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History of the Credit Card

Excellent video on this topic provided on the Frontline Documentary: The Secret History of the Credit Card

  • With more than 641 million credit cards in circulation and accounting for an estimated $1.5 trillion of consumer spending, the U.S. economy has clearly gone plastic.
  • When Bank of America launched the nation's first general-purpose credit card in 1958, it simply dropped 60,000 of them in a mass mailing to residents in Fresno, California.
  • Those banks that survived these early debacles began to find their footing in the 1970s. Technological innovations brought automation to their back rooms. Two competing umbrella associations, which would eventually become Visa and Master Card, linked nationwide networks of merchants. Fraud was receding and banks were finally beginning to see profits after sending out more than 100 million credit cards. By 1978, the plastic revolution seemed like it was here to stay.
  • By 1980 Citibank was being squeezed between New York state usury laws and double-digit inflation rates.
  • A little-noticed December 1978 Supreme Court ruling. The Marquette Bank opinion permitted national banks to export interest rates on consumer loans from the state where credit decisions were made to borrowers nationwide.
  • if South Dakota would quickly pass a bill inviting Citibank into the state, he would bring 400 jobs.
  • "Citibank actually drafted the legislation,'' he said. "Literally we introduced it, and it passed our legislature in one day.''
  • The arrangement ultimately brought 3,000 high-paying jobs to South Dakota and a host of new suitors from banks across the country. Citibank seemed to just be the beginning.
  • The elimination of usury restrictions paved the way for double-digit growth. Cardholders, it turned out, were willing to keep on paying 18 percent interest long after inflation subsided and the Federal Reserve lowered the interest rates it charged banks.
  • Between 1980 and 1990, the number of credit cards more than doubled, credit card spending increased more than five-fold and the average household credit card balance rose from $518 to nearly $2,700. With the cost of money sinking and average balances climbing, profits soared.
  • The industry also got an unintended boost from President Carter. In 1980, as part of a short-lived effort to tame inflation, the White House imposed a freeze on soliciting new credit card accounts. The freeze only lasted for a few months, but it was long enough for credit card companies to introduce a new concept -- the $20 annual fee -- without inciting mass defections.
  • In 1990, AT&T entered the market by offering a credit card with no annual fee. Competitors panicked and quickly followed suit, spelling doom to the lucrative annual fees.
  • Nov. 12, 1991 began "the Big Scare" when President Bush said "I'd frankly like to see credit cards rates down" to get the economy moving again. Alfonse M. D'Amato, a senator from New York (R) who had been critical of the 10-point gap between the prime rate and the interest rate proposed the very next day national legislation to cap credit card interest rates at 14 percent. After some 30 minutes of debate, the Senate voted 74-19 to approve the measure.
    Panic swept through the banking industry. By Friday, economists were speculating about huge bank failures and the stock market plunged. The fervor for reform quickly cooled. In a television interview that weekend, Vice President Dan Quayle said if the proposed cap survived a House vote, it would likely be vetoed. By Monday, the tough talk about a national usury law became a call for a study of industry pricing practices.
  • Andrew S. Kahr, a child prodigy who earned his Ph.D. in mathematics from MIT by age 20 and now a financial industry consultant, pioneered several ground-breaking consumer banking products and founded a small credit card company in 1984 that would eventually become Providian, one of today's top 10 issuers. Kahr discovered that it was possible to analyze vast troves of consumer financial data and reliably predict which customers were least likely to pay off their credit card balances each month.
  • Mr. Kahr saw that credit lines could be increased by slashing the required minimum payment. This increased revenue in two ways. First, since it would take longer to pay off balances, each dollar of principal would generate more interest income. Second, the principal itself would be increased because cardholders would be able to take on more debt while maintaining the same monthly payments.
  • Today, two percent is the standard minimum payment, a practice that critics say obscures the true cost of debt and keeps consumers dangerously leveraged. Average household credit card debt, they point out, has nearly tripled since 1990 -- from about $2500 to $7500.
  • As with interest rates, an obscure ruling by the U.S. Supreme Court, this one in 1996, cleared the way for higher fees. Duncan A. Mac Donald, a former general counsel of Citibank's credit card division, spearheaded the case. "We were working this thing here for a good cause, free-market pricing,'' he said in an interview. "The late fees that were common across the industry, up until [the Supreme Court ruling], were in the $5 and the $10 range. And the economic thinking was that there had to be flexibility to allow up to $15.'' Instead, Mr. Mac Donald said, the decision "took the lid off,'' as fees quickly shot up from $15 to $29 to as high as $39. "I certainly didn't imagine that someday we might've ended up creating Frankenstein,'' he said.
  • Last year, penalty fees alone generated $12 billion in revenue. "Banks [are] raising interest rates, adding new fees, making the due date for your payment a holiday or a Sunday on the hopes that maybe you'll trip up and get a payment in late," said Mr. Mc Kinley.
  • Americans' financial habits are monitored by one or more of the three national credit reporting agencies (CRAs): Equifax, Experian, and Trans Union. Every month, financial institutions or creditors send the CRAs credit files which include consumers' account numbers, their types of credit (e.g. mortgages, credit card loans, automobile loans), their outstanding balances, collection actions taken against them, and their bill-payment histories.
    • More than 4.5 billion pieces of data are entered each month into credit records, which in turn become part of the more than 1 billion consumer credit reports issued annually in the United States.
    • These credit records also include information supplied by the consumer (primarily from filling out credit application forms), as well as public records such as bankruptcies, court judgments, overdue child support, foreclosures and liens. By law, credit bureaus can list negative information for seven years. Many national and international creditors, such as banks and department stores, are registered with all three CRAs. Lenders supply the CRAs with information about their customers and in turn have access to credit records.
  • visit http://www.annualcreditreport.com to request your free credit report.

