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Statements to the Congress.


H.R.2440 would amend the Truth in Lending Act to provide for additional disclosures to accompany credit and charge card applications and preapproved solicitations mailed to consumers. The bill would also expand the disclosure requirements of the Truth in Lending Act for credit and charge card advertisements. Finally, the bill would require additional disclosures and provide substantive rights to consumers in connection with certain changes in the terms of card accounts.

The Board believes that existing law generally provides adequate disclosure to consumers of the key costs associated with credit and charge card accounts. Furthermore, a wealth of public information is available to consumers about credit card rates and nonrate terms. For example, the Federal Reserve Board collects information and then publishes a semiannual report of the terms of credit card plans offered by the largest card issuers in the United States. The Board's September 1991 report (attached to this statement) includes twenty-eight card issuers that offer a rate below 16 percent. (1) Seventeen issuers impose no annual membership fee. Lists of rates and other fees offered by card issuers also are available from groups such as Bankcard Holders of America and from commercial sources. In addition, the media report on credit card rates. In short, it is not apparent to the Board that the current disclosure rules and public information on credit card charges need to be supplemented by further legislation.

Disclosures on Card Applications

and Solicitations

In March 1989, the Fair Credit and Charge Card Disclosure Act amendments to the Truth in Lending law went into effect. Before these amendments were enacted, consumers sometimes did not receive full disclosure of the credit terms on their card accounts until after they had received a credit card accessing the account.

The Fair Credit and Charge Card Disclosure Act requires that card issuers provide early disclosure of rate and other cost information to potential cardholders. The disclosures generally must be provided in direct mail or telephone applications and preapproved solicitations and in applications made available to the general public. Most of the required disclosures must be provided in the form of a table (attached to this statement) that the Board prescribes to allow easy comparison of the terms offered by different card issuers.

H.R.2440 would require that the prescribed disclosure table appear on envelopes containing card applications or preapproved solicitations mailed to consumers. For card issuers that operate in several states, providing their disclosure tables on the outside of envelopes could be difficult given the length of the disclosures.

Although the Board recognizes the value of early disclosure of essential credit information to consumers to facilitate credit shopping, it believes that this proposed requirement would not offer any meaningful benefit to consumers. The consumer who is intrigued by a card issuer's offer to open an account will of necessity have to open the envelope to act on the offer and therefore will encounter the current disclosure table. The consumer who fails to open the envelope (and thereby does not see the disclosure table) obviously is not taking the offer, has not been misled by the card issuer's marketing, and cannot be deemed to have been harmed just because the table is not on the outside of the envelope. Accordingly, the Board believes that this additional disclosure requirement is unnecessary.

Credit Card Advertising

Under the current Truth in Lending Act, creditors that mention specific costs in advertisements for any type of open-end credit product must also disclose other relevant cost information. Under this "trigger term" approach, a card issuer that advertisers its annual percentage rate, for example, must also disclose any minimum finance charge, transaction fee, or similar charge. The Board by regulation also requires that any fee for membership or participation be disclosed.

In general credit card advertisements, when no specific costs are stated, the law does not mandate that any other cost information be provided. In addition, if creditors advertise that certain fees are not charged on an account, no additional disclosures are required. For example, a card issuer may advertise that annual fee is imposed on a card account, without disclosing the rate. Or a card issuer may represent in an advertisement that the annual percentage rate on its accounts is "low," without providing additional disclosure. Consequently, although the Truth in Lending Act and the Board's implementing regulation generally require uniform disclosure of cost information in credit advertisements, they do not require full cost information about credit and charge cards in all advertisements--only in those in which the advertiser triggers the need for further detail.

H.R.2440 would expand the advertising provisions of the Truth in Lending Act to specifically mandate detailed disclosure in any advertisement that promotes credit and charge card accounts. The bill would require that the prescribed Fair Credit and Charge Card Disclosure Act table as well as information about cash advance fees be included, or referred to, in all advertisements of card accounts no matter how brief or general. Disclosure requirements would vary according to the medium (such as television, radio, or print) in which the card advertisement appears.

The Board understands the apparent concern behind this provision of the proposed legislation--that consumers may not be getting full disclosure of credit terms in general advertisements. Nevertheless, the Board believes that the Congress should not require cost information in all advertisements. Mandated disclosures in advertisements could lead to a decrease in advertising as opposed to an increase in disclosure. The costs of compliance as well as the possible length and complexity of the proposed disclosure requirements--inclusion of a disclosure table in any form of advertising--could cause some card issuers to cut back on advertising.

