November 28, 2025 • 44 mins
Some people pay off their credit cards at the end of each month. They use the cards as a payment method and collect points and rewards, and never have to pay any interest. For other users, interest can be sky high — way higher than what would be expected simply based on a user's credit or default risk. Why is this? And how do credit card companies get away with charging interest at these levels? On this episode, we speak with Itamar Drechsler, a finance professor at Wharton, who recently co-authored a piece titled Why Are Credit Card Rates so High? Drechsler walks us through the costs of running a credit card operation and explains what borrowers are really paying for.
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Episode Transcript
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Speaker 1 (00:02):
Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2 (00:18):
Hello and welcome to another episode of the Odd Lots podcast.
Speaker 3 (00:22):
I'm Jolle Wisenthal and I'm Tracy Alloway.
Speaker 2 (00:24):
Tracy, are you good about like frequent flyer miles and
hotel rewards and cash back and using your credit card
to get like good seats at the US Open like
all the dining? Are you good about maximizing that stuff?
Speaker 3 (00:38):
Nope, I am not.
Speaker 4 (00:39):
I'm trying to be better, you know, I'm finally signing
up to a bunch of frequent flyer programs and things
like that. But in general, I am not a points strategy.
Some people get really into it.
Speaker 5 (00:51):
Now.
Speaker 2 (00:51):
I do not have a very busy life. I do
not have mental energy towards, you know, maximizing points or
learning about the newest cars. It's like, oh's this card
worth a four hundred dollars fee because I can get
upgraded to Platinum faster this year. I do not want
to think about that stuff. I'm not that interested. But
I get the impression that means I'm probably paying for
(01:12):
someone who is or something like that, or maybe you know,
I'm paying these fees on my credit cards or these
interchange fees, et cetera. Maybe I'm leaving money on the
table by not doing it.
Speaker 5 (01:22):
I don't know.
Speaker 2 (01:22):
I find credit cards to be a weird business, Like
I don't really know what visa does relative to say,
the bank that issues a visa card, et cetera, to
know how they slice them. I don't know any about
credit cards.
Speaker 4 (01:32):
It's a very opaque business, for sure, and it's a
weird business. I would say, like it's competitive, but also
it's like not, you know, like everyone's kind of doing
the same thing in many ways, so we should talk
about it. It's also, I imagine, kind of sticky, in
the same way that deposits at banks are sticky.
Speaker 3 (01:50):
We spoke with Joe Obote about that a while back.
Speaker 2 (01:53):
So I don't cycle through them a bunch and stuff
like that. And there's so much credit card advertising. I
don't know what's good, bad or whatever.
Speaker 5 (02:00):
I know.
Speaker 2 (02:01):
Yeah, Look, I use my credit card as a payments
card because I don't really I don't carry a balance
from month to month, so I don't I don't know,
I think my interest rates or whatever. I pay it
off at the end of every month because I just
basically use it for payments et cetera. So I just
don't know much about them, but they're a huge, major
consumer financing source. Yeah, and every want to talk about
fintech and BNPL and all these other things and stable
(02:22):
coins and all this other stuff, and it's like, yeah,
but the big one. Who's talking about the big one?
Credit cards?
Speaker 3 (02:27):
Well that's the thing.
Speaker 4 (02:28):
So points have become a bigger attractant, I guess, to
credit cards, and so people are spending more with their
credit cards and carrying a bigger balance, which means that
the rate that you're paying on the credit card is
actually more important potentially than something like your mortgage rate.
Speaker 2 (02:44):
Totally well pleased to say. We do, in fact have
the perfect guests. Someone we've had on the podcast before.
I think the last time we were talking about red Q,
which is main lending in the seventies. I like his
work because he goes back to the simple things like
let's talk about how this works. Let's talk about how
this works, because I think we move on too quickly
without sort of understanding the basics. Maybe there are stones
(03:07):
left unturned.
Speaker 5 (03:08):
Literally.
Speaker 2 (03:08):
The perfect guest Itamar Drexler. He has a finance professor
at Warden and he was the co author of a
fairly recent paper sort of looking at the question of
why are credit card rates so high? Because if you
actually do borrow from them, sometimes the rates are like
twenty something percent. Seems way higher than any other sort
of lending. So itamar Thank you so much for coming
back on odd lots.
Speaker 5 (03:29):
Thank you very much. It's really nice to be back.
Thank you for having me.
Speaker 2 (03:31):
When I was doing some prep for this episode, there
is not a ton of actually like fresh academic work
on the credit card industry. There's not a ton of papers,
but it's this huge space.
Speaker 5 (03:42):
Why did you.
Speaker 2 (03:43):
See a reason to go back and revisit the sort
of basic simple question of looking at interest rates on
credit cards?
Speaker 5 (03:52):
Yeah, so my interest is usually like we talked about
when I was here last time's monetary policy, macro and
out of banking and had some student to our co
authors now on this paper a couple of years ago,
I want to talk about fintech because fintech is a
very popular topic. And then I was thinking, well, how
do we analyze fintech and what's the potential room for
(04:12):
fintech to grow if we don't really understand how the
dominant incumbent players the credit card banks work. And then
we look at this and I was very surprised to
see something kind of simple, which is that the return
on assets for credit card banks are just way higher
than the average bank. So bank ROAs are typically you know,
(04:32):
one one point two percent, they move a couple basis
points are very exciting. Credit card banks ROAs and you know,
most banks are not just credit cards, so it's actually
even higher than this, are in the three and a
half often four percent. So it's very shocked by this.
How come it's so high when it's so hard to
squeeze out a couple basis points. And then one of
the reasons is just they you charge really high rates,
(04:53):
Like okay, how did they get away with this? You
know what is going on here? Just very simple question
about how to decompose that rate into the pieces and
kind of what's left over at the end.
Speaker 4 (05:02):
In the spirit of starting at basics, walk us through
the revenue that credit card issuers or credit card banks
are actually earning, the different types and who the players
are in the system.
Speaker 5 (05:14):
Yeah, so let's separate first into two categories. One are
people who revolve their balance, and that's what most of
the papers about it I think that's the more interesting
part and there's more details, and it's kind of the
banking part of it. And there are actually a lot
of people who revolve often. I find people are surprised
to hear this, but about sixty percent of the credit
(05:34):
card users actually revolve, so meaning that they don't pay
in the grace period at the end of the month,
and so they're hit with these very high usually interest charges.
