American Economic association The Failure of Competition in the Credit Card Market Author(s): Lawrence M. Ausubel Source: The American Economic Review, Vol. 81, No. 1(Mar, 1991), pp. 50-81 Published by: American Economic Association StableUrl:http://www.jstor.org/stable/2006788 Accessed: 17-12-201707: 42 UTC JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact supportejstor org Your use of the JSTOR archive indicates your acceptance of the Terms Conditions of Use, available at http://about.jstor.org/terms American Economic Association is collaborating with JSTOR to digitize, preserve and extend access to The American Economic review STOR This content downloaded from 202. 120.224.93 on Sun, 17 Dec 201707: 42: 57UTC Allusesubjecttohttp:/aboutjstor.org/terms
American Economic Association The Failure of Competition in the Credit Card Market Author(s): Lawrence M. Ausubel Source: The American Economic Review, Vol. 81, No. 1 (Mar., 1991), pp. 50-81 Published by: American Economic Association Stable URL: http://www.jstor.org/stable/2006788 Accessed: 17-12-2017 07:42 UTC JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at http://about.jstor.org/terms American Economic Association is collaborating with JSTOR to digitize, preserve and extend access to The American Economic Review This content downloaded from 202.120.224.93 on Sun, 17 Dec 2017 07:42:57 UTC All use subject to http://about.jstor.org/terms
The Failure of Competition in the credit Card Market By LAWRENCE M. AUSUBEL* The bank credit card market, containing 4,000 firms and lacking regulatory barriers, casually appears to be a hospitable environment for the model of perfect competition. Nevertheless, this article reports that credit card interest rates have been exceptionally sticky relative to the cost of funds. Moreover, major credit card issuers have persistently earned from three to fiue times the ordinary rate of return in banking during the period 1983-1988. The failure of be partly attributable to credit card choices without taking account of the very high probability that they will pay interest on their outstanding balances (JEL 315, 612) This article presents and discusses a col- strained inputs, significant sunk costs, or lection of data which is paradoxical within significant barriers to entry. Finally, there is the paradigm of perfect ition The no evidence of any explicit collusion on market studied the bank credit card indus- price or quantity in the United States, contains literally ch a favorable market do 4,000 firms who sell a relatively homoge- tion, or one not even half so optimistic, neous good to 75 million consumers. The many economists would prefer to presume ten largest firms account for only about that the market must behave as a competi wo-fifths of market share. Firms have his- tive spot market in continuous equilibrium orically operated without regulatory bar- It is the purpose of this article to argue that riers to conducting business across state this presumption is empirically unjustified lines-and at least 20 firms aggressively so- in the market for bank credit cards in the licit business on a national scale. firms have 1980 s Section I outlines the market struc also operated in the virtual absence of price ture of the bank credit card industry. Sec gulations for most of a decade. There do tion Il offers empirical evidence of extreme not appear to be any particularly con- price stickiness in credit card interest rates Section Ill provides direct profit data on dustry, arguing that the 50 large credit card issuers have earned from three Department of Managerial Economics and deci- to five times the ordinary rate of return for gement, Northwestern University, Evanston, IL 60208 the banking industry during the period The author acknowledges the support of the Kellogg 1983-1988 Section IV examines profits over School,s Banking Research Cen he Lynde and a larger sample of banks and a longer time Harry Bradley Foundation, and the C. V. Starr Center period. Section V presents additional data at New York university and appreciates the diligent on resales of credit card portfolios between Alan Blinder, Charles calomiris, Raymond Deneckere, banks, suggesting that the extraordinary Peter Diamond, Stuart Greenbaum, Robert Johnson, profits exist ex ante as well as ex post (and Meetings, the Econometric society meetings, the explanations for price stickiness and supra western University Summer Industrial Organizat Conference, the Federal Reserve Bank of Chicago, tion VIll briefly discusses the extent of wel New York University, Princeton University, and the fare loss in the market and the merits of the officers of 21 major banks who cooperatively re- regulation to correct market failure. Con clusions are presented in Section IX. This content downloaded from 202. 120. 224.93 on Sun. 17 Dec 201707: 42: 57 UTC Allusesubjecttohttp:/about.jstor.org/terms
