Distinguish between transactional and revolving credit
[M]aybe it’s worth remembering that the tyranny that credit scores exercise over our imagination have everything to do with the fact that we’ve built a society so utterly dependent on credit.
Kevin Drum responds…
[T]here’s nothing per se wrong with the fact that modern economies are so dependent on credit. Widespread use of credit really does make life more convenient, really does make banking more efficient, really does enable useful advances like online shopping, and really does allow easier access to goods and services that would otherwise be difficult to get hold of. Used in moderation, it’s good stuff. I sure don’t want to return to the days of hauling around travelers checks whenever I fly off to Europe.
Speaking for myself, my jeremiads against the credit-industrial complex have never been meant as an attack on widespread access to credit itself. Used reasonably, credit cards are a boon and credit reporting is a necessary part of providing credit responsibly in a big, complex world. That said, credit is critically important to everyday living now, and that means that it needs to handled fairly and transparently.
We won’t get very far in the debate about credit in the US economy if we fail to distinguish between transactional and revolving credit. These are two are fundamentally different products, and much ill has come from conflation of the two. All of the good things Kevin attributes to widespread credit access are benefits of transactional credit. Because credit cards have often bundled transactional and revolving credit together, it is easy to attribute these good things to revolving credit. That’s a mistake. Transactional credit is essential, and might even be publicly provided. Revolving credit is a double-edged sword.
Transactional credit is a means of decoupling the process of making payments from the form in which ones liquid wealth is held. More simply, if you have the money to pay for what you are buying, but just don’t want to carry cash or keep track of your checking account balance every day, you are making use of transactional credit. Many people only use credit cards for transactional credit. They pay off their entire balance each month.
Revolving credit is a different product. It provides a means by which people can spread the cost of purchases over an indefinite period of time. If you wish to go on a vacation, and can afford to pay for it from your next six months’ salary, but could not easily come up with the money now, you are making use of revolving credit.
Both transactional and revolving credit are useful, and conventional credit cards give consumers access to both. But revolving credit is much more prone to abuse than transactional credit. Though economists hate to admit it, it is a fact of life that human beings do not, in general, seem to have time-consistent preferences. If preferences aren’t time-consistent then people are prone to making short-term deals that they will seriously regret in the distant future. Revolving credit is like morphine: When used properly, it can be very useful. But experience has shown that it can cause great harm if used incautiously.
Revolving credit needn’t be bundled with transactional credit. The traditional American Express card, for which you are charged a flat annual fee and pay your balance in full each month, is a transactional pure play. Transactional credit has different characteristics than revolving credit. In particular, consumers can get most of the benefits of transactional credit with low credit limits, perhaps twice a typical month’s expenses. (If restricted to transactional credit, consumers may have to find other means of paying for occasional large purchases. They might need to put funds into a bank account in advance, and pay via debit. As long as such purchases are infrequent, this is not a terrible burden.)
If we set aside “tricks and traps“, transactional and revolving credit products should inspire very different business models. Transactional credit resembles an insurance product, while revolving credit is like a traditional loan. The primary benefit a consumer receives from transactional credit is not the financing debt, but the option to purchase at any time without having to track specific account balances or coordinate transfers. This service is provided regardless of the size of any given month’s balance. Consumers should be (and historically have been) willing to pay a flat fee for it. Even very modest interchange fees more than cover the cost of capital on the loans, so fees can be quite low and might go to zero for some customers. (A 1% interchange fee amounts to a 12% annualized rate for a low-balance, 1 month loan. Conventional interchange fees of 2-3% offers exorbitant returns on 1-month loans, part of which may be rebated via rewards programs.) There is no reason why transactional credit can’t be a fine business, and it has been, both for American Express and every other credit card provider sending unsolicited offers to people whom they know pay their balances off monthly.
Revolving credit, when it is not about tricks and traps, is all about the interest rate. Revolving credit is prone to abuse, and should be made available cautiously, not automatically or indiscriminately. Credit card interest rates should simply be capped, which would prevent less creditworthy borrowers from gaining access to revolving credit lines. That is a feature, not a bug. In a world where agents have inconsistent time preferences, paying high interest rates for present consumption is prima facie evidence of selling out future selves for present goods. Rational high interest rate borrowers are either those who intend to default (thereby extracting a wealth transfer from the more responsible subset of the population), those who are financing goods that will yield benefits over time, and those who face an unusual emergency which requires the future be held hostage to the present. We want to deny credit to the first group, the rational defaulters. People who are financing goods that will yield benefits over time can usually get credit on much better terms by taking out securable, asset-specific loans. We should encourage the resurgence of secured vendor financing, because that form of credit can offer huge savings to less creditworthy borrowers, compared with ubiquitous unsecured plastic. Finally, the usefulness of high limit credit cards as kind of insurance is undeniable, but dangerous. Every day has its crises; that is the human condition. It is easy to err by taking on “absolutely necessary” debt today that leaves one absolutely destitute tomorrow. We should develop better forms of emergency insurance than unsecured debt. To the degree that we do rely upon access to credit as a reserve cushion, it shouldn’t be attached to our instrument of casual commerce. It should be special, and have a “break-glass-in-case-of-emergency” feel to it.
