Tuesday, July 19, 2011

Cash is king (12 March 2009)

For a while, I've wondered if I should use cash for more of my purchases. Research has found that we are more conscious of what we are spending when we are peeling off bills rather than swiping a card and signing a receipt. We feel the pain of loss as giving up greenbacks, which is some sort of testimony to their fetishistic power.

Also, the paranoid in me worries that my purchases will be tracked and used in targeting marketing at me or at people like me. It may be forbidden to sell off records of our purchases (I'm not sure), but even then it still may be permissible to lump yours in with others in a demographic, and sell that information. If this is true, aggregate purchasing decisions by a particular group -- one assembled by credit-card companies -- can develop momentum, shaping the marketing it receives, further shaping the same sorts of choices, until the realm of options open to that group have become curtailed in practical terms. And these groups could end up having less and less in common with one another, leaving us a society segmented into demographics formed not by any voluntary affiliation but by underlying spending patterns -- that is, a society defined in terms of how classes shop. This, in turn, probably reinforces the tendencies to self-identify in that way, further entrenching that we must shop in order to be -- in order to have social identity at all.

There's also the matter of credit card fees -- I'm usually successful at evading the ones the credit-card companies would love to charge me, but the stores at which I pay in credit have to pay a vig (the interchange fee) to Discover and MasterCard. Theoretically, interchange fees are passed through to we the customers in the form of higher prices, so if we all paid in cash, we all could afford more. (And if we all recycled, there would never be any more trash again.) These fees are why some restaurants won't take cards -- well, that and tax evasion -- and why stores like Ikea offer discounts for purchases made with debit cards. But I'm sure that many large-scale retailers prefer when we pay in credit as this cuts down on till tapping and employees' thieving.

It's hard to remember when credit cards weren't so widely accepted; they used to be verboten at grocery stores. And if I'm remembering right, you used to need the specific oil-company credit card to pay in credit at gas stations, and even them there would be a punitive per-gallon markup. Now I experience a weird frisson when I pay for groceries or gas with cash: "Look at me! I'm paying with cash!" It's as if I'm doing something novel, something almost outrageous -- it feels like I am on the lam and trying to avoid leaving a paper trail, or that I am making some laudable gesture of voluntary simplicity. But the convenience of using credit and consolidating my expenses into one monthly payment is hard to resist and seems like a net gain for me -- think of all those free short-term loans I'm getting!

Anyway, that's a long preamble to my wanting to link to a few articles about how credit-card companies are now scrambling to cut credit lines. In the New Yorker, James Surowiecki's most recent column explains the ins and outs of the situation pretty well, emphasizing the credit-card companies "strange" business model:

credit-card companies have created a strange business, in which there’s a fine line between good and bad customers. Their best customers aren’t those who dutifully pay off their balance every month; instead, they’re the ones who charge a lot and pay only a little every month, carrying a sizable balance and racking up interest charges and late fees. These are the “revolvers,” and the credit-card business feeds on them.

In other words, credit-card companies are always on a knife edge; they have to encourage imprudent -- but not too imprudent -- behavior in a sizable portion of their customers to thrive. This makes their customers extremely unlikely to be loyal to them, seeing as they thrive by undermining the morals of their customers. (Hence the variety of loyalty programs credit cards routinely roll out. My favorite is Citi's -- the "Thank You" program. No, Citi, thank you.)

The efforts of credit-card issuers to retract some of the credit they eagerly extended during the boom (trying to hook some more "revolvers" on the line) now threaten to put us squarely into paradox-of-thrift territory. Credit lines are being reduced somewhat indiscriminately, worsening consumer confidence and increasing the likelihood of defaults. That is what analyst Meredith Whitney discusses in this WSJ op-ed. Whitney enumerates reasons that credit lines are being pulled -- overoptimistic underwriting standards, tarring entire zip codes as credit risks when a few in it foreclose, credit-card companies trying to avoid being the one card in the pocket of a likely defaulter, and coming regulation that makes it harder for companies to change rates on customers. Her conclusion:
Over the past 20 years, Americans have also grown to use their credit card as a cash-flow management tool. For example, 90% of credit-card users revolve a balance (i.e., don't pay it off in full) at least once a year, and over 45% of credit-card users revolve every month. Undeniably, consumers look at their unused credit balances as a "what if" reserve. "What if" my kid needs braces? "What if" my dog gets sick? "What if" I lose one of my jobs? This unused credit portion has grown to be relied on as a source of liquidity and a liquidity management tool for many U.S. consumers. In fact, a relatively small portion of U.S. consumers have actually maxed out their credit cards, and most currently have ample room to spare on their unused credit lines. For example, the industry credit line utilization rate (or percentage of total credit lines outstanding drawn upon) was just 17% at the end of 2008. However, this is in the process of changing dramatically.

Without doubt, credit was extended too freely over the past 15 years, and a rationalization of lending is unavoidable. What is avoidable, however, is taking credit away from people who have the ability to pay their bills. If credit is taken away from what otherwise is an able borrower, that borrower's financial position weakens considerably. With two-thirds of the U.S. economy dependent upon consumer spending, we should tread carefully and act collectively.

This is true as far as it goes, but the underlying question is whether most people should be using credit cards as a "liquidity management tool" by revolving debt rather than living on a more consistently realistic budget. Credit-card companies have incentives to find those people and entice them to carry a balance; this increased "liquidity" in practice amounts to consumers reconfiguring their standard of living in unsustainable terms. Some rely on credit in emergencies, but many choose to revolve credit to keep spending more than they make. As Surowiecki explains, "The easy availability of credit cards encouraged people to live beyond their means—studies suggest that people really do spend more when they can pay with a credit card, and that big credit lines further encourage extravagance." This has externalities to it: the rest of us need to spend more (and go into debt) to feel like we are keeping up, or we need to make the difficult and somewhat isolating choice to fly in the face of new social norms -- forgoing the stuff that seems to have become de rigueur for our social class. We experience a kind of declassing even if we are content with what we have. Credit being extended to traditionally poor credit risks exacerbates that tendency further -- those we considered beneath us suddenly seem to have more of life's good things than we do. All of which is to say that accessibility to credit accelerates the cycling through of class signifiers and inflates the value of all of the ones in play. This seems highly unstable -- financially and emotionally.

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