And then the other part are what people call transactors,
so they're the kind that do pay during the grace periods,
so they're not paying interest. Okay, So for the revolvers,
there's again multiple parts, so you pay interest on the
(05:55):
balance that you have. But before then there's the part
which applies both to the transactor and revolvers. When you
swipe the card, then there's immediately a percentage taken. People
call it the swipe fee, and that is split up
into a bunch of pieces. The ones that I used
to be aware of that most people are aware of is
the card network like Visa, MasterCard, Amex. There was Discover
(06:18):
which is now part of Capital One, and that's there's
a whole menu, but basically it's like fifteen twenty basis points. Okay, okay,
it doesn't sound like a lot, but there's like ten
trillion dollars of purchases between debit and credit cards. Turns
out when you take twenty basis points of ten trillion
dollars kind of adds.
Speaker 3 (06:34):
Up nice business if you can get it.
Speaker 5 (06:36):
It's really nice. Actually, be surprised that usually Visa and
JP Morgan are the two most valuable financial services firms.
They change who's number one, So Visa's, you know, been
worth over six hundred billion dollars. It's a lot, yea
and MasterCards is gigantic too, so there's that. Then the
majority of that swipe fee, the majority of that remain there,
(06:58):
actually goes to the bank that issued the card to
the consumer. So that's called interchange fee. And again they
don't make this like very easy to tell, but in
our data it's a little over one point eight percent
on average. I think it's largely been trending up over
time slowly. So the bank gets that, it actually gets
the vast majority of that, and then they pay your
(07:18):
rewards and things. From that, a lot of that goes
to just pass through to the rewards and things, and
they keep a small portion of it for themselves. But
the big part of their business where most of the
money comes from that we analyze here is all these
people that revolved. They pay an interest rate, and that
interest rate now is on average twenty three percent, which
(07:38):
is just like a shockingly high number. I mean, I
guess I've seen that. It just when you work on
assets and like, you know, think the kind of things
you guys talk about bonds and bonds pay you know whatever,
five percent investment grades spread is not even eighty basis points. Now,
on top of it, high yield spreads under three percent, Like,
how the hell do we get to twenty three percent?
Speaker 2 (07:57):
When you hear this number twenty three percent and you
think about the fact that credit card users can be
decomposed into transactors and revolvers, my first instinct would be, well,
the transactors are very on the ball. They're like, not
credit risks. I've always been just a transactor. I've never revolved.
(08:18):
How much of that increase spread can just be explained
by likelihood of default from the revolvers, which I presume
are perhaps a little more you know, financially precurious and
maybe less financially sophisticated.
Speaker 5 (08:33):
Right, So I think, if like me, you didn't know
much about this, your assumption. If I think, if you
ask most financial economists, the first thing they would think is, well,
must be that most of the remainders is a charge offs, right, defaults,
And that's not true. So you can find that pretty easily.
So the average charge off rate on the revolvers, okay,
so when you look at it, let's say you look
it up online, you'll see kind of, you know, relative
(08:56):
to the whole balance sheets includes both groups, and like
you're saying, by definition, transactors don't borrow, so they can't default.
That kind of makes it go down a little bit.
But the majority our revolvers, So if we kind of
clean that out, then on average in our sample it's
five point seventy five percent of bounces are charged off,
So it's not trivial by any means. That's a high number.
(09:17):
But again we were talking about eighteen percent spread, so
if you think, oh, it must be about eighteen percent
charge us, it's not even close. And it's like never
been that high, So you might think, well, maybe it's
just that's on average, but sometimes it'll spike to be
ridiculous numbers it does spike, but not for very long
periods of time. So the bottom line is it's a
substantial chunk of it, but not even close to a
(09:38):
majority of it. So you know people default, but they
don't default that much.
Speaker 4 (09:42):
Can I ask one more question on APR and the
average there? Did you observe any trend over time? Like
did the rate actually get higher as time went on?
Speaker 5 (09:51):
So that's something we haven't spent a lot of time
on in this paper. But the answer to your question
is this is obviously yes. So if you look at it.
I think what can be found online is again it's
I think there's something a little misleading there, but that
has trended up pretty strongly. I think not as much
as somebody you know goes to their computer and looks up.
I'll say, Fred from the Call reports, what is the
average APR? It looks crazy. It looks like it's gone
(10:13):
up ten percent. It's gone up. We're gonna get to
the bottom of like exactly how much I think it's
gone up substantially since ten years ago. Let's say that
trend is clear. I don't think it's as much as
it looks like there, but yeah, it's been going up.
Speaker 4 (10:26):
Actually, okay, so you've established default rates for credit cards,
and as you said, like this business is about volume, right,
so is there an argument to be made that maybe
if the world, you know, falls apart, then you have
lots and lots and lots of consumers who are defaulting,
but you know, potentially at a low rate of the total.
(10:47):
But the volume makes it meaningful for banks.
Speaker 5 (10:50):
I mean, we are already looking at as a percentage
of assets, so that kind of like valuates, it takes
it all into consideration. I think the question, like in
our minds was at first, you know, maybe in a crisis,
something extreme happens. In a sense, it does, but this
is already the average default rates so usually it's lower,
and then you kind of include this in there, so
(11:11):
we'll talk I guess a little bit about risk premium,
which it turns out to be very clear here and important,
but it's you know, just the average default rate is
what it is, so it's not in expected defaults again
they're it's surprising. But at the same time, if you
just look at where banks actually suffer default losses in
an average year, not a crisis year, something like fifty
percent of banks default losses are actually coming from credit cards.
(11:33):
The thing is is that they're not surprising, they're not
unexpected losses. They're kind of the expected, but it's still
really big. And the reason for that is even though
credit cards only take up about five percent of banks
balance sheet, the charge offs or the defaults on average
bank assets is very low. I mean, you know, we
have this impression of banks as being these like crazy,
like risk taking lunatic to actually, I think the right
(11:56):
way to look at them is that their average asset
is extremely boring and low risk. They do take a
lot of leverage, which is only possible because the average
asset is extremely boring and low risk. But even after
all that, their amount of defaults is not really that high.
So if your average asset has about forty basis points
average charge off and this thing has over five percent,
(12:16):
then even if it's only five percent of the balance sheet,
it can act like it's fifty percent of the charge of.
Speaker 2 (12:36):
Other forms of consumer borrowing. Right, Like, people are very
assiduous about making their car payments making I don't know
if up until recently, until recently, but historically the perception
was people really prioritize car payments, right because that's essential
to live and you can't have your car repossessed. Home
mortgages obviously for obvious reason. I imagine that a stretched
(13:01):
household will miss credit card payments are more inclined to
if they're going to have to miss a payment, it's
going to be there versus some of these other popular
areas are borrowing.
