Monday, November 16, 2009

The Credit Card "Business"

By Mike Dorf

As various commentators have noted, the traditional business model of credit card companies is peculiar.  Here is how James Surowiecki described it in a May issue of the New Yorker:
Their best customers aren’t those who dutifully pay off their balance every month; instead, they’re the ones who charge a lot and pay only a little every month, carrying a sizable balance and racking up interest charges and late fees. These are the “revolvers,” and the credit-card business feeds on them. Credit-card companies don’t necessarily want revolvers to pay off their debts; if they did, there’d be no interest or fees to collect.
. . . The catch is that while revolvers are the companies’ best customers, they’re also more likely to default, which would make them the worst.


  1. This is a wonderfully instructive anecdote, Mike, and your reflections thereon are characteristically just as edifying if not indeed moreso -- many thanks! One quick complementary anecdote that many 'out there in the world' might not know is this: While we tend to think of the paradigmatic 'subprime' mortgage debtor as someone who would not otherwise have qualified for mortgage credit at all, this is not the case. A substantial percentage were in fact 'converts' from prime mortgages. They were, in other words, people more like you who were successfully converted to the mortgage analogue of credit card 'revolvers.' The aim of getting prime mortgage debtors to 'refi' into subprime mortgages lay at the core of the business model of subprime mortgage orginators, as well as those of subprime mortgage bundlers and mortgage-backed security sellers. And the reason for this is much the same as that which you intimate here: These firms profit only when they succeed in luring large numbers of people into debt peonage, just as London bankers did in the 18th century with colonial Virginian and North Carolinian planters, and just as many NY and Philadelphia banking interests did with midwestern farmers in the late 19th and early 20th centuries. Plus ca change!

    Thanks again,

  2. One point of clarification:

    I'm pretty sure the "credit card companies" (Visa, Mastercard, etc.) don't own the card balances; they mostly make money via card transactions at retailers and other outlets. Banks on the other hand, manage balances and other account fees.

    This means that companies like Visa make money no matter how much you "free ride" your account.

    Just throwing that out there to highlight the fact that interests in the business aren't all perfectly aligned.

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  4. How fitting, that a 'credit' card company of another sort has seen fit to advertise its wares in connection with this post!

  5. weird. Just looked today online, and one of my accounts is pegged, "suspicious activity." A new card is being sent.

    But the account balance is still at zero, where I left it. Right in the wheelhouse of this post!

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