Zywicki Discusses Failures in Credit Card Lending on Fox Business and in WSJ

"Congress can pass all the laws it wants, but it can't repeal the law of supply and demand and the law of unintended consequences," said Professor Todd Zywicki in an op-ed published in the Wall Street Journal.

Zywicki wrote that the least surprising event of 2010 was that more Americans were forced to use payday lenders, pawn shops, and local loan sharks to get credit as a direct result of new federal limits on how credit card issuers can price risk and adjust interest rates.

Despite promises accompanying passage of the 2009 Credit CARD Act, the new law resulted in higher interest rates, an increase in other fees, and reduced credit limits, with the worst impact accruing to lower-income Americans, who lost access to credit cards and were forced to rely on resources outside the traditional banking system.

Further, Zywicki argued that the Durbin Amendment to the Dodd-Frank banking reform law, which places price controls on debit-card interchange fees, will result in a windfall to merchants but have a devastating impact on low-income customers, many of whom will be unable to qualify for free checking under the new fee structure.

Zywicki made a January 4 appearance on The Willis Report, a Fox Business program, to discuss the op-ed with the show's host, Gerri Willis, telling her the scenario was part of a recurring problem in American history in which good intentions designed to protect consumers sometimes have the unintended result of actually hurting them.

Zywicki expressed his concern that folks in Washington might be "wishing away" people's need for credit. He explained that consumers use credit for the same reasons that businesses use it—to make capital investments in their homes and to deal with short-term fluctuations in income and expenses. A wishing away of the need for credit is a self-defeating practice, he said.

Dodd-Frank and the Return of the Loan Shark, The Wall Street Journal, January 4, 2011. By Todd Zywicki.

"In a competitive market, regulation of consumer credit has three predictable types of unintended consequences. First, regulation of some terms of the credit contract will result in the repricing of other terms. Thus restrictions on the ability to raise interest rates in response to a change in a borrower's risk profile lead card issuers to raise interest rates on all cardholders, good and bad risks alike.

"But even if card issuers reprice some terms, they may still be unable to price risk efficiently under the new rules. This gives rise to a second type of unintended consequence: product substitution. Card issuers can't price risk, so they issue fewer cards—pushing would-be customers to payday lenders and other nontraditional credit products.

"Third, if issuers can't price risk effectively, they will ration lending. In order to make a loan, a lender must be able to price its risk efficiently or to reduce risk exposure by rationing credit. One way to do the latter is to lend less to existing borrowers, which is part of the reason why more than $1 trillion in credit-card lines have been slashed since the onset of the credit crunch.

"Banks can also drop riskier borrowers completely. In his letter to shareholders last spring, Jamie Dimon of J.P. Morgan Chase reported that, 'In the future, we no longer will be offering credit cards to approximately 15% of the customers to whom we currently offer them. This is mostly because we deem them too risky in light of new regulations restricting our ability to make adjustments over time as the client's risk profile changes.' Meet the new payday loan customers."