Access to revolving credit should be rationed, but transactional credit should indeed be ubiquitous. Not having to carry and count cash, deal with paper checks, or even worry about some particular account’s balance at the time of purchase are important benefits. Indeed, an efficient payments system is a public good. That’s why states are in the business of establishing currencies, right?
In fact, while transactional credit provision is a perfectly good business, it might be reasonable for the state to offer basic transactional credit as a public good. This would be very simple to do. Every adult would be offered a Treasury Express card, which would have, say, a $1000 limit. Balances would be payable in full monthly. The only penalty for nonpayment would be denial of access of further credit, both by the government and by private creditors. (Private creditors would be expected to inquire whether a person is in arrears on their public card when making credit decisions, but would not be permitted to obtain or retain historical information. Nonpayment of public advances would not constitute default, but the exercise of an explicit forbearance option in exchange for denial of further credit.) Unpaid balances would be forgiven automatically after a period of five years. No interest would ever be charged.
Let’s think about how this would work. For most people, access to various forms credit — transactional credit, auto and home loans, unsecured revolving credit, whatever — is worth more than $200 per year. Although people might occasionally fall behind, for the most part borrowers would pay off their government cards, simply because convenient participation in the economy is worth more than a once-in-five-years $1K windfall. However, people with no savings and irregular income (for whom transactional credit is a misnomer, since they haven’t the capacity to pay) might well take the money and run. The terms of the deal amount to a very small transfer program to the marginal and disorganized, and a ubiquitous form of currency for everyone else. People with higher incomes would want more transactional credit, or revolving credit, which they would acquire from the private sector.
I’ve posited that people often have time-inconsistent preferences. Am I, them, inconsistent to suggest that most people wouldn’t people take a free $1K today and be stuck without credit thereafter? No. The degree to which people underweight future costs varies between individuals, and is changeable. Most people do work to avoid present choices that will create future hardship. (Many people arguably overweight the future.) However, high-limit revolving credit is a particularly nasty trap for those who even slightly underweight future costs. One nice aspect of a low-limit, indiscriminate, mechanical public credit system would be educational. Many younger people would spend some period of time modestly in debt and shut out of the credit economy. This would provide a more gentle lesson than the current practice of running up revolving balances in college and working desperately for years to pay them down.
The notion of transactional credit as a state-provided public good is speculative. Maybe it’s a terrible idea. Regardless, the distinction between transactional and revolving credit is crucial. A modern economy probably does require widespread access to transactional credit. But revolving credit is a different story entirely, and we would be better off controlling it more carefully. We shouldn’t be shy about adopting policies that would curtail the provision of unsecured revolving credit, as long as transactional credit is protected.
Some of this was inspired by a conversation with the excellent keyholez over Twitter. (I have been playing on Twitter recently, and am still trying to decide what I think of it. If you’re into that here’s me and here’s keyholez.)
- 22-May-2009, 1:15 p.m. EDT: Minor fixes, took out overly wordy “role of” stuff from first para, fixed spelling of forbearance, clarified an apparent redundancy, “is variable…and is not fixed”.
why a public and not a private system? do you expect that it would lose money?
i think that what is really lacking is a micropayment / authentication system linked to the internet. (then we could count time on your blog toward GDP!)
May 21st, 2009 at 8:50 pm PDT
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babar — i’ve no problem with private transactional credit provision. the advantage of a basic public system would be inclusiveness: if access to credit is automatic (and consequences for abusing it leave one no worse than having no access at all) it might help integrate marginal people into the “new money”, and provide a downscale alternative for people who dislike the terms on which private transactional credit is offered, or who don’t want to do business with the institutions offering. (as we are learning, practical exit is an important prerequisite for market discipline. both the banking system and the US Treasury are currently relying upon this.)
but the idea of a public transactional credit system is really something i just wanted to throw out for consideration. i can see reasons for it, and some real problems as well, but it struck me as an interesting what if. most money is now transactional credit. debit cards are just overnight transactional credit. why shouldn’t basic access be provided on generously accessible terms, and with training wheels to help people learn to use credit well?
May 21st, 2009 at 9:15 pm PDT
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babar — more. also, i do think that the core payments system should be considered a public resource, to which private institutions serve as a convenience / user interface layer. and this kind of thing would help set the stage for a universal transfers infrastructure, something i really favor…
i didn’t really answer your questions: 1) i think private transactional credit provision needn’t be (and hasn’t been) a money loser, but universal transactional credit provision would imply either losses or cross-subsidization, and maybe cross-subsidization by taxpayers is fairer and less-distorting than higher fees on good customers; 2) i’d love to see a micropayments scheme succeed, for personal as well as policy reason… but by any reckoning, whatever it is that i do ought to be subtracted from GDP…
May 21st, 2009 at 9:26 pm PDT
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I’d like to see it just because it would be an instant test to see how much collusion is going on in the banking/credit card world. How much would interchange fees overnight drop if gas stations suddenly had a public credit option? It may actually become competitive, like a real market.
The real loss would be, without charging interest, you’d need people to administer it, handle card replacements, sit on the phones for fraud and complaints, work wit businesses, etc. Is a 1% handling fee a good estimate? $1,000 * 200,000,000 adults * 1% = around $2bn a year to run it after it gets started. Is that a good tradeoff?