The Failure of Competition in the Credit Card Market By LAWRENCE M. AUSUBEL* The bank credit card market, containing 4,000 firms and lacking regulatory barriers, casually appears to be a hospitable environment for the model of perfect competition. Nevertheless, this article reports that credit card interest rates have been exceptionally sticky relative to the cost of funds. Moreover, major credit card issuers have persistently earned from three to five times the ordinary rate of return in banking during the period 1983-1988. The failure of the competitive model appears to be partly attributable to consumers, making credit card choices without taking account of the very high probability that they will pay interest on their outstanding balances. (JEL 315, 612) This article presents and discusses a col- lection of data which is paradoxical within the paradigm of perfect competition. The market studied, the bank credit card indus- try in the United States, contains literally 4,000 firms who sell a relatively homoge- neous good to 75 million consumers. The ten largest firms account for only about two-fifths of market share. Firms have his- torically operated without regulatory bar- riers to conducting business across state lines-and at least 20 firms aggressively so- licit business on a national scale. Firms have also operated in the virtual absence of price regulations for most of a decade. There do not appear to be any particularly con- strained inputs, significant sunk costs, or significant barriers to entry. Finally, there is no evidence of any explicit collusion on price or quantity. Given such a favorable market descrip- tion, or one not even half so optimistic, many economists would prefer to presume that the market must behave as a competi- tive spot market in continuous equilibrium. It is the purpose of this article to argue that this presumption is empirically unjustified in the market for bank credit cards in the 1980's. Section I outlines the market struc- ture of the bank credit card industry. Sec- tion II offers empirical evidence of extreme price stickiness in credit card interest rates. Section III provides direct profit data on the industry, arguing that the 50 largest credit card issuers have earned from three to five times the ordinary rate of return for the banking industry during the period 1983-1988. Section IV examines profits over a larger sample of banks and a longer time period. Section V presents additional data on resales of credit card portfolios between banks, suggesting that the extraordinary profits exist ex ante as well as ex post (and that bankers expect the profitability to per- sist). Section VI explores some theoretical explanations for price stickiness and supra- normal profits. Section VII calculates what would be "competitive" interest rates. Sec- tion VIII briefly discusses the extent of wel- fare loss in the market and the merits of regulation to correct market failure. Con- clusions are presented in Section IX. *Department of Managerial Economics and Deci- sion Sciences, J. L. Kellogg Graduate School of Man- agement, Northwestern University, Evanston, IL 60208. The author acknowledges the support of the Kellogg School's Banking Research Center, The Lynde and Harry Bradley Foundation, and the C. V. Starr Center at New York University and appreciates the diligent research work of Gail Eynon and Paul Palmer. I thank Alan Blinder, Charles Calomiris, Raymond Deneckere, Peter Diamond, Stuart Greenbaum, Robert Johnson, Charles Kahn, Robert Porter, and three anonymous referees for helpful comments. I also thank seminar participants at the American Economic Association Meetings, the Econometric Society Meetings, the NBER Economic Fluctuations Conference, the North- western University Summer Industrial Organization Conference, the Federal Reserve Bank of Chicago, New York University, Princeton University, and the University of Delaware. Special thanks are also due to the officers of 21 major banks who cooperatively re- sponded to my requests for data. 50 This content downloaded from 202.120.224.93 on Sun, 17 Dec 2017 07:42:57 UTC All use subject to http://about.jstor.org/terms
