The Credit Card Industry
Brian Trumbore
President/Editor, StocksandNews.com

A few weeks ago PBS' "Frontline" had a fascinating story on the credit card industry. Sounds like a dry topic, doesn't it? Well, its genesis, the modern era that is, may not be that familiar to some of you so I thought I'd take a few snippets from the program and splice them together.

But first, a quiz?

1. How many credit cards does the average American family have?

2. Nearly 144 million Americans have general-purpose credit cards. Approximately how many of them pay off their bill 'in full' each month?

3. Approximately how many Americans pay only 'the minimum' payment required each month?

4. What is the credit card debt carried by the average American family?

Answers below.

Walter Wriston, chairman and CEO Citicorp / Citibank for 17 years.

Q: What was the world like before credit cards, and why did Citibank get involved in credit cards?

Wriston: Well, the world was partitioned, and after the debacle of the Great Depression in the 1930s, a group of restrictive laws were passed, the net of which was that Citibank, for example, was prohibited from opening any offices outside the five boroughs of New York. And so the world (had) 30,000 banks in 1930, and by 1946, there were about 15,000 banks, and today there are somewhere in the order of 6,000 or 7,000. Because each one was partitioned?the object of the exercise on a credit card was to find a way to serve customers outside of the prescribed market area by the statutes, and so the driving force behind it was to create a delivery system for financial products to people across the country.

We bought a piece of Carte Blanche in '65 or so, and then the Bank of America started a credit card called Bank Americard, and Citibank started one, and the wonderful name was the Everything Card. It was a regional card and one day I was invited by a Midwestern bank to come out and talk to their board about whatever the issue was in those days, and walking home that night about midnight, the chairman of the bank said to me, "Citibank's pretty smart, but?if you're pumping gas in Palo Alto (Calif.) and you see Everything Card, you never heard of it, you'd throw it on the ground." And so he said, "If you want to succeed in the business, you have to have a national name." He was right. The next morning I picked up the phone and called Dick Cooley, who is the chairman of Wells Fargo, and he (had) just started a thing called MasterCard. And I said, "Dick, I want to join."

We mailed out 20 million cards across the country?I remember going to St. Louis and just about being stoned by the local banker. One of them said to me: "You sent my wife a credit card with a $1,000 credit line. What are you doing in my market?" And I said, "Where is it written that this is your market?" But out of that huge mailing and so forth, the momentum was created that produced what is now Citigroup (and) now has approximately 142 million cards in more than 40 countries. So that's what the early start was like, long before we understood the use of statistics for credit losses and all that sort of thing?.

Q: And what was the reason behind going to South Dakota?

Wriston: Well, it was very simple. We were going broke.

If you are lending money at 12 percent and paying 20 percent, you don't have to be Einstein to realize you're out of business. So the state of New York had this usury law, so we went to the governor and said, "We have to stop the business because we're losing money for our shareowners." We said: "Look, we want to continue our credit card, but we can't do it because we're losing too much money. And all you have to do is lift the usury ceiling to some reasonable amount and we'll stay here." And they said: "Aha! You really won't move. We're not going to do anything." So we went there three times and the legislature refused to do (budge).

So we made a study of the five states that had either no usury law or very high amounts. One of them was Hawaii, and that was too far away; one of them was Missouri; one of them was South Dakota?.So there was a Supreme Court decision called Marquette v. First of Omaha Services Corporation (1978) which said that you could export the interest rate from the state from which the credit card was issued?.So we went out to South Dakota and the governor there was Bill Janklow (who has had some recent problems you may have heard about). And we said, "Look, we'll bring a couple of thousand jobs out here." And the local bank said, "Well, you'll compete with us, and we can't stand that." And so we said: "Well, we'll open a limited national bank in which we will not compete with the local banks, and we'll put the facility in an inconvenient place for customers, and we'll pay different interest rates than you guys, and you can be happy. All we want to do is use it to issue cards."

And so after about a year and a half of negotiation, the comptroller of the currency?issued us a charter of a limited national bank of South Dakota. And we went out and built a facility out there which is now the largest employer in the state of South Dakota. And that was the start, and they exported the interest rate that would make a profit for the bank right across the country.

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Bill Janklow, governor of South Dakota from 1979 to 1987 and from 1994 to 2003.

Q: Do you remember how it is that credit cards came to your fair state?

Janklow: Let me set the time for you, because I think that puts it in perspective. Interest rates were going into orbit. They were climbing all the time. The cost of money was getting more and more expensive. South Dakota had laws - when I came to the governor's office - on what you could charge to borrow. In other words, there was one interest rate by law that they could charge for new cars, another one for used cars less than five years old, another one for used cars more than five years old. If you went to a bank, if you went to the consumer-loan department, they could by law charge you rates of interest that couldn't be charged by the mortgage department or another department at the bank?

The marketplace exceeded all of those numbers at that point in time, and what I'm trying to say is, we may have a law that said you could charge 9 percent, but money cost 11 percent, so banks weren't loaning money. It stopped credit. In this city, Sioux Falls, there were only five houses, seven houses built in 1981. That's all. There were only seven housing permits, because nobody could afford the financing for a home?.