Credit reporting was born more than 100 ago, when small retail merchants banded together to trade financial information about their customers. The merchant associations then turned into small credit bureaus, which later consolidated into larger ones with the advent of computerization.

By the 1960s, controversy surfaced over the CRAs, according to Chris Hoofnagle of the Electronic Privacy Information Center, a public interest research center. Hoofnagle says the credit reports were being used to deny services and opportunities, and individuals had no right to see what was in their files. In addition, CRAs back then reported only negative financial information as well as "lifestyle" information culled from newspapers and other sources -- information such as sexual orientation, drinking habits, and cleanliness.

The controversy led to a congressional inquiry, and in 1971, Congress passed the Fair Credit Reporting Act (FCRA), which established a framework for fair information practices to protect privacy and promote accuracy in credit reporting. Consumers gained the right to view, dispute and correct their records, and CRAs began to supplement the often-bleak reports with information on consumers' positive financial history.

Despite improvements introduced by the FCRA, many credit reports (and hence credit scores) still contain errors. According to a June 2004 study by the consumer advocacy group U.S. Public Interest Research Group (U.S. PIRG), as many as 79 percent of credit reports have errors -- 25 percent of which are serious enough to potentially result in a credit denial. More than half of the reports had information that was either outdated or belonged to someone else.

Although consumers can now monitor their credit ratings with the national credit bureaus, a new practice may be undermining the privacy and access rights Americans gained with the FCRA. Some credit card companies, like Citigroup, now develop and use their own internal credit scores. In its testimony before the U.S. Senate Banking Committee in June 2003 in defense of affiliate sharing, Citigroup said it uses information collected from its affiliates to create internal scores that help determine eligibility for credit, supplementing credit reports and FICO scores.

"Sharing information with affiliates is simply not fair, because consumers have no access, knowledge of, or control over the use of their information," Mierzwinski says. "Consumers should have the right to look at their file and to dispute the file. These large banks are using consumer information to create unregulated databases. It could be used to redline people -- and they wouldn't even know about it."

Despite the drawbacks, critics agree that credit scoring has dramatically improved the efficiency of credit markets. "What credit reporting does, and does especially well in the U.S., is that it improves risk assessment," says Michael Staten of Georgetown Univeristy. "It gives the lender a better picture of whether the loan will be repaid, based entirely on how the consumer has handled loans in the past. You could say that it takes out a lot of the factors that you would consider discriminatory."

How does that help consumers seeking credit? These investments make available huge quantities of additional funds to the lender that can then be made available in consumer credit markets. This lowers the price of loans or the interest rates to the consumer and makes credit more widely available, Staten says.

Collection Industry

The collection industry is regulated by the Fair Debt Collection Practices Act (FDCPA) of 1977, a federal act that limits how and when collectors can contact a debtor about past-due amounts owed to their clients. The Federal Trade Commission is primarily responsible for enforcing the act.

Before passage of the bill, most states lacked consumer protection laws that adequately shielded borrowers from unreasonable debt collection behavior, says Robert Hobbs, deputy director of the National Consumer Law Center in Boston.

The collection industry is regulated by the Fair Debt Collection Practices Act (FDCPA) of 1977, a federal act that limits how and when collectors can contact a debtor about past-due amounts owed to their clients. The Federal Trade Commission is primarily responsible for enforcing the act.

Before passage of the bill, most states lacked consumer protection laws that adequately shielded borrowers from unreasonable debt collection behavior, says Robert Hobbs, deputy director of the National Consumer Law Center in Boston.

In the 1990s, small and specialty agencies continued to consolidate into conglomerates backed by Wall Street and private equity firms. Since 1995, the combined revenues of the top 10 players in the debt collection industry, which includes all forms of debt collection -- credit cards, mortgages and others -- has skyrocketed from $910 million in 1995 to $2.5 billion in 2000, according to the Kaulkin Report.

-- Raymond Lutz - 11 Sep 2007
Topic revision: r1 - 2007-09-11, RaymondLutz
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