May 21st, 2009 at 10:34 pm PDT
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While your public good idea incorporates modern conveniences, it reminds me of one of the oldest forms of government sponsored charity: http://en.wikipedia.org/wiki/Monte_di_Pieta
May 22nd, 2009 at 1:17 am PDT
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r-bomb — actually competitive? i think for that we’d have to expose interchange fees outright. imagine if interchange fees were just tacked on top of quoted prices, like sales tax. market forces might be harnessed.
that said, there’s nothing wrong with interchange fees, or there wouldn’t be if they were competitively priced.
a public program could charge interchange fees to cover its costs, but i’d probably prefer not and just run the program at your guesstimate of $2B. sounds like a cheap date to me. i think the cost of expected defaults would dwarf this. say on average 10% choose to take the $ and do without credit. at an avg cost of $200/yr, that gives $4B annually in net transfers. So, we’d have a $6B p.a. program. That’s a cheap date, a pretty transformative program for less than 0.25% of Federal pre-crisis spending.
if a public program provided $1K of transactional credit with no fees at all, private credit provision would basically be a “jumbo” market: higher costs for those who want more than what’s cheaply provided. i don’t see anything wrong with that. private credit providers would grumble about the volume of business “stolen” by the govt subsidized program. but they’d benefit from reduced pressure to supply credit to customers they deem commercially marginal. (of course from a “tricks and traps” perspective, the loss of squeezable marginal borrowers may indeed be a hardship. my tears flow in rivers.)
May 22nd, 2009 at 4:41 am PDT
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Anon — re http://en.wikipedia.org/wiki/Monte_di_Pieta
very cool story. who knew that the first pawn shops in Europe were charitable organizations? something changed between 1361 and Dostoevsky’s day… it is still surprising to me that credit was deemed so essential in the 14th century that it was charitably provided. but at this point, i’ve seen so-many far historical crisis analogs that i guess i’m just waiting evidence that proto credit default swaps were used by Hammurabi.
May 22nd, 2009 at 4:50 am PDT
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Steve: “..but [if you] just don’t want to carry cash or keep track of your checking account balance every day, you are making use of transactional credit.”
It’s not jut a matter of wishing or not wanting. If you pay your typical daily expenses with cash or with your debit card/checking account balance, then you have an overview of your expenses. I really think that a lot of the problems are due to most people NOT having an overview of their expenses. How many people write down at the start of each year a likely cash flow schedule: income, taxes, rent/mortage, utilities, insurances, car/bike/public transport, food, clothes, phone, etc., and check every month how they are doing?
Not wanting to keep track of one’s account balance is too lazy for me.
Steve: “Revolving credit is a different product. If you wish to go on a vacation, and can afford to pay for it from your next six months’ salary, but could not easily come up with the money now, you are making use of revolving credit.”
It’s not just a matter of wishing or not wanting. If you wish to go on a vacation, but could not easily come up with the money now, then you better change your vacation plans. Go camping, stay closer to home, don’t go to Disney world, but take a nice hike, etc., and save some money. In that way next year, you probably do have the money up-front to take your vacation.
The concept of revolving credit — to take the waiting out of the wanting — is bound to cause trouble!!
Also, just last week I read an article referring to research about credit card usages: it showed people are willing to pay up to twice as much for attending a sporting game, if paid by credit card, compared to paying by cash. Conclusion: most people do not realize the consequences of paying by plastic.
I do know that for most people real income has fallen over the last 3 decades, especially the last one, and many people tried to keep up by taking on an extra job, or going from 1 to 2 income per household, or using house as ATM, and using multiple credit cards, but the latter two methods were not proper solutions, but means to postpone the inevitable.
May 22nd, 2009 at 6:53 am PDT
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@srw, i’ve no problem with a public transactional system except for the following:
— politics could enter more easily into the way it is run, and that could be a bad thing (f&f, aig, etc). but given that it would be ‘too important to fail’ we might just have to live with that. the US does not have a good track record with ‘independent’ govt agencies.
— if private systems develop that are cheaper or more interesting to the end user, the govt system could fall into disuse or only be used by those who game it
these are general considerations.
i think the government should partially own the authentication technology, given that it will pay the costs of law enforcement vs fraud. this is the same situation with paper money (govt owns the printing presses and tries to stay a step ahead of the counterfeiters)
May 22nd, 2009 at 9:51 am PDT
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“It’s not just a matter of wishing or not wanting. If you wish to go on a vacation, but could not easily come up with the money now, then you better change your vacation plans.”
Maybe that’s not the best example – how about – if you become ill and can’t afford the doctor’s bill? You can’t exactly change your plans for being ill, but you can change your plans as to how you spend in the future.
On another note, when you have monopolies you should either regulation heavily or regulate lightly with a public alternative. Otherwise costs rise and markets are distorted.
In a strange way, light government participation is how markets remain free.
May 22nd, 2009 at 10:43 am PDT
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Came over from Naked Capitalism. This is an interesting idea. I’m thinking about it from the perspective of the dirt poor: the $1000 gift is great, but I’m not sure this would be helpful in the long run. The loss of the ability to run up emergency credit debt would leave a lot of people very screwed. People would get private credit cards and run up debt on them anyway, but the rates on the private cards would probably be even worse since there wasn’t the money coming in to the private cards from the first 1000 of most people’s monthy usage…
Seems like a first step would be for the government to provide free checking/check cashing, so at least the dirt poor would have a place to put what money they got without having to get scalped by check cashing services. Right now, people who don’t have direct deposit or $200 to keep in an account, and so who can’t get free checking at most banks, don’t have checking accounts… Without checking accounts, how would people pay off their Treasury card? It would cost too much for the government to have storefronts that accepted cash.
