The Fed Gives Consumers an Early Christmas Present

Last week the Federal Reserve released some long awaited new credit card rules that will provide important new protections for consumers. They represent some of the biggest changes to the regulation of the credit card industry in decades. While new restrictions and rules are necessary and long overdue to correct inadequate regulation and abuse of consumers in the credit card industry, there are additional steps that can and should be taken.

Earlier this year, New America published a paper by Michael Barr, Sendhil Mullainathan and Eldar Shafir, which has several interesting proposals to improve financial services regulation, including credit card regulation. The proposals are based on insights from behavioral economics and include an opt-out credit card, new regulations for late fees, and an opt-out credit card payment plan.

Under the opt-out credit card proposal, all consumers would be offered a "safe" and standard credit card with straightforward terms and pricing. If they preferred a different type of credit card, they would have the option to opt-out of the standard card. However, credit card companies would be required to provide meaningful disclosure and be subject to increased liability if that disclosure is found to be inadequate. Many details would have to be worked out before this could be implemented, but it is a promising first step. Proposals like these provide good examples of how we could help consumers make better and more rational financial decisions without greatly inhibiting innovation in the industry, reducing credit availability or increasing costs for card users.

The new rules introduced by the Fed are a good start, but they do not incorporate the above mentioned insights from behavioral economics. They include limits on the ability of credit card issuers to arbitrarily change interest rates. Credit card issuers will no longer be allowed to retroactively increase the interest rate on existing credit card balances, with a few exceptions such as if the cardholder is more than 30 days late in paying his or her credit card bill. They will also no longer be allowed to apply payments above the minimum to balances with the lowest interest rates. In fact, they will now be required to apply these payments to either balances with the highest interest rates or proportionately among all the balances. Another practice that will be prohibited is double-cycle billing, where cardholders end up paying interest on debts that were paid in full the previous month during the grace period. And credit card issuers will no longer be able treat a payment as late unless they provide a consumer with a reasonable amount of time to make that payment beforehand. The Fed encourages issuers to send out statements at least 21 days prior to the payment due date.

The bad news is that the new rules will not take effect till July 2010. This means that families struggling with credit card debt and rate hikes in light of the economic crisis will not see any relief in the near future. The new regulations also do not go far enough to correct abuses and misaligned incentives in the credit card industry. For example, no new regulations regarding late and penalty fees were adopted.

The U.S. House of Representatives passed a bill earlier this year that takes additional steps to improve regulation of the credit card industry. The bill was never brought up for a vote in the Senate, but similar legislation is likely to be revisited by both chambers next year. Hopefully when that time comes, Congress will go one step further and consider adopting new regulations based on proposals like those of Barr, Mullainathan and Shafir, that build on insights from behavioral economics.