of the fears that 
people and many of the concerns that people have laid out today 
regarding the credit card companies.
    I have to tell you, I feel like I am semi-sophisticated--
semi--and I get incredibly confused by all these things I get 
in the mail, and candidly, throw most of them in the trash. I 
just don't understand. So the marketing practices, I think, are 
things that need to be looked at.
    So the only thing I would say is that we have this rule of 
unintended consequences that continues to sort of haunt us with 
actions that we take. While I think that certainly there have 
been abuses in fairness, at the same time, I think we have to 
be very careful. It seems that when we do things like this, in 
many cases, it is the lowest-income people that end up getting 
hurt the worst by our good efforts by virtue of having a lack 
of availability of credit. So I hope as we move through this, 
we will do this in a balanced way that does take into account 
some of the concerns that have been raised and I think are very 
fair. But at the same time, we understand that at the end of 
the day, these businesses are going to do those things in their 
self-interest, and when they do that, it may, in fact, end up 
harming the very people that this legislation is intended to 
help.
    So thank you very much for this great hearing.
    Chairman Dodd. I appreciate that very much, Senator. We 
always appreciate that point. It is a worthwhile one. This is 
an ongoing issue.
    I just say regarding young people and unsolicited mail, I 
have a 3-year-old that got a credit card the other day and they 
wanted to thank her for her wonderful performance as a 
consumer. She is a delightful consumer, I want you to know 
that, but the idea that she warrants a credit card at the age 
of three is troubling, needless to say. And the idea of having 
some ability to demonstrate you can pay or some cosponsorship, 
I think these are basic things that one would require. Let me 
stop there.
    Senator Johnson?
    Senator Johnson. Mr. Plunkett, the new Fed rules prohibit 
banks from increasing interest rates on credit card debt that a 
consumer has already accrued, increase the amount of time 
consumers have to make payments, change how a consumer's 
balance is computed each billing cycle, ensure that consumer 
payments go first to balances with the highest interest rates, 
and crack down on credit cards with low credit limits and APs. 
What other areas would you like to see improvements regarding 
consumer protections for credit cards?
    Mr. Plunkett. Thank you for the question, Senator. A couple 
more areas we would like to see improvements. First, as we 
heard, fees have been growing faster than the cost of living. 
In many cases, penalty fees in particular seem to bear no 
relationship to the costs incurred by issuers if somebody pays 
late or goes over limit. So we like Senator Dodd's provision 
that fees should be reasonably related to the costs incurred by 
issuers.
    We like the provisions in that bill and others related to 
lending to young people. Two things there. Senator Dodd talked 
about extending credit responsibly to young people or having a 
cosigner with income who can pay for the loan and not offering 
the loan to young people without much income.
    The second issue in the bill, give young people a choice of 
whether they want to accept--a real choice--whether they want 
to accept credit card solicitations. So the bill has an opt in. 
You don't get solicited between 18 and 21 unless you 
affirmatively choose to allow it.
    A third issue is bringing down rates after somebody makes a 
mistake. In many cases, issuers appear to be reserving the 
right to charge those rates for a long time, you know, many, 
many, many months. What the Dodd bill says is after 6 months, 
if you have been on time, if you haven't violated your 
agreement, rates have to come back down again.
    Senator Johnson. I believe the time is incorrect.
    Chairman Dodd. Just keep going.
    Senator Johnson. Mr. Clayton, I understand that the Fed's 
rules are not effective until July 2010. We have heard from 
some that this is too long and that legislation needs to be 
passed now to shorten this to a few months. Why do you think 
the Fed gives the industry so much time to put the rules in 
place?
    Mr. Clayton. Thank you, Senator. One of the things that the 
staff and the regulators were careful to articulate when they 
issued this rule was the immensity of what was involved in 
changing what they are requiring. There are significant 
operational changes in terms of everything under the sun, in 
terms of how banks actually send out billing statements, how 
they coordinate, how they do anything that you see in paper has 
to be obviously tested, because there are significant 
compliance concerns that go with this and significant penalties 
for failure to get it right.
    They also have to significantly rewrite how they price for 
risk because the rule places significant limitations on that. 
And as a practical matter, that takes time to figure out what 
is acceptable to consumers as well as what is acceptable to 
regulators and others.
    The third point, and this is something I wanted to stress, 
is the funding aspect of this. As others have noted and I have 
tried to note in my testimony, the credit card industry and 
consumers are essentially dependent on funding from investors. 
Half of the credit card funding that is provided for credit 
card loans comes out of the asset-backed securities market. It 
is why, in fact, the Treasury Department and the Federal 
Reserve are trying to come up with a way to unlock that market 
because it is currently locked right now.
    The problem is, those securities were issued with the 
expectation by investors that there could be a risk-based 
repricing in the process, and so it has built into the models 
of those securities that people will actually pay back at 
certain rates and that the institutions have the right to 
change those rates in order to compensate for higher risk in 
the marketplace.
    If you move this date up, in addition to all the 
operational headaches you run, you are going to end up changing 
the nature of that calculation and reducing the ability of 
credit card companies to meet the requirements of those 
securities. As a result, investors start running. They get 
nervous. They won't purchase it going forward, which actually 
operates in direct conflict with what the Treasury and the Fed 
are trying to do in unlocking this market, and it runs the risk 
in the worst case scenario, and we are not saying this happens, 
that some of these trusts have to be devolved. What that means 
is the hundreds of billions of dollars of repurchases back off 
from these receivables and you have to hold tens of billions of 
dollars in capital against that. That will significantly 
contract the availability of credit in the marketplace.
    Senator Johnson. Mr. Ausubel, in recent months, we have 
seen lenders cut back the amount of new credit that they offer 
and reduce credit card lines. How has this impacted consumers?
    Mr. Ausubel. Clearly, the financial crisis has led to the 
reduction in credit lines and this has been adverse to 
consumers. However, there is no evidence that credit card 
regulation or the Dodd bill would cause any further contraction 
in the availability of credit or increase the cost of credit. 
This has all been presented as industry rhetoric with no hard 
evidence.
    The other thing just to add is people are using things--
this is always done--people are using random recent events, 
like the cutback in the securitization market--I should say the 
freezing of the securitization market to raise red flags here. 
The reason for the securitization market's freeze is the 
financial crisis and it is not a matter of concern whether 
banks can impose penalty rates on consumers.
    Senator Johnson. Thank you. I yield back.
    Chairman Dodd. Thank you very much.
    Senator Reed?
    Senator Reed. Thank you, Mr. Chairman.
    Following on Senator Johnson's question about this 18-month 
interval, just to be clear, Mr. Clayton, is there anything in 
the rules that would prevent credit card issuers from raising 
interest rates and increasing fees in that 18-month period?
    Mr. Clayton. No.
    Senator Reed. Would there be an incentive to do so if these 
fees can be maintained after 18 months?
    Mr. Clayton. Not necessarily, because ultimately the card 
companies have to answer to the marketplace, and if they raise 
rates, there is always the opportunity for consumers to take it 
to another company. So it is not-- credit card companies are 
not in the business of hurting their customers. Ultimately, 
they want them for the long term and long-term profit. So they 
are not looking to drive people away. If there are choices in 
the marketplace to provide a better deal, they know the 
consumers will take it.
    Senator Reed. Professor Levitin, what is the spread between 
the rates here? What is this price competition that Mr. Clayton 
has referred to that goes on so vigorously?
    Mr. Levitin. Well, here is the problem with Mr. Clayton's 
story. It is that he is saying you can just say no. If a 
consumer doesn't like a prospective rate increase, the consumer 
can walk away. But that is not costless. There is a lot of 
lock-in with credit cards. If you want to walk away from a card 
because you don't like what the issuer is doing, it is not that 
simple. You have to go and find a new card. That takes some 
time. There are some transaction costs there, not high, but 
there are some, and you take a hit to your credit report. If 
you have a line of credit that was functioning just fine and 
you close it, that hurts your credit score.
    Walking away is not costless, and I believe Professor 
Ausubel has a study on this and I should defer to him for a 
characterization of it, but if I recall, I think he estimated 
the costs of switching a card being around $150 in total costs 
to a consumer.
    Senator Reed. Before I go to the Professor, just a response 
to my initial question. There is no disincentive to raising 
rates, and another particular question, there are certain 
categories of fees or charges that are prohibited after the 18-
month period. If those fees or charges exist on that date for 
card customers, will they stay in effect or would they have to 
be conformed?
    Mr. Levitin. Regarding your second question, I am not sure. 
Regarding the first question, there really is no disincentive 
for raising the cost because if you have a consumer who is 
locked in, if you raise their rates some--I mean, consider 
this. Right now, consumers can already walk away, but yet we 
see Citibank going and raising interest rates. On one of my 
Citi credit cards, Citi raised the rate. It went up--it was a 
70-percent increase, seven-zero percent. Citi had to be 
calculating that I wasn't going to walk away.
    Now, that card is way above the rate that I have from other 
cards, but the idea that Citi wouldn't do this, I mean, if Citi 
is smart and if banks are self-interested, as Mr. Clayton says, 
they wouldn't do this unless they know that I am not going to 
walk away, that they know that there is a serious lock-in 
effect. And that is why I don't think we are going to see that 
going forward the Fed rules are going to help us much.
    Senator Reed. Well, let me----
    Mr. Plunkett. Senator, on your second question----
    Senator Reed. Mr. Plunkett, please.
    Mr. Plunkett. I think the understanding is that the rule is 
prospective. So the baseline will be what issuers are doing at 
the time the rule takes effect in 17 months and it will not be 
retroactive in any way. It will affect behavior from that point 
on.
    Senator Reed. Let me ask another question. So a new 
customer comes online. They would still be subjected to the 
same policies and practices, just essentially grandfathered, 
even though they have come online after 2010?
    Mr. Plunkett. Well, going--on July 1, 2010, no matter when 
the customer comes on, they will be prohibited from certain 
things, like raising interest rates on existing balances if 
somebody is--unless somebody is more than 30 days late.
    Senator Reed. OK. But that existing interest rate is the 
baseline starting in 2010?
    Mr. Plunkett. Yes, sir.
    Senator Reed. Professor Ausubel, Professor Levitin referred 
to your study. Could you comment?
    Mr. Ausubel. Sure. One thing just to say on that last point 
is I do have serious concerns that issuers might exercise their 
prerogative under their any-time, any-reason clauses on June 
30, 2010, to raise interest rates on existing balances.
    As far as what Professor Levitin referred to, it is well 
established in the economics literature that consumers are 
subject to what are variously called search costs and switch 
costs. Search cost means the expense in time, resources of 
finding a better deal. Switch cost simply means the expense in 
time and resource of switching over, say, to a new card issuer. 
If you actually look at consumer-level data, consumers behave 
as if these search costs and switch costs are quite large.
    Part of it is that it does take a while to restructure your 
financial affairs and move to a cheaper lender. Another thing 
that comes up is simply consumers behave as if they are, you 
might say, overly optimistic. So they have a $3,000 balance 
right now, but sure, I am going to pay it off in a few months 
so the interest rate differential doesn't matter that much and 
I don't put as much effort into it.
    Senator Reed. Let me, if I may, a final question. If there 
is data out there, Professor, there is a search cost, but if 
the interest rate is not significantly lower, people make a 
rough calculation that those search costs are too expensive, 
what is the differential rate between Card A, Card B, and Card 
C? Again, I ask this because I don't know. It just strikes me 
as that most of these cards sort of parallel consciousness seem 
to have similar rate structures, similar terms, and maybe there 
is some differential, and I ask this because I don't know the 
answer, not to be rhetorical.
    Mr. Ausubel. I would say in terms of the basic deal, there 
is a lot of similarity. I think what they are referring to is, 
say, take a consumer who has triggered a penalty rate. So it 
may be that they have access to credit card offers which end up 
having ongoing rates of 10 percent, 12 percent, and it might be 
because they were 5 days late on a repayment. Their existing 
issuer is charging them 26 percent. So that is where you are 
going to find the largest differentials.
    Senator Reed. But if they switch, the information of their 
default goes with them, or will it catch up with them?
    Mr. Ausubel. Yes and no, and it looks like Travis might add 
to what I say. If it is triggered by less than 30 days past 
due, I believe that standard practice is that that is not 
reported to credit bureaus so it might not be obvious. On the 
other hand, if it is triggered by certain other things, 
including universal default, they had to learn about it some 
way, other issuers would learn about it the same way.
    Senator Reed. Mr. Plunkett?
    Mr. Plunkett. That is correct, Senator, and the obvious 
point here is if there is a record on a credit report, for 
example, somebody is more than 30 days late or there is another 
issue with their credit report that would allow the issuer to 
use universal default to reprice them, they are not going to 
switch in this climate. They are not going to be able to 
switch. It is going to be much harder. Issuers are being much 
more cautious and their ability to change cards will be very 
limited.
    Senator Reed. Thank you very much. Thank you, Mr. Chairman. 
I apologize for going over.
    Chairman Dodd. Not at all.
    Senator Bennet, Michael?
    Senator Bennet. Thank you, Mr. Chairman.
    I just have a couple questions about interchange fees, and 
maybe for Mr. Plunkett and Mr. Clayton. The first question is, 
is there a way that I, as a card user, know what interchange 
fee is being charged by my credit card company or imposed on 
the merchants from whom I am buying products?
    Mr. Levitin. It is impossible to know that as a consumer. 
The interchange fee schedules are incredibly complex. You would 
have to know what category your card falls in out of several 
categories. You would have to know what category a merchant 
falls in under several categories. So is the merchant 
considered a grocery store or is it considered a warehouse 
club, or is it considered a gas station or a restaurant? Some 
of these are fairly simple to figure out, some are not. Then 
you would have to know within those how much business the 
merchant does. So grocery stores that do over some hundred 
million dollars of business have a different rate than those 
that do less. And then you don't know what kind of--for a few 
very large merchants like Wal-Mart, they are able to get a 
sweetheart deal by basically being put in a special interchange 
category. There is really no way of knowing what costs you are 
imposing on the merchant.
    What is important to note, though, is interchange means 
that it is not free to use a credit card. If you are a pure 
transactor like Professor Zywicki, there is still a cost for 
using the credit card. There is no free lunch here. You go to a 
merchant and you make a purchase with the card, and let us say 
the interchange rate is 2 percent on that card. That is 2 
percent for what we should assume is really about a 15-day 
extension of credit. You make most--maybe your purchases on 
average are made in the middle of the month, so you have the 
extension of credit to the end of the month. On 2 percent for a 
15-day extension of credit as an APR, it puts you at something 
around 52 percent APR.
    There is a real cost for just using a card to transact, 
even if you aren't borrowing, and that is not a cost that is 
apparent to consumers because it is passed on to merchants in 
what is called the merchant discount fee and merchants are not 
allowed by credit card network rules to pass that on to card 
consumers. So people who are using credit cards, and especially 
people who are using fancy, high-cost credit cards are being 
subsidized by other consumers. They are being subsidized by 
people who use cash, by people who pay with checks, by people 
who pay with Food Stamps, and that is a really inequitable 
subsidization.
    Senator Bennet. I want to come back to that in a second, 
and I want to give Mr. Clayton a chance to respond, but is 
there a way, and anybody can answer this, but given how opaque 
that is and untransparent that is, are there things we could do 
to address that issue so that consumers and merchants have the 
information?
    Mr. Zywicki. Well, it is a more--Senator, it is a more 
general issue. There are costs to every payment mechanism. 
There are interchange fees for credit cards. There are check 
clearing fees when you write a check that we are not aware of. 
There are costs to print currency when we use money.
    Senator Bennet. Let us stick with credit cards, though.
    Mr. Zywicki. So we have a general sort of problem with 
respect to consumers who never bear the full cost of whatever 
their payment mechanism is. And so I would ask the question, if 
we are going to insist on making it more transparent for credit 
cards, should we also make it more transparent when you write a 
check or when you use a dollar bill, the full cost that goes 
into processing those transactions, and how exactly would 
consumers be better off? It is not clear to me that consumers 
would be better off if we forced revelation of that information 
for every payment device that they use.
    Senator Bennet. I don't know, maybe we should, but I think 
that what I have heard from the small businesses in my State is 