May 22nd, 2009 at 1:38 pm PDT
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Perhaps instead of having the government offer credit directly, they could just regulate private banks such that people who overdraw their checking accounts would have the choice of paying back the money at the end of the month with no interest in the way you describe (with banks being compensated by the government for their trouble.) That way, you’d be able to do this while keeping the government at arm’s length.
May 22nd, 2009 at 2:51 pm PDT
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Madeline F’s concerns with regard to worsening problems with revolving credit have stimulated my curiosity: what do you think the emergency revolving credit market would then look like with the transactional reforms you describe? Would the loan business change to make it possible to, say, get very fast loans with lower standards for whom to lend to if a medical emergency is cited? Is there a business model for standalone revolving credit businesses that isn’t explicitly predicated on screwing people over when you no longer have the transactional credit involved? What would these “smash in case of emergency” rules look like?
I think the public option you describe is very interesting and at least on its face a good idea.
May 22nd, 2009 at 5:13 pm PDT
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To make it more useful to people who sometimes spend more than $1000 in a month, you could be allowed to overpay/prepay the card so they could then charge the amount they overpaid plus the $1000. Also, maybe people running balances could have that deducted from any tax refund. It seems to me there should be lots of way to minimize the cases of the taxpayer losing $1000.
May 22nd, 2009 at 6:08 pm PDT
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“Finally, the usefulness of high limit credit cards as kind of insurance is undeniable, but dangerous. Every day has its crises; that is the human condition. It is easy to err by taking on “absolutely necessary” debt today that leaves one absolutely destitute tomorrow. We should develop better forms of emergency insurance than unsecured debt.”
Below is what Harvard bankruptcy and personal finance expert Elizabeth Warren and I recommend. This is a working version of the Budgeting page for the University of Arizona Free Personal Finance site, which should be launched in a few months:
Budgeting
By Richard Serlin
Adjunct Professor of Personal Finance, the University of Arizona
President, National Personal Finance Education
The foundation of budgeting, and personal finance in general, is the Balanced Money Plan of Harvard Professor Elizabeth Warren. This plan says to:
– Spend no more than 50% of your after tax income on fixed expenses, which are anything you have to pay for each month, and cannot cut back in the short run. This includes your rent or mortgage, any car payments, basic food, basic utilities, insurance, etc. Professor Warren calls these things “Must-Haves”.
– Save at least 20% of your after-tax income every month.
– And the rest of the money can be spent on anything you’d like. This is your discretionary spending, for example eating out, a new dress, a big screen TV, anything you’d like. Professor Warren calls this spending “Wants”.
If saving 20% every month seems very hard, or impossible to you, this is probably because you are spending much too much on Must-Haves. The most important single piece of advice in personal finance is to cut your Must-Haves to under 50% of your after-tax income. If this means selling your new SUV and Honda Accord, and buying two 10 year old Honda Civic EX 4-Doors, then that’s what you must do. It will be well worth it to stop constant financial stress (and possibly ruin), and constantly denying yourself the little day-to-day pleasures, to pay hundreds of extra dollars each month to your cars.
If it means selling a home you can’t truly afford, then you just have to do it, and move to a smaller one, or a less fancy neighborhood, until you save enough that you can really afford it without constant financial stress, deprivation, and danger of ruin. Your Must-Haves must be brought under 50% of your take home pay. The little things like clipping coupons, bringing a bag lunch, etc. are good, but they are just dwarfed by the big fixed expenses – These have got to be dealt with, and eventually cut to less than 50% of your after tax pay.
An important note on Must-Haves is that although they should essentially never exceed 50% of your after tax income, the riskier your income, and life in general, the lower they should be. For example, if you are self employed, and there is a substantial risk of business going bad, and your income dropping in half, your Must-Haves should be much lower than 50%, so that if this does happen, you can weather it without descending into a spiral of debt leading to ruin.
If you have children and a mortgage, you are unfortunately usually more at risk financially; if things go wrong, you are not some 25 year old who can easily ask his landlord to find a new tenant, and then bunk with a friend, or move back in with Mom and Dad.
And the older you get, typically, the more specialized and high income your job gets. Unfortunately, this usually makes it much more likely that if you lose your job, you won’t be able to find another one paying nearly as much. As a result, for most people it makes sense to lower your Must-Haves by about 5% relative to your income every 10 years, at least until your Must-Have percentage is in the 30’s. A great way to do this is, when it does make sense to buy a home, you obtain a fixed payment mortgage. That way, as your income goes up, your mortgage stays the same, lowering your Must-Have percentage. It is also always a great idea for financial security to pay off your mortgage as quickly as possible.
For more details on the Balanced Money Plan and its implementation, please read the first 40 pages of our free personal finance course (and hopefully finish the course).
