Assorted links

1) Should perspective home buyers be required to watch a video about the pain of foreclosure before they qualify for a mortgage? Draft a budget? Pass an exam about loans?

2) Stefan Wobben reports on deceptive marketing defaults online; one for RyanAir and another for the Wifi at the Amsterdamn airport.

3) NIH is looking to give two $7.5 million grants to investigate health care nudges. Application here. Hat tip: Dan Goldstein.

4) Extremeness aversion and Starbucks coffee.

5) Before credit cards were accepted in cabs, New York riders averaged a 10 percent tip. Now that cabs allow cards, tips have jumped to an average of 22 percent. Hat tip: Steven Shechter.

Consumer purchase battle over defaults

Barry Ritholtz takes note of an ongoing battle between retailers and credit card companies over the processing fee that credit card companies take from retailers with each consumer purchase.

An increasing number of stores have changed their default card settings to “Debit” from “Credit.”

I first noticed this during a visit to Target. I swiped my bank debit card — also a Visa — thru the machine. Sometime ago, the default setting was Credit, but now it seems the default setting was Debit.

So too is the default setting at the Supermarket. If you wanted cash back, you previously had to select Debit, than punch in a dollar amount. Now, the default is debit, and you are automatically asked if you want cash back (some consumer groups advocate sticking with credit over debit).

Addendum: @ Jon. Hilarious.

Addendum Too: Reader David Glenn passes this observation along: “Lately the price of gasoline advertised along I-95 in the northeastern U.S. can be a low (for here) $1.64. But when you pull up to the tank, the default price is a cash only price. The credit card price might be $1.79 or higher for regular. The default option has switched from credit to cash, but the advertised price has not kept up!”

Default rules to help reduce credit card defaults

Reader Aaron Keating writes in with two interesting and thoughtful ideas on ways that credit card companies could nudge their customers to manage their credit better.

The social and economic problems caused by excessive credit card debt are widely known. Below I’ve outlined two default choices currently used by most credit card companies, and suggest nudges that could help consumers rein in excessive credit card use, minimize future credit problems, and use available credit more wisely.

1. “Suggested” vs. “Minimum” Payments

Credit card statements are required by law to require a minimum payment that includes a small percentage (2%-4%) of the principal carried on the card, as well as the interest accrued to date. Depending on the balance carried, the minimum payment can be as low as $10. But as recent research has noted:

“…although minimum payments are designed to protect consumers from the effect of compounding interest, they actually act as “psychological anchors”. In other words, when people are assigned a minimum amount, they generally pay less than they would have if no amount had been listed. A lower payment results in greater interest payments as the debt accrues. If this is the case, the laws that are supposed to protect consumers are unintentionally providing a greater barrier to avoiding credit card debt.”[1]

To combat this problem — while preserving individual choice about payment amounts — I suggest credit card companies present a different default payment option to consumers when the total balance exceeds a predetermined amount, as follows:

If the total balance is small enough that by making the minimum payment the balance would be paid in full within one year, the credit card company calculates and display the minimum payment due as it does now. However, two other pieces of information are also shown: the number of months remaining before the balance is paid in full at that payment level, and the total cost, including interest, the consumer will pay by the end of that time period.[2]

If the total balance is large enough that the minimum payment is not sufficient to pay the balance within one year, a second payment choice is also presented: the “suggested” payment, which shows monthly payment required to pay the balance in full (with interest) in 1 year. As noted above, the number of months remaining before the balance will be paid in full, and the total cost the consumer will pay over that time period (with interest) are also displayed.

If the total balance is large enough that the minimum payment is not sufficient to pay the balance plus interest within 1 year, the “suggested” payment, months remaining, and total interest information could reflect a 2- or even 3-year repayment plan. But for those consumers with credit card debt levels high enough that their minimum payment won’t pay the balance within three years, a brief sentence suggesting they contact a local, non-profit credit counseling agency – along with the agency’s name and phone number – should be included with the credit card statement.

Presenting a “suggested” payment alongside the minimum amount due, with information about the outcomes of each choice, will provide two defaults from which consumers can choose. By highlighting the consequences of their choice and making outcomes easily comparable, consumers can be gently encouraged to pay off their cards sooner and avoid overextending their debt.

