it's not what you think...po pre-non-rev/post non-rev m pre-non-rev/post-rev source:...
TRANSCRIPT
UMELVENY & MYERS LLP
It's Not What You ThinkConsumer Credit And The Financial Crisis
0 O'Melven & M ers LLP
Thomas P. BrownNYU And NY Federal Reserve Bank
January 2010
The Big PictureMean Income And Consumer Debt (1989-2007) (000s)
160
140
120
100
80
60
40
20
0
0 Median Income0Median Credit Card Debt
ka Median Mortgage Debt
The claims of neo-paternalists
The empirical case against neo-paternalism
If not a consumer protection problem, then what?
CYMELVENY & MYERS LIP
Behavioral EconomicsHuman beings are hopelessly flawed
Five general deviations from the traditional rationalchoice model:
(1) Myopia or hyperbolic discounting; (2) cumulative costneglect; (3) procrastination; (4) unrealistic optimism; (5)miswanting
These deficiencies amount to a market failureCompetition can't be trusted to yield "efficient"outcomes if consumers make bad decisions
Hyperbolic DiscountingA More Formal Description
Future effects are heavily discounted relative tocurrent effectsLonger term future effects are only slightly morediscounted than more immediate, but stillfuture, effects.This leads people to overweight current benefitsrelative to future costs.
The RestRemaining flaws are fairly intuitive
Cumulative cost neglectA series of small losses somehow cost less than a single lossof the same amount
ProcrastinationPeople don't do what they should when they should
Unrealistic optimism (or magical thinking)People systematically overestimate the likelihood that goodthings will happen to them
MiswantingPeople buy today (and thus pay for tomorrow) stuff that isn'tgood for them
Seduction By Plastic"Features" line-up with "flaws"
Loan acquisition separate from loan useConsumers can go into debt a little at a time
Receipt of goods is separate in time (andoften place) from paymentNon-contingent prices are low and fixedContingent prices are high and variable
0.MELVENY isAYERS LIP
With Unfortunate ConsequencesDragging consumers into bankruptcy
Growth in credit card debt is leading to a risein debt-to-income levelsCredit card debt has taken over the entireinstallment debt category
"Credit card debt has led the way tobankruptcy for an increasing number ofAmericans"
Rewards CardsPoster child for industry critics
Rewards programs lead to systematic overuse ofcredit cards
Ronald Mann
Rewards programs prey upon consumers' tendencyto overweight the present
Oren Bar-Gill
Rewards cards reduce the "pain of paying," leading toover-indebtedness
George Loewenstein
> The claims of neo-paternalists
The empirical case against neo-paternalism
> If not a consumer protection problem, then what?
Seems Like A Big LeapWhat's the evidence?
Do rewards cards actually lead consumers toincur larger debts?
-OR-
Are consumers less likely to revolve onrewards cards than other cards?
0 MELVENY & MYERS LLP
Let's Test It And See
Howard Beales and Lacey Plache examinedeffect of rewards on revolving behaviorTwo-step analysis
Do people revolve balances after they acquirerewards cards?
Does the rewards feature increase or decreasethe tendency to revolve?
Payment PanelRepresentative sample of card users
Each quarter, three panels of 1,600 are drawn from a nationalsample of 475,000 householdsMust be 18, have 1 credit card and annual income greater than$10,000Collect data on individual and household, all transactionsgreater than $5 and payment cardsRewards cards results based on acquisition of -7,700 cards and-43,000 observationsAll cards results based on acquisition of -26,000 cards and-200,000 observations
0. ME LVENY &. MYERS LIP
Step OneImpact of card acquisition
BehaviorBefore Acquisition
Non-revolvers43%
Revolvers57%
BehaviorAfter Acquisition
Don't Revolve
Revolve
Revolve
Don't Revolve
Percentage of reward acquirers
Prior Non-revolversRevolve after getting rewards card?
100
12 go
-E, 80
c(L) 70
60zw50
4001
30
.2,20
CD
0- 10
0II
y0q0 y1q1 y1q2 y1q3 y1q4 y2q1
Year-Quarter after Acquisition
PO Pre-Non-Rev/Post Non-Rev M Pre-Non-Rev/Post-Rev
Source: Beales/Plache
y2q2 y2q3 y2q4
Very unlikely to revolve on anew rewards card
92% do not revolve in 01after card acquisitionRevolving behavior ebbsover time
95% are not revolving twoyears later
Prior RevolversRevolve after getting a rewards card?
70
Source: Beales/Plache
-T-
-
Pre-period revolvers are morelikely to revolve
58% will revolve on a newrewards card in 01Revolving behavior declinesover time
Two year later, only 50% arerevolving
0q0 y1 q1 y1 q2 y1 q3 y1 q4 y2q1 y2q2 y2q3 y2q4
Year-Quarter after Acquisition
0 Pre-Rev/Post Non-Rev II Pre-Rev/Post-Rev
Step TwoDo rewards explain revolving?
Used a model to identify variables thatexplain revolving behaviorExamined which variables explain revolvingbehavior, e.g.,
Prior revolving behavior
Card features
Demographics
Predicting Revolving BehaviorOne dominant factor
Behavior prior to card acquisition is biggest singlefactor by a wide margin
Revolved before and you're very likely to revolve after
Didn't revolve before and you're very unlikely to revolveafter
Everything else is secondary
Predicting Revolving BehaviorMany Secondary Factors
Less Likely
Rewards
APRs
Higher Income
Homeowner
More Likely
Bigger Household
Younger
First House
Had A Baby
No Effect
Got Married
Got Divorced
Retired
Became Unemployed
And This Isn't A Bait & SwitchQuarter-to-Quarter APR Changes by Type ('94-'05)
Decrease1.2%
No Change97.4%
Increase if PreviousTeaser Rate or 0 APR
0.3%
Increase if NoPrevious
Teaser Rate or 0 APR1.2%
Rates Go Up And DownAPR Changes and Changes in the Prime Rate
0.MILVLNY & MYERS LIP
I
.
2.5%
g 2.0%..>,..
-.:
Ihuh
9.0%
8.0%
7.0%
11
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
= Increase if No Previous = Decrease 6PrimeTeaser Rate or 0 APR
Figure 5: Credit Card APRs versus Prime1994-2005
14.0% '
12.0%
10.0%
;e'
8.0%
..
0.0%
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
PrimeFed Avg APR
The claims of neo-paternalists
The empirical case against neo-paternalism
If not a consumer protection problem, then what?
0 M LVE NY & MYERS LLP
Not Completely UnexpectedSustained job losses produce delinquent cardholders
Bureau of Labor Statistics, Federal Reserve
2200 12%
1800
1400
1000
600
200-200
-600
-1000
-1400
-1800-
-2200
4.94%w
6.588%
4%
0%
0
-4%
-8%
-12%
I= Seasonally Adjusted Nonfarm Payroll (3 month net) (000s)
0Credit Card Deliquencies (30 Days) (Unadjusted)
2002 (01) 2003 (01) 2004(01) 2005(01) 2006 (01) 2007(01) 2008 (01) 2009(01)
But Not The Whole PictureDelinquent mortgages rose before employment fell
Bureau of Labor Statistics, Federal Reserve
0.MELVENY & MYERS LLP
12%2200
1800
1400
1000
600
200
-200
-600
-1000
-1400
-1800
_2.24%
9.81%
40/0
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-4%
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1== Seasonally Adjusted Nonfarm Payroll (3 month net) (000s)
0Residential Real Estate Loan Deliquencies (30 Days) (Unadjusted) 1-
-2200
2002 (01) 2003 (01) 2004(01) 2005 (01) 2006 (01) 2007 (01) 2008 (01) 2009 (01)
Not Moving Together!
Bureau of Labor Statistics, Federal Reserve
12%2200
1800
1400
1000 _
600
200
-200-
-600
-1000
-1400
-1800
-2200
-- 4%
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EN.....
-4%
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L=1 Seasonally Adjusted Nonfarm Payroll (3 month net) (000s)
0Residential Real Estate Loan Deliquencies (30 Days) (Unadjusted)
0Credit Card Deliquencies (30 Days) (Unadjusted)
2002 (01) 2003 (01) 2004(01) 2005(01) 2006(01) 2007(01) 2008(01) 2009 (01)
Home Values Rose, Stopped Rising ...35% -
30% -
25%
20%
15%
10% -5%
0%-5%
-10%
- 0Case Schiller NPI °/.0
-SCF Primary Residence %
1992 1998 2001 2004 2007
And Then Fell(With Predictable Consequences)350
300
250
200
150
100
0Case Schiller NPI (Jan. 2000 = 100)Foreclosure Index (Aug. 2005=100)
.411111111
2007 2007 2007 2007 2008 2008 2008 2008 2009 2009 2009(01) (02) (03) (04) (01) (02) (03) (04) (01) (02) (03)
And What Precipitated The Fall?(Hint: It wasn't a problem with the T&Cs)
"Low yields on ten-year treasuries encouragedmoney to flow into higher-yielding assets backed by,inter alia, residential mortgages. ... To meet thedemand for mortgage-back securities, lendingstandards for residential mortgages were relaxed.Agency problems between mortgage brokers whooriginated the loans, financial institutions whopackaged and distributed them, and investors whopurchased them allowed this problem to gouncorrected."
Barry Eichengreen, The Financial Crisis andGlobal Policy Reforms 23-24 (October 2009)
These slides do not represent legal advice,and they do not offer anyone's views
on this subject but my own.
Tom Brown, Partner,
O'Melveny & Myers LLP San Francisco, CAtbrown @omm.com
(415) 984-8947