> > > > >
The Payment Cards Center of the Federal Reserve Bank of Philadelphia celebrated its 10th anniversary in 2010. To mark this milestone, the center hosted a conference, “The New Landscape for Consumer Credit and Payments,” at the Bank on December 2 and 3, 2010. This special edition of the Payment Cards Center Update newsletter highlights the presentations1 made at the conference.
This conference brought together 120 participants from the financial services industry, research institutions, nonprofit organizations, and regulatory agencies to examine important research and policy questions. It also provided a forum for participants to discuss the effects of the recent financial crisis and new regulation on consumers’ use of credit and payment instruments, the industry’s response, and important lessons for improving the design of financial products and services. Federal Reserve Board Governor Elizabeth Duke delivered a keynote address on December 2. In her remarks,2 Duke noted that — based on the available data — the unprecedented decline in revolving consumer credit outstanding that occurred during the financial crisis can be attributed to a number of factors, including higher charge-offs, lower availability of credit, and less consumer willingness to take on debt. The recession also appears to have affected consumer payment preferences. While the use of electronic payments in the form of credit and debit cards has increased markedly since the late 1990s, during the most recent recession, consumers shifted away from credit cards as a method of payment and toward debit cards. Disentangling the effects of the recession from regulatory changes on credit and debit card usage will be particularly difficult given that they occurred at nearly the same time. Looking ahead, Duke suggested that technological innovation through the development of new payment methods and products will also play an important role in shaping the behavior of consumers and lenders.
In his opening remarks, Bob Hunt, vice president and director of the Payment Cards Center, reminded the audience that while many of the issues at the forefront of today’s policy debates are hardly new, there are still significant gaps in our understanding of the markets for unsecured credit and consumer payments. He added that — especially in times of uncertainty — advancing our understanding of decisions made by consumers and firms in these markets is imperative. The sound theories that are needed to make better policy decisions will require new and better techniques as well as better data, often different data than we currently have.
Hunt pointed out that many policy questions also arise from new business models, new financial instruments, and new industries. In many ways, these are the places where the greatest value can be created by “making data,” a process that often begins by establishing basic definitions. He noted that much of what the Payment Cards Center has done over its 10-year history is to focus on those areas that lack data and to expand the available information about how the markets for consumer credit and payments function. This is one of the center’s unique contributions and one it will continue to make.
William Lang of the Federal Reserve Bank of Philadelphia moderated the first conference panel. The panel featured Mark Zandi of Moody’s Analytics, Glenn Canner of the Federal Reserve Board, Kevin Rhein of Wells Fargo & Company, and Raj Date of the U.S. Department of the Treasury. The panelists considered the state of financial markets and changes in regulation, how financial institutions and consumers are responding to the economic climate and new regulatory environment, and the plans for the Consumer Financial Protection Bureau. Zandi described the improvement in household credit conditions resulting from a number of different factors, including a dramatic tightening in lenders’ underwriting standards, the efforts of households to repair their balance sheets, and gradual improvement in the job market. Zandi’s optimism with respect to future credit conditions was tempered by the significant risks posed by the uncertainty surrounding the willingness of businesses to expand and hire and the ongoing foreclosure crisis.
Canner discussed the effects of the new credit card regulations on the credit card market, focusing on restrictions in card issuers’ ability to change interest rates and impose fees. He outlined the challenges in trying to distinguish the issuers’ responses to rule changes from responses to deteriorating economic conditions. Canner suggested three distinct approaches to attack this problem: surveying lenders, comparing changes in product markets affected by the regulations with other markets (e.g., consumer vs. commercial credit cards), and comparing variations in effects by geography with variations in local economic conditions.
Rhein provided an issuer’s perspective on recent trends in the payment industry. In general, credit card issuers responded to worsening economic and credit conditions via more stringent underwriting criteria for new accounts and closing inactive accounts or accounts with deteriorating risk profiles. In anticipation of legislative changes that limited the tools available for account management, issuers also re-priced some accounts based on risk criteria. While it is too early to gauge all of the consequences of the new rules and regulations governing the card industry, he expects there will be transformations in the type and amount of credit offerings as well the sources of revenue for credit providers. Going forward, Rhein emphasized the importance of providing consumers with simple and transparent products and the tools to help them manage their finances.
Date characterized the consumer credit industry as being in a state of flux as consumers deleverage, financial services companies rework their business models, and policymakers change the pre-crisis regulatory scheme. Date focused on one part of the regulatory restructuring — the establishment of the Consumer Financial Protection Bureau (CFPB). Date stressed that fact-based research and market analytics will play an important role in rule-making, supervision, enforcement, and even the design of a consumer response center. He also described plans to improve market surveillance with the objective of detecting and responding more rapidly to emerging consumer protection issues.
Peter Tufano of the Harvard Business School was a keynote speaker at the Payment Cards Center’s 10th anniversary conference.
On December 3, Professor Peter Tufano of the Harvard Business School opened the second day of the conference with his keynote address entitled ”Listening to Consumers: Informing the Regulatory Agenda.” Tufano engaged the audience in a discussion of his recent research, which examines how regulatory priorities might be set at this critical time. He outlined what economic principles, in particular market failures, tell us should be driving regulation and presented information from a survey administered in October 2010 in which consumers were asked where they think regulators and businesses should focus their attention.
The preliminary survey results revealed that over one-quarter of the respondents did not think their financial interests were appropriately protected. The financially fragile (including those who were unemployed or reported being over-indebted) registered considerably greater dissatisfaction than other consumers. In terms of products, credit cards, particularly for those who carry a balance, and debt collection, for those classified as financially fragile, engendered a relatively higher level of dissatisfaction with financial regulation.
Tufano suggested that while much additional research is needed, this approach may provide useful input into the ongoing process of establishing priorities among agencies tasked with protecting consumers. He cautioned, however, that while the survey data can identify areas of dissatisfaction and which products are problematic and for whom, it cannot tell regulators what to do. He encouraged the audience to think about defining metrics that could be used to determine whether regulators are making progress in protecting consumers.
Loretta Mester of the Federal Reserve Bank of Philadelphia moderated the second panel of the conference, featuring Robert Avery of the Federal Reserve Board, Jonathan Zinman of Dartmouth College, and Satyajit Chatterjee of the Federal Reserve Bank of Philadelphia. The panelists explored the ability of research to inform public policy decisions using promising new data sources and techniques.
Pictured left to right are: Jonathan Zinman, Dartmouth College; Satyajit Chatterjee, Federal Reserve Bank of Philadelphia; Robert Avery, Federal Reserve Board of Governors; and Loretta Mester, Federal Reserve Bank of Philadelphia.
Avery argued that institutional loan-level micro data remain underutilized in formal research, policy-making, and oversight. While this is beginning to change, much work is needed to understand the strengths and weaknesses of these data. For example, it is important to know that the data used to inform a policy decision are representative of the population of consumers one is trying to protect and the markets that will be affected. Avery placed particular emphasis on making better use of credit bureau data and suggested that the new CFPB start its data collection efforts there.
Zinman described how researchers, working with partners such as financial institutions and nonprofit organizations, implement tests using randomized experiments in order to better identify cause and effect relationships. Zinman provided examples from his own research in retail financial services, including experiments that introduced a new product, a new marketing strategy, and a new messaging strategy. In each case, the research suggests that consumer behavior does respond to these changes. But he cautioned that such findings are not sufficient for making good policy decisions. In order to show that innovations can improve outcomes, researchers must have a holistic view of consumers’ financial decisions and an appreciation for how the marketplace will respond to the introduction of such innovations.
Chatterjee described calibration — a research methodology that is common in macroeconomics — and how it can be used to examine the ways in which policy might influence outcomes in the market for consumer credit. This technique uses numerical methods to solve complex models of the economy based on the optimizing behavior of individual consumers and firms and a realistic description of the information problems they face. When carried out carefully, calibration can be used to simulate the likely general equilibrium outcomes of a policy experiment. This approach is becoming an increasingly important complement to traditional empirical microeconomic studies of credit markets. Chatterjee provided examples of consumer finance questions being analyzed using calibrated models. These include measuring the effects of restricting lenders’ access to information about borrower characteristics that are relevant for estimating default probabilities and the effects of innovation in mortgage financing on housing markets and consumer behavior.
Bob Hunt moderated the final conference panel, which featured Marianne Verdier of Université Paris Ouest Nanterre, Peter Schnall of Capital One, and Mark Olson of Treliant Risk Advisors. The purpose of this panel was to provide forward-looking perspectives on consumer payment systems research, the role of design in credit and payment products, and the challenges facing regulators.
Pictured left to right are: Marianne Verdier, Université Paris Ouest Nanterre; Peter Schnall, Capital One; Mark Olson, Treliant Risk Advisors; and Bob Hunt, Payment Cards Center.
Verdier emphasized that the payment card industry stands at a critical point in its development and regulation. Policy decisions made around the world could have significant implications for efficiency, competition, access, pricing, investment, and innovation. Policymaking is complicated by the externalities associated with the economics of platforms and networks. Verdier argued that this is an area that requires much more empirical as well as theoretical research, especially in terms of the dynamics of how payment systems are invented, developed, and then replaced over time.
Schnall reflected on the core strategic choices industry participants will face in the future, including focusing on fairness in credit card products, maintaining the breadth of credit access, navigating the changing bases of competition, and responding to new products and channels of product delivery.
Olson discussed the difficulties in trying to predict the future, especially in the banking industry. In terms of new regulatory developments, Olson speculated about the application of new prudential regulations for “systemically important” payment systems and considered whether future consumer protection regulation will focus on better disclosures or explicit restrictions on pricing. He suggested that one metric for gauging the effects of new regulation of financial institutions might be the extent to which the more appealing financial products are developed and offered by organizations outside the financial sector. Olson concluded by encouraging the audience to be engaged in gaining an understanding of how new regulations will affect users of financial services and to provide feedback to rule writers at this important time.
Hunt closed the conference by stressing the importance of proceeding scientifically in examining the questions articulated during the conference. This approach entails relying on well-developed and rigorously tested models of the choices that consumers and businesses make. Equally important is maintaining a rich and candid conversation among researchers, policymakers, consumer groups, and industry participants. The Payment Cards Center will continue its efforts along both dimensions in setting its agenda of future events and publications.