Speaker 5 (13:11):
Totally, so the other ones are secured, and this is unsecured.
So in that sense, this is an actual asset that's
kind of risky and interesting for my vantage point, and
that it's unsecured lending to normal people. All the rest
of the stuff is secured, Like homes are obviously very important,
collateral cars pretty much so the rates on those are
(13:32):
much much lower. In these, they're nowhere near you know,
the spread, there's nowhere near as juicy. I mean, when
I teach students, we go through, like you know, the
hierarchy of borrowing that the vast majority of borrowing is secured.
You have to think it's crazy for a bank to
come to somebody with the medium or lower credit score
and say here have the line of credit of like
five ten thousand dollars and you can default on it.
(13:54):
You don't get shot for that. It's it's part of
the law, it's part of the game.
Speaker 1 (13:58):
Yeah.
Speaker 4 (13:59):
I was reading an art from life in nineteen seventy
where they were talking about how credit cards are becoming
a big thing, and oh my god, these credit card
companies are just mailing out applications to Americans. It's like
giving sugar to diabetics. That was their analogy, speaking of
unsecured versus secured. I'm also looking right now at a
website that claims to have invented the first credit card
(14:23):
that's based on your stock portfolio, So borrowing against your.
Speaker 3 (14:26):
Stock portfolio with the card. I gotta say, the card
does look pretty nice. It's made of glass. Maybe that
tells you something intentional metaphor yeah, exactly.
Speaker 4 (14:36):
Okay, So if it's not about risk premiums, if the
rate isn't compensating for something like default, could it be
compensating for all the points and benefits that customers are accruing.
Speaker 5 (14:48):
So it's not just compensation for expected default. I want
I want to separate them from the risk premium. The
risk premium is kind of the competition for unexpected default,
which turns out to be pretty big here. But let's
go back and talk about the point and stuff. So
I find that people are more excited to talk about
points than anything. The term rewards was really a marketing flourish.
So yeah, So in total number of dollars this interchange was,
(15:12):
I mean, again you have to look at fine exact numbers,
but for credit cards alone, I think it was over
one hundred and fifty billion dollars. So, like the GDP
of a medium sized country gets transferred as interchange, and
we find that about eighty five percent of that gets
transferred through as rewards, you could wonder, I think it'd
be natural to say, what is the point of this?
(15:32):
Why charge people one point eight percent and then pass
through one point five to seven percent as rewards? Where well,
at least some people like I guess you and I
Joe don't pay that much attention. I think I have
enormous amounts of United Miles I'm never going to use
because I have to actually travel to whatever place to
use them. So why is that? I mean, I think
(15:52):
a good economic question, and people have tackled this. I
do think it creates a very strong network effect, so
you are not actually seeing a charge for this. It's
the retailer that has to eat it, and if you
do not use a card that gives rewards, you're not
going to get in most cases a lower price. So
there's a whole series of litigation and fights over the
years amazing about what retailers can do to discriminate prices
(16:17):
based people who using cards and hurt And I thought
a couple of years ago. The last couple years, I'm
seeing more restaurants give you back a percentage or not
charge you a percentage if you didn't do that. But
it's a little bit beyond my legal expertise to sometimes
understand these because for the longest time, I think you
could give people a discount, but you couldn't do a searcharge.
There was some like legal discrimination between those things. And
(16:38):
as a result, people mostly don't pay attention to that
kind of thing, and so you really want to stay
inside the network and it kind of keeps you there.
Even if at the end it would be a total
pass through, it still helps for them to keep this business.
Speaker 2 (16:52):
You know, it's interesting. There's this crypto company. Have you
heard of a Blackbird. Yeah, it's a crypto thing and
they have a bunch of restaurants. You sign up and
you're like pay in a coin. I don't know exactly
how it works, but I think that they have to
in some way because in theory would be nice, like
maybe we'll get a little bit in the stable coins.
It's like a payments rail in the future or in
this conversation, and think it would be a nice way
(17:13):
to like circumvent this. But even they, I think implicitly
have to reinvent the rewards model to do it. Maybe
you get premium seeds or you get reservations, et cetera.
In order to sort of like bootstrap a new network,
you start end up having to reinvent a lot of
the rebates and the benefits, et cetera that come up
the old network. Maybe we'll get into crypto a little
(17:35):
bit more, but talk to us a little bit more
then about like the persistence of this spread that can't
fully be explained by defaults.
Speaker 5 (17:44):
Yes, so the default, like I said, is like a
little under six percent, then I'll just I'll mention it.
So defaults that do spike in bad times. So we estimate,
using kind of the cross section of different Fyco scores,
how much extra compensation you get as you go to
lower and lower Fyco scores in terms of extra APR
net of the defaults. So we estimate that the risk
(18:04):
premium there is accounting for about similar sized piece. So
there's a risk preum about five percent on average, which
is much smaller. For let's say you're an eight hundred
FICHO borrower, there's not that much risk premium. But if
you're a six hundred Fyco borrower, the risk preum goes
up to, like, you know, nine percent. So I think
it's means something very important. I think the person who's
borrowing there may not realize that they are paying a
(18:27):
very large risk bemum. So if you're a low Fyco
borrower and you aren't going to default like you know
you're not, you're paying a very high risk premium. And
that is because other people default in bad times. Even
if you do think you're going to default. Sometimes I
think one should realize how much of a risk premium
you're actually paying for this. So but now let's go
back to something else before we maybe talk more about
(18:49):
that is the other pieces of this. So we talked
about interchange and rewards. It's not zero. They do earn
a little bit from it. Most of the transactors what
they make off transactors. Is that difference because transactors spend,
you know, recurringly a lot. Borrowers tend to kind of
accumulate and they don't have that much more room to
spend because they've borrowed. So that's not a big portion
of the revenues there. Then there's fees that's another couple
(19:10):
percent is actually making the puzzle worse. And then the
part that turned out to be really big that surprised
us is operating expenses, of which marketing you mentioned, this
turns out to be really big, and.
Speaker 3 (19:23):
Yeah, this is the thing that I don't get.
Speaker 4 (19:25):
So there is so much marketing for credit cards, and
as I said, like they're all kind of similar in
many ways. And I remember this was often the blockage
for new entrants from the fintech space trying to get
into this business. I remember talking to Lending Club about
this back when they were a thing. They were spending
so much money on mail advertisements, and I just don't
(19:46):
get why that's the primary acquisition channel and why it
seems to be so important to the business model.