I'd never heard of all this credit card stuff. I'd like to take credit for it, but I had nothing to do with it. I received four communications in one day. A former governor, Frank Farrar, who served as governor for years and then went into banking and had a lot of banks that he was involved in, he called me, and he had been contacted through banking circles. The state Economic Development Department contacted me and told me they had been contacted by Citibank, and Citibank wanted to meet with me?.

We had a phone conversation, and a couple of days later a couple of people came to South Dakota?and they explained to me what condition their bank was in?.There was a New York state law that said that if you bought goods and services, you could charge 15 or 18 percent, but if you had a cash advance, it was 12, so it cost the bank more money to borrow money to loan you money than you were paying in interest?

Q: So why come to South Dakota?

Well, the government had passed a law in the 30s called (the Glass-Steagall Act and it) was an attempt to keep big national banks from taking over all the banking in America. The trustbusters were involved in a lot of that back in the 30s, and so they had passed legislation that said that a nationally chartered bank cannot go across state lines into another state and practice banking?.

We had exceptions to that in the Great Plains, because our money-center banks were really the Minneapolis banks. They were the monolithic giants in this region. In those days it was called Norwest Bank and First Bank (which) were in Montana, Wyoming, North and South Dakota, Nebraska, Minnesota, Iowa and Wisconsin?.

So we were allowed to have a Minneapolis bank in South Dakota?.Then they passed an amendment called the Douglas Amendment to the McFadden Act. The Douglas Amendment? said you could go across state lines if the state invited you in?And no state had ever invited because all the community bankers made sure that no one would pass legislation inviting an out-of-state bank in.

[Citibank wasn't sure South Dakota or any other state would let them in.]

There had been another Supreme Court decision (Marquette v. First of Omaha). (This) decision said forget where the bank is chartered; wherever the credit decision is made, in whatever state locality the credit decision is made - the "lex loci" rule - that's the place where you can apply interest?In other words, let's just say that if South Dakota had a 5 percent ceiling on interest, and that's where the decision was made, the bank couldn't charge more than 5 percent, even if they loaned the money to somebody in Florida. But if South Dakota had a 25 percent ceiling, then you could charge 25 percent, even to a loan in Florida?.

I lived in a state where the economy was, at that time, dead. I was governor of South Dakota at the only time in this state's history when the economy shrunk from one year to the next?.Our sales-tax collections actually took in less total money one year than the previous year?.I was desperately looking for an opportunity for jobs for South Dakotans. To me, this wasn't a credit card deal; it was a jobs deal?.

What Citibank got out of it?they had 3 ? million total cards, and (more than) 2 million of them were in New York, New Jersey, and Connecticut, but they had rolled out a national program and were mailing credit cards all over the country?.

Credit cards saved Citibank?through the early 80s and into the 90s, and gave them the opportunity to survive?.

Those 3,000 jobs (Citibank brought) to Sioux Falls, based on our population back then?would have taken 300,000 jobs in New York City to equal it at Citibank.

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[Wriston also had some interesting comments on the Depression and today's environment.]

The Great Depression, which came on in a failure of the Bank of the United States in 1931 and so forth, and Roosevelt closed the bank, was perpetrated - any scholar will tell you now - by the fact that the Federal Reserve didn't supply any liquidity. And so (Federal Reserve Chairman) Alan Greenspan will tell you that; (Fed Chairman from 1979-87) Paul Volcker will tell you that. They did exactly the wrong thing. They refused to lend any money to the banks, and it perpetuated 20 years of the Depression. We had 18 million people unemployed in 1933. And in 1939, after the whole New Deal, well, there's still 18 million people unemployed because the Fed just did the wrong thing.

Today when you have a crisis - ?take the last one, (which) was Long-Term Capital Management, which was a hedge fund - they made a bunch of bad bets, and the Fed put together a group of lenders to bail them out. And whether that was right or wrong is another issue.?Monday morning the Fed flooded the market with liquidity, and you don't even remember that that was the biggest bankruptcy in American history at that time?So it isn't the question of the regulation. We tried all that. The question is, how does the central bank supply liquidity in a timely manner if there is a crisis?

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Credit Card Quiz Answers:

1. The average American family has 8 credit cards.

2. Approximately 55 million of 144 million Americans pay off their bill in full each month.

3. Approximately 35 million pay only the minimum payment each month.

4. The average American family carries approximately $8,000 in credit card debt.

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Finally, here is some useful information.

--Even if you make your credit card payments on time, the credit card bank can raise your interest rate automatically if you're late on payments elsewhere - such as on another credit card or on a phone, car, or house payment - or simply because the bank feels you have taken on too much debt.

This practice is called the "universal default" clause. The logic behind it is that the bank is not being unreasonable in raising rates when it has reason to believe that the risk of being repaid by the customer has increased.

--There is no limit on the amount a credit card company can charge a cardholder for being even an hour late with a payment.

--There is no federal limit on the interest rate a credit card company can charge. That's why, as above, the issuers choose states such as South Dakota and Delaware that don't have "usury laws," meaning there is no cap on the interest rate that is charged.

Source: PBS.org

--- I'm off on a trip to South America. Merry Christmas and I'll report back on December 31 with an article on year end.

Brian Trumbore

BUYandHOLD does not recommend any securities. The securities mentioned above are being used for illustrative and informational purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy.