The Economics of Credit Cards

The skyrocketing bankruptcy filing rates of recent years are well known. Some commentators and scholars have charged that the cause of the bankruptcy boom has been promiscuous lending by credit card issuers and irrational borrowing by credit card users. Spurred on by high-profits, it is argued that credit card issuers have extended ever-larger amounts of credit to ever-riskier borrowers. In turn, irrational consumers have borrowed ever increasing amounts, generating a downward spiral into bankruptcy. This theory rests on a substantial number of assumptions about the nature of the credit card market and the nature of rational credit card use by consumers. The thesis requires assuming that credit card users are homogenously concerned only about interest rates and not about any other term of the credit card contract, whether benefits, grace periods, or annual fees. In short, for the argument to be plausible, it requires a series of heroic assumptions about persistent profits in a market with low barriers to entry, a failure of competition in a market with all structural indicia of competitiveness, a peculiar and extraordinarily narrow definition of the indicia for measuring competition, and a failure of consumer rationality in a situation where there are strong incentives for consumers to act rationally and to learn over time. Alternatively, it could be argued that the credit card market is competitive and that consumers use credit cards rationally. As this article will show, both credit card issuers and consumers appear to act in a manner consistent with the predictions of economic theory. It is not necessary to rely on implausible assumptions about consumer irrationality or to devise idiosyncratic models of a failure of competition in the credit card market. This article will present voluminous empirical evidence - most of which has heretofore been ignored in the legal literature - demonstrating that the operation of the credit card market and consumer choice is consistent with rational decision-making subject to real-world constraints. Moreover, this suggests that there is some efficiency loss as a result of bankruptcy, and that at least some of the losses of credit card issuers are absorbed by other consumers. Finally the paper suggests some bankruptcy implications of a proper understanding of the nature of the credit card market and rational credit card use by consumers.