that this is an enormous cost of doing business. Obviously, the 
convenience of having customers use credit cards is important 
to them, as well. But when we are talking about the consumers 
being able to make choices in a marketplace and some of the 
most important information is actually obscure to them and 
there is not any way in the present environment for them to 
know what the true cost really is, I think that is a problem. 
And so I would like to come back to how we would address it, 
but Mr. Clayton, maybe you would like to respond.
    Mr. Clayton. Yes, Senator. There are so many issues in 
there we would be glad to have further conversations with you 
when time allows for a little bit more conversation, but 
essentially interchange is a cost of doing business. It is not 
really any different than the cost of labor, than the cost of 
turning on the lights, than the cost of paying for cash 
registers and the like. And as a practical matter, if you want 
to disclose all of that to consumers, you can do that. But it 
is inherent to the business and it is not any different than 
that.
    What we are really seeing here is, and this is our 
perspective, obviously, and not shared by the merchant 
community, but the merchant community trying to transfer the 
costs of this off of their backs and onto the consumers, 
because as a frank matter, this is something that provides 
enormous benefit. It provides ticket lift, which means more 
purchases coming for a merchant. It provides a great deal of 
security. Remember, as soon as that card is swiped through the 
machine, all of a sudden, the risk of being paid back moves 
from the merchant to the lender. Now, all of a sudden, the 
lender is the one that takes on all that risk of borrowing and 
all that risk on the debit card side and everything, whether 
they will actually have money in the account to pay. So there 
is a significant risk here to the lender involved.
    And I want to stress something, too. This is an every-bank 
issue. I mean, every community bank in America that issues a 
debit card, which is nearly every one of them, uses interchange 
fees to help support its ability to offer product and services 
to its local communities. If you go in and snuff out the 
ability to have any kind of return on this investment and to 
take those risks, then you are telling them that they cannot be 
competitive with the largest institutions in America. We think 
that is a bad idea.
    Senator Bennet. Doctor, did you have something?
    Mr. Ausubel. Mr. Clayton is overstretching a bit in saying 
that an interchange fee is just like, what did you say, the 
cost of labor and things like that. The difference is that 
there is market power to be exercised in setting the 
interchange fee. The interchange fee is set by Visa, by 
MasterCard, and a few other select organizations. There is 
market power there which is not present in most of the other 
costs facing small businesses.
    Mr. Clayton. There is, by the way, a consolidated lawsuit 
in New York to determine whether, in fact, market power has 
been illegally exercised, and we can determine that. We would 
argue that it is not the case and that there is competitive 
pricing in that market, but that court will determine it.
    Mr. Levitin. Also, the European Union's antitrust 
enforcement body has actually said that interchange fees are 
anticompetitive. That is being appealed, but we at least have a 
broad several countries that have recognized the problems with 
interchange fees.
    I think it is important to note, though, that what 
Professor Zywicki said is incorrect about interchange fees. 
There is a serious difference between interchange fees on 
credit cards and the cost of cash or checks or payment devices 
like that. If a merchant wants to charge more for cash, that is 
the merchant's prerogative. The merchant cannot surcharge for a 
credit card. If the merchant does so, the merchant is violating 
its agreement with its acquirer bank.
    Also, 45 percent of the cost of interchange fees, that is 
just going to fund rewards programs. Merchants don't get any 
benefit from that. That is going for frequent flyer miles for 
rewards junkies. So at least 45 percent of the cost of 
interchange has really no benefit for merchants.
    There is no evidence of ticket lift, contrary to what Mr. 
Clayton says. If you want to find out how happy merchants are 
when they have adopted credit cards, talk to McDonald's. 
McDonald's adopted credit cards thinking that they would get 
some ticket lift. Everything I hear is they have not been real 
pleased with it, but they have had to sink in a lot of money 
and that they are kind of trapped in that now.
    Mr. Zywicki. May I have an opportunity to respond briefly?
    Senator Bennet. I am out of time, so it is up to the 
Chairman.
    Chairman Dodd. Respond briefly, if you will.
    Mr. Zywicki. The issue is whether or not consumers are 
paying the full cost of the transaction that they are using, 
and the fact is, when a consumer writes a check, that is 
subsidized by the Federal Reserve. When a consumer uses cash, 
that currency is printed by the government. So every payment 
device has a subsidy somewhere in it. Sometimes it is the 
Federal Reserve. Sometimes it is printing currency. And so the 
issue I was referring to is whether or not consumers are 
subsidized in their transaction device, not the particular 
issue that Professor Levitin responded to.
    Chairman Dodd. Thank you. One of my concerns about this, 
and we have had long discussions in the past about interchange 
fees, it is about a $48 billion revenue stream this year alone, 
the estimates are, just from interchange fees coming in. What 
it does, it creates the climate of sort of the liar loan 
problem we saw with the residential mortgage market because 
there, the idea is then the sheer volume of the number of cards 
out there create a revenue stream, just by the volume of the 
cards out. And the incentive then to determine whether or not 
the borrower actually is creditworthy reduces tremendously 
under this system.
    That is one of the concerns I have about it and one of the 
reasons we ought to have--again, I am not trying to deny 
someone the access to a credit card, but at least having some 
responsibility and some understanding of that, that when you 
have a revenue stream of $48 billion coming in, on the average, 
it is 2 percent, I think is the average interchange fee, more 
or less, coming in. That is a remarkable revenue stream and the 
disincentive to have some verification of the ability of the 
consumer to meet those obligations, and that contributes, I 
think, to that environment, which is important.
    Senator Tester?
    Senator Tester. Thank you, Mr. Chairman, and I think it is 
in order to congratulate you for having a daughter, a 3-year-
old daughter that has effectively used a credit card very, very 
well.
    [Laughter.]
    Senator Tester. You know, there have been some comparisons 
here between using credit cards and buying sweaters, and I 
think it is OK to make those kind of comparisons, but very 
seldom when I go home back to Montana do I see three or four 
sweaters laying on the kitchen table for my kids. This is 
about--and my concern isn't about adults who know better. I am 
talking about folks who have been in the business world a bit 
or the workforce a bit. My concern is about credit card 
companies that put out an offer that is just too good to be 
true, and then once the fish is hooked, then the fees go up, 
people starting getting jerked around, and it is just totally 
not right. It is simply not right.
    There has been talk of several bills here today. I have got 
another one. I think just about every one of these can be 
incorporated, not to squash the credit card companies, but 
quite frankly, when I go home, and they don't know the earning 
history of any of my kids, and they have got a decent earning 
history now--and I hope they don't get credit cards because I 
said that--but the truth is that when they were in college, 
they didn't have much earnings history. When they were in high 
school, they certainly didn't have much of an earnings history. 
Then you go home and there are these credit cards laying there.
    So the question is this. It is for Mr. Clayton, because 
several times today during the testimony, you talked about 
these are significantly risky loans that are out there. If 
these really are significantly risky loans out there, why is 
there no requirement for any sort of earnings history 
whatsoever when you give a person a card, particularly a young 
person, but it could apply to anybody, and say, here it is. 
There is a line of credit for X-number of dollars. Go out and 
have fun.
    Mr. Clayton. Well, first of all, card companies do look at 
income and employment history and otherwise to make----
    Senator Tester. Well, just real quick, if they are looking 
at income and earnings history, I can guarantee you they don't 
look very doggone deep, because when kids in school, when a 3-
year-old daughter gets a credit card application, what kind of 
earnings history are they looking at?
    Mr. Clayton. I don't think that 3-year-old daughter 
actually got a card, nor could they be obligated to pay under 
that card, so--look, marketing, people get letters because they 
are on some other lists. It doesn't mean they are going to get 
a credit card. And so to be real clear, I doubt--Senator, 
please feel free to correct me--I mean, it is a solicitation 
and so it is nothing more than an advertisement to apply.
    Credit card companies look carefully at trying to cultivate 
relationships with 18-year-olds, 20-year-olds, 22-year-olds, 
24-year-olds, because they recognize they are in for the long 
haul. They take that responsibility seriously, and in fact, 
they take special care. They make sure that their minimum 
limits are actually--their credit limits are low, and they 
start off typically with a $500 credit limit and it doesn't 
grow that quickly. And they work with care to make sure they--
and monitor the card account to make sure they don't get into 
trouble.
    One of the things that gets lost in this debate is that, in 
fact, students perform well in their use of credit cards. There 
are lots of different studies and different numbers. The 
numbers that we see are that they perform as well as or if not 
better than the general population, and they have average 
balances that are much lower than the general population. So as 
a practical matter, the vast majority of students are using 
their cards responsibly and well.
    Do people get into trouble? Absolutely. Should we be 
sensitive to that and figure out better ways to address that? I 
think we would be willing to work with you and figure out how 
to best do that.
    Senator Tester. And I appreciate that because I think it 
does need to be done. The fact is, and I will go back to 
Senator Brown's comments because he brought it up with the Web 
site from Ohio State. If, in fact, this is true, then why do we 
see consumer debt going up for kids, going through the roof? 
And quite frankly, if we are paying tuition with credit cards, 
we are heading way, way, way down the wrong road there.
    Mr. Clayton. And that clearly is an underlying problem that 
has nothing to do really with the credit card but the 
underlying cost of----
    Senator Tester. You had a point you wanted to make, Mr. 
Levitin?
    Mr. Levitin. Yes. As the Chairman noted, all credit card 
loans are stated income loans. They are all liar loans. When I 
get a credit card solicitation, I fill in what my income is, 
there is no way to check on that. The credit card issuers might 
look at a credit report, but that doesn't say what my income 
is. That only says whether I have been paying past bills. So if 
they are looking to be repaid from a future income stream, 
there is no way to tell.
    Senator Tester. Right.
    Mr. Levitin. And I think it is also--I just want to try and 
link up two pieces of this, because I think often interchange 
and the consumer side are seen as separate issues. These are 
very intimately linked. This is a complete cycle. So 
interchange funds rewards programs. Rewards programs and teaser 
rates, those are the honey that lure in the consumer flies into 
this venus fly trap of sticky interest rates, of hidden fees, 
and so forth. So if you are concerned about an unsafe and 
unsound underwriting model, it is not enough just to go out to 
try and focus on solicitations. You have to look at the entire 
business model with this.
    Senator Tester. I appreciate that. I want to talk a little 
bit, and I know that the House Financial Services Committee 
yesterday had an extensively reported hearing on what is going 
on with the TARP money. I just want to ask, and I think if 
there is anybody else that this question applies to, answer, 
and I don't mean to direct them all to you, Mr. Clayton, but 
have any of your members raised rates on credit cards that 
received TARP funds?
    Mr. Clayton. Let me step back for a second and look at the 
Fed's recent G-19 report on interest rates, and they basically 
have shown that interest rates, while they have ticked up a 
bit, are still approximately 12 percent and are like 136 basis 
points below what they were a year ago today. And so interest 
rates are, in fact, on average, relatively low. Are card 
companies adjusting their interest rates because of the 
perceived and real risk in the marketplace? Yes.
    Senator Tester. So what you are saying is they did increase 
the interest rates if they received TARP funds. That was----
    Mr. Clayton. I don't think that there is more than one 
relationship. I don't think that has anything to do with the 
TARP funds. I think they are focusing on the risk in the--I 
mean, one of the things that gets lost is the complete 
flexibility and unsecured nature of this product. I mean, I 
know you look at this as a negative, but also remember there is 
a positive to this. The flexibility it provides to consumers at 
two o'clock in the morning when the car breaks down and the tow 
truck has to take you home, or to pay for some kind of medical 
service or some kind of treatment for a child if you don't have 
the money but they need to pay for that is all provided in this 
little card. And lenders take risks in doing that because 
people may not pay them back. We talk about liar loans. We are 
talking about promise loans. These are promise loans made to 
hundreds of millions of people every day.
    Senator Tester. OK. Go ahead, Travis.
    Mr. Plunkett. Senator, no one is denying credit cards are 
convenient and useful for consumers. The question is are their 
practices fair. I mean, the first thing to say to Mr. Clayton 
is why are interest rates ticking up when the Federal funds 
rate has dropped through the floor?
    The next thing to say is that many national banks, as you 
point out, have received TARP financing, and then Secretary 
Paulson set up and Secretary Geithner says he will expand this 
new program called the Term Asset-Backed Securities Loan 
Facility to support credit card lending. It is not just a 
question of interest rates. Are the terms fair that will be 
supported through this program?
    Mr. Clayton. Let me jump in for a second in terms of 
answering that first question. Interest rates are not just 
determined by how much it costs, the Fed prices its loans. 
Interest rates are determined by lots of other things, 
including delinquencies in the marketplace, which have gone up, 
as well as the cost of securitization, where spreads have 
increased significantly. What that means is investors are 
demanding more return in order to underwrite or fund card 
loans.
    Senator Tester. Real quickly, Doctor.
    Mr. Ausubel. Credit cards are extremely useful, but that is 
not an excuse for completely opaque pricing. I mean, the whole 
issue--lots of other products, price competition works better 
because, first of all, it is easier to figure out the true 
price that the consumer is paying, and second, the price is 
predictable. Most other consumer products do not have any-time, 
any-reason clauses.
    Senator Tester. Thank you. Just very quickly, Mr. Chairman. 
Thank you very much for holding the hearing. Thank you very 
much for putting your bill in. I will just tell you that you 
try to teach the next generation the right thing to do. My 
parents said, you aren't going to have a credit card, and in 
the days when I got my first credit card, I paid a fee and the 
interest rates were pretty clear cut. That has all changed now, 
I think. I know it has changed.
    But I can tell you that I have so many examples of young 
people under the age of 35 that get a credit card. They use it, 
they go on a vacation, their payment comes in late, and the 
fees and the interest rates take up all the money that was 
going to the principal. I have got to tell you, that is flat 
not right.
    My time has long since run out, but I will just tell you, 
it is not fair, it is not right, and it is not the way the 
program should work. People are getting into people's pockets 
by making it darn easy to sign up with these things, and then 
if they make one mistake, they put the boots to them.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator, very much.
    Senator Merkley?
    Senator Merkley. Thank you very much, Mr. Chair.
    Professor Zywicki, I think from your comments I could 
describe you as an advocate for the--there is a competitive 
market here between cards. But it has been pointed out by 
Professor Ausubel that that credit market would be stronger if 
consumers had the ability to have more transparency to 
understand the rates better, the terms better, if they weren't 
so complicated, they didn't have so many hidden ways of 
charging you later, will you pretty much agree with that, or 
would you contest that?
    Mr. Zywicki. Thank you for that. First, Senator Tester is 
leaving. I will just note that with respect to the cost of 
credit card operations, the cost of funds are about 30 to 40 
percent of total costs. Charge-offs are about 30 to 40 percent, 
and operating costs are about 20 to 30 percent. So the reason 
we don't is exactly as Mr. Clayton was saying. The reason is 
when charge-offs go up and risk goes up, the amount that goes 
obviously to charge-offs goes up and so that dampens any 
interest-rate effect. So I just thought that would be some 
facts to put on the record.
    And I appreciate your question, Senator, because I think it 
is the most important question here and one that is worth 
focusing on. This is about complexity, right? These are very 
complex products. They do have a lot of price points that can 
confuse consumers. But the reason they are complex is precisely 
because consumers use these in so many different ways. They use 
an auto loan to buy a car. They use a mortgage to buy a house. 
They use a credit card to do a cash advance, to make a 
purchase, to revolve debt, to travel to Europe, to do all the 
different sorts of things that they do with it. So there are a 
lot of price points, but it is precisely because of the myriad 
different ways in which consumers use these products.
    We do need a better way of dealing with this. The market is 
already ahead of us. There is a new Web site called 
Cardhub.com. I have nothing to do with Cardhub.com. What 
Cardhub.com is is a Web site you can go to and you can 
basically get tailormade disclosures. You could say, I am 
interested in a card that has no annual fee, low transaction 
fees for travel to Europe, and gas benefits when I use my card, 
and they have about 1,000 credit cards in their system and you 
can basically create a tailormade disclosure for exactly the 
fees that you are looking for.
    What I get concerned about this is that we take a one-size-
fits-all proposal and put it on top of a market where consumers 
