Mixed in with the millions of holiday cards to be opened this month will be small white envelopes stuffed with some very unfestive surprises. Credit card bills, once cheerfully polite in their requests for a mere $10 or $15 each month, will start abrasively demanding much higher minimum payments in December and January. The move is pinching shoppers’ wallets, and sparking uproar among consumer advocacy groups.

After two years of dragging their feet, several of the big-name U.S. banks are finally heeding grumblings of the Treasury Department and redlining their policies to encourage consumers to pay off credit balances “in a reasonable amount of time”.

According to the Cambridge Consumer Credit Index (CCC), which measures credit behavior, 45% of credit card holders show patterns of making just the minimum payment or no payment at all. This worries Treasury Department economists, who see these consumers stretched way too thin in times of rising interest rates, and are scrambling to make sure this pocket of the economy doesn’t snap.

So now, at the Treasury Department’s request, instead of requiring customers to fork out only ten bucks or some nominal amount that doesn’t touch principal of the balance each month, banks are begrudgingly wording their policies to demand things like 1% of the outstanding balance plus fees and finance charges.

Although the change is groundbreaking in principal, the “reasonable amount of time” still seems mildly shy of devastating for most. By paying only the minimum, a person is still dragging repayment over an intolerable timeline. In fact, at a 15% interest rate, it would take over 100 years to reduce a $1000 balance to $100 if the person was making 1% minimum payments plus finance charges.

Even so, consumer advocacy groups are still saying that the measure is too harsh.

Interestingly, CCC itself states that the new policies are going to “hurt a lot of consumers living on the threshold" of financial stability.

And some economists are saying that the measure is too intrusive to markets. If the banks were allowing such easy policies before the Treasury got involved, they must have been making enough in fees and finance charges from the more stable customers to make up for the defaults the low payments were encouraging for their less creditworthy customers.

An important question here is, should the government mind its own business and let the market decide the “price” of the minimum payment? Or do America’s current circumstances of negative savings rates and massive debt levels warrant the installation of a protective safety net?

In more moderate times, it would probably be wise for the government to stay out of the credit card market because it is truly an unaffected party. But in more extreme debt-ridden circumstances, the government is affected, because having thousands of people default may lead them to eventually require government assistance (welfare, food stamps, etc.). This externality is not considered by the banks when they make their minimum payment pricing decisions, so government action may well be warranted. The key is to identify what level of debt should be the threshold that triggers intervention.

Perhaps this extra squeeze will push consumers to be more responsible with their purchases and get our nation back into happy black. Until then, looks like cheerless white will be this season's popular color.

Posted by Michelle Smith on December 19, 2005 10:08 AM