VOL 81 NO. I AUSUBEL: CREDIT CARD MARKET tion. It is fair to say that the bank credit mailing(11 responses) included a request card market in the United States was func- for direct profit calculations, which were tionally deregulated in 198 provided by seven banks. Appendix a pro- vides details of the construction of the I. Credit Card Interest Rate Behavior BCCS. Table 2 includes the size distribution of banks that reported data. Respondents A. Sticky Interest Rates were promised anonymity. The most aesthetically pleasing way for The cost of funds is obviously the primary an economist to determine the cost of funds determinant of the marginal cost of lending is to"let the market decide it. "In the case via credit cards, and it is usually the only of credit cards, this is feasible because of omponent of marginal cost that varies the phenomenon of credit card securitiza- idely from quarter o quarter. Thus, a tion. Consistently, during 1987-1989, model of continuous spot market equilil credit-card-backed securities offered yields rium would predict a substantial degree of in the vicinity of 0. 75 percent above those of onnection between the interest rate Treasury securities with comparable maturi charged on credit cards and the banks ' cost ties 2 Meanwhile the visa systemwide av- of funds. However, Figure 1, which com- erage cardholder payment rate (i.e, card- pares credit card interest rates with the cost holder payments as a percentage of out of funds, displays stark empirical rejection standing balances) ranged from 13 to 17 of this prediction. Credit card interest rates percent per month during the years were highly sticky during the period 1983-1987, implying an average maturity for 1982-1989 and, in fact, were virtually con- credit card receivables of 6-8 months. 3To ervative. i will define the cost of In this section, credit card interest rates funds to equal the one-year Treasury bill are captured by two distinct sets of data: yield 4 plus 0.75 percent, averaged over ne aggregated and one disaggregated. The each quarter. This series is also plotted in first set of data is the Federal Reserve Bul- Figure 1 letin series for credit card interest rates The proposition that interest rates are based on the Federal Reserve Board's quar- sticky can be formally supported by regress terly survey of banks. Reported are arith- ing credit card interest rates on the cost of metic averages of each bank's"most com mon"rate charged during the first week of each mid-quarter month This series is plotted in Figure 1. The second set of data IsEe, for example, "Credit Card Bonds are Hot (and much of the empirical discussion of 16. 1990.p. cIn: Credit icard the authors own bank credit card survey (November 15, 1988), p. 7; Credit Card management BCCS)of 58 of the largest bank issuers of May/June 1988, p. 34 credit cards. The first mailing(21 responses) asked primarily for pricing and cost data: it rate is Standard Poor's Asset-Backed Securitization generated a quarterly interest rate series for CreditReview, March 16, 1987, p. 19. Individual banks rospectuses have reported cardholder payment rates 17 credit card issuers and an annual loan- of 9-23 percent per month, never implying an average loss series for 10 issuers. The follow-up tuses in Appendix B). This impression was substanti. maturity of more port quote INDeed, the al Bank( First Chicago' s Delaware ary, listed fourth in Table 1)as Reserve bullet the period 1982-1989 is 18.85 saying that his bank finances its credit card portfolio ted is 17.77 percent(fourth quarter, 1988/lue re- with a variety of financial instruments with combined 985) and the lowest va maturit nt to a 145-day duration (Credir Federal Reserve Boards G. 19 stat April 5, 1990; Federal Reserve Bulletin, April 1990 table 1.56, line 4(and previous issue April 1990, table 1.35 line 21(and previous This content downloaded from 202. 120. 224.93 on Sun. 17 Dec 201707: 42: 57 UTC Allusesubjecttohttp:/about.jstor.org/termsVOL. 81 NO. 1 AUSUBEL: CREDIT CARD MARKET 53 tion. It is fair to say that the bank credit card market in the United States was func- tionally deregulated in 1982. II. Credit Card Interest Rate Behavior A. Sticky Interest Rates The cost of funds is obviously the primary determinant of the marginal cost of lending via credit cards, and it is usually the only component of marginal cost that varies widely from quarter to quarter. Thus, a model of continuous spot market equilib- rium would predict a substantial degree of connection between the interest rate charged on credit cards and the banks' cost of funds. However, Figure 1, which com- pares credit card interest rates with the cost of funds, displays stark empirical rejection of this prediction. Credit card interest rates were highly sticky during the period 1982-1989 and, in fact, were virtually con- stant.'0 In this section, credit card interest rates are captured by two distinct sets of data: one aggregated and one disaggregated. The first set of data is the Federal Reserve Bul- letin series for credit card interest rates, based on the Federal Reserve Board's quar- terly survey of banks. Reported are arith- metic averages of each bank's "most com- mon" rate charged during the first week of each mid-quarter month." This series is plotted in Figure 1. The second set of data (and much of the empirical discussion of this and the next section) is derived from the author's own bank credit card survey (BCCS) of 58 of the largest bank issuers of credit cards. The first mailing (21 responses) asked primarily for pricing and cost data; it generated a quarterly interest rate series for 17 credit card issuers and an annual loan- loss series for 10 issuers. The follow-up mailing (11 responses) included a request for direct profit calculations, which were provided by seven banks. Appendix A pro- vides details of the construction of the BCCS. Table 2 includes the size distribution of banks that reported data. Respondents were promised anonymity. The most aesthetically pleasing way for an economist to determine the cost of funds is to "let the market decide it." In the case of credit cards, this is feasible because of the phenomenon of credit card securitiza- tion. Consistently, during 1987-1989, credit-card-backed securities offered yields in the vicinity of 0.75 percent above those of Treasury securities with comparable maturi- ties.12 Meanwhile, the Visa systemwide av- erage cardholder payment rate (i.e., card- holder payments as a percentage of out- standing balances) ranged from 13 to 17 percent per month during the years 1983-1987, implying an average maturity for credit card receivables of 6-8 months.13 To be conservative, I will define the cost of funds to equal the one-year Treasury bill yield14 plus 0.75 percent, averaged over each quarter. This series is also plotted in Figure 1. The proposition that interest rates are sticky can be formally supported by regress- ing credit card interest rates on the cost of 10Indeed, the highest value reported in the Federal Reserve Bulletin series in the period 1982-1989 is 18.85 percent (first quarter, 1985) and the lowest value re- ported is 17.77 percent (fourth quarter, 1988). "1Federal Reserve Board's G.19 statistical release, April 5, 1990; Federal Reserve Bulletin, April 1990, table 1.56, line 4 (and previous issues). 12See, for example, "Credit Card Bonds are Hot, but Maybe Stingy on Yield," Wall Street Journal, April 16, 1990, p. C1; Credit Card News, Volume 1, Number 3 (June 15, 1988), p. 2, and Volume 1, Number 14 (November 15, 1988), p. 7; Credit Card Management, May/June 1988, p. 34. O3The source of the systemwide cardholder payment rate is Standard & Poor's Asset-Backed Securitization CreditReview, March 16, 1987, p. 19. Individual banks' prospectuses have reported cardholder payment rates of 9-23 percent per month, never implying an average maturity of more than one year (see list of prospec- tuses in Appendix B). This impression was substanti- ated by a trade-publication report quoting the chair- man of FCC National Bank (First Chicago's Delaware credit card subsidiary, listed fourth in Table 1) as saying that his bank finances its credit card portfolio with a variety of financial instruments with combined maturities equivalent to a 145-day duration (Credit Card News, March 15, 1989, p. 2). "Federal Reserve Bulletin, April 1990, table 1.35, line 21 (and previous issues). This content downloaded from 202.120.224.93 on Sun, 17 Dec 2017 07:42:57 UTC All use subject to http://about.jstor.org/terms