Avoiding the Pitfalls of Credit Card Debt

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“Credit card debt is now clobbering millions of Americans like a wrecking ball,” Sen. Ron Wyden (D-OR) told attendees today at a Center for American Progress Action Fund event.

Wyden and a panel of experts—including Leonard Chanin from the Federal Reserve Board; Tamara Draut, author and director at Demos USA; and Jonathan Orszag from Compass Lexecon—discussed why we may soon see a credit card crisis on par with the subprime mortgage crisis if the government doesn’t step in to protect consumers and ensure a fair marketplace.

The U.S. credit card market is showing signs of difficulty as the home mortgage foreclosure crisis surges to unprecedented levels. As fewer Americans are able to tap into their home equity, they are increasing their reliance on credit card debt to finance their everyday purchases. Just like subprime mortgage-backed securities, credit card debt is packaged and sold to investors. An increase in credit card defaults could lead to losses not just for credit card lenders, but for pension funds and investors who bought the debt.

But too many Americans find themselves unable to make the minimum payment, carrying a monthly balance, or increasingly paying late fees. Wyden argued that while Americans have a “constitutional right to be foolish” by not understanding their credit cards, the market needs to provide sufficient information for informed decisions. He has therefore proposed a five-star rating system for credit cards administered by the Federal Reserve, similar to that used in auto safety ratings. The rating system would ensure transparency for consumers and accountability for credit card companies.

By mixing openness of information with public education, Wyden explained, the market will be increasingly efficient since consumers have access to information without wading through “pages of material incomprehensible to anybody who doesn’t spend their free time reading the Uniform Commercial Code.”

Yet not all the panelists agreed on which method is best for improving transparency of credit card terms. Chanin, Associate Director of the Division of Consumer and Community Affairs at the Federal Reserve Board, called Wyden’s proposal “intriguing,” but argued that a star system is impractical because different types of consumers use cards differently, and thus a star system would not provide efficient information. Orszag, Senior Managing Director of Compass Lexecon, added that by increasing government regulation in a private sector, the resulting inefficiencies might outweigh the benefits.

Regardless of the solution, the refrain from event panelists was that something needs to be done. Draut, Director of the Economic Opportunity Program at Demos USA, described the current situation as “the nation’s premier banks being able to do whatever they want to their customers,” a situation which threatens to create greater economic instability.

Credit cards are now acting as an economic stabilizer for families experiencing job loss or with stagnant real wages, making it important that we find a solution that benefits credit card owners without creating market inefficiencies. Greater transparency and increased consumer information about the dangers of credit card lending are important if the nation wants to avoid a credit card crisis.

For more information on this issue, see:

• House of Cards: Consumers Turn to Credit Cards Amid the Mortgage Crisis, Delaying Inevitable Defaults