Speaker 5 (19:52):
It's a really interesting question. Maybe the answer would be,
like people listening this will be like I knew that,
which is the reason you do it. Because it works,
which means which I wish. I mean, this goes back
to Joe's question. I think you can see we look,
we do this analysis there that if you spend more
on operating expenses, which I think largely means additional marketing
(20:12):
because the actual operational side of this apparently is very expensive.
But there's big differences across these guys in operating expenses,
and I don't think it's because their systems are like
much more and we actually see no relation between that
and defaults. So it's once you control for fighters. So
it's not about screening people for better borrowers. But what
it is it's an effective, apparently at the margin, customer
acquisition strategy. So think the following thought process. You could say, well,
(20:35):
why don't somebody just cut all this marketing out and
just charge a lower rate and that'll get people.
Speaker 3 (20:41):
Yeah, that's that's your acquisition advertising, right.
Speaker 5 (20:45):
Apparently it doesn't work. So so people are not are
not rate sensitive, which is a recurring theme I'm starting to,
you know, learn when we talked about we talk about
banks and bank deposit rates. People are They're not completely
insensitive obviously, but they're not that sensitive to the rates
get paid, and they're not that sensitive to the rates
that get charged on this, so there are actually this
(21:05):
is a surprising thing. The CFPP has a spreadsheet, well,
when there are people still working there. They used to
have a spreadsheet that they updated with essentially every single
card there is and what the rate on it. And
all the cheapest cards are credit unions, and they're significantly cheaper,
much cheaper than your average credit card. But I'm sure
almost nobody's accept their customers have heard about them, and
(21:26):
it's because they don't advertise much. And so you say, well,
if their rates are so cheap, why don't people go there.
It's like they haven't heard about them and they don't
care that much about the rate. Is my inference from this.
So the more you pay for marketing and operating expenses
and the data, the higher is the average amount you're
able to charge this for very funny.
Speaker 2 (21:43):
Does some of the stuff repel the brain of the
academic economists, No, for real, like this idea that the
borrower wouldn't be raided sensitive, the idea that we're actually
paying more to be advertised to et cetera. Because this
is their cost, the idea that their lower cost options
out there and all we have to do is search
for them and they're available.
Speaker 4 (22:03):
Like well, also for macro economists specifically, right, because we
talk about benchmark rates and the importance of how those
feed into the economy, and here we are talking about
the credit card rate, which is actually potentially more important.
Speaker 2 (22:16):
Like I'm serious though, Like rates are high because to
some extent consumers just aren't paying attention to them, et cetera.
Do counter people who think, no, there must be something,
There must be some variable you're missing, because we're rational
and we would take out the lower rate.
Speaker 5 (22:29):
I want to talk to people like you're saying, I
haven't really held up the chance, because you know, when
you pitch this to a finance audience, not macro people,
and I have a finance president, then they're more open.
I mean, credit cards is the thing in finance. People
like credit cards. But I think the interaction with macro
and monetary is really interesting, so it doesn't bother me.
I think it's interesting. I mean, I think it's kind
(22:51):
of bad that a lot of people who are usually
not in the best shape are essentially adding six percent
rate to their credit card because they're paying for the
advertising that they responded to. But you know that's you know,
you could get it if you didn't respond to the advertising,
responded to the rate, they would do that instead, but
they don't, So you know, think about you know, you
guys often talk about the FED lowering or hiking rates.
(23:13):
At the risk of sounding heretical here, I am not
a huge believer that consumers at all are very sensitive
to these changes in the policy rate and the FED
funds rate, even though the standard model works through their
inner temporal consumption savings decision. I think most of the
events is very weak that they care about that. And
then the credit card, I think on top of that
(23:33):
is really makes this clear because if you're paying twenty
three percent and you are the kind of person that
wants to borrow, I mean, obviously because you've borrowed, how
much is a half of percent going to matter to you?
If the FED hikes plus you could have been getting
a much cheaper rate anyway, and that didn't compel you
to go looking for it. So I think it kind
of puts a big question mark over whether that's really
(23:55):
the channel, which which is a lot of people have
said that, but it's still kind of the main way
with those things.
Speaker 4 (24:01):
Can we talk a little bit more about competition and
why doesn't someone just come in with a lower rate
and disrupt the entire business.
Speaker 5 (24:09):
Let's give you another example, personal lines of credit. These
were all new things to me. I find this. I
think where you've put retail people with the financial sector,
you actually get a lot of explosions. They're like weird stuff.
So that's the place where sort of academics should go looking,
and many do, but it's not the place where I
kind of having worked at like hedge fund market maker,
ever thought about these things you want to think about,
like the fancy people, like the people who are sophisticated
(24:31):
do all the math, but they kind of cancel each
other out. Where the real fireworks are is when you
get into the retail sector. And if you look at
personal lines of credit from the same companies at the
same FICO, they're substantially cheaper, plus you get all the
money up front. That's something it's still very puzzling that
there is almost no marketing there. You don't get marketed
a lot on personal lines of credit, and the people
(24:52):
who discover them do use them to consolidate these debts
and pay them off in one shot at a lower interester.
It's a very I think, very logical thing to do
don't do, but I mean, just to get back to
I think we see them over and over and you're
talking about BNPL and stuff. This idea of how do
you acquire customers in what role the rate actually has
there is just keep seeing it. It's like a movie.
(25:14):
I've seen this before. It's more effective at the margin
than lowering the rates, and it explains a lot. I
think of how the finance sector interacts with retail, which
is not just like canceling out. So that's the issues, Like, oh, well,
they spend five percent of assets on marketing, then they
add five percent to the cost. I guess there's no
harm in that. Well not really, because what people have
(25:35):
done is paid the five percent in order to get
the marketing. So if you really like the commercials, you
should be really happy. But I don't think most people
would sign up for that.
Speaker 4 (25:59):
I'm just I've still stunned that the advertising actually works,
because like, I get the mail and I just throw
it out without looking at it.
Speaker 3 (26:06):
Maybe I should be looking at it.
Speaker 4 (26:08):
On the disruption front, you mentioned BNPL, and we've done
at least one episode on it. We should probably do
more at some point. Is that the big disruptor, you know,
if they're plugged into websites and some of them are
getting rewarded for being plugged into those websites by retailers,
then they bypass the high acquisition costs. And presumably it
(26:29):
can still acquire customers because you see them everywhere online.
Speaker 5 (26:33):
So I do think that has a lot to do
with what their angle is, is it gets in front
of you in that way. I listened to a recent
episode of Yours. I think you guys were talking about BNPL,
SOO I wasn't going back to a much earlier episode.