The Balanced Money Plan was first designed by Harvard bankruptcy and personal finance expert Elizabeth Warren, who among her many achievements was selected during the economic crisis of 2008 to chair the Congressional Oversight Panel for Economic Stabilization. Her inexpensive book, “All Your Worth: The Ultimate Lifetime Money Plan”, I believe, is by far the best personal finance book available today. I strongly recommend anyone read it.
May 22nd, 2009 at 6:25 pm PDT
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I revised this a little bit after posting, adding an important paragraph:
Budgeting
By Richard Serlin
Adjunct Professor of Personal Finance, the University of Arizona
President, National Personal Finance Education
The foundation of budgeting, and personal finance in general, is the Balanced Money Plan of Harvard Professor Elizabeth Warren. This plan says to:
– Spend no more than 50% of your after tax income on fixed expenses, which are anything you have to pay for each month, and cannot cut back in the short run. This includes your rent or mortgage, any car payments, basic food, basic utilities, insurance, etc. Professor Warren calls these things “Must-Haves”.
– Save at least 20% of your after-tax income every month.
– And the rest of the money can be spent on anything you’d like. This is your discretionary spending, for example eating out, a new dress, a big screen TV, anything you’d like. Professor Warren calls this spending “Wants”.
If saving 20% every month seems very hard, or impossible to you, this is probably because you are spending much too much on Must-Haves. The most important single piece of advice in personal finance is to cut your Must-Haves to under 50% of your after-tax income. If this means selling your new SUV and Honda Accord, and buying two 10 year old Honda Civic EX 4-Doors, then that’s what you must do. It will be well worth it to stop constant financial stress (and possibly ruin), and constantly denying yourself the little day-to-day pleasures, to pay hundreds of extra dollars each month to your cars.
If it means selling a home you can’t truly afford, then you just have to do it, and move to a smaller one, or a less fancy neighborhood, until you save enough that you can really afford it without constant financial stress, deprivation, and danger of ruin. Your Must-Haves must be brought under 50% of your take home pay. The little things like clipping coupons, bringing a bag lunch, etc. are good, but they are just dwarfed by the big fixed expenses – These have got to be dealt with, and eventually cut to less than 50% of your after tax pay.
With Must-Haves under 50%, if a crisis hits, like losing your job, you have over 50% of your spending (and saving) that can still be cut back immediately, as only Must-Haves are not immediately cutable. This means that you may be able to weather the storm just on the income of a spouse, or unemployment compensation, without destroying your savings, and after that falling into a ruinous debt spiral.
An important note on Must-Haves is that although they should essentially never exceed 50% of your after tax income, the riskier your income, and life in general, the lower they should be. For example, if you are self employed, and there is a substantial risk of business going bad, and your income dropping in half, your Must-Haves should be much lower than 50%, so that if this does happen, you can weather it without descending into a spiral of debt leading to ruin.
If you have children and a mortgage, you are unfortunately usually more at risk financially; if things go wrong, you are not some 25 year old who can easily ask his landlord to find a new tenant, and then bunk with a friend, or move back in with Mom and Dad.
And the older you get, typically, the more specialized and high income your job gets. Unfortunately, this usually makes it much more likely that if you lose your job, you won’t be able to find another one paying nearly as much. As a result, for most people it makes sense to lower your Must-Haves by about 5% relative to your income every 10 years, at least until your Must-Have percentage is in the 30’s. A great way to do this is, when it does make sense to buy a home, you obtain a fixed payment mortgage. That way, as your income goes up, your mortgage stays the same, lowering your Must-Have percentage. It is also always a great idea for financial security to pay off your mortgage as quickly as possible.
For more details on the Balanced Money Plan and its implementation, please read the first 40 pages of our free personal finance course (and hopefully finish the course).
The Balanced Money Plan was first designed by Harvard bankruptcy and personal finance expert Elizabeth Warren, who among her many achievements was selected during the economic crisis of 2008 to chair the Congressional Oversight Panel for Economic Stabilization. Her inexpensive book, “All Your Worth: The Ultimate Lifetime Money Plan”, I believe, is by far the best personal finance book available today. I strongly recommend anyone read it.
May 22nd, 2009 at 7:06 pm PDT
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carol — beautiful turn of phrase: “to take the waiting out of the wanting”
one of the reasons why people might pay more with credit is that you can roll indefinitely. at some level, you never actually have to pay back a CC loan. you only have to service it, which is expensive, but comes in dribs and drabs. so you can go a long time before getting sharp feedback about the cost and unsustainability of expenditures. eventually there is usually a reckoning, as even servicing the debt becomes burdensome. but those overpriced game tickers were years ago by then.
i’d argue that easy access to credit was not just a response to stagnant real incomes, but also a cause. we would have intervened to change the terms of economic growth if consumption had been pinned to real incomes.
