Political Pavement

Story Highlights:

• Congress approved new credit card regulation aimed at limiting sudden rate hikes, punitive fees, and adjustable rates, and requiring better disclosure up front.
• Perhaps new rules on disclosure will help folks make wiser decisions, but limits on how and when firms determine risk and rates will undoubtedly skew things, hurting both banks and customers.
• Luckily, investors needn't worry about a wider market impact in this case. The new rules might hurt some bank shares a bit, but shouldn't have major implications elsewhere.

_________________________________________________________________

Everyone knows roads are paved with asphalt—everywhere but Washington, of course. Politicians prefer paving the Beltway with good intentions. (And we don't have to tell you where that can lead.) In a 90-5 vote Tuesday, the Senate approved new credit card regulation aimed at limiting sudden rate hikes, punitive fees, and adjustable rates, and requiring better disclosure up front. A further proposed rule capping interest rates at 15% failed by a healthy margin. Senator Chris Dodd explained, "This is a very important industry....We just want it to work better." And of course, the feds are the experts.

Perhaps new rules on disclosure will help borrowers make wiser decisions. More transparency is always good. Though to be fair, no one's claiming credit cards are being outright dishonest. The lengthy legal jargon typically accompanying credit card offers or rate changes complies with already stringent regulation. And if folks are ignoring those "25-million page" mea culpas, it's hard to imagine more disclosure will help. Hopefully, the result will be clearer disclosure as stated.

But what about those new rules on raising interest rates, punitive fees, and adjustable rates? Well, monkeying with prices is virtually never a good idea. Banks are in the business of pricing risk. That's what rates do—higher perceived risk means a higher cost to rent the money. By definition, a delinquent or minimum payment borrower is riskier. Start placing limits on how and when firms determine risk and rates, and things tend to get skewed.

For example, who pays the higher price (because the price must still be paid) in this case? Otherwise responsible, credit-worthy customers of course! Banks have no choice but raise rates, annual fees, and cut rewards on "sterling" borrowers to fund their less credit-worthy clients. Exactly backwards. Overall, rates will be higher for more people. Banks will lose money by "going easy" on riskier customers. And good clients will likely cut suddenly more expensive credit purchases, meaning less money from merchants. Both banks and customers get hurt—good intentions gone bad.

But investors needn't worry that there will be much of a wider market impact in this case. The new rules might hurt some bank shares a bit, but shouldn't have major implications elsewhere. Simply, this is a great example of the "law of unintended consequences" hard at work in Washington. It reminds us to be ever vigilant of new laws and regulations—some can cause major market dislocations, as the fallout from mark-to-market rules proved last fall. The key is to understand the relative magnitude and the potential unintended consequences.