The Board believes that the current disclosure scheme under the Truth in Lending Act gives consumers ample opportunity to ascertain and review account terms being obligated on a card account. The advertising rules provide for the uniform disclosure of credit terms when specific costs are mentioned. The Fair Credit and Charge Card Disclosure Act requires disclosure of key terms in those situations in which card issuers are aggressively marketing their card accounts--for example, in direct mail or telephone campaigns. In addition, the Truth in Lending Act has always required that consumers receive full disclosure before they become obligated on open-end plans. Moreover, the Board by regulation has provided that, if full disclosure is not given beforehand, a consumer may reject the plan once disclosures are received and the creditor must refund any membership fee that has already been paid.

If the Congress nonetheless decides to go forward with legislation to amend the open-end advertising rules, the Board urges the Congress to retain the trigger concept of advertising, perhaps adopting the approach used in the Home Equity Loan Consumer Protection Act of 1988. That law provides that both affirmative and negative references to "trigger" terms in advertisements would require additional Truth in Lending disclosure. Under such a rule, advertising "no annual fee" or "no transaction charge" would call for further disclosure. The Board believes that this more limited approach would effectively address most of the congressional concerns about credit card advertising. In general however, we do not believe that a compelling need to amend the law exists at this time.

Changes in the Terms of a Card Account

Currently, creditors are required to provide consumers with advance notice of changes in rates and other key costs terms initially required to be disclosed under the Truth in Lending Act. the notice must be provided at least fifteen days before a change takes effect. The act itself does not require this notification. The change in terms requirement, which the Board established by regulation, has been in effect since 1969.

H.R.2440 would provide a statutory requirement of notice for a change in terms. The proposed legislation would require a thirty-day advance notice of any adverse change in the items that appear in the disclosure table required under the Fair Credit and Charge Card Disclosure Act as well as of any increase in a cash advance fee. The proposed legislation would also require that, before the change, the notice along with the entire disclosure table be provided on one or more periodic statements of account activity sent to consumers.

The Board does not believe that this additional disclosure requirement is needed. The Board has little evidence that additional disclosure is required to adequately inform consumers about changes in the terms of their accounts. Rather, consumer concern is likely based on the fact that a change takes places, not the lack of advance knowledge of the change. This conclusion is borne out somewhat by the consumer complaints received by the Board in this area, although they are few. Furthermore, if the legislation became law, two different time periods would apply to notifications of a change in terms--fifteen days and thirty days--depending on whether or not the open-end plan had a card associated with it. This feature seems to be unnecessarily complicated.

H.R.2440 would also provide a substantive right to cardholders, permitting them to cancel an account and pay off any outstanding balance under existing terms when certain changes in terms occur (for example, an increase in the annual percentage rate). Although the Truth in Lending Act includes some substantive provisions, it remains primarily a disclosure statute. The Board continues to believe that substantive laws should generally be left to the realm of state law. Some states have, in fact, legislated in this area, although it should be noted that only about a half-dozen states have been the need to give cardholders the right to pay off existing balances on the terms in effect at the time of change. If the Congress nonetheless decides to adopt this opt-out provision, it should at least limit the time period in which consumers can pay back the outstanding amounts owed.

Although the proposed legislation seeks to protect consumers, adverse consequences for consumers themselves may arise. Faced with a federal law that essentially restricts their ability to change the terms on accounts, card issuers may tighten the availability of credit or they may adjust the pricing on card accounts, making the use of credit cards more expensive. Issuers might, for example, stiffen the penalty for late payments or for exceeding a credit limit. some issuers might charge fees that typically have not been imposed, such as application processing fees or transaction fees for purchases. Other issuers might eliminate or shorten grace periods. These actions could have a negative effect on consumers in general and on less affluent borrowers in particular. Furthermore, restricting the ability of card issuers to change terms would not give them much of an incentive to reduce credit card interest rates when conditions might permit reductions; if rates were lowered, it would then be more difficult for card issuers to increase these rates when necessary.

In summary, the Board does not believe that new disclosure or substantive requirements are needed in connection with credit and charge card accounts.


The Fair Credit and Charge Card Disclosure Act directs the Federal Reserve to report to the Congress annual about the profitability of credit card operations of depository institutions. The Board has issued two reports, one in 1990 and another in September 1991. The 1990 report showed that in recent years, credit card profitability generally was higher than returns on other major bank product lines. The 1991 report found that net earnings of credit card banks were higher in 1990 than they were in both 1989 and 1988.

Competition among card issuers is intense and has taken several forms. For example, some card issuers are lowering or waiving fees such as annual membership fees, raising credit limits available to customers, offering enhacements such as purchase protection plans and travel insurance, or offering rebate programs for purchases or discounts on various services. These changes have effectively reduced the costs that many consumers incur, or increased the benefits that many consumers enjoy, in holding and using their credit cards.

Although some industry consolidation has occurred recently, new firms continue to enter the market, and existing firms continue to expand operations. Over the past few years, the availability of credit cards to consumers has increased. Several major new card issuers have entered the market. One issuer, Greenwood Trust, which issues the Discover Card, is now the largest card issuer in the country. A second issuer, Universal Bank, which issues the At&T Universal card, has attracted about 8 million cardholders in less than one year. Further entry into the market by large businesses is anticipated, as evidenced by the announced intention of major U.S. automobile companies and at least one large regional telephone company to offer credit cards.

At the same time, problem loans have increased recently. Credit card delinquency rates and consumer bankruptcies, which directly relate to credit card losses, have risen substantially. In 1990, more than 717,000 nonbusiness bankruptices were filed, compared with 616,000 in 1989 and just over 284,000 in 1984. For bank credit cards in 1984, 3.3 percent of outstanding debt was thrity or more days delinquent. That figure has increased, and by the end of 1990, 4.46 percent of outstanding bank credit card debt was delinquent. In spite of this rising delinquency, credit card operations continue to be a strong-performing segment of the banking industry.

Lack of Change in Credit Card

Interest Rates

A notable phenomenon in the card market is that interest rates on credit card debt have remained quite stable in recent years. The Board, of course, is aware of the long-standing concerns of some consumers about the sustained high level and rigidity of credit card interest rates.

As with other types of credit, the cost of funds for credit card operations is an important component of average and marginal costs, although it is substantially less important for credit card operations than it is for other major types of bank lending. On average, credit card rates have not responded significantly to changes in funding costs. In analyzing the reasons for this response, it is important to bear in mind that the interest rate is only one element of credit card pricing. Other features, such as annual fees, grace periods, late payment fees, and enhancements, are also important components of overall pricing. Card issuers may choose to modify these elements, rather than lending rates, when costs of funds change. Issuers may also choose to relax credit requirements or raise credit limits to broaden and maintain their customer base. Or, of course, they may simply benefit from the public's willingness to continue to borrow on their credit cards even when the interest rates charged do not respond to a decline in card issuers' costs of funds.

There is a debate about why credit card interest rates seem to be so stable. One possible explanation of price "stickiness" relates to the differences in consumer behavior or the type of consumer that card issuers encounter as a result of rate increases or decreases. A presumption under this theory is that card issuers face at least two classes of consumers whose behavior makes rate reductions unattractive even when funding costs decline. The first class of consumers do not intend to borrow on their accounts, but instead, maintain credit card accounts primarily for convenience. Although these convenience users may unexpectedly borrow at high rates, their use of credit is not responsive to changes in interest rates. They are valuable customers for the bank because they may be better credit risks and unlikely to respond to interest rate changes. The second class of consumers fully intend to borrow on their credit card accounts and are therefore more responsive to rate changes. These consumers may, however, be less attractive credit risks.

Because a reduction in rates will attract few of the more creditworthy consumers but perhaps will attract many consumers that could cause losses from deliquency or default, this theory proposes that issuers faced with these results will be reluctant to reduce rates in response to reductions in funding costs. This theory is somewhat controversial because it assumes persistent irrational behavior on the part of a class of consumers.