VOL. 8I NO. I AUSUBEL: CREDIT CARD MARKET I. The Bank Credit Card Market: Is 4.000 nection with the credit card industry apply also to other forms of consumer borrowing (especially other unsecured credit) Credit cards are the currency of late If visa and Master Card were the relevant 20th-century America. The aggregate charge levels of business to examine, then two firms volume on plastic in the United States was would control a substantial part of the credit half of this total-$165 billion in volume- ness decisions are made at the level of the was charged on Master Card and Visa credit issuing bank. Individual banks own their cards(the primary focus of this article), and cardholders' accounts and determine the in volume was growing at well over 10 percent terest rate, annual fee, grace period, credit per year. The remaining volume arose limit, and other terms of the accounts. (only largely from similar credit cards (e. g, the charges such as the"interchange fee"from Discover and Optima cards), "travel and the merchant's bank to the cardholder's entertainment"cards (e.g, the American bank are standardized, and the cardholder's Express card), and retail cards (e. g, depart- bank appears only to break even on such ment store and oil company cards) charges. Moreover, there is absolutely no borrowing via credit cards (and all con- indication that the Master Card and Visa sumer borrowing) is also significant and has organizations serve to facilitate collusion on een even more of a growth industry Out- other prices. )In essence, Master Card In standing U.S. balances on revolving credit ternational and Visa U.S.a. are organiza accounts equaled $203 billion at year-end tions largely irrelevant to this discussion; 1989, up from only $70 billion in 1982.3"firms"will henceforth refer to the issuing More than S130 billion of this total con- banks sisted of Master Card and visa balances The market for MasterCard and Visa nore than a threefold increase from 1982, cards, thus, is relatively unconcentrated the and bank card balances were still increasing top ten firms control only about two-fifths of at more than a 15-percent annual rate. 4 the market, and the next ten firms control Overall outstanding consumer installment only one-tenth of the market(see Table 1) credit balances in the United States reached moreover the market is exceptionally broad S717 billion, up from $356 billion in 1982; a bank that ranked number 100 in 1987 still it is worth observing that many of the con- had approximately 160,000 active accounts, siderations explicitly discussed here in con- $125 million in outstanding balances, and $250 million in annual charge volume Unlike most aspects of American bank- ing, the credit card business has historically Moreover, Americans were estimated to have made 9.1 billion credit card transactions in 1987(The Nilson operated free of interstate banking and Report, Number 428, May 1988, p 5) me in 1987 consisted of $138 billion in counted for 59 percent mOreover, the observed interest rate behavior does of this value and Master Card accounted for the not seem to fit the conventional view of collusive haining 41 percent (The Nilson R prIc nd 1985, three major issuers(CI February 1988, p. 6, and Number 423, March 1988, pp ufacturers Hanover, and Maryland Bank interest rates on standard cards to the fEderal Reserve Boards series of Consumer In- 17.5-17,9-percent range ar from this stallment Credit, as published in Federal Reserve Bul- industry price war, other major issuers (e.g, Citibank tin,April 1990, table 1.55, line 15(and previous and First go)steadfastly maintained 19.8-percent lines 16, 19, cial bank m2计 three price-cutters announced rate increases, appa ently find on that the earlie 27, 1989, p. 32; Wall Street Journal, March 22, 1989, p FEderal Reserve Bulletin, April 1990, table 1.55, line B1) (June1987),p.7. This content downloaded from 202. 120. 224.93 on Sun. 17 Dec 201707: 42: 57 UTC Allusesubjecttohttp:/about.jstor.org/terms
VOL. 81 NO. 1 AUSUBEL: CREDIT CARD MARKET 51 I. The Bank Credit Card Market: Is 4,000 Enough for Competition? Credit cards are the currency of late 20th-century America. The aggregate charge volume on plastic in the United States was estimated at $375 billion in 1987.1 Almost half of this total-$165 billion in volume- was charged on MasterCard and Visa credit cards (the primary focus of this article), and volume was growing at well over 10 percent 2 per year. The remaining volume arose largely from similar credit cards (e.g., the Discover and Optima cards), "travel and entertainment" cards (e.g., the American Express card), and retail cards (e.g., depart- ment store and oil company cards). Borrowing via credit cards (and all con- sumer borrowing) is also significant and has been even more of a growth industry. Out- standing U.S. balances on revolving credit accounts equaled $203 billion at year-end 1989, up from only $70 billion in 1982.3 More than $130 billion of this total con- sisted of MasterCard and Visa balances, more than a threefold increase from 1982, and bank card balances were still increasing at more than a 15-percent annual rate.4 Overall outstanding consumer installment credit balances in the United States reached $717 