An Interest Charge to Defy Logic

It’s been my intent to devote this week’s article to credit card interest rates, but with the horrendous  shootings taking place in El Paso, Texas, on Sunday, Aug. 4, and in Dayton, Ohio, the following day, it’s my fear few people will express interest in something as mundane as what they’re paying to the credit card companies when they can revel in such exotic matters as what goes on in the deranged head of a mass murderer, whether the legal technicalities of the offense the El Paso shooter will be charged with constitutes a hate crime.

There’s a possibility he might never be executed for the atrocity. Most certainly, if he committed the offense in my State of California, he’d be around to cast his vote for president in 2060 (if legal to do so).

After reviewing numerous articles on the rampages, and trying to make some sense of what I read, I’ve made my decision. At the risk of attracting no viewers, you’re going to get a report on how our credit card companies conduct business. What brought this to my attention was a short commentary by Robert Armstrong, a remarkably experienced member of Financial Times Ltd., and previously its Chief Editorial Writer, appearing in one of the newspapers I subscribe to. The sentence attracting me: “Consumers are paying higher interest rates on their credit card balances than in more than a quarter-century, and the Federal Reserve’s rate cuts are no guarantee they will receive much relief.”

Before we get into the details of how rates are set, we must take a look at the Federal Reserve System. The Federal Reserve System, often referred to as the Federal Reserve, or simply the Fed, is the central bank of the United States. It was created by Congress to provide the nation with a safer, more flexible, and more stable monetary and financial system. The Federal Reserve System is the central bank of the United States. The Fed regulates the U.S. monetary and financial system and is composed of a central governmental agency in Washington, D.C., the Board of Governors, and 12 regional Federal Reserve Banks in major cities throughout the United States.

The Federal Reserve performs five general functions: conducting the nation’s monetary policy regulating banking institutions, monitoring and protecting the credit rights of consumers, maintaining the stability of the financial system, and providing financial services to the U.S. government.

The Fed was established by the Federal Reserve Act, signed by President Woodrow Wilson on Dec. 23, 1913, in response to the financial panic of 1907. Before then, the United States was the only major financial power without a central bank. It has broad power to act to ensure financial stability, and it is the primary regulator of banks that are members of the Federal Reserve System. It acts as the lender of last resort to member institutions with no place else to borrow. The Fed is a major force in the economy and banking.

Fed’s monetary policy-making body manages the country’s money supply. It is made up of the seven members of Fed’s board of governors, the president of the New York Fed, and four of the remaining 11 regional Fed presidents, who serve one-year terms on a rotating basis.

The FOMC meets regularly eight times a year and additionally on an as-needed basis to discuss the outlook for the national economy and review options for its monetary policy. Most importantly, it adjusts the target for the overnight controlling of short-term interest rates, at its meetings based on its view of the strength of the economy. When it wants to stimulate the economy, it reduces the target rate. Conversely, it raises the federal funds rate to slow the economy.

To give you a clearer picture of what sort of events can transpire, the target rate was lowered to 0.25% in response to the recession in 2008 and stayed there for seven years. On Dec. 15, 2015, the Fed raised the target rate to a range of 0.25% to 0.5% – the first rate hike in almost 10 years.

Since 2015, the FOMC increased the rate, saying it will continue to do so in the future. However, the system is not immune to politics, and when Chairman of the Board of Governors Jay Powell’s desire to raise rates ran afoul of President Trump’s preference for an aggressive rate-cutting cycle to keep pace with China, they came into conflict.

Although Powell acceded to a quarter percent cut on July 31, 2019, with the comment the move “isn’t the start of a lengthy rate-cutting cycle, though I don’t rule out future decreases … it will depend on whether threats to the Fed’s outlook – a sluggish global economy, Trump’s trade war with China and meager inflation – ease.”

Trump’s response: “As usual, Powell let us down, but at least he is ending quantitative tightening, which shouldn’t have started in the first place – no inflation. We are winning anyway, but I am certainly not getting much help from the Federal Reserve!” How it will end is uncertain. The President may or may possess the legal authority to dismiss the Chairman, but he certainly has the ability not to reappoint him when he comes up for reappointment in February 2022. We shall see.

This brings us to the true point of this article. How can it be, as Robert Armstrong of Financial Times Ltd reports, if the interest rates set by the Federal Reserve Board are the basis of our interest rates, “Consumers are paying higher interest rates on their credit card balances than in more than a quarter-century, and the Federal Reserve’s rate cuts are no guarantee they will receive much relief.”

As I began to research the data available – and there’s plenty to be found – it’s clear the prime rate set by the Fed is not the rate mandated for credit card interest. The Credit Card Accountability Responsibility and Disclosure Act of 2009 is the U.S. law designed to establish – though not necessarily to protect cardholders – the limits set on banks’ ability to raise rates on existing balances. It appears the card issuers cannot reprice you once they sell you a card, but this doesn’t prevent them from pricing in all the possible risks.

And in their marketing technique, they take full advantage of the average customer’s concern to focus on the many perks offered, such as cash back and airline miles their cards brought, while ignoring what rates they pay.

As recently as May of this year, the rate on interest-bearing card accounts averaged 17.8%, and both Citigroup, and JPMorgan the two top U.S. card banks by volume, are expected to raise their rates. This will most certainly flow through to the rates paid by many cardholders, at least initially, but card rates and prime rates do not move in tandem.  Brian Riley of Mercator, a research group, points out since 2004, prime rates rose by 1.25 percent, whereas card rates are up by 5.5 percent – more than three times as much.  I hope this comes as no surprise to you.

Now on to rationality: My credit card bill just arrived in the mail today. After checking the statement for accuracy, I write a check for that amount, insert it into the envelope provided, affix a postage stamp, and set it in my outgoing mail stack. It will be en route to the bank tomorrow morning at the latest. This is an engrained habit since I acquired the card years ago.

This gets us to the bare bones of the matter.  My belief a credit card fulfills a single purposea convenience when neither check nor cash is handy.  Most importantly, when the monthly statement arrives, pay the full cash balance before the date interest is charged.  Follow this rule and the interest rate means nothing.  If for any reason you cannot regulate your credit card use in this manner, destroy your cards, swear off cold turkey, and fashion your life accordingly.

A final thought: Be aware of what this insidious piece of plastic … known as a credit card … is doing to the American consumer. According to the Fed, there’s currently about $850 billion in outstanding credit card debt in the U.S. At the 7.85% average card rate, the card users are out-of-pocket $66.3 billion annually. My sole question is: How can moderately sane persons be so involved? I’ve no answer?

Al Jacobs, a professional investor for nearly a half-century, issues weekly financial articles in which he shares his financial knowledge and experience. Al can be contacted at al@abjacobs.com.