Credit Cards, Debit Cards, and Crazy Americans

As I have written several times in the past (e.g. here and here) there seems to be no subject on which I am more out of step with normal folks than those plastic cards, credit and debit, that we all use to buy stuff.

Credit-cards Lotus Head In the past I have politely implied that this is a failing of mine, that I am just too old or too dense to understand what everybody else does. I hope nobody was fooled by that. I really think I may be the last person in America who can think clearly about plastic.

A few weeks ago, SmartMoney ran a round-up of the best credit card deals. The listing of best offers for the various categories of credit cards was fine, but the introductory gloss managed to encapsulate just about all the craziness (and I do mean craziness) that clouds thinking about cards in America.

… credit cards have lately emerged as the surprise champs, offering fewer fees and better rewards than the typical debit card.

Surprise to who? As far as I know, credit cards, in general, have always had lower fees and better rewards than debit.

One of the clearest indications that something is not right in the credit vs. debit discussion is how hard journalists seem to work trying to justify one type over the other, introducing spurious criteria that mask the relatively simple bottom-line.

… consumers may find they’re more protected with credit cards than with debit cards. Fraudulent credit card charges are forgiven by banks, but with debit cards, card holders could be on the hook for hundreds of dollars, if not more.

Of course, like much else written on identity theft, this is more urban myth than fact. While it is the case that the regulations that set the maximum consumer liabilities are different for credit and debit cards (they are regulated by different branches of the government, after all) for most practical purposes the legal cap is $50 for both, provided the consumer reports the fraud soon after discovering it. And in any case, for practical purposes consumer liability is zero, because both Visa and MasterCard cover it all for both types of card.

Until recently, debit cards offered a one-two punch credit cards couldn’t match: a convenient way to access money without the fear of going into debt, along with generous reward programs… .

I believe that the single largest manifestation of America’s money neurosis is the fact that debit transactions outnumber credit transactions. Given the terms offered consumers on the two kinds of plastic, if we were being objective and rational, debit cards would be a tiny minority the the business. A credit card can do everything a debit card can, also provides credit if needed, and is cheaper.

Indeed, so far off the deep end are we about debit vs. credit that we cannot even plausibly explain why we prefer debit. Choosing it because you can buy stuff “without the fear of going into debt” would be crazy enough. It would only make sense if your spending was akin to an addiction: that mere willpower could not keep you from whipping out the plastic at the mall.

If you think about it, that sort of compulsion being widespread would be remarkable. It lacks the base biological drivers that underlie substance abuse or even adultery. And yet the majority of us, apparently, have so little control over our spending impulses that we must resort to the drastic measure of paying more to not have the option to borrow.

If that were the whole story, it would be crazy enough. But I do not think it is. The guardrail feature of debit cards, that you can’t spend more than you have, does not quite hold water as an explanation for why we prefer debit cards. Even within the perverse twilight logic of our compulsion to spend, it does not make much sense.

First, many, if not most, debit cards carry an overdraft protection feature, meaning you are just as able to go into debt as with a credit card, but under worse terms. Second, you could get exactly the same guardrail effect by carrying a credit card with a low credit limit. (I imagine that card companies are very happy to lower your limit if you ask nicely.) And third, limiting your spending to every penny you have leaves something to be desired as a means of behavior modification.

I have another theory to explain debit vs. credit which I think fits better with the evidence. Many consumers, at least in the abstract, wish that they spent less money. That in itself may not be rational, but I think we can agree it is a common phenomenon. And those consumers prefer debit not because they are ultimately limited in their spending to cash in the bank, but because they are (or think they are) more reluctant to spend money out of their checking account than incur an otherwise identical debt they will be billed for in a few weeks.

That is layers of crazy. But there is more. At the highest level, it would be reasonable to suppose that debit cards would be cheaper to use than credit cards. They provide less of a service and are, or should be, less expensive to issue. Credit cards, even if normally paid off every month, involve some credit risk as the bank fronts the money to the merchant before it gets paid by the customer. Debit cards, of course, just involve moving money from one account to another.

And yet debit cards are not cheaper. They are more expensive because credit cards are such a remarkably, even implausibly, good business for issuers. And the way that business is so profitable is itself a bit odd. Some consumers (apparently just under 60% of them) carry a balance on their cards, that is, they borrow money at high interest rates from the issuing bank.

This is such a profitable business that it subsidizes all that is near it. Wet blankets like me in the 40+% who pay off the balance every month get a really useful service essentially for free. Actually, better than free if you consider rewards and the short-term interest free loans. And the whole amazing infrastructure that allows me to buy just about anything, just about anywhere in the world, from complete stranger and without using cash, exists because loaning money to the people who do not pay their balances is so profitable.

And that is more than a bit crazy. I am not ideologically against debt, and I can imagine all sorts of emergencies and semi-emergencies that would reasonably result in carrying a credit card balance. But there is just no way that habitually borrowing money in this way is rational for more than half of American consumers.

The icing on this layer cake of irrationality is the reason why debit cards are getting even less economical for consumers relative to credit cards. The Durbin Amendment, one of the few bits of the Dodd-Frank financial reform law that actually did anything, introduced government regulation of the fees that merchants pay on debit card transactions. (And by “regulation” I mean it cut those fees roughly in half by fiat.)

It is not entirely clear what the goals for Sen. Durbin’s (D-Illinois) pet project were. But I am betting that increased use of credit cards was not among them. I will even speculate that the folks in Washington consider the banks’ newfound eagerness to issue credit cards and comparative lack of interest in debit, just because debit is no longer so profitable, to be an unforeseeable consequence of the legislation. And that is crazy.

[Photo: Lotus Head]

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