An alternative explanation offered for the stickiness in rates assumes that established credit card issuers have a solid customer base that does not change its use of credit cards in response to changes in interest rates because of the costs of searching for, and switching to, another card provider. These cost include the following: (1) the time and effort to identify a more attractive credit card and to complete a new credit card application, (2) the potential effect of having a credit rejection added to a credit bureau report, (3) the possibility of a reduced credit limit with the new issuer, (4) uncertainty about the quality of service with a new card issuer, and (5) uncertainty about future rates and fees. Also, the potential savings in interest costs from switching from a high-rate issuer to a low-rate issuer may not be substantial. Because the average balance outstanding for those consumers who regularly borrow is approximately $1,500, a reduction in credit card rates from, for example, 20 percent to 16 percent is likely to save the consumer about $60 per year. I suspect that for many consumers this potential savings is not sufficiently great to overcome the convenience of retaining their current accounts and the costs of changing accounts.

If credit card issuers perceive that the demand for their credit cards is not very sensitive to interest rates, they may have little incentive to adjust their rates rapidly to changing financial conditions. This is particularly true if, in addition, they must incur some costs to change credit card rates (such as costs to advertise, change solicitation literature, and generally inform customers of changes). The gain from changing prices simply may not justify the cost of doing so for those card issuers.

Although these explanations and others have been offered for the marked stickiness in credit card interest rates, little consensus exists as to which explanation has the most merit.

In closing, I would like to emphasize that the Board believes it is important that consumers have adequate information to shop for credit. But more disclosure is not necessarily better disclosure. The federal law requiring early disclosure of credit card terms has been in effect for only about two and one-half years. The full effect of this law should be realized before additional federal legislation in the credit card area is adopted. Moreover, compliance with ever-changing laws and regulations imposes substantial costs on creditors. We believe that these costs will ultimately be borne by consumers through increased prices or reduced services.

Thank you for this opportunity to present the Federal Reserve Board's views on legislative proposals pertaining to the regulation of the government securities market.

As I noted in testimony before you in September, the Board considers the U.S. government securities market to be the most important securities market in the world. It is important for at least three reasons. First, market conditions there determine the cost to the taxpayer of financing U.S. government operations. Second, this market serves as the foundation for other money and capital markets here and abroad and as a prime source of liquidity for financial institutions. Finally, and for us perhaps most important, it is the market in which the Federal Reserve implements monetary policy; in this role, it must be an efficient and reliable transmitter of policy actions.

The U.S. government securities market is a valuable national resource and has performed very well throughout the years. Nevertheless, it is not immutable, and it is certainly not perfect--as the admissions of wrongdoing by Salomon Brothers have quite clearly pointed out. But, changes--especially government-mandated changes--in market practices, structure, and regulation must be rigorously derived from thoughtful study of this marketplace so that the chance of inadvertent damage to the market is minimized. These hearings contribute to that process of careful consideration. Without such a process, regulatory changes--however well-intentioned--risk producing costly mistakes.

The unparalleled depth and liquidity of the market must be preserved in any reforms that are instituted. Useful changes can likely be made, but the bulk of them should await the results of a thorough, full-scale investigation of the market. Such a study is under way by the Treasury Department, the Federal Reserve, and the Securities and Exchange Commission (SEC). This interagency study encompasses both the primary and secondary markets in government securities, and the proposals emerging from it will likely interact in complex ways. A piecemeal approach cannot capture these interactions; a coordinated approach is needed.

While the interagency study is in process, some actions are being taken in response to the abuses that Salomon Brothers committed. In particular, surveillance and enforcement activities have been intensified. A permanent, interagency surveillance group has been created to formalize and expand information sharing among the Treasury, the Federal Reserve, and the SEC. And plans for automating the auction process have been accelerated. The objective is to build a fully computerized bidding procedure. This initiative should not only broaden access to the primary market and enhance enforcement efforts but also should facilitate other potential improvements in the auction process. Broader-based participation in auctions should reduce the vulnerability to abuses and result in a deeper, more efficient market.

More sweeping changes are, I believe, premature at this time; for the reasons I noted earlier, I feel that it is too early to move forward with specific legislative initiatives prompted by the Salomon Brothers episode. A comprehensive review of the market and the abuses has not yet been completed. Rigorous study is required to determine the need for change, to weigh the costs and benefits of alternatives, and to craft any requisite legislation that would improve the market without significant adverse consequences.

