Credit Card Firms Won as Users Lost

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THE NATIONCredit Card Firms Won as Users LostThey sought new laws but found ways

to make money even on people who went bankrupt.By Peter G. Gosselin

Times Staff Writer

 

March 4, 2005

 

WASHINGTON — In the eight years since they began pressing for the tough

bankruptcy bill being debated in the Senate, America's big credit card companies

have effectively inoculated themselves from many of the problems that sparked

their call for the measure.

 

By charging customers different interest rates depending on how likely they are

to repay their debts and by adding substantial fees for an array of items such

as late payments and foreign currency transactions, the major card companies

have managed to keep their profits rising steadily even as personal bankruptcies

have soared, industry figures show.

 

As a result, while they continue to press for legislation that would make it

harder for individuals to declare bankruptcy, the companies have found ways to

make money even on cardholders who eventually go broke.

 

At the same time, under the companies' new systems, many cardholders —

especially low-income users — have ended up on a financial treadmill, required

to make ever-larger monthly payments to keep their credit card balances from

rising and to avoid insolvency.

 

" Most of the credit cards that end up in bankruptcy proceedings have already

made a profit for the companies that issued them, " said Robert R. Weed, a

Virginia bankruptcy lawyer and onetime aide to former Republican House Speaker

Newt Gingrich.

 

" That's because people are paying so many fees that they've already paid more

than was originally borrowed, " he said.

 

In addition, some experts say, the changes proposed in the Senate bill would

fundamentally alter long-standing American legal policy on debt. Under

bankruptcy laws as they have existed for more than a century, creditors can

seize almost all of a bankrupt debtor's assets, but they cannot lay claim to

future earnings.

 

The proposed law, by preventing many debtors from seeking bankruptcy protection,

would compel financially insolvent borrowers to continue trying to pay off the

old debts almost indefinitely.

 

" Until now, the principle in this country has been that people's future human

capital is their own, " said David A. Moss, an economic historian at Harvard

University. " If a person gets on a financial treadmill, they can declare

bankruptcy and have what can't be paid discharged. But that would change with

this bill. "

 

Debate about the bill continued Thursday, with the Republican-controlled Senate

refusing to limit consumer interest rates to 30%. The vote was a bipartisan 74

to 24 to kill a proposed amendment by Sen. Mark Dayton (D-Minn.). Senate passage

of the bill is expected next week.

 

The House has not taken up the issue this year, although it passed a version of

the bill last year, as did the Senate. Attempts to reconcile the two bills

failed.

 

Industry officials have sought to minimize the role of credit card companies in

pushing for bankruptcy legislation since 1998. They have argued that the bill

introduced last month by Republican Senate Finance Committee Chairman Charles E.

Grassley of Iowa and supported by President Bush would affect about 5% of the

roughly 1.6 million Americans who file for bankruptcy each year.

 

They have portrayed the measure's principal target as high-income individuals

who are abusing the law to escape their debts.

 

" The bottom line is that there are people out there who are able to pay their

bills who are not paying, " said Tracey Mills, a spokeswoman for the American

Bankers Assn., which represents most of the major credit card companies.

 

But consumer advocates, many academics and some judges and court officials argue

that the bill would sharply reduce the number of Americans able to file for

bankruptcy, even in instances where doing so would buy them time to repay their

debts.

 

The critics argue that people unable to file would be at the mercy of

increasingly aggressive efforts by lenders — especially credit card companies —

to raise fees and boost collections.

 

People like Josephine McCarthy, for instance, a 71-year-old secretary at the

Salem Baptist Church, less than a mile from where the Senate bill is being

debating.

 

According to papers in her recent bankruptcy, McCarthy discovered at about the

time of her husband's death in 2003 that the couple had a $4,888 balance on a

Providian Financial Corp. Visa card and another $2,020 balance on a Providian

Mastercard.

 

Over the two years from 2002 until early 2004, when she filed for bankruptcy,

McCarthy charged an additional $218 on the first card and made more than $3,000

in payments, the court papers show. But instead of her balance going down,

finance charges — at what the bankruptcy judge termed a " whopping " 29.99% rate,

together with late fees, over-limit fees and phone payments fees — pushed what

she owed up to more than $5,350.