May 23rd, 2009 at 1:35 am PDT
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babar — i agree about the hazards of politicization of a public credit system. that can be mitigated, somewhat, by keeping the terms of the credit very mechanical — unifirm limits, automatic and uniform response to nonpayment, etc. but it’d be bad if, say, we ended up arguing about whether the government should lend money to people to buy guns or to pay for abortion. anonymous cash is inherently neutral, sometimes too neutral in that it serves to mediate even payments to hitmen and the like. we’d want any public credit system to be neutral at least between legal transactions, but if ‘independence’ fails, we might end up with a very prissy form of money that only consents to buying broccoli.
i don’t think it’s much of a problem if a public system is in practice underutilized, or used primarily by people who take the money and don’t use credit (as long as the fraction of people willing to have no credit in exchange for a few bucks is small). a public credit system would be a form of insurance: it would guarantee access to basic electronic transactional credit to everyone. if there are other better options for everyone, great, there’s nothing wrong with insurance that goes unused. but historically, the private banking and credit system has always left an “unbanked” or “underbanked” population (and when it has attracted the traditionally unbanked, it has often been with crappy deals). so i suspect there would be use of the program at least by the traditionally unbanked. i also suspect that at the margins, some people who might otherwise have sought private credit would content themselves with the public card, so users of state credit would be a somewhat larger group that the current “unbanked”.
how to authenticate and guarantee the integrity of this kind of system is obviously a big deal. i presume that what paypal can do the government could do as well. but maybe that’s a presumption too far. you are right that, with this sort of system, the government would end up “owning” technologies that serve as the digital equivalent of the all anticounterfeiting features they put into a dollar bill.
May 23rd, 2009 at 1:54 am PDT
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pebird — genuine emergencies are one of the better justifications for widespread access to high-limit, revolving credit. i certainly feel safer knowing that if, say, a loved one were hurt while we were traveling, i could muster resources to move heaven and earth to escape the fix, even if that implies taking in unaffordable debt. there are some matters that will always be more important to human beings than any financial concern. that causes problems in the aggregate, for example re health care, but i’d not condemn anyone for any level of debt-financed expenditure in a life and death emergency, and credit cards do empower us in desperate situations.
I agree with both parts. One can argue that even though the banking/credit card industry is in some sense competitive, it is also somewhat cartelized. (a cartel coordinated in part by regulation and supervision…offer loans on unusually customer friendly terms, and regulators might be concerned a bank is trading safety for volume, and object.)
May 23rd, 2009 at 2:16 am PDT
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Madeline F — so if people have a “Treasury Express” account, than they have in some sense a bank account. all that’s necessary (as Crust argues) is to permit people to overpay, that is to have a credit balance. there are advantages to keeping separate checking accounts that are not automatically debited (users of credit cards have greater ability to review and dispute transactions than debit card users, whose funds have already been taken), but for the totally unbanked, an automatic check card with $1000K free overdraft protection would be a pretty good deal.
As far as storefronts, I don’t think it’s as hard as you think. Post-offices could accept payments, and the government could deputize (and require) banks to as well. Paychecks could direct-deposit to the card account. For savvier customers, there might be lots of digital payment options too.
Re emergencies, more below.
May 23rd, 2009 at 2:31 am PDT
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UserGoogol — yeah, you could simulate something like the public credit system proposed within the banking system. but a few questions are 1) would it be universal, would it include the traditionally unbanked; and 2) would it be gentle, that is could both the degree of potential indebtedness and consequences for nonpayment be kept mild in a bank-managed system; and 3) would banks encourage (as they historically have) users to “trade up” to ever more dangerous credit products?
May 23rd, 2009 at 2:32 am PDT
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Miwome — So, fundamentally high interest rate revolving credit is a bad form of insurance for any sort of foreseeable emergency. Health insurance should cover ordinary medical emergencies, one can and should by traveller’s health insurance, with medevac options if the destination country’s healthcare is suboptimal, etc. Any dedicated form of insurance is going to be cheaper in aggregate than ad hoc use of credit cards to get out of various scrapes. We should certainly encourage the use of dedicated insurance products for the emergency risks we understand.
That said, I think that there are emergencies that we can’t foresee well enough to insure. People justifiably want the insurance against those emergencies that access to credit provides. I think that there might evolve products very much along the lines that you suggest, where one could set up fairly automatic access to a large credit line if and only if one attests to an emergency. Lenders might or might not serves as gatekeepers, in the sense of requiring an explanation and judging whether the circumstances constitute a sufficient emergency. The terms of such credit would ideally be quite different from credit cards: there might be a high transaction fee (to discourage casual emergencies), followed by a fixed term amortizing payment schedule (like a mortgage) with no prepayment fees for paying off the debt. Overlapping emergencies (which might happen as a result of bad luck or abuse of the facility), i.e. when you want a new loan while you’re still paying for the last emergency, might be discouraged by higher fees.
That all sounds elaborate. But really, any scheme for which frequent lending is not the norm and that would require an active contact and approval before accepting charges would be much better than using everyday credit cards for insurance. Conventional credit card lenders intentionally blur the distinction between casual and necessary use. It might not take much to undo this blurring, if transactional and emergency credit were explicitly distinct products.
May 23rd, 2009 at 3:02 am PDT
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Crust — Good suggestions all.
May 23rd, 2009 at 3:02 am PDT
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Richard — That all looks to me like pretty good advice.
May 23rd, 2009 at 3:03 am PDT
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Wow! I was visiting links from Mish’s page and stumbled across this one. Reminds me of when I was in high school. I use to sit around and think how Government could actually solve any problem we had. If we just had the right people in charge and it was set-up in the correct way, everything would be pardise. Does this sound familiar? Instead of sitting on your asses and daydreaming of how you can deploy the government to help other people, why don’t you go out and do it yourself? Go out and create wealth that other people want. The more weatlth you create, the more wealthier and better off you make our society.