But I don't think the economics of the BNPL beyond
that aspect of it, are that different from the credit cards,
(26:54):
and there still is very high operating and acquisition cost
if you look at like BNPL companies also then don't
really make money, and so I think they're still in
that stage where they're building up to it. And you
mentioned lending club bunding club didn't make money now it
did not, It didn't, so because I think you want
to grab these juicy customers but they respond to the
marketing and just to go even back to that, so
(27:16):
Amex is one of It's really hard to find aggregate
marketing numbers across companies, but from lists I've seen, Amex
might even be it's definitely, I think a top ten
marketer in the whole country. It might even be in
top five. I'm not sure, along with some of the
It spends over six billion dollars a year on marketing.
And this is not including the lounges and all this,
which has been like articles about how everybody's like investing
(27:38):
like millions of dollars in these lines. That's that's a
separate category. And Capital one spends over four billion dollars
a year. So I looked it up, and amics is
bigger than Nike and Coke and marketing, and you think
of like those being the ones that got to be
like the gigantic ones, and Capital one's about as big.
Speaker 2 (27:55):
Wait, a personal line of credit, Yeah, that's just a
good classic is the product. I've never looked into one
of those. An unsecured loan from the bank.
Speaker 5 (28:05):
It's an unsecure line.
Speaker 2 (28:06):
But this is just like classic bank borrowing. I go
to the bank, guys, they can um borrow some money.
Speaker 5 (28:10):
Surprisingly that the I mean you can make you can
look it up even like it's so easy to look
it up. They offer you it's a relatively large amount
compared to a credit card, and you put in your fight. Oh,
they give you a rate. The rate's almost for sure
always lower than the credit card. I don't get it either,
but you know, you know, and.
Speaker 2 (28:29):
One could use these to payoff of all.
Speaker 5 (28:31):
That's mostly what people do, which they should. I had
a journalist ask me about this, and I was like,
this is a great idea, Like I should look this
up and talk about this. I mean, there's no you know,
how do you explain this spread? I mean, I think
largely it's got a lot of this less of this
retail focus to it. But yeah, it's the same companies too.
If you go to amex MS lineup credit Discover offers
a discovered line of credit capital one capital one line
(28:52):
of credit. It's the same thing.
Speaker 3 (28:54):
It's so strange, this whole conversation.
Speaker 2 (28:57):
It edges into some frankly like slightly uncomfortable territory in
my opinion, because you write, because especially when you characterize something,
it's like you're kind of end up paying a lot
for them to advertise to you, and you apparently like
the advertisement because that's you responded to it, et cetera.
Like you edge into this territory where it's like these
(29:18):
are not like it must be not the most sophisticated base, right,
It's like, why do Nigerian email scams have all kinds
of typos, et cetera. And the theory is because they
want to select for people who will be foolish enough
to respond to them, because if you go down the chain,
they don't want you to be too savvy and asking questions.
(29:38):
So like, let's just get all the savvy customers out
of the way who would instantly recognize a scam email,
and then you like get there. It's right, Like it's
a little.
Speaker 5 (29:46):
Saying that the Nigerian princess don't pay you back.
Speaker 2 (29:50):
I'm just saying like it seems like there's a filtration
process going on where you end up with the base
of revolvers where all this money is made, where it's
clearly not that because otherwise they would be doing the
personal line of credit or not doing these things, or
looking for that credit union credit card.
Speaker 5 (30:05):
Well, I'll say something about marketing, and I mean we
all do respond that. You know, you guys are you
guys are very not elitist here and every anti elitist.
So marketing is just a huge industry. Is As a
finance person, I'm like, we do have a marketing department
at the business school, and I'm like, wow, there's a
reason because you look at let's say you look at
(30:27):
Alphabet and Meta. Meta's revenues are almost one hundred percent
from marketing, and Google's are like close to eighty percent.
We're talking hundreds of billions of dollars a year and
all the very sophisticated stuff. And at the end, it's
to sell, you sell, you advertise.
Speaker 2 (30:42):
It works and I've I've certainly been taken I get
taken in by marketing all the time.
Speaker 1 (30:47):
Just say.
Speaker 5 (30:48):
One of the thing is I think the reason that
because the ros here are high, when we decompose this
at the end, it sort of does most If you
take the alpha of this, think of this as alpha
relative to the average bank asset. We get that it's
about of percent, So how do you get down two percent?
So the risk premium here is quite big. We compare
it to the risk premium on bonds. You have to
compare it to high old corporate bonds, and it looks
(31:09):
similar for all but the lowest FIICO bonds versus let's
say triple C rated bonds, where the lowest FYCO seems
to have a big chunk the risk cream over and
above the bonds. I'd actually see the bonds look low
relative to that because it's the risk premum on credit
cards that kind of rises linearly and it's the bonds
that kind of don't. But for the not so bad credits,
it's pretty similar risk premium to highyield bond market. So
(31:31):
that sense doesn't look it's big, but it doesn't look crazy,
but it should, say you know, Goldman, I think they
when they got in before they got into credit cards
and it did not work out, it's apparently it is
competitive in that sense. I think they were eyeing this
and saying this is a good business. You see the
highest roe's by far of all the you know, if
you go look through the banks ten k's, you know,
some of them break this out. I think JP Morgan
(31:51):
for example, and you see like that's got the highest
roe by far, that it's bigger than the you know,
all the other parts of the bank. So I think
they were thinking that now it got into it paid
very high operating costs and had higher defaults than other
ones that didn't obviously did not work out because they
turned away from it.
Speaker 4 (32:06):
Do you see any signs of rates eventually coming down?
It sounds like it's probably not going to be through
competition or new entrance like FinTechs. But could it be
something like regulation. I have vague memories of the Credit
Card Act doing something on this front, but could it
be something.
Speaker 5 (32:23):
Like that the Credit Card Act? There are tons of
papers on it when it came out, mostly limited your
ability to increase rates on existing borrowing, and it sort
of put caps on all kinds of fees and charges,
and then people were looking for whether banks would move
that to something else. I think in the long run
the answer is yes. I don't know if they move
that or just something else. But I mean, so far
(32:45):
rates if you could just plot it on fred even
though I think it's like a little bit distorted, it's
been going up and up, I mean before it starts
going down because I got to stop going up. So
they're in pretty strong position. But there is this by
now pay later, there were lending club kind of things
A largely crashed and burned, and payments in general. I mean,
you know these companies for payments are huge is because
(33:06):
there is this you know PayPal A these guys, this
is just to take off a little bit off the
top of this swipe fee and then we're gonna get
to the interest rates on this borrowing. I mean, I
think that there is constantly like movement in this space,
but it has not been to drive down things, driven
up acquisition costs more than just driven down the actual rates.