billion, up from $356 billion in 1982;5 it is worth observing that many of the con- siderations explicitly discussed here in con- nection with the credit card industry apply also to other forms of consumer borrowing (especially other unsecured credit). If Visa and MasterCard were the relevant levels of business to examine, then two firms would control a substantial part of the credit card market. However, most relevant busi- ness decisions are made at the level of the issuing bank. Individual banks own their cardholders' accounts and determine the in- terest rate, annual fee, grace period, credit limit, and other terms of the accounts. (Only charges such as the "interchange fee" from the merchant's bank to the cardholder's bank are standardized, and the cardholder's bank appears only to break even on such charges. Moreover, there is absolutely no indication that the MasterCard and Visa organizations serve to facilitate collusion on other prices.6) In essence, MasterCard In- ternational and Visa U.S.A. are organiza- tions largely irrelevant to this discussion; "firms" will henceforth refer to the issuing banks. The market for MasterCard and Visa cards, thus, is relatively unconcentrated. The top ten firms control only about two-fifths of the market, and the next ten firms control only one-tenth of the market (see Table 1). Moreover, the market is exceptionally broad. A bank that ranked number 100 in 1987 still had approximately 160,000 active accounts, $125 million in outstanding balances, and $250 million in annual charge volume.7 Unlike most aspects of American bank- ing, the credit card business has historically operated free of interstate banking and 1Moreover, Americans were estimated to have made 9.1 billion credit card transactions in 1987 (The Nilson Report, Number 428, May 1988, p. 5). 2U.S. volume in 1987 consisted of $138 billion in sales slips (i.e., charged goods and services) and $27 billion in cash advances. Visa accounted for 59 percent of this value and MasterCard accounted for the re- maining 41 percent. (The Nilson Report, Number 422, February 1988, p. 6, and Number 423, March 1988, pp. 4-5). 3Federal Reserve Board's series of Consumer In- stallment Credit, as published in Federal Reserve Bul- letin, April 1990, table 1.55, line 15 (and previous issues). 4Federal Reserve Bulletin, April 1990, table 1.55, lines 16, 19, and 21. Revolving credit held by commer- cial banks, savings institutions, and pools of securitized assets consists almost entirely of MasterCard and Visa balances. 5Federal Reserve Bulletin, April 1990, table 1.55, line 1 (and previous issues). 6Moreover, the observed interest rate behavior does not seem to fit the conventional view of collusive pricing. Around 1985, three major issuers (Chase Man- hattan, Manufacturers Hanover, and Maryland Bank) reduced their interest rates on standard cards to the 17.5-17.9-percent range. Far from this triggering an industry price war, other major issuers (e.g., Citibank and First Chicago) steadfastly maintained 19.8-percent rates on most accounts, without apparent detriment to their customer bases. Finally, in the spring of 1989, the three price-cutters announced rate increases, appar- ently finding without facing retaliation that the earlier cuts had been unprofitable (The New York Times, April 27, 1989, p. 32; Wall Street Journal, March 22, 1989, p. B1). 7The Nilson Report, Number 406 (June 1987), p. 7. This content downloaded from 202.120.224.93 on Sun, 17 Dec 2017 07:42:57 UTC All use subject to http://about.jstor.org/terms
THE AMERICAN ECONOMIC REVIEW MARCH 1991 TABLE 1-TOP TEN ISSUERS OF MASTERCARD AND VISA CARDS. 1987 Percentage market Percentage market share Number of share(by number (by outstandi Bank of accounts) (S billion) Citibank 153B Chase manhattan Bank S5. 4B Wells Fargo Bank 1,800,00 28 Marylan 1,800,000 Marine Midland Bank 1,700,00 Chemical bank 1,500,000 Associates National Bank Top ten 414 Second ten Total 118,900,00 100 Sources: Individual banks' numbers of accounts surveyed by American Banker, March 1, 1988, pp. 1-2)and Credi ard News(August 15, 1988, pp. 4-16); total number of accounts from Nilson Report(Number June 1987), p. 4). Individual banks' outstanding balances based on American Banker(September 21, 1987, p. 43 [call report datap utstanding at Greenwood Trust Co [ Discover card] and American Express Centurion Bank). Data reported for December 31, 1986, adjusted for acquisitions effective in 1987. Conflicts between sources were resolved using best branch banking restrictions. Indeed, the Court held that only the usury ceiling of the largest issuers today conduct truly national state in which the bank is located, and not businesses. For example, Maryland Bank that of the state in which the consumer is (ranked number seven in Table 1)conducts located, restricts the interest rate the bank business in all 50 states and has only five may charge. This gave banks the option of percent of its accounts in its home state. shifting their credit card operations to cent of its business is concentrated are Cali- without usury laws. By 1982, amid fornia(10.7 percent), Texas (6.7 percent), quette-created bank pressure and histori Pennsylvania(6.0 percent), and New Jersey cally high market interest rates, most lead ing banking states had relaxed or repealed In the past, credit card issuers were con- their interest rate ceilings. Meanwhile rained by state usury laws. However, the South Dakota and Delaware had estab U.S. Supreme Court's December 1978 Mar- lished themselves as attractive homes- quette decision paved the way for the practi- away-from-home for credit card issuers cal elimination of price regulations The While a number of states maintain bindin usury laws at this writing (most notably Arkansas, with a ceiling of five percentage Prospectus for Maryland Bank, N.A. Credit C points above the Federal Reserve discount Trust 1987-A, December 9, 1987, pp 17- rate), essentially all major issuers can pur Marquette National Bank v. First of Omaha Service sue business in those states free of restric- Corporation, 439 U.S. 299(1978). The Marquette de on applies to credit cards issued by nationally char. tered banks, but not to retail cards (e. g, oil company credit cards). The decision explicitly permits banks to ther customer fees. at this writing, at the behest of export"their interest rates; banks have interpreted the lowa Attorney General, courts are considering this also to permit the export"of annual fees and whether this rule does indeed apply to fees This content downloaded from 202. 120. 224.93 on Sun. 17 Dec 201707: 42: 57 UTC Allusesubjecttohttp:/about.jstor.org/terms
52 THE AMERICAN ECONOMIC REVIEW MARCH 1991 TABLE 1 -Top TEN ISSUERS OF MASTERCARD AND VISA CARDS, 1987 Percentage market Outstanding Percentage market share Number of share (by number balances (by outstanding Bank accounts of accounts) ($ billion) balances) Citibank 10,000,000 8.4 $15.3B 16.3 Chase Manhattan Bank 5,000,000 4.2 $5.4B 5.8 Bank of America 4,800,000 4.0 $5.2B 5.5 First Chicago 4,500,000 3.8 $4.6B 4.9 Manufacturers Hanover 3,300,000 2.8 $2.0B 2.1 Wells Fargo Bank 1,800,000 1.5 $2.8B 3.0 Maryland Bank 1,800,000 1.5 $1.7B 1.8 Marine Midland Bank 1,700,000 1.4 $1.4B 1.5 Chemical Bank 1,500,000 1.3 $1.3B 1.4 Associates National Bank 1,200,000 1.0 $1.0B 1.1 Top ten 35,600,000 30.0 $40.7B 43.4 Second ten 11,500,000 9.7 $9.0B 9.6 Total 118,900,000 100.0 $93.9B 100.0 Sources: Individual banks' numbers of accounts surveyed by American Banker, (March 1, 1988, pp. 1-2) and Credit Card News (August 15, 1988, pp. 4-16); total number of accounts from Nilson Report (Number 406 [June 1987], p. 4). Individual banks' outstanding balances based on American Banker (September 21, 1987, p. 43 [call report data]) and Nilson Report (Number 406 [June 1987], pp. 4-5); total outstanding balances from Federal Reserve Bulletin (December 1988, table 1.55; revolving credit outstanding at commercial banks and savings institutions, minus loans outstanding at Greenwood Trust Co. [Discover card] and American Express Centurion Bank). Data reported for December 31, 1986, adjusted for acquisitions effective in 1987. Conflicts between sources were resolved using best available information. branch banking restrictions. Indeed, the largest issuers today conduct truly national businesses. For example, Maryland Bank (ranked number seven in Table 1) conducts business in all 50 states and has only five percent of its accounts in its home state.8 The only states where more than five per- cent of its business is concentrated are Cali- fornia (10.7 percent), Texas (6.7 percent), Pennsylvania (6.0 percent), and New Jersey (5.8 percent). In the past, credit card issuers were con- strained by state usury laws. However, the U.S. Supreme Court's December 1978 Mar- quette decision paved the way for the practi- cal elimination of price regulations.9 The Court held that only the usury ceiling of the state in which the bank is located, and not that of the state in which the consumer is located, restricts the interest rate the bank may charge. This gave banks the option of shifting their credit card operations to wholly owned subsidiaries situated in states without usury laws. By 1982, amid Mar- quette-created bank pressure and histori- cally high market interest rates, most lead- ing banking states had relaxed or repealed their interest rate ceilings. Meanwhile, South Dakota and Delaware had estab- lished themselves as attractive homes- away-from-home for credit card issuers. While a number of states maintain binding usury laws at this writing (most notably, Arkansas, with a ceiling of five percentage points above the Federal Reserve discount rate), essentially all major issuers can pur- sue business in those states free of restric- 8"Prospectus for Maryland Bank, N.A., Credit Card Trust 1987-A," December 9, 1987, pp. 17-18. 