Nicholas Anthony
I previously explained how the Consumer Financial Protection Bureau (CFPB) had effectively proposed restricting access to credit by calling for greater price controls on credit card late fees. Yet there are two questions I did not touch on that require further attention: namely, what is a fee and when should business owners be able to change their prices?
What Exactly is a Fee?
CFPB Director Rohit Chopra stated: “Markets work best when companies compete on price and service, rather than relying on back‐end fees that obscure the true cost.” But this statement is misleading insofar as it suggests fees are not a price for a service. Just like wages, fees are prices.
This assertion might lead you to ask: What service is a credit card issuer providing when someone makes their payment later than they promised to? It’s a good question, as it seems both the CFPB and Congress have struggled to answer it. Put simply, that issuer is essentially providing a no‐notice loan. In fact, the same is true when people overdraft their checking accounts. Rather than shut down the account and leave people stranded, this option provides a way for people to maintain access while they get their affairs in order.
With that said, late fees can account for more than the price of a sudden loan. As Andrew Ackerman pointed out in the Wall Street Journal, banks also use fees to discourage and penalize late payments. Rather than involve the police when a person violates a contractual agreement, these fees provide the option for private parties to work out the issue on their own. And this idea shouldn’t be seen as unique to banks. Representative Patrick McHenry (R‑NC) was quick to point out that “Director Chopra is attacking the same tool—fees—that the IRS uses to deter late tax payments.” From the United States Postal Service to county governments, government agencies have a full suite of penalty fees for late payments (Table 1).
Is the CFPB so committed to its war on fees that it will denounce these fees as well? To be fair, one might argue these fees are outside the purview of the CFPB. But they are certainly appropriate for President Biden to comment on given he declared war on everything from airline fees to concert ticket fees at the State of the Union Address earlier this year. Are these agencies next on his list? It would be logically consistent, but it’s doubtful.
What Does the Law Say About Fees?
The CFPB has based its feud on fees on the requirements in Regulation Z. In short, the regulation states that credit card fees must only be used to recoup costs:
A card issuer may impose a fee for violating the terms or other requirements of an account if the card issuer has determined that the dollar amount of the fee represents a reasonable proportion of the total costs incurred by the card issuer as a result of that type of violation. A card issuer must reevaluate this determination at least once every twelve months.
This language is why the entire approach needs to be reformed. It completely overlooks that fees are fundamentally a price of a service, and prices do not serve to solely recoup costs. The argument is akin to suggesting that it should be illegal to price goods at anything other than the manufacturing cost. Worse yet, the argument suggests that the government is in a position to decide when, where, and how a private business may be permitted to make a profit—and how much profit they may earn. Business owners will certainly have costs in mind when considering prices, but whether those prices are ultimately viable should be a decision left to the market.
Beyond costs, the language in Regulation Z also overlooks that fees can be used to deter bad actions. Prohibiting credit card issuers from deterring bad behavior exposes them to greater risk and strips them of the tools to mitigate that risk. In fact, this idea that a fee cannot be used to penalize bad actions is so misplaced that it should be no surprise that the Federal Reserve created the safe harbor provisions, or “expansive immunity provision” as the CFPB termed it.
Rather than force businesses into this model, it would be better for the CFPB to allow a wide range of options.
Should Fees Change with Inflation?
Most headlines have focused on the fact that the CFPB has proposed restricting credit card late fees from the current maximum range of $30-$41 to just $8. However, that’s not the full story: the CFPB’s true end goal appears to be eliminating the late fees entirely. For while the maximum amount would be reduced to $8 under the proposal, the CFPB also wants to remove the option for businesses to adjust their fees for inflation. The CFPB seems to have taken issue with this adjustment because inflation has been high and therefore resulted in fees increasing under the current rules. There are several problems with this approach, but this leads to an interesting question: should fees (and prices generally) be able to change with inflation?
The answer is yes.
If inflation is defined as an increase in the general level of prices and fees are prices, then it stands to reason that fees should be able to increase just the same. But price controls similar to what the CFPB is proposing do not only serve to distort the market, the controls also serve as an underhanded attempt to use inflation as a policy tool to prohibit firms from charging late fees.
The CFPB is proposing restricting prices from $30-$41 to $8 in the short term, but the absence of an inflation adjustment will bring that number effectively to $0 in the long term. Let’s consider the current rate of inflation at 5.0 percent. If this rate persists, the $8.00 price ceiling proposed by the CFPB will be nearly cut in half in real terms in just ten years (Figure 1). Even a more modest rate of inflation at 2% would lead to around a quarter reduction during that time. If the CFPB wants to propose outlawing fees entirely, it should say it out loud.
Conclusion
Whether it’s when you are turning in a library book that fell behind the couch or paying off a credit card balance after hitting a rough patch, paying fees is never fun. But not liking something is not enough to justify the government restricting it. The CFPB was right to draw attention to these provisions, but it was wrong to call on greater restrictions. Rather, it’s time to reconsider the foundations of the CARD Act and Regulation Z.
The author thanks Mariana F. Trujillo and Nicholas Thielman for providing research assistance during the preparation of this essay.