May 23rd, 2009 at 7:48 am PDT
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Here some easy questions for you to ponder.
Why just 1k? How about 5k or 10k?
Why 5 years? Why not 10 years or 1 year or no time penalty?
What are you going to do when a majority of the people you are trying to help are banned from the system because of failure to repay? You can see the changes coming.
I think alot of people will take the 1k and run.
May 23rd, 2009 at 7:58 am PDT
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We are in the 21st century. Transactional credit shouldn’t exist at all. It would be feasible to provide everybody in the country an account with the central bank, with instantaneous debit of money whenever a transaction is made.
I am also ready to bet that it can be done with much less overheads than with what credit card companies are providing today. From a transactional standpoint, credit card became a racket business :
– consumers are forced to get a credit card to build a credit history
– shops are then forced to accept credit cards not to loose potential customers
– by their contracts with the CC company, shops are prohibited to pass the charge to customers (or, equivalently, to give a rebate for cash payment)
– shops are forced to charge higher prices to compensate for retailer fees.
The end result is that the shop and the consumer loose value at the expense of a credit card company that just provides a ludicrously priced money transfer.
May 23rd, 2009 at 8:47 am PDT
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I was just now googling around about this when I found your post. I’m just visiting to say that I really liked reading this post, it is really clear and well written. Are you planning towrite more on this? It seems like there’s more material here for future posts.
May 23rd, 2009 at 9:29 am PDT
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Steve,
1000 bucks of credit by Uncle Sam for every citizen is not real credit, since Uncle Sam needs to tax 1000 bucks for every citizen in advance of implementing the plan. Setting aside the potential of wealth redistribution (who gets taxed != who gets the money) I see no difference in requiring every citizen to maintain a $1000 account balance at the end of the month and pay stuff with a debit card, instead of a credit card.
This is how thing worked until not long ago here in Italy, all non-cash transactions were performed with Bancomat cards and after checking for funds availability and booked to people’s account within a few days. You just need to save $1000 once in the whole of your life and you don’t need no stinking credit card.
It all come down to living within (or below) your means. If you can’t keep consistently a balance of $1000 on your demand account your income doesn’t support your life-style and no stinking Treasury Express is going to change a thing.
Excellent and provocative post as always! It’s quite some time that I wonder who on earth wants to lend unsecured, it’s mind boggling stupidity!
May 23rd, 2009 at 11:38 am PDT
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It’s a nice idea, but it won’t work because 1) the credit card companies would never let it happen and 2) the working poor who most need relief from rapacious lenders also need revolving credit. See my post here for a full explanation of point 2.
May 23rd, 2009 at 3:03 pm PDT
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i really hate to perform any kind of “moderation”, but there were about 10 repetitions by “w I Got a Free iPhone With Free iPhone Apps”, and i’ve deleted all but one, which is left to linger in the thread, for whatever value it has to offer. (i’ve also banned the originating IP.)
in general, the “moderation” policy here is that i don’t do it, but i’ll make exceptions of in my judgment comments comments are off-topic spam and interfere with the flow of a substantive conversation.
this is actually the first time i’ve deleted comments. i feel yukky.
May 23rd, 2009 at 7:03 pm PDT
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Truth. Culture is shaped by incentives, and the culture of credit and consumption is shaped by the ease of obtaining credit. I don’t think we would have current imbalances if credit was extended less freely.
May 24th, 2009 at 1:52 am PDT
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SW:
I just realized what you are talking about. EC Harwood of the American Institute of Economic Research in Great Barrington, Mass. did some work in this field in the 1930s. He distinguished say letters of credit and accounts receivable financing from installment loans which might be used to purchase equipment. He considered the latter to be inappropriate for banks in that they created what he called “inflationary purchasing media”.
May 24th, 2009 at 2:28 am PDT
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@srw, if it would make you feel better, you may delete this comment as well.
May 24th, 2009 at 10:52 am PDT
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Steve, there’s no reason to feel bad about deleting an unpaid unrequested advertisement that has nothing to do with the subject.
Should we allow a V-ra huckster to just walk in on a meeting with our dentist and start pitching his pills? Obviously not. This is not a serious free speech issue (plus, your software won’t let me write the V-word anyway).
May 24th, 2009 at 1:47 pm PDT
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revolving credit is the modern form of “payment in kind.”
because i’m a nice guy, steve, i offer you this ur-metaphor of modern econ, absolutely free: credit is what land used to be, in the pre- and proto-capitalist economies of the west.
May 24th, 2009 at 4:58 pm PDT
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Steve,
I abhor the entire issue of relying on credit to buy anything. I’ve done it… Dug my way out… And now am convinced you become a slave to it.
The only way to gain dignity over your situation if to cut expectations and live within/below your means. There once was a day when saving for what you needed was the accepted mode of behavior. I remember lay-a-way plans. The point is you could not have anything until it was paid for.
As a society I think we have to return there.
Once the CC companies figured out they could make more money expecting $15 a month on a $1,000 balance instead of $100 – we were doomed.
May 24th, 2009 at 6:55 pm PDT
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And here I always thought it was because seignoirage is so fantastically profitable.
May 25th, 2009 at 1:15 am PDT
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Its blowing my mind that a wordsearch on the post+comments page only returns two references to “debit card”, one by Steve and the other by Carol.