Of course, I do welcome the opportunity to discuss the proposals before us today. These proposals fall into two broad categories--those designed to address the Salomon Brothers abuses and those associated more generally with the debate on the reauthorization of the Government Securities Act. With respect to the latter proposals, several of them involves issues that were analyzed in 1990 by the General Accounting Office in its report on the Government Securities Act and by the Treasury, the Board, and the SEC in their joint report. Progress on these proposals can certainly be made now. In particular, as the October 1990 joint report and earlier Board testimony stated, the Board supports extending--or more correctly, now reinstating--the rulemaking authority of the Treasury Department that expired at the beginning of October. And it would want this authority to be made permanent.

With regard to mandated dissemination of trading information and sales practice rules, the Board still believes that a decisive case has not yet been presented for adding statutory requirements. Nevertheless, the Board would not oppose a modest broadening of current law, with adequate safeguards/

Specifically, in the case of information on secuties trading, the Board would urge that the current private-sector initiative in this area be given adequate opportunity to satisfy congressional concerns, with backstop authority to mandate dissemination if necessary. The Board has some reservations, however, about whether the current proposal on dissemination of information includes enough leeway to allow for a more efficient, more flexible, market-based solution to the problem before the government steps in with regulation. For example, adding language that requires the government to make specific findings before invoking its backstop authority to mandate information disclosure would help provide some additional safeguards against unnecessary regulation.

If the Congress feels that a provision for sales practice rules, too, is necessary, perhaps the least costly and most responsive added measure would be a simple removal of the prohibition that blocks the National Association of Securities Dealers (NASD) from applying its sales practice rules to government securities transactions. That change would bring NASD firms into line with what is already the case for member firms of the New York Stock Exchange, extending rules for sales practices to all nonbank brokers and dealers. In this process, which would, in essence, take place with oversight by the SEC, the Board would favor substantive consultation and cooperation with the Treasury Department as the primary regulator of this market. In general, the Board favors consultation and cooperation and opposes the granting of veto powers over other agencies' regulations in this market. The Board is pleased that the committee's legislative proposals include extensive consultation provisions.

The other four proposals on which you requested the Board's views appear to represent responses to the Salomon Brothers episode and thus fall into the category of proposals that, in the Board's view, are better considered as part of a comprehensive review of the market. Although the Board is not prepared to express a definitive view, I would like to share some preliminary reactions to these proposals.

Perhaps the strongest potential concerns are associated with the proposed system of reporting by large traders in the government securities market. Additional recordkeeping and reporting by brokers and dealers may well be worthwhile. But imposing this burden with respect to all large traders may not be necessary and could well involve significant costs.

Although a system for large-trader reporting may be appropriate for the stock market, the market for government securities is very different. The need for large-trader reporting must be rigorously determined, based upon the findings of the Board's study of this episode, because of the possibly considerable costs associated with this reporting burden. These costs include the direct cost incurred by market participants in producing and maintaining reports. More important, such a reporting system could cause some investors to withdraw from a Treasury market in which their finances and trading strategies may be revealed. Because reduced investor demand could translate into higher interest rates required to finance Treasury debt, the Board must carefully assess this potential increase in taxpayer cost. Indeed, equally efficacious but much less costly alternatives to a large-trader reporting system may exist. The stakes are high; the consequences of mistakes are severe; and the Board believes that careful study is required before proceeding with proposals in this area.

Concerning the proposals for requiring internal controls and extending SEC authority to prevent fraudulent and manipulative acts and practices, I expects that the Board's review of the market and its regulation will shed light on the need for such legislation. Certainly, securities firms must have adequate internal procedures to prevent wrongdoing by their employees, and adequate provisions to prevent fraud in this market are needed. However, a determination on whether these two provisions would represent significant, cost-effective, additions that are appropriate in this regard should, in the Board's view, await the results of further study.

The Salomon Brothers episode highlighted some vulnerabilities in the government securities market; it also presented the Board with an opportunity not only to solve the specific problems but also to initiate a comprehensive study for designing and implementing fundamental improvements in market practices, structure, and regulation. I fully expect that the Board will be able to use this opportunity to enhance the integrity and efficiency of this important market.

(1) The attachments to this statement are available on request from Publications Services, Board of Governors of the Federal Reserve System, Washington, D.C. 20551.
COPYRIGHT 1991 Board of Governors of the Federal Reserve System
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Title Annotation:policy statements by members of the Board of Governors Federal Reserve System
Publication:Federal Reserve Bulletin
Article Type:Transcript
Date:Dec 1, 1991
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