are using cards for all myriad sorts of things. So regulation, 
I hope, can encourage and be a mechanism for encouraging 
further innovation, development in these cards, and allowing 
consumers to get what they want.
    If I could just add one last fact----
    Senator Merkley. One quick point. Go ahead.
    Mr. Zywicki. Sure. One last fact is there has been some 
talk about fees, interchange fees. Just to kind of get the 
facts on the record, according to the GAO report, about 70 
percent of credit card revenues come from interest. About 20 
percent come from interchange fees. And about 10 percent come 
from fees. The fee amount of 10 percent has basically been 
constant over time. What we have seen is it used to be 10 
percent were annual fees, and now they have gone down. Annual 
fees have basically disappeared. Late fees and that sort of 
thing have gone up to 10 percent. So the total amount that are 
fees has remained about 10 percent. Just the nature of the fees 
has changed.
    Senator Merkley. OK. Well, let me get another perspective 
on this. I will tell you that I use checks in just as many 
complicated ways as I use a credit card, so I am not 
particularly persuaded by your argument on that, but let us get 
another perspective from Professor Ausubel. And could you also 
address the fee rate, as well, point?
    Mr. Ausubel. Right. First of all, on fees, it is well 
documented that the level of fees has gone up at a very rapid 
pace over the past 10 years. I mean, you can see it very 
clearly if you just look at any particular fee, like if you 
look at the level of the late payment fee that was present in 
the past and you look at the $39 now.
    Mr. Zywicki. How about the annual fee?
    Mr. Levitin. May I jump in, Senator?
    [Laughter.]
    Senator Merkley. Let Professor Ausubel finish and then we 
will let you jump in.
    Mr. Ausubel. I am talking about fees in aggregate. What was 
the next thing?
    Senator Merkley. Well, the first was the complexity of 
purchases----
    Mr. Ausubel. Oh, the complexity. So here is a way to think 
about the business model in the credit card market. What 
happens is there is a certain number of terms of the credit 
card account that people pay the most attention to. So, for 
example, at a certain point, people might have been paying 
attention to annual fees. Competition steps in and annual fees 
get competed down. But simultaneously, the banks add new fees 
which are not on consumers' radar screens which generate real 
revenues and which take a while for consumers to catch up to. 
So if you ask, why has the number of fees multiplied, it is to 
have new revenue sources that are not on consumer radar 
screens.
    Can I give you one quick example that is unambiguous? Most 
issuers have 3 percent fees if you purchase anything in foreign 
currency. Note that there is absolutely no cost associated with 
this because the currency conversion fees are already built 
into the whole operation.
    Senator Merkley. Thank you. I am out of time. Can we allow 
another person to respond?
    Chairman Dodd. Please go ahead.
    Senator Merkley. Mr. Levitin?
    Mr. Levitin. Yes. I think it is really important to note 
that while some credit card fees do relate to particular usage 
patterns, the credit card billing practices that are really 
problematic have no relationship to the way anyone uses a card. 
Double-cycle billing? How does--I just can't see how that 
relates to the different ways consumers use cards. Any time, 
any reason term changes, the same thing. It is not based on 
usage patterns. These are just hidden fees--these are billing 
points that function as hidden fees and don't relate to the way 
consumers actually use cards. They just relate to an ability to 
snooker consumers in with low teaser rates and then whack them 
over the head with back-end fees that they aren't expecting.
    Mr. Sturdevant. Senator----
    Senator Merkley. My time has expired.
    Mr. Sturdevant. I had one point----
    Chairman Dodd. Go ahead.
    Mr. Sturdevant. There is no more complexity in how 
consumers use cards today than there was in 1964 when Bank of 
America introduced them except that we have the Internet now. 
People make purchases in the same way, in the same variety of 
ways, and as Senator Tester, I believe, pointed out, in 1964--
and the Chairman did, as well--you had a membership fee, maybe, 
and you had an interest rate.
    And that is how the product was marketed until the late 
1970s when interest rates hit an historic high of 21 percent 
and the credit card industry said, we can't make any money. We 
can't make money anymore from the interest rate to the customer 
and the interchange fee. So all of a sudden, we had the 
introduction of the over-limit fee and the late payment fee. 
And then as time went on, we had more and more fees, the access 
fee, the quick look fee, the returned check fee, the 
administrative fee, the extra card fee, et cetera, et cetera, 
et cetera.
    As interest rates came down--interest rates were very slow 
to come down in credit cards and none of the fees went away. 
The only thing that happened is that the amount of the dollars 
increased sharply. So in 1996, the credit card industry earned 
$1.7 billion in penalty fee revenue. In 2004, it earned $14.8 
billion. If you combine penalty fees, cash advance fees, and 
annual fees, those three items alone, that reached nearly $25 
billion in 2004, and they were sitting in the Dirksen Building 
and Senator Dirksen was famous for his remark that a million 
here and a million there, we are talking about real money. In 
today's climate, a million is nothing and even a billion seems 
to be nothing. But where I come from, $25 billion is a 
significant revenue stream.
    As we have heard today, credit card companies have engaged 
in conduct to create late payments, to prevent timely payments, 
to receive the payment and not post the payment, anything it 
can do to trigger that. With respect to over-limit 
transactions, the credit card companies through its systems 
totally control usage. They want over-limit transactions so 
long as the customer continues to make a payment, and they use 
the $39 fee when the customer calls to complain to enable the 
company to raise the credit limit so that there is more debt 
out there so that the minimum payment is higher on that dollar 
value.
    But nothing principally has changed in the marketplace 
since 1964 except the escalation of the types of fees and the 
amount of dollars imposed on those fees.
    Mr. Clayton. Senator, I know I am belaboring the point 
here. I would say that GAO in a 2006 study basically said that 
total aggregate fees, comparing 1990 to 2004, remained 
relatively stable, meaning they didn't change. There was a 
transfer from annual fees to these other types of kind of 
transaction fees, all of which were basically transferring a 
fee that a consumer had no control over, an annual fee, versus 
one--late fees and other things, over-limit fees--that they 
have some control over.
    Chairman Dodd. I appreciate the point. I mean, an annual 
fee, that is in terms of the pricing points, that when you pay 
an annual fee, you know what it is. The question then of when 
these additional fees kick in, how they kick in, has been the 
source of the contention. In too many cases, they appear to be 
for reasons that should be unrelated to the performance of the 
consumer when it comes to the credit card, and we have talked 
about them before, the universal default issue, the double-
cycle billing. Now, some of these have been changed, I agree 
with the things, but clearly these fees were not ones that a 
consumer can price necessarily when they increase them in ways 
that seem not terribly relevant to the behavior by the 
consumer.
    I don't think anybody is suggesting that when a consumer 
behaves poorly, if you will, in this matter that there are 
obviously going to be charges associated when that occurs. The 
question is, it is not so much performing poorly but rather 
what appears to be, I say to you, that designs to rather get 
around the fact, because the annual fee wasn't producing the 
kind of revenues. The competition reduced it, so what other 
ways can we do this, to find that?
    And obviously, look, marketing--I know this is probably 
true no longer, but there was a while not long ago when the 
parlance of the industry, if you were someone that paid off 
whatever the obligations were on a monthly basis, you were 
called a deadbeat, because frankly, you weren't very good 
financially. Someone who pays that thing off every month, you 
are not making much money off of them.
    The ideal consumer is someone who is paying the minimums 
here each month because that person is going to pay a lot more 
for that service or product over an extended period of time 
than the person who pays it off immediately. And it seems to me 
that by marketing to a lot of people, in a sense, who are in 
that situation, obviously raises certain concerns.
    Again, I have got credit cards. I understand the value of 
them, the importance of them for people, and I want the 
industry to know this is not a hostile situation we are talking 
about. We are talking about trying to make it work right for 
people in a sense at a time of great difficulty, when people 
are feeling a tremendous pinch.
    And obviously we have got securitization of this industry, 
which is another incentive in a way. If you are able to 
securitize that debt and sell it off someplace, then the 
incentives for you to want to manage it better are reduced, 
much as it was in the residential mortgage market. When you can 
securitize that product and sell it, your interest in having 
underwriting standards and so forth and to demand greater 
accountability begin to diminish significantly, and this has 
been a significant problem.
    In fact, it is one of the problems the banks have, because 
they are looking down the road and they are seeing a lot of 
this debt coming at them, not only in commercial real estate, 
but also in student loans and in credit card obligations. So 
obviously one of the reasons they are not lending a lot, I 
suspect, is because they recognize they have got these 
obligations coming.
    Why are they coming? Because they market a lot of products 
to people who couldn't afford them, in a sense. And had they 
done a little more work and determined whether or not that 
person out there was actually going to be able to meet those 
obligations instead of basically giving them out to anybody and 
everyone, then we wouldn't be facing this situation, much as we 
are facing in the residential mortgage market. There are 
distinctions, obviously, between a mortgage and a credit card 
obligation, but nonetheless, a little more adherence to those 
principles would reduce the very problems we are looking at in 
real estate as well as in commercial transactions such as 
credit cards.
    So it is sort of a self-fulfilling prophecy, in a way, we 
are dealing with in this issue. There is less accountability, 
marketing to more people who can less likely afford the 
obligations. Obviously, a lot to be made off of it because 
obviously someone who has to pay every month something on that 
over a long period of time increases tremendously the amount 
they will pay for that.
    That is why I disagree with you, Mr. Zywicki. I know you 
don't--I don't disagree with your point, the point I think you 
were making. I think there is some legitimacy to this. If you 
load up a load of consumer warnings, there is a point at which 
no one reads any of it. It is like on prescription drugs or 
something, or over-the-counter stuff. You begin to read so much 
that you just--you can't remember any of it.
    But I do think the idea of saying to people, let me show 
you that if you purchase a product and make just the minimum 
monthly payment on this, how much more you are likely to pay 
for a product, I think that warning to a consumer has value. If 
you know that, I think you are going to have second thoughts 
that that item doesn't cost $50, but it is rather going to cost 
you $150 by the time you are through with it. It has a value. 
And I don't disagree that if you load it up with a lot of 
stuff, no one reads any of it, but I think it is an important 
point.
    I raised the issue on the securitization and I wonder if 
you--I will raise the question if any of you want to respond to 
it. The securitization of credit card loans permitted companies 
to engage in at least lending practices that are less vigilant. 
Mr. Clayton, what about that?
    Mr. Clayton. Securitization was engaged in to lower the 
cost of borrowing so that we could lower the cost of credit.
    Chairman Dodd. But doesn't it also basically--in other 
words, the incentive for the issuer to make sure that the 
borrower is going to be more creditworthy diminishes when you 
know you are going to be able to sell that debt off. Isn't that 
also true?
    Mr. Clayton. There is a significant difference between 
credit card securitizations and mortgage securitizations. 
Mortgage securitizations involve, as I understand it, a great 
deal of pooled loans from a lot of different issuers and 
underwriters. Credit card loans, they come from one company and 
that company's reputation and cost of future issuances is 
dictated by the performance of that underlying securitization.
    Chairman Dodd. Yes.
    Mr. Clayton. So as a practical matter, it is--they hold the 
risk, and if these trusts unwind, that comes back on the 
balance sheet. So there are real risks and checks and balances, 
which is what I think you are referring to, in this area. If 
the marketplace believes that this doesn't work, the cost of 
borrowing for that company goes up significantly. So there are 
real prices to be paid.
    Chairman Dodd. Anyone else? Yes, Mr. Levitin?
    Mr. Levitin. There is another significant difference 
between credit card and mortgage securitization. Mortgage 
securitization, a typical securitization deal, the originator 
sells off the loans and has no further interest in them. That 
is not, as Mr. Clayton points out, that is not what happens 
with credit cards. The card issuer retains essentially the 
residual interest. Every month, if after--if the cards generate 
enough income to pay off all the mortgage-backed security 
bonds, anything left over goes to the card issuer. That is 
called the excess spread.
    What this means is that the card issuer holds all the 
upside, but it has sold off most of the downside to investors. 
This gives card issuers an incentive to apply more late fees 
and over-limit fees because that will result in some people 
defaulting on the debt entirely, but others, it will result in 
them paying more. This increases volatility. For credit card 
securitization, the more volatile the accounts are, that all 
accrues to the benefit of the issuer, and the downside of the 
volatility goes to the investors.
    Chairman Dodd. Yes, Mr. Ausubel?
    Mr. Ausubel. I would generally agree with what has been 
said. I mean, that securitization in the credit card market is 
fundamentally different than the mortgage market because the 
credit card issuer remains the residual claimant in the whole 
business operation.
    The place where you can find some similarity is that when 
consumers get distressed, there are some parallels between it 
giving bad dynamics in one market than the other. I mean, so 
you have been hearing on the mortgage market you have this 
problem that the whole system may be better off because--the 
whole system may be better off if there were some forgiveness, 
like you modify the terms. When we securitize it, you have one 
group of people who own the mortgage, another set of people who 
service the mortgage. The people who service the mortgage may 
not want to relax the terms because it is not in their benefit.
    You have the same thing in the credit card market with 
universal default and that sort of thing, that if a consumer 
gets into trouble, all the banks, the entire system may be 
better off if there were some forgiveness, but instead what 
each bank does is they try to load up what is owed to them and 
they try to collect as rapidly as possible from the consumer 
before the consumer goes bankrupt. So you have the same sort of 
divergence of interests which leads to a sub-optimal level of 
forgiveness.
    Chairman Dodd. Well, listen, this has been very worthwhile, 
and Mr. Clayton, I appreciate very much your being here. You 
know the industry obviously very well and I speak with some 
frequency to obviously my own bankers in Connecticut and others 
who have strong views on the issue, as well. My interest is 
doing something balanced and responsible as we move forward.
    I am concerned about the lateness of this July effective 
date in terms of what happens between now and then, and 
regulations and rules, while they are important and they are 
not insignificant, statutory changes have a way of bringing 
more permanency to a process than obviously the vagaries of 
rulemaking, which can be undone pretty quickly. And so there is 
a reason, I think, if we can come to some common understandings 
about some of these points here, that we will be all better off 
in some ways.
    But I think all of us up here--I believe all of us up 
here--have no interest in destroying the credit card industry. 
We realize the value of it and the importance of it, and I 
think it is a very important point to take away from a hearing 
like this, how best we do that.
    And going back to the point that I hope we learned, because 
we certainly got away from it, and I am sounding like a broken 
record on this point, but for too long, I think there was the 
assumption that consumer protection laws were more than just an 
annoyance. They were antithetical to the notion of economic 
growth and prosperity. And we have learned painfully over the 
last several years how dangerous that mentality is, that, in 
fact, had consumer protection been very much on the minds of 
people, on regulators and others, we wouldn't be in the mess we 
are in today. This was not a natural disaster. This is one that 
was avoidable.
    And so it is very important, if we learn anything out of 
all of this as we try to get back on our feet again, is that 
that notion of consumer protection ought not to be seen--there 
are unintended consequences. Bob Corker makes a legitimate 
point. You want to be careful how you proceed in all of this. 
But the notion once again that we could ever start thinking 
about regulation, reform, and creating new architectures for 
the 21st century, very much a part of that has to be that that 
end user, that consumer user of products, be they credit cards, 
mortgages, car loans, student loans, they have got to be 
paramount in our minds. And when they are, then we have strong 
economies that grow well, create wealth, create prosperity. 
When we avoid it and subjugate it or reduce it in its 
importance, then I think we get ourselves into the kind of mess 
we have seen recently.
    So I am very grateful to all of you for your testimony 
today. We will leave the record open. I am sure there are 
members who may have some additional questions. You may have 
some additional information and material you think it would be 
worthwhile for us to consider in our discussions here as we go 
forward and we will certainly leave the record open for that.
    With that, the hearing stands adjourned. I thank you.
    [Whereupon, at 12:28 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
follow:]























































































































































































































































































































































 RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM ADAM J. 
                            LEVITIN

    Q.1. Access to Credit: A potential outcome of the new rules 
could be that consumers with less than a 620 FICO score could 
be denied access to a credit card. Such an exclusion could 
affect 45.5 million individuals or over 20 percent of the U.S. 
population.
    Without access to traditional credit, where do you believe 
that individuals would turn to finance their consumer needs?

    A.2. I am unsure to which ``rules'' the question refers; I 
assume it refers to the recent unfair and deceptive acts and 
practices regulations adopted by the Federal Reserve, Office of 
Thrift Supervision, and National Credit Union Administration 
under section 5 of the Federal Trade Commission Act. If so, I 
strongly but respectfully dispute the premise of the question; 
the scenario that is presented is exceedingly alarmist. The 
question wrongly implies that all individuals with FICO scores 
of 620 or lower currently have access to ``traditional'' credit 
cards. They assuredly do not. First, nearly 10 percent of the 
United States adult population is ``unbanked,'' and that means 
almost by definition that they do not have credit cards; card 
penetration into the unbanked market is de minimis. Thus, at 
least half of the impact implied by the scenario is not 
possible. For the remaining 10 percent or so who have FICOs 
under 620, many do not currently have access to ``traditional'' 
credit. Instead, they have access to predatory new credit 
products like ``fee harvester'' or ``secured'' credit cards. 
Even if these non-traditional products were included in the 
term ``traditional,'' I think it is also dubious that all or 
even most of them would cease to be able to get ``traditional'' 
credit; nothing in the proposed regulations limits issuers' 
ability to protect against credit risk through either lower 
credit limits or higher interest rates or other fees.
    To the extent that these individuals are not able to get 
credit cards or choose not to accept them because of onerously 
high interest rates, the answer to where they would turn for 
financing needs depends on the particular circumstances of the 
individual, but I believe that many consumers would first cut 
down or eliminate non-essential expenses, which would reduce 
their financing needs. Demand for credit is not entirely 
inelastic. For these consumers' remaining financing needs, many 
would turn to family and friends for assistance. See Angela 
Littwin, Testing the Substitution Hypothesis: Would Credit Card 
Regulations Force Low-Income Borrowers into Less Desirable 
Lending Alternatives? 2009 Ill. L. Rev. 403, 434-35 (2009) 
(noting that borrowing from family and friends is the most 
frequent form of borrowing for low-income women). It is also 
important to note that empirical evidence suggests that 
``credit cards are actually among low-income consumers' least-
preferred sources of credit, meaning that there is no ``worse'' 
alternative to which they would turn if credit card access were 
reduced.'' Id. at 454.
    Beyond family and friends, there are also other legitimate, 
high-cost sources of credit besides credit cards--pawn shops, 
rent-to-own, and overdraft protection, e.g. There, of course, 
is a possibility that some low-income consumers will turn to 
illegitimate sources of credit, such as loan sharks, but this 
possibility could be tempered by community-based small loan 
programs. Indeed, given that the Federal Government is 
currently subsidizing credit card lending through the Term 
Asset-Backed Securities Lending Facility (TALF), it seems quite 
reasonable to support other forms of consumer credit lending. 
Indeed, in Japan, where there is a 20 percent usury cap, credit 
rationing and product substitution are significantly tempered 
by a government-supported small loan system. Nor is it clear 
that the terms on which ``loan sharks'' lend are actually worse 
than some subprime credit card products. As Woody Guthrie sang 
in the Ballad of Pretty Boy Floyd:

        Now as through this world I ramble
        I see lots of funny men
        Some will rob you with a Six gun
        And some with a fountain pen.
        But as through your life you travel
        As through your life you roam
        You won't never see an outlaw
        Drive a family from their home.

Woody Guthrie, American Folksong 27 (1961).

     Finally, given the terms on which individuals with FICO 
scores of under 620 are able to obtain ``traditional'' credit, 
I think it is quite debatable whether ``traditional'' credit is 
in any way beneficial to them; fee-harvester cards and other 
subprime credit card products are as likely to harm consumers 
with poor credit ratings as they are to help them; these cards 
can improve consumers' credit scores over time, if the consumer 
is able to make all the payments in full and on time, but by 
definition a consumer with a FICO of under 620 is someone who 
is unlikely to be able to do that.

    Q.2. Risk-Based Pricing: Banks need to make judgments about 
the credit-worthiness of consumers and then price the risk 
accordingly. Credit cards differ from closed-end consumer 
transactions, such as mortgages or car loans, because the 
relationship is ongoing. I am concerned by the Federal 
Reserve's new rules on risk-based repricing for a couple of 
reasons. First, without the ability to price for risks, banks 
will be forced to treat everyone with equally stringent terms, 
even though many of these individuals perform quite differently 
over time. Second, without a mechanism to reprice according to 
risk as a consumer's risk profile changes, many lenders will 
simply refuse to extend credit to a large portion of the 
population.
    Do you believe that consumers will have access to less 
credit and fewer choices because of the Fed's new rule? If so, 
is this a desirable outcome?

    A.2. Again, I respectfully disagree with the premise of the 
question. The new uniform Unfair and Deceptive Act and 
Practices regulations adopted by the Federal Reserve Board, the 
Office of Thrift Supervision and National Credit Union 
Administration under section 5 of the Federal Trade Commission 
Act (``Reg AA'') do not prohibit risk-based pricing. Reg AA 
only prohibits retroactive repricing of existing balances. Card 
issuers remain free to increase interest rates prospectively 
with proper notice or to protect themselves immediately by 
closing off credit lines.
     That said, I would expect that Reg AA would likely reduce 
credit availability to some degree, although perhaps not to all 
consumers. This is not necessarily a bad outcome. Credit is a 
double-edged sword. It can be a great boon that fuels economic 
growth, but that is only when credit does not exceed a 
borrower's ability to repay. Credit can also be a millstone 
around the neck of a borrower when it exceeds the ability to 
repay. Overleverage is just as bad for consumers as it is for 
financial institutions. To the extent that Reg AA reduces 
credit availability, it might be a good thing by bringing 
credit availability more in line with consumers' ability to 
repay.

    Q.3. Consumer Disclosure: You state that the sheer number 
of price mechanisms make it difficult for consumers to 
accurately and easily gauge the cost of credit. You cite things 
such as annual fees, merchant fees, over-the-limit fees, and 
cash advance fees. You seem to suggest that credit cards should 
become much more plain vanilla because people simply can't 
understand the different uses and costs for those uses.
    Don't these different pricing mechanisms also provide more 
choices for consumers as they make purchasing decisions?

    A.3. That depends on the particular pricing mechanism. Many 
of them provide dubious choices or value for consumers. 
Consider over-limit fees, late fees, cash advance interest 
rates, and residual interest and double cycle billing.

  (1). LOverlimit fees. A consumer has no right to go overlimit 
        and cannot assume that an over-limit transaction will 
        be allowed. Moreover, overlimit can be the result of 
        the application of fees, rather than of purchases. 
        Therefore, overlimit is not exactly a ``choice.''

  (2). LA late fee is no different than interest, just applied 
        in a lump sum. I am doubtful that most consumers would 
        prefer an up-front lump sum late fee rather than a 
        higher interest rate. For the large number of ``sloppy 
        payers'' who pay their bills a few days late, a higher 
        interest rate is much better than a large flat late 
        fee, but because consumers systematically underestimate 
        the likelihood that they will pay late, they are less 
        concerned about the late fee than the interest rate.

  (3). LMost cards charge a higher interest rate for ``cash 
        advances.'' A cash advance, however, is not necessarily 
        the payment of cash to the consumer. Instead, cash 
        advances include the use of so-called ``convenience 
        checks'' that card issuers send to consumers with their 
        billing statements. (Incidentally, convenience checks 
        present a considerable identity theft problem because 
        they lack cards' security features and the cardholder 
        has no way of knowing if they have been stolen. They 
        expose issuers to significant fraud losses and should 
        be prohibited as an unsafe and unsound banking 
        practice.) Convenience checks permit cardholders to use 
        their card to pay merchants that do not accept cards, 
        like landlords, utilities, and insurers. This allows 
        consumers to pay these bills even when they do not have 
        funds in their bank account. But convenience checks 
        carry the cash advance interest rate plus a fee (often 
        a flat 3 percent with a minimum amount). These terms 
        are usually disclosed on the convenience checks only 
        partially and by reference to the cardholder agreement. 
        It is doubtful that most consumers retain their 
        cardholder agreement, so whether consumers understand 
        the cost of using convenience checks is a dubious 
        proposition.

  (4). LSimilarly, billing tricks and traps like residual 
        interest or double cycle billing are hardly a 
        ``choice'' for consumers; these are not product 
        differentiations that are tailored to consumer 
        preferences, as few consumers know about them, let 
        alone understand them.

    Restricting card pricing could limit innovation in the card 
market, but it is important to recognize that not all 
innovation is good. There has been very little innovation in 
the card industry over the last twenty years, either in terms 
of technology or in terms of product. Cards still operate on 
the same old magnetic stripe technology they had in the 1970s. 
The card product still performs the same basic service. To the 
extent there has been innovation, it has been in the business 
model, and it has frequently not been good for consumers. Even 
things like the 0 percent teaser rate are hardly unambiguous 
goods. While 0 percent teasers are great for consumers who can 
pay off the balance, they also encourage consumers to load up 
on credit card debt, and if there is a shock to the consumer's 
income, such as a death, an illness, a divorce, or 
unemployment, the consumer is much more exposed than otherwise.
    I recognize that it is important to protect the ability of 
the card industry to innovate in the future, and that is why I 
believe the best solution is to set a default rule that 
simplifies credit card pricing, but to allow a regulatory 
agency, such as the Federal consumer financial product safety 
commission proposed by Senators Durbin, Kennedy, and Schumer 
and Representative Delahunt (S. 566/H.R. 1705, the Financial 
Product Safety Commission Act of 2009) to have the power to 
card issuers to introduce new products and product features 
provided that they meet regulatory consumer safety standards.

    Q.4. Bankruptcy Filings: As the recession worsens, many 
American families will likely rely on credit cards to bridge 
the gap for many of their consumer finance needs. Mr. Levitin 
and Mr. Zywicki, you seem to have contrasting points of view on 
whether credit cards actually force more consumers into 
bankruptcy, or whether credit cards help consumers avoid 
bankruptcy.
    Could both of you briefly explain whether the newly enacted 
credit card rules will help consumers avoid bankruptcy or push 
more consumers into bankruptcy?

    A.4. The newly enacted Federal Reserve credit card 
regulations will not have any impact on bankruptcy filings 
presently, as they do not go into effect until summer of 2010. 
When they do go into effect, their impact on consumer 
bankruptcy filings will likely be mixed.
    Credit card debt has a stronger correlation with bankruptcy 
filings than other types of debt. But this is not necessarily a 
function of credit card billing practices. Card debt reflects 
the macroeconomic problems of the American family--rising costs 
of health care, education, and housing but stagnant wages and 
depleted savings. The card billing tricks and traps targeted by 
the Fed's rules amplify this distress, but the Fed's rules will 
not solve the fundamental problems of the American family. To 
the extent that they limit the amplifying effect that card 
billing tricks and traps have on card debt levels, it will help 
some consumers avoid bankruptcy.
    If the rules result in contraction of credit availability, 
it might push consumers into bankruptcy, but that would have to 
be netted out against the number that are helped by a reduction 
in the amplification effect, and I am skeptical that there 
would be much contraction.
     I agree with Professor Zywicki that credit cards can help 
some consumers avoid bankruptcy. If a consumer has a temporary 
setback in income, credit cards can provide the consumer with 
enough funds to hang on until their financial situation 
reverses. But credit cards can also exacerbate financial 
difficulties, and even if the consumer's fortunes pick up, it 
might be impossible to service the card debt. Moreover, there 
are many consumers whose financial situations are not going to 
pick up, and for these consumers, card debt just adds to their 
distress.

    Q.5. Safety and Soundness and Consumer Protection: I 
believe firmly that safety and soundness and consumer 
protection go hand-in-hand. One needs only to look at the 
disaster in our mortgage markets, for clear evidence of what 
happens when regulators and lenders divorce these two concepts. 
A prudent loan is one where the financial institution fully 
believes that the consumer has a reasonable ability to repay.
    Do you agree that prudential regulation and consumer 
protection should both be rigorously pursued together by 
regulators?

    A.5. Yes, but not by the same regulators. There is an 
essential conflict between safety-and-soundness and consumer 
protection. A financial institution can only be safe and sound 
if it is profitable. And abusive and predatory lending 
practices can often be extremely profitable, especially in the 
short term, and can compensate for the lender's other less 
profitable activities. The experience of the past decade shows 
that when Federal regulators like the Office of Comptroller of 
the Currency, the Office of Thrift Supervision, and the Federal 
Reserve are charged with both safety-and-soundness and consumer 
protection, they inevitably (and perhaps rightly) favor safety-
and-soundness at the expense of consumer protection. These 
functions cannot coexist in the same agency, and consumer 
protection responsibilities for financial products should be 
shifted to a single independent Federal agency (which would not 
claim preemptive authority over state consumer protection 
actions) to protect consumer protection.

    Q.6. Subsidization of High-Risk Customers: I have been 
receiving letters and calls from constituents of mine who have 
seen the interest rates on their credit cards rise sharply in 
recent weeks. Many of these people have not missed payments. 
Mr. Clayton, in your testimony you note that credit card 
lenders have increased interest rates across the board and 
lowered credit lines for many consumers, including low-risk 
customers who have never missed a payment.
    Why are banks raising interest rates and limiting credit 
apparently so arbitrarily?

    A.6. Banks are raising interest rates on consumers and 
limiting credit to cover for their own inability to 
appropriately price for risk in mortgage, securities, and 
derivatives markets has resulted in their solvency being 
threatened. Therefore, banks are trying to limit their credit 
card exposures and are trying to increase revenue from credit 
card accounts by raising rates. If banks are unable to 
competently price for risk for mortgages, where there is often 
robust underwriting, what confidence should we have in their 
ability to price for risk for credit cards where every loan is 
a stated income ``liar'' loan? The current financial debacle 
should cause us to seriously question banks' claims of risk-
based pricing for credit cards. The original pricing failed to 
properly account for risk and the new arbitrary repricing 
certainly fails to account for risk on an individualized level. 
The only risk being reflected in the new pricing is the bank's 
default risk, not the consumer's.

    Does this result in low-risk customers subsidizing people 
who are high-risk due to a track record of high-risk behavior?

    Yes, it probably does because it is being done so 
arbitrarily.

    Q.7. Effects on Low-income Consumers: I want to put forward 
a scenario for the witnesses. Suppose a credit card customer 
has a low income and a low credit limit, but a strong credit 
history. They use their credit card for unexpected expenses and 
pay it off as soon as possible, never incurring late fees. With 
the new regulations approved by the Federal Reserve, banks will 
be restricted in their use of risk-based pricing. This means 
our cardholder could see his or her interest rates and fees 
increased to pay for the actions of other card holders, many of 
whom have higher incomes.
    Do any of the witnesses have concerns that moving away from 
risk-based pricing could result in the subsidization of credit 
to wealthy yet riskier borrowers, by poorer but lower-risk 
borrowers?

    A.7. No. The issue is a red-herring. As an initial matter, 
it is important to emphasize that the Federal Reserve's new 
regulations do not prohibit risk-based pricing. They only 
prohibit retroactive repricing of existing balances. In other 
words, they say that card issuers only get one bit at the risk 
pricing apple, just like any normal contract counterparty. Card 
issuers remain free to price however they want prospectively or 
to reduce or cutoff credit lines if they are concerned about 
risk.
    Second, it is important to underscore that to the extent 
that card issuers engage in risk-based pricing, it is only a 
small component of the cost of credit. I discuss this at length 
in my written testimony, but I will note that Professor Zywicki 
has himself written that 87 percent of the cost of credit cards 
has nothing to do with consumer risk; it is entirely a function 
of the cost of operations and the cost of funds. Todd J. 
Zywicki, The Economics of Credit Cards, 3 Chap. L. Rev. 79, 121 
(2000). The remaining 13 percent represents both a risk premium 
and opportunity pricing. In many cases the opportunity-pricing 
component predominates. Therefore, there to the extent that 
credit card issuers do risk based pricing, it only has a 
marginal impact on the total cost of cards. As Professor 
Ausubel demonstrated in his written and oral testimony, a 
significant component of some credit card fees, like late fees, 
are opportunity costs. Likewise, in my written testimony, the 
section comparing my own credit cards, three of which are from 
the same issuer, but which have different rates that do not 
correspond with credit limits, indicates that there is 
significant opportunity pricing in the card market. Regulations 
that make cards fairer and more transparent would be unlikely 
to have much impact on consumer pricing.
    Third, it is not clear why cross subsidization should be a 
particular concern. It is a common fact of life. Consider flat-
fee parking lots. Those consumers who park for 5 minutes 
subsidize those who park for hours. Similarly, at by-the-pound 
salad bars, consumers who eat only carrots subsidize those who 
eat only truffles. When cross-subsidization is regressive, it 
elicits additional concerns, but there are far more serious 
regressive price structures, not the least of which is the 
Internal Revenue Code.
    That said, I believe the cross-subsidization in the 
scenario to be unlikely because the risk that matters to card 
issuers is nonpayment risk, not late payment risk, and income 
and wealth generally correlate with low nonpayment risk. In 
sum, then, I think the cross-subsidization scenario presented 
is unlikely, and to the extent it occurs, the cross-
subsidization will only be de minimis because of the limited 
extent of risk-based pricing. The problem presented by the 
scenario is a red herring concern and not a reason to shy away 
from regulating credit cards.
                                ------                                


RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM KENNETH J. 
                            CLAYTON

    Q.1. Access to Credit: A potential outcome of the new rules 
could be that consumers with less than a 620 FICO score could 
be denied access to a credit card. Such an exclusion could 
affect 45.5 million individuals or over 20 percent of the U.S. 
population.
    Without access to traditional credit, where do you believe 
that individuals would turn to finance their consumer needs?

    A.1. It is likely that consumers perceived to have higher 
levels of risk--including those that are new to credit--will 
bear the brunt of credit reductions resulting from the rule. 
Thus, as noted in your question, the inability to price risk 
effectively may well mean less access to credit for very 
deserving individuals just because card issuers are unsure of 
the credit risk involved and will not be able to price for that 
risk as it becomes more apparent. As the credit needs of these 
individuals are unlikely to disappear--and, in fact, may 
actually increase due to exigent economic circumstances, e.g., 
unemployment--these consumers will likely be forced to turn to 
non-federally regulated lenders including payday lenders and 
loan sharks.

    Q.2. Risk-Based Pricing: Banks need to make judgments about 
the credit-worthiness of consumers and then price the risk 
accordingly. Credit cards differ from closed-end consumer 
transactions, such as mortgages or car loans, because the 
relationship is ongoing. I am concerned by the Federal 
Reserve's new rules on risk-based repricing for a couple of 
reasons. First, without the ability to price for risks, banks 
will be forced to treat everyone with equally stringent terms, 
even though many of these individuals perform quite differently 
over time. Second, without a mechanism to reprice according to 
risk as a consumer's risk profile changes, many lenders will 
simply refuse to extend credit to a large portion of the 
population.
    Do you believe that consumers will have access to less 
credit and fewer choices because of the Fed's new rule? If so, 
is this a desirable outcome?

    A.2. The new rule will affect every aspect of the credit 
card business, from how cards are funded, to how they are 
priced, to how they are marketed, and to how credit is 
allocated among customers of differing credit histories and 
risk. Because the rules are so strong, card lenders may have to 
increase interest rates in general, lower credit lines, assess 
more annual fees, and reduce credit options for some customers. 
The full impact of these changes will likely not be fully known 
for several years as business practices are changed and as the 
credit availability works its way through the economy.
    The new rule may also lead to higher interest rates or fees 
(such as annual fees) for all cardholders in order to 
compensate for the inability to price risk effectively. Thus, 
the least risky borrowers must now bear the cost for higher 
risk borrowers because the higher-risk borrowers will no longer 
bear the full cost of the exposure they pose to lenders. It may 
also be the case that payment allocation requirements will lead 
to the elimination of low-rate balance transfers that consumers 
and small businesses previously used to lower overall debt 
costs. Simply put, the sum total of all these rules will likely 
lead to reduced access to credit and higher prices to all 
consumers, in addition to many fewer choices on card products. 
We do not believe this is a desirable outcome for both 
consumers and the broader economy.

    Q.3. Safety and Soundness and Consumer Protection: I 
believe firmly that safety and soundness and consumer 
protection go hand-in-hand. One needs only to look at the 
disaster in our mortgage markets, for clear evidence of what 
happens when regulators and lenders divorce these two concepts. 
A prudent loan is one where the financial institution fully 
believes that the consumer has a reasonable ability to repay.
    Do you agree that prudential regulation and consumer 
protection should both be rigorously pursued together by 
regulators?

    A.3. A system linking bank regulation and consumer 
protection forces more balanced supervision without the turf 
battles and inefficiency inherent in bifurcated jurisdiction. 
The two are highly integrated, and that one aspect cannot and 
should not be divorced from the other. This ensures that, for 
example, safe and sound lending would not be compromised by fee 
and rate restrictions envisioned by a consumer regulator only 
concerned with driving consumer costs down unencumbered by a 
need to consider the impact such restrictions may have on 
adequate return.

    Q.4. Subsidization of High-Risk Customers: I have been 
receiving letters and calls from constituents of mine who have 
seen the interest rates on their credit cards rise sharply in 
recent weeks. Many of these people have not missed payments. 
Mr. Clayton, in your testimony you note that credit card 
lenders have increased interest rates across the board and 
lowered credit lines for many consumers, including low-risk 
customers who have never missed a payment.
    Why are banks raising interest rates and limiting credit 
apparently so arbitrarily?
    Does this result in low-risk customers subsidizing people 
who are high-risk due to a track record of high-risk behavior?

    A.4. The rising interest rates and limitations on credit 
are due primarily to three factors. First, in the present 
challenging economic time, lenders are being more careful. 
Delinquencies on credit card accounts have significantly 
increased as a result of rising unemployment and uncertainty in 
the economy. This substantial increase in repayment risk 
affects the ability of lenders to make new loans, and requires 
companies to carefully evaluate and minimize their risk across 
the board so that they may stay in business and continue to 
make new loans.
    Second, funding costs have increased dramatically in the 
secondary market, which funds nearly half (or approximately 
$450 billion) of all credit card loans made by commercial 
banks. Investors are extremely sensitive to changes in the 
terms and conditions of the underlying asset, as has been 
evident in the current market, where investors have shunned 
nearly all forms of asset-backed securities over fears in the 
underlying economy. This drives up the cost of funding new 
credit, and leads to higher costs to consumers.
    Third, all businesses are concerned for the future, as 
borrowers' ability to repay may become severely compromised. 
This is particularly true with respect to credit card loans, 
which are open-end lines of credit, unsecured and greatly 
subject to changing risk profiles of borrowers. Banks need to 
ensure they will be paid for the risks they have taken in 
credit card loans; otherwise they will not be able to continue 
to make loans. As a result, many institutions must raise rates 
and reduce risk exposure in order to continue to lend. This 
results in all borrowers having to bear the cost of higher risk 
generally, a trend that will be exacerbated by the new 
regulations that limit the ability of lenders to price 
particular individuals for the risk they pose.

    Q.5. Effects on Low-income Consumers: I want to put forward 
a scenario for the witnesses. Suppose a credit card customer 
has a low income and a low credit limit, but a strong credit 
history. They use their credit card for unexpected expenses and 
pay it off as soon as possible, never incurring late fees. With 
the new regulations approved by the Federal Reserve, banks will 
be restricted in their use of risk-based pricing. This means 
our cardholder could see his or her interest rates and fees 
increased to pay for the actions of other card holders, many of 
whom have higher incomes.
    Do any of the witnesses have concerns that moving away from 
risk-based pricing could result in the subsidization of credit 
to wealthy yet riskier borrowers, by poorer but lower-risk 
borrowers?

    A.5. Reducing the ability of lenders to manage risk forces 
them to apply more general models to all account holders. The 
consequence of applying general models is that all account 
holders pay somewhat equally. Lower-risk borrowers at all 
income levels bear the brunt of this burden.

    Q.6. Role of Securitization: It is my understanding that 
during the height of the credit boom nearly half of all credit 
card debt outstanding was held in securitization trusts. Over 
the last 18 months much of the securitization market has been 
severely constrained. The Federal Reserve wants to revive the 
securitization markets through the Term Asset Lending Facility 
(TALF), but it is not yet operational.
    How important is a rebound in the securitization market to 
the availability of consumer credit? In other words, how much 
greater will the contraction be in the credit card space 
without securitization?

    A.6. The rebound in the securitization market is a critical 
component to the availability of credit in our economy. Credit 
cards are funded from two primary sources: deposits and 
secondary market funding, each accounting for about half--
approximately $0.5 trillion dollars--of the total funding of 
card loans to consumers. Funding in the secondary market relies 
on investors' willingness to hold securities that are backed by 
credit card receivables. Any change in the terms of issuance 
can greatly impact the receptivity of investors to holding 
these securities. If investors perceive that there is greater 
risk, they are less likely to hold these securities, or may 
require significantly higher interest rates or other 
enhancements to compensate them for the risk. This means that 
less funding will be available, and if available, more costly. 
This translates into less credit available at higher cost to 
customers. It is hard to speculate as to the extent of greater 
contraction caused by a non-functioning securitization market, 
as lenders will have to turn to a limited number of 
alternative--and higher priced--funding mechanisms. However, we 
do believe the additional contraction would be very 
significant, and is reflected in the Administration's concern 
over this important aspect of the marketplace.
                                ------                                


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM JAMES C. 
                           STURDEVANT

    Q.1. Access to Credit: A potential outcome of the new rules 
could be that consumers with less than a 620 FICO score could 
be denied access to a credit card. Such an exclusion could 
affect 45.5 million individuals or over 20 percent of the U.S. 
population.
    Without access to traditional credit, where do you believe 
that individuals would turn to finance their consumer needs?

    A.1. Did not respond by publication deadline.

    Q.2. Risk-Based Pricing: Banks need to make judgments about 
the credit-worthiness of consumers and then price the risk 
accordingly. Credit cards differ from closed-end consumer 
transactions, such as mortgages or car loans, because the 
relationship is ongoing. I am concerned by the Federal 
Reserve's new rules on risk-based repricing for a couple of 
reasons. First, without the ability to price for risks, banks 
will be forced to treat everyone with equally stringent terms, 
even though many of these individuals perform quite differently 
over time. Second, without a mechanism to reprice according to 
risk as a consumer's risk profile changes, many lenders will 
simply refuse to extend credit to a large portion of the 
population.
    Do you believe that consumers will have access to less 
credit and fewer choices because of the Fed's new rule? If so, 
is this a desirable outcome?

    A.2. Did not respond by publication deadline.

    Q.3. Safety and Soundness and Consumer Protection: I 
believe firmly that safety and soundness and consumer 
protection go hand-in-hand. One needs only to look at the 
disaster in our mortgage markets, for clear evidence of what 
happens when regulators and lenders divorce these two concepts. 
A prudent loan is one where the financial institution fully 
believes that the consumer has a reasonable ability to repay.
    Do you agree that prudential regulation and consumer 
protection should both be rigorously pursued together by 
regulators?

    A.3. Did not respond by publication deadline.

    Q.4. Subsidization of High-Risk Customers: I have been 
receiving letters and calls from constituents of mine who have 
seen the interest rates on their credit cards rise sharply in 
recent weeks. Many of these people have not missed payments. 
Mr. Clayton, in your testimony you note that credit card 
lenders have increased interest rates across the board and 
lowered credit lines for many consumers, including low-risk 
customers who have never missed a payment.

    Why are banks raising interest rates and limiting credit 
apparently so arbitrarily?
    Does this result in low-risk customers subsidizing people 
who are high-risk due to a track record of high-risk behavior?

    A.4. Did not respond by publication deadline.

    Q.5. Effects on Low-income Consumers: I want to put forward 
a scenario for the witnesses. Suppose a credit card customer 
has a low income and a low credit limit, but a strong credit 
history. They use their credit card for unexpected expenses and 
pay it off as soon as possible, never incurring late fees. With 
the new regulations approved by the Federal Reserve, banks will 
be restricted in their use of risk-based pricing. This means 
our cardholder could see his or her interest rates and fees 
increased to pay for the actions of other card holders, many of 
whom have higher incomes.
    Do any of the witnesses have concerns that moving away from 
risk-based pricing could result in the subsidization of credit 
to wealthy yet riskier borrowers, by poorer but lower-risk 
borrowers?

    A.5. Did not respond by publication deadline.

    Q.6. Transactional Users vs. Revolving Users: Mr. Zywicki 
has said in previous Congressional testimony that prior pricing 
mechanisms--which relied to a large degree on annual fees--
forced transactional users of credit cards to subsidize the 
actions of consumers who carry revolving debts. I do not 
believe that the two categories should be treated in the same 
manner. The new regulations seem to limit the ability of 
lenders to use tools to distinguish between the borrowers 
characteristics.
    Do you believe that borrowers' rates and fees should be 
determined based on their own actions and not on those of 
others?
    Do you think that credit card offerings from the past, 
which had high APR's and annual fees for all customers were 
more consumer friendly than recent offerings that use other 
tools to determine fees and interest rates?
    A.6. Did not respond by publication deadline.
                                ------                                


   RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM TODD 
                            ZYWICKI

    Q.1. Access to Credit: A potential outcome of the new rules 
could be that consumers with less than a 620 FICO score could 
be denied access to a credit card. Such an exclusion could 
affect 45.5 million individuals or over 20 percent of the U.S. 
population.
    Without access to traditional credit, where do you believe 
that individuals would turn to finance their consumer needs?

    A.1. This is the most worrisome aspect of well-intentioned 
consumer credit regulations that will have unintended 
consequences of driving borrowers, especially credit-impaired 
borrowers, to other less-attractive forms of credit. Those who 
ore unable to get a credit card will likely be forced to turn 
to alternatives such as payday lending. Those unable to get 
credit from a payday lender will likely be forced to turn to 
pawn shops. And those who are unable to gain access to pawn 
shop credit may find themselves unable to get legal credit at 
all.
    Consumers often have emergencies or necessities for which 
they need credit. For instance, a young person needs credit to 
start a life away from home--clothes for a job, furniture for 
an apartment, etc. Consumers may have emergencies such as car 
repairs, for which they will have to find credit somewhere. If 
good credit is not available consumers will turn toward less-
attractive terms of credit instead.

    Q.2. Benefits of Credit Card Use: Professor Zywicki, in 
previous testimony you suggested growth in credit cards as a 
source of consumer credit has replaced installment lending, 
pawnshops, and payday lending. I am concerned that the newly 
finalized rules may result in a lack of available consumer 
credit. I believe that there were clearly some egregious 
practices that the Federal Reserve and others should 
appropriately eliminate, but many who have criticized the 
credit card industry for facilitating excessive consumer debt, 
fail to point out the benefits of open access to consumer 
credit.
    Does the consumer benefit from access to open ended 
consumer credit over other less regulated forms of credit such 
as pawn shops, payday lenders, and installment lending?

    A.2. Consumers absolutely benefit from access to open-ended 
consumer credit. The dramatic growth in credit card use in 
recent decades testifies to this fact. Installment lending, 
such as retail store credit is limited because it requires 
consumers to ``buy'' goods and credit as a bundle. Personal 
finance company loans are typically both more expensive for the 
buyer to apply for, offer higher interest rates and other 
costs, and impose a rigid repayment schedule. A borrower also 
might be unable to get a personal finance company loan at the 
moment that he needs it. Payday lending and pawnshops are 
obviously inferior to credit cards and these other options.
    Credit cards offer consumers many benefits that these other 
products do not. Credit cards have flexible use and repayment 
terms. Borrowers can pay as much as they want and can switch 
easily among alternative card issuers. They are also generally 
acceptable, thereby allowing the unhooking of the credit 
transaction from the goods transaction. This allows consumers 
to shop more vigorously in both markets. General-acceptance 
credit cards also permit small businesses to compete on an 
equal footing with large businesses and department stores by 
relieving those small businesses of the risk and cost of 
maintaining their own in-house credit' operations. According to 
one survey conduct by the Federal Reserve, 73 percent of 
consumers report that the option to revolve balances on their 
credit cards makes it ``easier'' to manage their finances 
versus only 10 percent who said this made it ``more 
difficult.'' Durkin, Credit Cards: Use and Consumer Attitudes 
at 623.

    Q.3. Risk-Based Pricing: Banks need to make judgments about 
the credit-worthiness of consumers and then price the risk 
accordingly. Credit cards differ from closed-end consumer 
transactions, such as mortgages or car loans, because the 
relationship is ongoing. I am concerned by the Federal 
Reserve's new rules on risk-based repricing for a couple of 
reasons. First, without the ability to price for risks, banks 
will be forced to treat everyone with equally stringent terms, 
even though many of these individuals perform quite differently 
over time. Second, without a mechanism to reprice according to 
risk as a consumer's risk profile changes, many lenders will 
simply refuse to extend credit to a large portion of the 
population.
    Do you believe that consumers will have access to less 
credit and fewer choices because of the Fed's new rule? If so, 
is this a desirable outcome?

    A.3. This is likely to be the case, for exactly the reasons 
stated. If lenders are permitted only to reduce interest rates 
but not raise them, they will have to charge a higher interest 
rate to all borrowers to compensate for this risk. Moreover, 
this would give borrowers an opportunity to reduce their 
interest rates by switching to another card but lenders would 
be unable to raise interest rates in response to a change in 
the borrowers risk profile.
    Credit cards are structured as revolving debt for a reason: 
unlike other loans, it amounts to a new loan every month. Thus, 
every month the borrower has the option to switch to another, 
lower-interest card.

    Q.4. Bankruptcy Filings: As the recession worsens, many 
American families will likely rely on credit cards to bridge 
the gap for many of their consumer finance needs. Mr. Levitin 
and Mr. Zywicki, you seem to have contrasting points of view on 
whether credit cards actually force more consumers into 
bankruptcy, or whether credit cards help consumers avoid 
bankruptcy.
    Could both of you briefly explain whether the newly enacted 
credit card rules will help consumers avoid bankruptcy or push 
more consumers into bankruptcy?

    A.4. By making credit cards less-available and less-
flexible, new stringent regulations will likely push more 
consumers into bankruptcy. Consumers in need of credit will 
seek that credit somewhere. Reducing access to good credit, 
like credit cards, will force these borrowers into the hands of 
much higher-cost credit, such as payday lenders. Moreover, 
credit cards are especially valuable because they provide a 
line of credit that the borrower can access when he needs it, 
such as when he loses his job and has medical bills. By 
contrast, if the borrower is required to apply for a bank loan 
after a job loss, he is likely to be rejected, which will 
accelerate his downward spiral. Moreover, credit cards are 
valuable in that they can be used to purchase almost any good 
or service. Again, the flexibility of credit cards is valuable 
to consumers.

    Q.5. Safety and Soundness and Consumer Protection: I 
believe firmly that safety and soundness and consumer 
protection go hand-in-hand. One needs only to look at the 
disaster in our mortgage markets, for clear evidence of what 
happens when regulators and lenders divorce these two concepts. 
A prudent loan is one where the financial institution fully 
believes that the consumer has a reasonable ability to repay.
    Do you agree that prudential regulation and consumer 
protection should both be rigorously pursued together by 
regulators?

    A.5. Yes. But not all safety and soundness issues related 
to consumers are also consumer protection issues. For instance, 
there were obviously a number of ordinary homeowners who 
essentially decided to act like investors with respect to their 
homes by taking out nothing-down, no-interest mortgages and 
then walking away when those homes fell into negative equity. 
If the consumers failed to understand the terms of those 
mortgages, then that is a consumer protection issue. If, 
however, the consumer consciously made this choice to speculate 
and the lender made the loan anyway, then while this would 
trigger a safety and soundness concern it is difficult to see 
how this would amount to a consumer protection issue.

    Q.6. Subsidization of High-Risk Customers: I have been 
receiving letters and calls from constituents of mine who have 
seen the interest rates on their credit cards rise sharply in 
recent weeks. Many of these people have not missed payments. 
Mr. Clayton, in your testimony you note that credit card 
lenders have increased interest rates across the board and 
lowered credit lines for many consumers, including low-risk 
customers who have never missed a payment.
    Why are banks raising interest rates and limiting credit 
apparently so arbitrarily?
    Does this result in low-risk customers subsidizing people 
who are high-risk due to a track record of high-risk behavior?

    A.6. Did not respond by publication deadline.

    Q.7. Effects on Low-income Consumers: I want to put forward 
a scenario for the witnesses. Suppose a credit card customer 
has a low income and a low credit limit, but a strong credit 
history. They use their credit card for unexpected expenses and 
pay it off as soon as possible, never incurring late fees. With 
the new regulations approved by the Federal Reserve, banks will 
be restricted in their use of risk-based pricing. This means 
our cardholder could see his or her interest rates and fees 
increased to pay for the actions of other card holders, many of 
whom have higher incomes.
    Do any of the witnesses have concerns that moving away from 
risk-based pricing could result in the subsidization of credit 
to wealthy yet riskier borrowers, by poorer but lower-risk 
borrowers?