Speaker 2 (33:27):
Unrelated macro question. One of the reasons I like your work.
They're sort of revisiting some of these like basic questions,
which I think is useful. And of course when we
talked to a couple of years ago, it was like,
let's revisit some of what we thought we knew about
the seventies and say if that inflation story is a
little bit different, just on the big macro question. These
days rates where they are inflation sort of persistently warm,
(33:52):
A lot of people are like, I got to talk
about our star must be therefore higher than it otherwise
would have been. What do you think we've learned? You know,
we had this very fast rate gig cycle twenty twenty
one through twenty twenty three. I would say many economists
would have expected the unemployment rate to rise a lot
more given that rate hike cycle it has.
Speaker 3 (34:08):
And spending to go down, you're spending.
Speaker 2 (34:11):
To go down, et cetera. But I personally am rarely
satisfied by the stories that people tell about how in
fact those raid hikes translated into lower inflation. Have you
yourself sort of learned anything interesting in the last I
don't know, three or four years, five years of this
macro experiment that we have post pandemic.
Speaker 5 (34:30):
I think it's a great topic in question. My inference
was that the cycle. I'm in the group that thought
that this was largely a supply shock issue. That COVID
disrupted supply chains tremendously. I mean, we saw that, and
I think if you look like the New York Fed
has this index that they put together on supply disruptions,
this predicted the trajectory of inflation with a three month
(34:52):
lead very well. I think we had a period where
we saw that there was increased employment and yet output
was going down. So usually when we talk about productivity
and things, there's all these compositional issues. Do you fire
at least productive people, so productivity goes up for mechanical reasons.
But when you have more people being employed and yet
outputs going down, as it did for several quarters, that
(35:12):
can't be the reason. So I took away from it.
You know, there's harsh arguments about this, that this was
largely supply driven, and how it relates to the seventies
is our argument there, for different reasons, was that it
was supply driven due to credit crunches and things. So
I tend to think that a lot of the business
cycle things and the inflations we've seen, like after wars,
were often switching the kind of production that you do,
(35:35):
which is a supply thing. I'm very much in the
supply camp, and I think the reason that employment held
up and spending held up because I don't think that
this was happening through decreasing demand and getting people fired
and so forth. I think it was products, you know,
components could ship again and so people could be more
productive with the labor they had. So to me, I'm
(35:56):
sure some people very very highly disagreed. To me, that
looked like a pretty clear story.
Speaker 4 (36:00):
So if you're at Jerome pal and you're worried about
inflation going up, and I should just mention we are
recording this.
Speaker 2 (36:06):
On October twenty nine.
Speaker 3 (36:08):
Yeah, FED, which is why we expect it to be
a cut, right, but you know, inflation is still, you know,
somewhat warm.
Speaker 4 (36:16):
As Joe said, if you're worried about it, should you
be looking at credit card rates versus you know, mortgage
rates or benchmark rates or things like that. How should
policy makers actually think about this problem between those?
Speaker 5 (36:29):
I think mortgage rates that people you know do seem
very much to respond to, it is a much bigger amount.
Maybe they are more sophisticated sensitive. It lasts with you
for a long time. I mean, I think that's much
more important the shifts in those spreads for the macro
economy than well, the credit card rates is just not
much movement. I mean, they are literally tacked on top
(36:50):
of the Fed Funds rates, so that's completely mechanical. Didn't
used to be the case thirty years ago. But the
spread will move one for one with the Fed Funds,
except when they expand it by issuing new cards and
making rates hire. So I think the mortgage market's much
more important for macro kind of stuff. I mean, I
don't envy, you know, Pal's job. It's a very hard job. Now,
I'm not sure. Last time was at the FED. I
(37:13):
was in the elevator when he got in, but I
didn't didn't want to bug in, so I didn't say
anything to him. But I got to see him in person.
Speaker 2 (37:19):
Drove our stars fake real good. Going back to you know,
you're talking about fintech et cetera, I personally like, I
actually think stable coins are going to be a very
big deal. I do not necessarily think they're going to
be a big deal for consumer transaction. It's not obvious
to me. My guess is that they'll open up new
transactions that we aren't thinking of right now, but not
(37:39):
for like buying coffee or buying you know whatever. But
from your research, whether into cards, et cetera, how would
that inform your or other fintech how would that inform
your thinking about the trajectory of the stable coin industry.
Speaker 5 (37:55):
It's stable coin. It's interesting, and I've heard you mentioned
this kind of view, which I think is not and
i'd considered I was thinking a lot about consumers. I'll
say this, I think for me and something I talk
to my co author's stable coin are they're like a
puzzle in the sense that maybe not all stable coin,
but the ones that have been around are kind of
like a money market fund that doesn't pay you interest.
(38:17):
That's how I would summarize them, because and that's why
I think these are some like the most profitable companies
ever per employee, because they don't do anything. So if
you give them a bunch of billion dollars, they just
take the whole interest. There's some advertising there too, but
not a tremendous amount compared to that, and people are
happy with that. I don't really get it, but you know,
(38:39):
now they've, like you mentioned, they've started to learn the
sort of tricks of the trade. They're going to do rewards.
It's better than paying people actual interests. You give them rewards.
So from the point of view consumers, it is kind
of a mystery. I mean, I would love to start
a money market fund and not pay anybody any interest.
Life economically, when you don't pay any interest on a dollar, ever,
you've taken the whole dollar. That's what the dollar does.
(39:01):
It pays you interest. So the net present value of
all the interest of a dollar is the dollar. So
if they never pay you and you stay there forever,
then if they have eight billion dollars, they've captured eight
billion dollars.
Speaker 3 (39:12):
Again, nice business, if you yeah, that's a great business.
Speaker 5 (39:15):
It's it's weird, but it's a great business.
Speaker 3 (39:17):
What's your next research project?
Speaker 5 (39:18):
So I think from this credit card stuff, there's definitely
interesting things to think about, you know, how people default
and how much this marketing stuff affects them. From another
point of view is one of my co authors in here,
a former student of mine. We have a bunch of
work on adjustable rate mortgages and why they kind of disappeared.
So they used to be a big thing and they've
(39:40):
kind of disappeared, and I think we kind of understand why.