 

In the case of the second card, the papers show that McCarthy charged an extra

$203 and made more than $2,000 in payments, but again fees and finance charges

pushed the balance up.

 

McCarthy refused to comment on the case. A spokesman for Providian could not be

reached last night.

 

But court papers show that McCarthy eventually paid all the bills in the case,

including back taxes. The way she did it, using provisions of bankruptcy law,

illustrates one of the problems with the proposed new law, critics say.

 

McCarthy had been making mortgage payments on two houses. She wanted to sell one

of the houses to pay off her debts, but the house was entangled in legal

difficulties. By declaring bankruptcy, she was able to stop the clock on her

escalating credit card debts and give her lawyer time to clear up the legal

problem, enabling her to sell the house and pay off the bills.

 

Under the proposed new law, McCarthy, who makes about $55,000 a year, would have

had a much harder time qualifying for the bankruptcy protection that allowed her

to pay creditors.

 

" The McCarthy case shows how hard-working people making good incomes can end up

in situations that they can't dig themselves out of unless they file for

bankruptcy, " said Weed, her lawyer.

 

Credit card companies have come in for harsh criticism in recent years for their

penalty fees and the " risk-based pricing " under which they charge customers

different interest rates depending on their credit histories and their

likelihood of paying.

 

Consumer advocates have accused firms of not adequately disclosing such

controversial practices as universal default, when a company can jack up a

cardholder's annual percentage rate, often to more than 30%, based on the

cardholder's performance with another creditor, not the card company.

 

Regulators and law enforcement officials have accused companies of deceptive

practices. In 2000, the U.S. Office of the Comptroller of the Currency and the

San Francisco district attorney's office ordered Providian to pay $300 million

in restitution after customers complained that the company didn't credit their

payments on time and then imposed late fees.

 

A stream of court cases involving credit card companies has produced public

outrage in various parts of the country.

 

In Cleveland, a municipal court judge tossed out a case that Discover Bank

brought against one of its cardholders after examining the woman's credit card

bill.

 

According to court papers, Ruth M. Owens, a 53-year-old disabled woman, paid the

company $3,492 over six years on a $1,963 debt only to find that late fees and

finance charges had more than doubled the size of her remaining balance to

$5,564.

 

When the firm took her to court to collect, she wrote the judge a note saying,

" I would like to inform you that I have no money to make payments. I am on

Social Security Disability…. If my situation was different I would pay. I just

don't have it. I'm sorry. "

 

Judge Robert Triozzi ruled that Owens didn't have to pay, saying she had

" clearly been the victim of [Discover's] unreasonable, unconscionable and unjust

business practices. "

 

Efforts to reach Owens were unsuccessful. A spokeswoman for Discover said she

could not comment on the case.

 

Analysts said that lost in the uproar over particular practices and cases is the

fact that the credit card industry has almost completely remade itself in the

years since it began pushing for passage of the bankruptcy bill — a makeover

that has left some analysts wondering why the industry needs the changes in

bankruptcy law.

 

" The idea that companies are losing their shirts on bankruptcies is a lot of

bull, " said Robert B. McKinley, chief executive of CardWeb.com, a Frederick,

Md., consulting group that tracks the credit card industry. " With these rates

and fees, the card industry is a gravy train right now. "

 

Mills, the bankers association spokeswoman, said bankruptcies affected all

American households in the form of higher costs and lower returns on

investments.

 

As recently as the late 1980s, credit card companies offered a one-size-fits-all

card with a fixed interest rate and an annual fee. Virtually all cards went to

middle-class borrowers with good credit histories; issuing cards to poor or

high-risk borrowers was almost unheard of.

 

But in the early 1990s, companies such as AT & T and General Motors began issuing

cards with variable rates and no fees, increasing competition. And by the middle

of the decade, card companies were finding their traditional middle-class

markets saturated.

 

Their response: lend to riskier customers and make up for the danger of more

defaults by charging higher rates and then new fees.

 

McKinley, the industry analyst, said the firms were helped by a 1996 Supreme

Court case that gave card companies new protections against state regulation of

fees.

 

" That really opened the flood gates. It set off a fee frenzy, " he said.

 

 

 

 

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