9Marquette National Bank v. First of Omaha Service Corporation, 439 U.S. 299 (1978). The Marquette deci- sion applies to credit cards issued by nationally char- tered banks, but not to retail cards (e.g., oil company credit cards). The decision explicitly permits banks to "export" their interest rates; banks have interpreted this also to permit the "export" of annual fees and other customer fees. At this writing, at the behest of the Iowa Attorney General, courts are considering whether this rule does indeed apply to fees. This content downloaded from 202.120.224.93 on Sun, 17 Dec 2017 07:42:57 UTC All use subject to http://about.jstor.org/terms
VOL 81 NO. I AUSUBEL: CREDIT CARD MARKET tion. It is fair to say that the bank credit mailing(11 responses) included a request card market in the United States was func- for direct profit calculations, which were tionally deregulated in 198 provided by seven banks. Appendix a pro- vides details of the construction of the I. Credit Card Interest Rate Behavior BCCS. Table 2 includes the size distribution of banks that reported data. Respondents A. Sticky Interest Rates were promised anonymity. The most aesthetically pleasing way for The cost of funds is obviously the primary an economist to determine the cost of funds determinant of the marginal cost of lending is to"let the market decide it. "In the case via credit cards, and it is usually the only of credit cards, this is feasible because of omponent of marginal cost that varies the phenomenon of credit card securitiza- idely from quarter o quarter. Thus, a tion. Consistently, during 1987-1989, model of continuous spot market equilil credit-card-backed securities offered yields rium would predict a substantial degree of in the vicinity of 0. 75 percent above those of onnection between the interest rate Treasury securities with comparable maturi charged on credit cards and the banks ' cost ties 2 Meanwhile the visa systemwide av- of funds. However, Figure 1, which com- erage cardholder payment rate (i.e, card- pares credit card interest rates with the cost holder payments as a percentage of out of funds, displays stark empirical rejection standing balances) ranged from 13 to 17 of this prediction. Credit card interest rates percent per month during the years were highly sticky during the period 1983-1987, implying an average maturity for 1982-1989 and, in fact, were virtually con- credit card receivables of 6-8 months. 3To ervative. i will define the cost of In this section, credit card interest rates funds to equal the one-year Treasury bill are captured by two distinct sets of data: yield 4 plus 0.75 percent, averaged over ne aggregated and one disaggregated. The each quarter. This series is also plotted in first set of data is the Federal Reserve Bul- Figure 1 letin series for credit card interest rates The proposition that interest rates are based on the Federal Reserve Board's quar- sticky can be formally supported by regress terly survey of banks. Reported are arith- ing credit card interest rates on the cost of metic averages of each bank's"most com mon"rate charged during the first week of each mid-quarter month This series is plotted in Figure 1. The second set of data IsEe, for example, "Credit Card Bonds are Hot (and much of the empirical discussion of 16. 1990.p. cIn: Credit icard the authors own bank credit card survey (November 15, 1988), p. 7; Credit Card management BCCS)of 58 of the largest bank issuers of May/June 1988, p. 34 credit cards. The first mailing(21 responses) asked primarily for pricing and cost data: it rate is Standard Poor's Asset-Backed Securitization generated a quarterly interest rate series for CreditReview, March 16, 1987, p. 19. Individual banks rospectuses have reported cardholder payment rates 17 credit card issuers and an annual loan- of 9-23 percent per month, never implying an average loss series for 10 issuers. The follow-up tuses in Appendix B). This impression was substanti. maturity of more port quote INDeed, the al Bank( First Chicago' s Delaware ary, listed fourth in Table 1)as Reserve bullet the period 1982-1989 is 18.85 saying that his bank finances its credit card portfolio ted is 17.77 percent(fourth quarter, 1988/lue re- with a variety of financial instruments with combined 985) and the lowest va maturit nt to a 145-day duration (Credir Federal Reserve Boards G. 19 stat April 5, 1990; Federal Reserve Bulletin, April 1990 table 1.56, line 4(and previous issue April 1990, table 1.35 line 21(and previous This content downloaded from 202. 120. 224.93 on Sun. 17 Dec 201707: 42: 57 UTC Allusesubjecttohttp:/about.jstor.org/terms