Wasn’t the idea of the debit card (which came after the credit card, or atleast became mainstream after) supposed to fulfill this black hole of transactional credit demand, minus the revolver component?
I understand it can become cumbersome and a sort of “gotcha” mechanism when a particular account may not have the correct balance. I think banks took a good hard look at the situation a decade ago or whenever they started issuing debit cards and determined that they would rake in more fees, in aggregate, on overdraft-style expenses rather than whatever flat user fee the populace would pay.
I’ve actually got the JPM/Citi/BofA annual reports sitting on my desk; here are the income numbers on Credit/Bank card commission/fee revenues ($ blns)
Citi, 2008: $4.517 (Credit Card Commissions/fees) pg. 139 annual report
BofA, 2008: $8.032 (Non-interest card income, managed basis). pg 33 annual report.
JPM, 2008: $0.939 (Retail credit card noninterest income) p. 57 annual report
May be missing something from the JPM data, that seems quite low for the now-largest deposit base in the country I’d normalize that to something like 3-4 bln (I suspect the other annual reports are including their business lending wing in there – JPM has $2.7 bln in fees on that end, bringing them to 3.7 overall.
Regardless- It appears that total yearly credit card noninterest income is something approaching $13 bln at the low end for three of the largest banks (I never printed out the Wells report, we can probably hit $17-19 bln with them included).
So comparing that to the $2bln figure that rortybomb came up with a few posts up… seems like its a good business to be in. Maybe it makes sense to completely segregate transactional/revolving credit, but its more lucrative for the banks to do it this way?
May 25th, 2009 at 11:46 pm PDT
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If this is such a great idea, why don’t you do it in the private sector? Essentially give people $1000 and charge no interest? I know why. The program will undoubtedly lose money. If you ran this operation in the private sector, you would have to foot the bill for the ungodly high expenses. In this nationalized credit program you are proposing, tax payers will have to pay for it, which is probably why a lot of you are for it. Why work hard and be fiscally responsible when the government is just giving out money?
Under this plan, I will pay (probably increased) taxes so that I will have access to $1000. Then, I will use that $1000 throughout the month, then pay it back? I am paying twice for the same $1000 which in turn takes more money out of my pocket.
If the private credit card company model is so broken, why don’t you fix it, instead of depending on the government to do it for you? The beauty of free markets is that whenever a business model is not working as efficiently as possible, there are large incentives to disrupt the inefficient model. If instead, the government heavily regulated the CC industry, all it would do is raise barriers to entry so that this necessary evolution would be all the more difficult to take place.
The insurance argument is one that is based on good intentions, but is much too similar to social security. Social Security’s intentions were to provide a backup for people’s savings and pensions. It was never intended to support the full retirements of the majority of our population, but that is exactly what it is doing and this nationalized credit plan would do the exact same thing.
May 26th, 2009 at 9:04 am PDT
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I wonder if this discussion would take a different tone if the word “credit” was replaced with the word “debt” every time it was used here. That is, after all, what is being discussed–“transactional debt,” “revolving debt.” Cash is the opposite of debt and imposes a discipline that, while unfashionable and inconvenient, is unremittingly essential to healthy economic function. Any attempt to blur that distinction is as dishonest as it is destructive.
The concept of good debt vs. bad debt must be resurrected and reinforced. If the current system of commerce cannot handle it (hotels, rental cars, internet purchases,) that system must evolve (or devolve, whichever the case may be.)
May 26th, 2009 at 12:26 pm PDT
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May 26th, 2009 at 5:56 pm PDT
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It seems to me, that this is a backdoor identity card scheme. Perhaps civil libertarians may have some objections (although as some one who lives in Germany and wishes he did have an identity card – apart from my passport – I’m not particularly sympathetic to anti-identity card paranoia).
But combine it with a citizens basic income (or call it something – I like “national dividend”) and I’ll be really happy. I like it. Then tag on the micro-payments system. And seriously, I don’t see much reason for having privately owned infrastructure – it just seems to be a source of rents without much plus side. At least if it is public, the interface definitions will be debated rather than (a la Microsoft) imposed.
May 27th, 2009 at 9:25 am PDT
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May 28th, 2009 at 11:01 pm PDT
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Thanks for the review!
May 28th, 2009 at 11:02 pm PDT
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Thanks for taking the time to write this. I think some commenters worries about the government taking a larger role in this type of activity are well founded, but not because of any fundamental reason. If we as a society agreed that having the gov’t in at the very ground floor of finance, but no higher, was a good thing, then I think we could implement this well, and I think it would be an improvement over the system we have now, because even if the entire financial establishment collapsed, there would be some basic financial services still in operation. A lot fewer banks might be too big to fail.
However that isn’t the society we have, and I’m not sure its even possible, given how large and complicated the government is. Special interest would warp this into something very ugly. That doesn’t mean discussing it does no good.
May 29th, 2009 at 1:26 pm PDT
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I’d also like to thank Richard Serlin for his posted information, and all the rest of the wise comments from commenters.
However, in response to the less wise comments, I think that your blog got linked to from somewhere a lot of bots travel to. In my brief blogging experience I can tell you this is going to get much worse very fast. You’ll want to institute some systematic method of killing/preventing bot comments quickly.
May 29th, 2009 at 1:28 pm PDT
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