Credit card annual fees and the self-appointed consumer protectors

Geoffrey Manne —  6 January 2010

Adam Levitin has a blog post up responding to Todd Zywicki’s recent WSJ editorial on credit card interchange fees.  As most readers know, this is a topic of significant interest around here, and Josh blogged about Todd’s op-ed just yesterday.  I’m on vacation so I’ll be brief, but I thought Adam’s post was so wrong it necessitated my getting off the beach for a reply.  Adam writes:

Todd is right that consumers are happy to see annual fees go away, but the disappearance of annual fees wasn’t a freebie for consumers.  It came about as part of a shift in the credit card business model whereby upfront fees were replaced with backend fees that have lesser salience to consumers when the consumers decide which cards to carry and use.  This was a move that was made to increase revenue for card issuers (or put another way, to siphon off more consumer surplus); it was not a charitable act.  The disappearance of annual fees is an important innovation, but I think it is a stretch to call it a pro-consumer innovation, when it is viewed contextually.

The disappearance of annual fees was a step in the democratization of credit (or put another way, the decline in underwriting standards).  Whether this was a good thing is unclear.  It certainly increased consumer’s borrowing ability and choices, and might have led to a substitution from secured installment credit to unsecured revolving credit.  But greater ability to borrow and more borrowing choices are not necessarily good.  They are only good to the extent that a consumer is capable of repaying the increased credit line and making informed choices among credit options.  Both of those are questionable for many consumers.

Adam’s incessant claims that consumers are idiots, fooled time and again by rapacious capitalists, is tiresome.  The behavioral econ/behavioral law and econ literature just doesn’t support these strong claims.  Yes, there are some interesting theories.  No, there is no empirical proof, and there are plenty of counter-explanations.  There are some experiments that support these claims.  And they have been called in to question (sorry I can’t take the time to link right now, but we’ve discussed the behavioral literature quite a bit on this blog).  Todd’s competition story is the Occam’s Razor argument here and unsupported claims to the contrary should be scoffed at.

The “contextual” reality is that the “backend” fees that have replaced annual fees are born by a small fraction of cardholders and are avoidable, as opposed to unavoidable annual fees born by all cardholders.  These backend fees have likewise been falling in magnitude and incidence over recent years.  And meanwhile, they act to make borrowing more expensive for the helpless people Adam and other self-appointed consumer advocates claim to want to protect from themselves and less expensive for those who don’t “need” Adam’s protection (scare quotes because I’d say no one “needs” Adam’s help).  On Adam’s own terms this should be a feature, not a bug, and it is arguably more efficient, lowering consumer credit costs for everyone.

Adam’s view that these backend fees make credit seem cheap to profligate spenders in a way that annual fees do not is absurd.  Maybe the first time, but I’d have to say that fees imposed directly when repayment is not forthcoming, for example, and showing up on a statement at the very moment they are incurred should have much more “salience” than annual fees imposed once a year with no relationship in time or magnitude to any behavior on the part of consumers.  Meanwhile, there is a whole industry of protectors warning consumers of the dangers of over-extending, and very few daytime talk shows warning of the perils of annual fees.  I’d wager the behavioral fee is much more “salient” than the annual fee.

This is the problem with the behavioral literature on which Adam relies: It is a set of non-rigorous, just-so stories that can be tortured to support any a priori policy view. The bottom line is that credit card markets have seen falling fees, increasing benefits (rental car insurance, airline miles, purchase protection, etc., etc.) and structural changes that respond to consumer preferences.  The just-so story that would turn this into a story of corporations preying on ignorant consumers is insulting and unsupported.

Geoffrey Manne


President & Founder, International Center for Law & Economics

8 responses to Credit card annual fees and the self-appointed consumer protectors


    I think the ‘increased conservatism’ is bogus– it’s just people whining that their taxes are too high, when clearly with a $1.4 trillion deficit they’re getting a boatload of government services at cut-rate prices. The bill comes due later? Who cares, we still don’t like making the downpayment now.

    The plain truth is, people will complain about high taxes all day long, right up until we propose abolishing unemployment benefits, or cutting the Medicare they depend on to keep Grandma in the nursing home rather than their spare bedroom, or ending housing subsidies and letting half the homes on the block go into foreclosure. They complain about the seen (the tax bill) and ignore the unseen (everything they get from government).

    Ask them to live without the unseen, and that’s when you’d see real revolution rather than self-absorbed tea parties.


    >>To my observation, there are quite many consumers who always pay off their balance and jealously shop around for the best rewards deals.

    If that were true, we would not be in the credit mess we’re in. In absolute terms, I’m sure ‘many’ people do pay off their balances promptly, etc. (I’m one of them.) But in relative terms, I’m sure a majority of consumers don’t, and a sizable fraction are financially functionally illiterate.


    Geoffrey: You have a fundamental flaw in your thinking–you aren’t seeing the big picture. You reference whether it is better that all cardholders paying a fee is better than a select few cardholders paying a fee. The fact is that all consumers–regardless of whether they are a cardholder or not–are paying these fees. I agree that it is a great deal for those precious few beautiful people with a visa black card who earn 5 miles for every dollar they spend. But how is it fair for the 80 year old woman who doesn’t have a credit card and has to pay an extra 25 cents in higher prices for her gallon of milk even though she is paying with cash just so the beautiful people can get their frequent flier miles? That’s bull! The fundamental principle here is that if you are enjoying the benefit, you should pay for the benefit. Taking the benefit without paying for it is stealing.


    I think Todd (and Adam) are both wrong because “free” has not been an innovation for a couple of millennia.

    At most it took some mildly innovative thinking for one and then other CC issuers to realize that they could make more money by giving away the razor to sell the blade (or something), but even that isn’t really innovative.

    That said, it is perhaps the most pro-consumer development in the last decade, or at least the most pro-consumer development for the Syms-type consumer, you know, the “educated consumer is our best customer”.



    To my observation, there are quite many consumers who always pay off their balance and jealously shop around for the best rewards deals. They make out pretty well under the current system.

    I don’t think that you can make any changes that would be unarguably “pro-consumer.” Most would hurt some groups while helping others.


    My reading of Adam’s passage is that he’s saying consumers are idiots because they’re just asleep at the switch, not that they’re being fooled by rapacious capitalists– the two are very different.

    Being fooled implies duplicity, yes, but also that the victim is trying to pay attention. If you really think consumers in this country are… well, you live in a very different USA than I do. To my observation, Adam’s criticism of consumers’ ignorance about credit and finance is spot-on.

Trackbacks and Pingbacks:

  1. - January 7, 2010

    10 Things I Think I Think: Politics…

    Gallup: “The increased conservatism that Gallup first identified among Americans last June persisted throughout the year, so that the final year-end political ideology figures confirm Gallup’s initial reporting: conservatives (40%) outnumbered both m…

  2. TRUTH ON THE MARKET » Credit card annual fees and the self … Counseling on me - January 6, 2010

    […] here to read the rest:  TRUTH ON THE MARKET » Credit card annual fees and the self … tags: a380-generally, airline-miles, credit-cards, first-journey, increasing-benefits, […]