VOL. 81 NO. 1 AUSUBEL: CREDIT CARD MARKET 53 tion. It is fair to say that the bank credit card market in the United States was func- tionally deregulated in 1982. II. Credit Card Interest Rate Behavior A. Sticky Interest Rates The cost of funds is obviously the primary determinant of the marginal cost of lending via credit cards, and it is usually the only component of marginal cost that varies widely from quarter to quarter. Thus, a model of continuous spot market equilib- rium would predict a substantial degree of connection between the interest rate charged on credit cards and the banks' cost of funds. However, Figure 1, which com- pares credit card interest rates with the cost of funds, displays stark empirical rejection of this prediction. Credit card interest rates were highly sticky during the period 1982-1989 and, in fact, were virtually con- stant.'0 In this section, credit card interest rates are captured by two distinct sets of data: one aggregated and one disaggregated. The first set of data is the Federal Reserve Bul- letin series for credit card interest rates, based on the Federal Reserve Board's quar- terly survey of banks. Reported are arith- metic averages of each bank's "most com- mon" rate charged during the first week of each mid-quarter month." This series is plotted in Figure 1. The second set of data (and much of the empirical discussion of this and the next section) is derived from the author's own bank credit card survey (BCCS) of 58 of the largest bank issuers of credit cards. The first mailing (21 responses) asked primarily for pricing and cost data; it generated a quarterly interest rate series for 17 credit card issuers and an annual loan- loss series for 10 issuers. The follow-up mailing (11 responses) included a request for direct profit calculations, which were provided by seven banks. Appendix A pro- vides details of the construction of the BCCS. Table 2 includes the size distribution of banks that reported data. Respondents were promised anonymity. The most aesthetically pleasing way for an economist to determine the cost of funds is to "let the market decide it." In the case of credit cards, this is feasible because of the phenomenon of credit card securitiza- tion. Consistently, during 1987-1989, credit-card-backed securities offered yields in the vicinity of 0.75 percent above those of Treasury securities with comparable maturi- ties.12 Meanwhile, the Visa systemwide av- erage cardholder payment rate (i.e., card- holder payments as a percentage of out- standing balances) ranged from 13 to 17 percent per month during the years 1983-1987, implying an average maturity for credit card receivables of 6-8 months.13 To be conservative, I will define the cost of funds to equal the one-year Treasury bill yield14 plus 0.75 percent, averaged over each quarter. This series is also plotted in Figure 1. The proposition that interest rates are sticky can be formally supported by regress- ing credit card interest rates on the cost of 10Indeed, the highest value reported in the Federal Reserve Bulletin series in the period 1982-1989 is 18.85 percent (first quarter, 1985) and the lowest value re- ported is 17.77 percent (fourth quarter, 1988). "1Federal Reserve Board's G.19 statistical release, April 5, 1990; Federal Reserve Bulletin, April 1990, table 1.56, line 4 (and previous issues). 12See, for example, "Credit Card Bonds are Hot, but Maybe Stingy on Yield," Wall Street Journal, April 16, 1990, p. C1; Credit Card News, Volume 1, Number 3 (June 15, 1988), p. 2, and Volume 1, Number 14 (November 15, 1988), p. 7; Credit Card Management, May/June 1988, p. 34. O3The source of the systemwide cardholder payment rate is Standard & Poor's Asset-Backed Securitization CreditReview, March 16, 1987, p. 19. Individual banks' prospectuses have reported cardholder payment rates of 9-23 percent per month, never implying an average maturity of more than one year (see list of prospec- tuses in Appendix B). This impression was substanti- ated by a trade-publication report quoting the chair- man of FCC National Bank (First Chicago's Delaware credit card subsidiary, listed fourth in Table 1) as saying that his bank finances its credit card portfolio with a variety of financial instruments with combined maturities equivalent to a 145-day duration (Credit Card News, March 15, 1989, p. 2). "Federal Reserve Bulletin, April 1990, table 1.35, line 21 (and previous issues). This content downloaded from 202.120.224.93 on Sun, 17 Dec 2017 07:42:57 UTC All use subject to http://about.jstor.org/terms