2. Opt-in to Credit Limit Increases

Credit card limit increases are often opt-out by default; consumers receive a letter from their credit card company informing them their credit line has been increased. An opt-in process should be used instead, so consumers can actively choose whether they wish to extend their credit lines.

Information about a proposed credit card limit increase should also include the total number of months required to pay the full balance of the card at the proposed new credit limit, using the minimum, one-year, and three-year payoff levels as outlined in #1 above.

Consumers would still be free to contact their credit card company to request an increase if they need it, and credit card companies would still be free to offer increases – but the information noted above will provide some context for the consumer’s decision, and ensure the choice to extend a credit line is conscious and deliberate.

These two suggestions would serve the consumer’s interest in credit management more effectively than policies currently in use by most credit card companies. The new defaults may cause smaller profit margins for credit card companies in the short-run, but improving economic and community stability for individuals, communities and the nation as a whole will benefit all consumers and businesses – credit card companies included – over the long-term.

Assorted links

1) Pepsi is calculating the carbon footprints of popular food products like Tropicana orange juice, Quaker granola bars, and Pepsi cola. No plans yet to put those footprints on its boxes, a la Sapporo.

2) More on credit cards. Companies will change interest rates depending on where you shop. They call it behavioral financing. The minimum payment acts as an anchor, but companies don’t want to anchor you on such a low number that you pile up so much interest that you go bankrupt. They want to push your debt load right up to the penultimate straw that breaks the camel’s back. Ahem, yours.

3) A Council of Economic Advisers? How about a Council of Psychological Advisers, says one psychologist.

4) A German group adapts the fly-in-the-urinal idea to Bulimia. Reducing it, that is. Hat tip: John Hsu.

A nudge buried in credit card regulations

Jeff Sovern, of Public Citizen’s Consumer Law and Policy blog smartly picks up on a nudge in FDIC rules on credit card standards. Buried within Regulation Z is a requirement that the late payment warning must be located adjacent to the payment’s due date. The warning explicitly states what many people willfully choose to ignore: Failure to pay on time will result in penalties! (A mock credit card statement showing how this will look is here.) Placing this warning close to the payment amount “appears likely to increase its effectiveness,” without ordering smart consumer credit choices. Sovern continues:

I gather that this nudge, together with another, the nearby “Minimum Payment Warning,” which gives consumers information about how long it will take to pay off balances if they make only the minimum payments, are products of the 2005 bankruptcy legislation.

Hopefully, there will be a good academic paper on this subject soon. For more on the reasons behind the 2005 legislation, you can read Federal Reserve Baord Governor and subprime soothsayer Edward Gramlich’s congressional testimony. The imprints of behavioralism are all over it. The key passage:

The question is…how might the Board revise its rules under (the Truth in Lending Act (TILA)) in a way that will enable consumers to more effectively use disclosures about the key financial elements of a particular credit card over the life of the account? Simplifying the content of disclosures may be one way; finding ways to enhance consumers’ ability to notice and understand disclosures may be another. Reviewing the adequacy of TILA’s substantive protections is a third, and the ANPR asks questions about each of these areas. As the Regulation Z review proceeds, the Board will be grappling with the challenge of issuing clear and simple rules for creditors that both provide consumers with key information about complicated products (while avoiding so-called “information overload”) and provide consumers adequate substantive protections, consistent with TILA.

A nudge forum on housing and credit

Jim Heskett of Harvard Business School asks two questions over at HBS Working Knowledge.

1) Can housing and credit be “nudged” back to health?

2) Did human frailty cause this crisis (as Sunstein and Thaler have suggested)?

Readers weigh in here.

Hat tip: Mostly Economics.

Your credit card’s minimum payment may affect how fast you pay off your bill

Credit card minimum payment amounts have an anchoring effect on many consumers’ repayment schedules. According to Neil Stewart of the University of Warwick, if you don’t pay the full amount every month or always pay just the minimum, your repayment level is correlated with your card’s minimum payment. Interestingly, among partial payers, the mere presence of repayment actually decreased the amount sent in to credit card companies (among those who pay their entire bill each month, there was no relationship). According to Stewart’s research, which relied on observational data and an experiment that manipulated minimum payment information, about one-third of consumers may fall into this partial-payer category.