    A.7. Interference with risk-based pricing makes it more 
difficult for lenders to tailor prices to the details of the 
behavior of particular consumers. As a result, lenders have to 
price card terms on less fine-grained assessments of risk. This 
leads to pricing risk across broader categories of borrowers, 
and in turn, increases the cross-subsidization among consumers. 
I can see no good policy reason why this should be encouraged.

    Q.8. Restriction on Access to Credit: One suggestion being 
made in order to encourage students not to become overly 
dependent on debt is to restrict access to credit to 
individuals under the age of 21.
    Mr. Zywicki, could you explain for the Committee the 
potential benefits and detriments of this policy?

    A.8. Benefit: A potential benefit, in theory, is that some 
younger consumers may avoid getting into debt trouble. I am not 
aware of any rigorous empirical evidence of how common this is.
    Detriments: There are several detriments:

  (1) LStudents who do not have access to credit cards may be 
        tempted to take out more in the way of student loans. 
        Because repayment on student loans is deferred until 
        after graduation, this could cause students to take on 
        more debt than they would if they had to pay some of 
        their balance every month.

  (2) LEmpirical studies find that one major reason that causes 
        students to drop out of college is a lack of access to 
        credit. Many students eventually tire of ``living like 
        a student,'' i.e., living in dorms and eating dorm food 
        and Ramen noodles. They want an opportunity to have 
        some sort of normal life, to go out to dinner every 
        once in a while. Many students use credit responsibly 
        and maturely and can have a happier student life 
        experience if they have access to a credit card.

  (3) LMany students need access to credit. Although under the 
        age of 21, many students essentially live on their own 
        in off-campus apartments and the like. They need credit 
        cards to pay for food, transportation, and the like. 
        Thus, the rule sweeps far too broadly.

  (4) LSince the early 1990s, the fastest-rising debt on 
        household balance sheets has been student loan debt. 
        Students routinely graduate with tens of thousands of 
        dollars in student loan debt. By contrast, very few 
        students have more than a few thousand dollars in 
        credit card debt. If Congress wants to seriously help 
        indebted students, it should investigate the 
        extraordinary level of student loan debt being 
        accumulated. While credit cards can be a problem in 
        some cases, the scope of the problem is dwarfed by the 
        deluge of student loan debt.
                                ------                                


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM LAWRENCE 
                           M. AUSUBEL

    Q.1. Access to Credit: A potential outcome of the new rules 
could be that consumers with less than a 620 FICO score could 
be denied access to a credit card. Such an exclusion could 
affect 45.5 million individuals or over 20 percent of the U.S. 
population.
    Without access to traditional credit, where do you believe 
that individuals would turn to finance their consumer needs?

    A.1. There is no reason to expect that the new rules will 
result in the wholesale denial of access to credit cards for 
any group of consumers that currently has access to credit 
cards. As such, individuals who currently have access to credit 
cards are likely to continue to rely primarily on credit cards 
for their consumer finance needs.

    Q.2. Risk-Based Pricing: Banks need to make judgments about 
the credit-worthiness of consumers and then price the risk 
accordingly. Credit cards differ from closed-end consumer 
transactions, such as mortgages or car loans, because the 
relationship is ongoing. I am concerned by the Federal 
Reserve's new rules on risk-based repricing for a couple of 
reasons. First, without the ability to price for risks, banks 
will be forced to treat everyone with equally stringent terms, 
even though many of these individuals perform quite differently 
over time. Second, without a mechanism to reprice according to 
risk as a consumer's risk profile changes, many lenders will 
simply refuse to extend credit to a large portion of the 
population.
    Do you believe that consumers will have access to less 
credit and fewer choices because of the Fed's new rule? If so, 
is this a desirable outcome?

    A.2. There is no reason to expect that consumers will have 
significantly less access to credit or fewer choices because of 
the Fed's new rule. The principal effect of the new rule will 
be to limit penalty pricing of credit card consumers, not to 
limit access to credit or consumer choices.

    Q.3. Safety and Soundness and Consumer Protection: I 
believe firmly that safety and soundness and consumer 
protection go hand-in-hand. One needs only to look at the 
disaster in our mortgage markets, for clear evidence of what 
happens when regulators and lenders divorce these two concepts. 
A prudent loan is one where the financial institution fully 
believes that the consumer has a reasonable ability to repay.
    Do you agree that prudential regulation and consumer 
protection should both be rigorously pursued together by 
regulators?

    A.3. It should be observed that consumer protection, as 
furthered by the Dodd bill, will help to contribute to the 
prudency of loans. Consumers will better understand whether 
they will be able to repay loans, and they will be more likely 
to avoid loans that they understand they do not have the 
reasonable ability to repay. Lenders will be unable to rely on 
penalty interest rates following delinquency, so they will be 
more likely to avoid making loans that are destined to go 
delinquent. It is difficult to state an opinion on prudential 
regulation more generally, without being provided some 
specificity about the form of prudential regulation being 
proposed.

    Q.4. Subsidization of High-Risk Customers: I have been 
receiving letters and calls from constituents of mine who have 
seen the interest rates on their credit cards rise sharply in 
recent weeks. Many of these people have not missed payments. 
Mr. Clayton, in your testimony you note that credit card 
lenders have increased interest rates across the board and 
lowered credit lines for many consumers, including low-risk 
customers who have never missed a payment.
    Why are banks raising interest rates and limiting credit 
apparently so arbitrarily?
    Does this result in low-risk customers subsidizing people 
who are high-risk due to a track record of high-risk behavior?

    A.4. If it is the case that banks are raising interest 
rates and limiting credit arbitrarily, this is probably due 
primarily to the financial crisis and the economic downturn. 
Under normal circumstances, credit card lending is highly 
profitable and there is little reason for banks to reduce 
credit lines. Banks do raise interest rates, but usually not 
across the board, as this would result in the loss of some 
profitable customers. There is no reason to expect that the new 
rules will lead to cross-subsidization of any particular group 
of customers.

    Q.5. Effects on Low-income Consumers: I want to put forward 
a scenario for the witnesses. Suppose a credit card customer 
has a low income and a low credit limit, but a strong credit 
history. They use their credit card for unexpected expenses and 
pay it off as soon as possible, never incurring late fees. With 
the new regulations approved by the Federal Reserve, banks will 
be restricted in their use of risk-based pricing. This means 
our cardholder could see his or her interest rates and fees 
increased to pay for the actions of other card holders, many of 
whom have higher incomes.
    Do any of the witnesses have concerns that moving away from 
risk-based pricing could result in the subsidization of credit 
to wealthy yet riskier borrowers, by poorer but lower-risk 
borrowers?

    A.5. No. There is no reason to expect that the new rules 
will lead to cross-subsidization of any particular group of 
customers. The principal effect of the new rules will be to 
limit increases in credit card interest rates following late 
payments. As documented in my written testimony, the typical 
increases in interest rates bear no reasonable relation to 
default risk. The penalties imposed on consumers are typically 
at least double or triple the enhanced credit losses 
attributable to these consumers. The terminology of ``risk-
based pricing'' for the regulated practices is a misnomer; it 
is more accurately viewed as ``penalty pricing.'' Under the new 
rules, banks will still be able to charge higher interest rates 
(upfront) to riskier customers. That is, true risk-based 
pricing will still be possible within the rules.
                                ------                                


  RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM TRAVIS 
                            PLUNKETT

    Q.1.  Without access to traditional credit, where do you 
believe that individuals would turn to finance their consumer 
needs?

    A.1.  As I mentioned in my testimony before the Committee, 
it is important to note that the lack of regulation can also 
lead to detrimental market conditions that ultimately limit 
access to credit for those with less-than-perfect credit 
histories. Credit card issuers have recently reduced the amount 
of credit they offer to both existing and new cardholders, for 
reasons that have virtually nothing to do with pending 
regulation of the market. Issuers losses have been increasing 
sharply, in part because of unsustainable lending practices. 
(Please see my written testimony for more information.) Had 
Congress stepped in earlier to require issuers to exercise more 
responsible lending, they might not be cutting back on 
available credit as sharply right now.
    Regarding access to affordable credit for individuals with 
an impaired or limited credit history, CFA has urged mainstream 
financial institutions to offer responsible small loan products 
to their depositors. We applaud FDIC Chairman Sheila Bair's 
leadership in proposing guidelines for responsible small loans 
and her call for military banks to develop products that meet 
the test of the Military Lending Act predatory lending 
protections. Banks and credit unions should extend their line 
of credit overdraft protection to more account holders. The 
FDIC has a pilot project with 31 participating banks making 
loans under the FDIC guidelines for responsible small-dollar 
lending.
    Offering affordable credit products is not the only 
strategy needed to help households more effectively deal with a 
financial shortfall. Borrower surveys reveal that many 
households are not using high-cost credit because of a single 
financial emergency, but instead have expenses that regularly 
exceed their income. For these households who may not be able 
to financially handle additional debt burdens at any interest 
rate, non-credit strategies may be more appropriate. These may 
include budget and financial counseling; getting help from 
friends, family, or an employer; negotiating with a creditor; 
setting up different bill payment dates that better align with 
the person's pay cycle; and putting off a purchase for a few 
days.
    Toward this end, it is very important that banks and credit 
unions encourage make emergency savings easy and attractive for 
their low- and moderate-income customers. Emergency savings are 
essential to keep low-income consumers out of the clutches of 
high-cost lenders. CFA's analysis based on Federal Reserve 
Board and other survey data found that families earning $25,000 
per year with no emergency savings were eight times as likely 
to use payday loans as families in the same income bracket who 
had more than $500 in emergency savings. We urge banks and 
credit unions to make emergency savings easy and attractive for 
their customers.

    Q.2.  Do you agree that prudential regulation and consumer 
protection should both be rigorously pursued together by 
regulators?

    A.2.  Absolutely. Credit card issuers must do a better job 
of ensuring that borrowers truly have the ability to repay the 
loans they are offered. As I mention in my testimony, card 
issuers and card holders would not be in as much financial 
trouble right now if issuers had done a better job of assessing 
ability to repay. This is why CFA has supported legislation 
that would require issuers to more carefully assess the 
repayment capacity of young borrowers and potential cardholders 
of all ages.

    Q.3.  Do any of the witnesses have concerns that moving 
away from risk-based pricing could result in the subsidization 
of credit to wealthy yet riskier borrowers, by poorer but 
lower-risk borrowers?

    A.3.  Under the Federal Reserve rules, card issuers will 
certainly have to be more careful about who they extend credit 
to and how much credit they offer. Given the current levels of 
indebtedness of many card holders--and the financial problems 
this indebtedness has caused these borrowers and card issuers--
it is hard to argue that this is a bad thing. However, the 
Federal Reserve rules still preserve the ability of card 
issuers to price for risk in many circumstances, if they wish. 
They can set the initial rate a cardholder is offered based on 
perceived financial risk, reprice on a cardholder's existing 
balance if the borrower is late in paying a bill by more than 
30 days, and change the borrower's prospective interest rate 
for virtually any reason, including a minor drop in the 
borrower's credit score or a problem the borrower has in paying 
off another debt. In addition, issuers can manage credit risk 
in more responsible ways by reducing borrowers' credit lines 
and limiting new offers of credit.

    Q.4.  Do you believe that borrowers' rates and fees should 
be determined based on their own actions and not on those of 
others?

    A.4.  It is certainly reasonable to base offers of credit 
on legitimate assessments of borrowers' credit worthiness. As I 
mention in my testimony, however, many of the pricing methods 
that card issuers have used to arbitrarily increase borrowers' 
interest rates and fees do not appear to be based on true 
credit risk, but rather on the judgment of issuers that they 
can get away with charging what the market will bear.

    Q.5.  Do you think that credit card offerings from the 
past, which had high APR's and annual fees for all customers 
were more consumer friendly than recent offerings that use 
other tools to determine fees and interest rates.

    A.5.  As I mention in my response above, the Federal 
Reserve rules leave plenty of room for card issuers to price 
according to borrower's risk, so I do not think it is likely 
that we will see a return to the uniform, undifferentiated 
pricing policies of the past.
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