These results should be of real concern to credit card companies. Virtually all credit card statements include minimum payments. But this consumer safeguard has an unexpected negative consequence: Minimum payments distort the behaviour of many customers in a way that increases interest charges and increases the duration of their debt. Those paying off the balance in full each month seem to be immune, but anyone repaying only part of the debt is at risk―not just those making only the minimum payment.

According to Stewart’s calculations, a 2 percent reduction of minimum payments on a 20 percent APR card with a $4,000 balance quadruples interest charges. Stewart’s suggestion is the inclusion of a table of repayment scenarios with each bill. A more paternalistic policy implication of this research is to raise minimum payment rates on all credit cards, which the U.S. government pressured banks to do back in 2005. The increase from 2 percent to 3 or 4 percent (depending on the person and the card) caused some short-term pain. According to the latest numbers, though, there’s still plenty of pain to come.

A copy of the paper is available by request at Stewart’s web page.

Addendum: From the Economist:

Economists will be interested in the results. Behavioural economists advocate “nudging” people in the right direction by subtly altering the choices that they are presented with. The insistence on minimum payments is a variation on this theme. Supposedly, those confronted by minimum-payment requirements should pay at least that much. In fact Mr Stewart’s work suggests that people who would have paid a lot, paid less. In economics, as in life, nudging needs to be done carefully.

Charity credit cards

Reader Marcello Piraino proposes a credit card cash back program where the cash goes to charity.

Virtually every person in the western world uses either Bank Cards or Credit Cards (in many cases both) for their purchases. Whether you buy stuff from the grocery round the corner or buy a Gucci Bag for your wife’s birthday there’s an electronic transaction that takes money from your bank account and transfers it to the seller’s bank account. The nudge is, “Donate 1 cent every 1 Dollar while doing your shopping.”

Every Dollar spent will give 1 Cent to a Charity Organisation. It would need to find an agreement between (1) Card holders, (2) Banks that issue the cards or Credit Card Issuer like MasterCard and (3) Charity Organisations.

Basically, one will be donating without even noticing and, at the end of the day (or month or year) a significant amount will be given to help someone else out. You can do the maths yourselves to see the nudge potential.

Shops should sponsor that because it could increase their business, Government and banks should sponsor that too because encourages even further the use of electronic transaction thus reducing the need for printed money (I can think of other advantages but it is not really important). Regularly, a statement of the donations made could be delivered to the card holder and the donations could be used to obtain a tax reduction.

One percent is typically the number that credit cards advertise as the amount of total purchases that they refund to customers, but there is nothing special about the number. A credit card company could allow customers to designate an extra 1-5 percent of purchases to a charity of their choice.

A credit card, a charge card – how about both?

Just as Americans are beginning to show some restraint with their credit cards, reader Rory Sutherland sends along an idea for a card that doubles as a credit card and a charge card. He says he proposed the idea to an as yet undecided American Express.

Create a card with two PINs. If you use one PIN at time of purchase (eg. 1234) the card acts as a credit card and you have the option of revolving at the end of the month. Use the second PIN (eg. 4321) and it acts like a charge card; you will be expected to pay that expense in full when the bill arrives.

You have hence created a hybrid card, half credit card and half charge card. The difference is one has an option not to be tempted to revolve at point of purchase, not only at point of payment. Hence you may sensibly revolve long-term purchases such as furniture or PCs. Meals out, however, you would sensibly pay off in that month. But my hunch is that people’s self-control and good intentions are better at moment of use than at moment of payment, by which point all one’s purchases have been aggregated into one single, and unexpectedly large bill.

This system would mean you would pay interest when it makes sense and not when it doesn’t. Yet it imposes no constraint on the card holder at all – it merely adds an extra layer of choice and control. You could also impose restrictions on the card – voluntarily – when you first signed up, and could revise these annually: eg. prevent me from revolving on purchases below $100.

As an added piece of choice architecture, the credit card PIN could be longer and more complicated than the charge card PIN.