So that's uh, you know, there's been a lot of
discussion about that for mortgages. Why is the US in
one camp and many other countries in another camp? But
the US kind of used to be in the adjustable
mortgage rate camp at least pre crisis and stuff.
Speaker 2 (39:56):
I remember when the rate hike, when we started surging.
Do popular theory that monetary policy would have more teeth
in countries like Canada, Australia, the UK because so many
more households would be more sensitive to faster resets. Has
that actually been born out? It sounds great, it's like
a theory. Intuitively that makes a lot of sense, I do.
(40:18):
I guess Canadian unemployment has trended higher than American but
the inflation trajectories I think have been roughly the same,
and those other Anglophone countries versus the US where they hit.
I don't know, like how strong effect was that, do
you know.
Speaker 5 (40:32):
I don't know exactly, but I don't get the impression
that it was tremendously different. I think it has impacted consumers.
One thing I should note, though, is there's two senses
in which monetary policy can have an effect. One is
that it makes people have to spend a lot of
money on that, so it's expensive for them. But the
other one is that here and I don't think that's
the effect we were going for, but people have just
(40:53):
you know, stopped taking out as many mortgages and don't move.
It was a negative effect. I'm just not sure it's
anti inflationary effect. So it's like if you're gonna have
floating rate stuff, and that's like the case with credit cards,
and it shouldn't affect the volume of it that much
into of producing it, but it's kind of people. It's
expensive for them, and then on the fixed rate one
(41:15):
they just stick to the old stuff and we don't
you know, mortgage credits really dried up in a way,
but it's not affecting the existing bar wars, only to
the extent that you don't want to move, which is
actually a big deal.
Speaker 2 (41:26):
Drexler, thank you so much for coming back on odd low.
It's always a trade. And next time you have a
new report out, let's talking let's talk arms next time.
Speaker 5 (41:34):
Okay, great, thank you very much having me.
Speaker 2 (41:48):
Tracy. I found that conversation to be fascinating. I have
to admit, like, yeah, like credit cards are the sort
of black box to me in many respects. I don't
really understand the business because I don't actually use them
for revolving purposes or borrowing against them. I don't think
I quite realized how crazy the numbers are. And I
certainly knew that there's tons of advertising, including direct mail
(42:09):
on credit cards, but the idea that this is so
substantial that a big part of what people are paying
for here is the advertising that was all very novel
to me.
Speaker 3 (42:19):
It's very surprising.
Speaker 4 (42:20):
My main takeaway is that people, I guess are not rational,
at least when it comes to credit cards. Right, the
marketing seems to work.
Speaker 2 (42:26):
Yeah, no, totally. I'm not rational because I don't take
advantage of all the points that I could, and I
don't like optimize the way I could. And when I,
like buy a plane ticket, only part of the time
do I think about is this the airlines?
Speaker 4 (42:38):
Well, you could also argue that it's rational to like
factor in the time and spend on doing that.
Speaker 2 (42:43):
Sorry, I justify all of this money left on the
tech's right by saying I make it irrational. My time
is valuable, Yeah, my time is valuable. It's but you know,
if there are all these other borrowing products out there
that are cheaper, et cetera, it does feel like someone
must be able to come along and make a product.
Speaker 5 (43:02):
And yeah, that is, let's going to.
Speaker 2 (43:04):
Compete on raid or you're gonna be able to borrow achiever.
I don't know, maybe b NPL will achieve that. I
don't know.
Speaker 3 (43:08):
I'm going to go take out a personal finance loan
right now.
Speaker 5 (43:11):
Go for it.
Speaker 3 (43:12):
Shall we leave it there, let's leave it there. This
has been another episode of the Audthlots podcast. I'm Tracy Alloway.
You can follow me at Tracy Alloway.
Speaker 2 (43:18):
And I'm Jill Wisenthal. You can follow me at the Stalwart.
Follow our guest Itamar Drexler. He's at Idres. Follow our
producers Carmen Rodriguez at Carman Arman, Dashel Bennett at Dashbot,
and kill Brooks at Kilbrooks. More odd Lots content go
to Bloomberg dot com slash odd lots. We have a
daily newsletter and all of our episodes, and you can
chet about all of these topics twenty four to seven
in our discord discord do gg slash odd lots.
Speaker 4 (43:42):
And if you enjoy ad lots, if you like it
when we talk about the very profitable business of credit cards,
then please leave us a review on your favorite podcast platform.
Speaker 3 (43:52):
And remember, if you are a Bloomberg.
Speaker 4 (43:54):
Subscriber and you enjoy getting benefits and rewards, then please
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Speaker 3 (44:09):
Thanks for listening
Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2 (00:18):
Hello and welcome to another episode of the Odd Lots podcast.
Speaker 3 (00:22):
I'm Jolle Wisenthal and I'm Tracy Alloway.
Speaker 2 (00:24):
Tracy, are you good about like frequent flyer miles and
hotel rewards and cash back and using your credit card
to get like good seats at the US Open like
all the dining? Are you good about maximizing that stuff?
Speaker 3 (00:38):
Nope, I am not.
Speaker 4 (00:39):
I'm trying to be better, you know, I'm finally signing
up to a bunch of frequent flyer programs and things
like that. But in general, I am not a points strategy.
Some people get really into it.
Speaker 5 (00:51):
Now.
Speaker 2 (00:51):
I do not have a very busy life. I do
not have mental energy towards, you know, maximizing points or
learning about the newest cars. It's like, oh's this card
worth a four hundred dollars fee because I can get
upgraded to Platinum faster this year. I do not want
to think about that stuff. I'm not that interested. But
I get the impression that means I'm probably paying for
(01:12):
someone who is or something like that, or maybe you know,
I'm paying these fees on my credit cards or these
interchange fees, et cetera. Maybe I'm leaving money on the
table by not doing it.
Speaker 5 (01:22):
I don't know.
Speaker 2 (01:22):
I find credit cards to be a weird business, Like
I don't really know what visa does relative to say,
the bank that issues a visa card, et cetera, to
know how they slice them. I don't know any about
credit cards.
Speaker 4 (01:32):
It's a very opaque business, for sure, and it's a
weird business. I would say, like it's competitive, but also
it's like not, you know, like everyone's kind of doing
the same thing in many ways, so we should talk
about it. It's also, I imagine, kind of sticky, in
the same way that deposits at banks are sticky.
Speaker 3 (01:50):
We spoke with Joe Obote about that a while back.
Speaker 2 (01:53):
So I don't cycle through them a bunch and stuff
like that. And there's so much credit card advertising. I
don't know what's good, bad or whatever.
Speaker 5 (02:00):
I know.
Speaker 2 (02:01):
Yeah, Look, I use my credit card as a payments
card because I don't really I don't carry a balance
from month to month, so I don't I don't know,
I think my interest rates or whatever. I pay it
off at the end of every month because I just
basically use it for payments et cetera. So I just
don't know much about them, but they're a huge, major
consumer financing source. Yeah, and every want to talk about
fintech and BNPL and all these other things and stable
(02:22):
coins and all this other stuff, and it's like, yeah,
but the big one. Who's talking about the big one?
Credit cards?
Speaker 3 (02:27):
Well that's the thing.
Speaker 4 (02:28):
So points have become a bigger attractant, I guess, to
credit cards, and so people are spending more with their
credit cards and carrying a bigger balance, which means that
the rate that you're paying on the credit card is
actually more important potentially than something like your mortgage rate.
Speaker 2 (02:44):
Totally well pleased to say. We do, in fact have
the perfect guests. Someone we've had on the podcast before.
I think the last time we were talking about red Q,
which is main lending in the seventies. I like his
work because he goes back to the simple things like
let's talk about how this works. Let's talk about how
this works, because I think we move on too quickly
without sort of understanding the basics. Maybe there are stones
(03:07):
left unturned.
Speaker 5 (03:08):
Literally.
Speaker 2 (03:08):
The perfect guest Itamar Drexler. He has a finance professor
at Warden and he was the co author of a
fairly recent paper sort of looking at the question of
why are credit card rates so high? Because if you
actually do borrow from them, sometimes the rates are like
twenty something percent. Seems way higher than any other sort
of lending. So itamar Thank you so much for coming
back on odd lots.
Speaker 5 (03:29):
Thank you very much. It's really nice to be back.
Thank you for having me.
Speaker 2 (03:31):
When I was doing some prep for this episode, there
is not a ton of actually like fresh academic work
on the credit card industry. There's not a ton of papers,
but it's this huge space.
Speaker 5 (03:42):
Why did you.
Speaker 2 (03:43):
See a reason to go back and revisit the sort
of basic simple question of looking at interest rates on
credit cards?
Speaker 5 (03:52):
Yeah, so my interest is usually like we talked about
when I was here last time's monetary policy, macro and
out of banking and had some student to our co
authors now on this paper a couple of years ago,
I want to talk about fintech because fintech is a
very popular topic. And then I was thinking, well, how
do we analyze fintech and what's the potential room for
(04:12):
fintech to grow if we don't really understand how the
dominant incumbent players the credit card banks work. And then
we look at this and I was very surprised to
see something kind of simple, which is that the return
on assets for credit card banks are just way higher
than the average bank. So bank ROAs are typically you know,
(04:32):
one one point two percent, they move a couple basis
points are very exciting. Credit card banks ROAs and you know,
most banks are not just credit cards, so it's actually
even higher than this, are in the three and a
half often four percent. So it's very shocked by this.
How come it's so high when it's so hard to
squeeze out a couple basis points. And then one of
the reasons is just they you charge really high rates,
(04:53):
Like okay, how did they get away with this? You
know what is going on here? Just very simple question
about how to decompose that rate into the pieces and
kind of what's left over at the end.
Speaker 4 (05:02):
In the spirit of starting at basics, walk us through
the revenue that credit card issuers or credit card banks
are actually earning, the different types and who the players
are in the system.
Speaker 5 (05:14):
Yeah, so let's separate first into two categories. One are
people who revolve their balance, and that's what most of
the papers about it I think that's the more interesting
part and there's more details, and it's kind of the
banking part of it. And there are actually a lot
of people who revolve often. I find people are surprised
to hear this, but about sixty percent of the credit
(05:34):
card users actually revolve, so meaning that they don't pay
in the grace period at the end of the month,
and so they're hit with these very high usually interest charges.
And then the other part are what people call transactors,
so they're the kind that do pay during the grace periods,
so they're not paying interest. Okay, So for the revolvers,
there's again multiple parts, so you pay interest on the
(05:55):
balance that you have. But before then there's the part
which applies both to the transactor and revolvers. When you
swipe the card, then there's immediately a percentage taken. People
call it the swipe fee, and that is split up
into a bunch of pieces. The ones that I used
to be aware of that most people are aware of is
the card network like Visa, MasterCard, Amex. There was Discover
(06:18):
which is now part of Capital One, and that's there's
a whole menu, but basically it's like fifteen twenty basis points. Okay, okay,
it doesn't sound like a lot, but there's like ten
trillion dollars of purchases between debit and credit cards. Turns
out when you take twenty basis points of ten trillion
dollars kind of adds.
Speaker 3 (06:34):
Up nice business if you can get it.
Speaker 5 (06:36):
It's really nice. Actually, be surprised that usually Visa and
JP Morgan are the two most valuable financial services firms.
They change who's number one, So Visa's, you know, been
worth over six hundred billion dollars. It's a lot, yea
and MasterCards is gigantic too, so there's that. Then the
majority of that swipe fee, the majority of that remain there,
(06:58):
actually goes to the bank that issued the card to
the consumer. So that's called interchange fee. And again they
don't make this like very easy to tell, but in
our data it's a little over one point eight percent
on average. I think it's largely been trending up over
time slowly. So the bank gets that, it actually gets
the vast majority of that, and then they pay your
(07:18):
rewards and things. From that, a lot of that goes
to just pass through to the rewards and things, and
they keep a small portion of it for themselves. But
the big part of their business where most of the
money comes from that we analyze here is all these
people that revolved. They pay an interest rate, and that
interest rate now is on average twenty three percent, which
(07:38):
is just like a shockingly high number. I mean, I
guess I've seen that. It just when you work on
assets and like, you know, think the kind of things
you guys talk about bonds and bonds pay you know whatever,
five percent investment grades spread is not even eighty basis points. Now,
on top of it, high yield spreads under three percent, Like,
how the hell do we get to twenty three percent?
Speaker 2 (07:57):
When you hear this number twenty three percent and you
think about the fact that credit card users can be
decomposed into transactors and revolvers, my first instinct would be, well,
the transactors are very on the ball. They're like, not
credit risks. I've always been just a transactor. I've never revolved.
(08:18):
How much of that increase spread can just be explained
by likelihood of default from the revolvers, which I presume
are perhaps a little more you know, financially precurious and
maybe less financially sophisticated.
Speaker 5 (08:33):
Right, So I think, if like me, you didn't know
much about this, your assumption. If I think, if you
ask most financial economists, the first thing they would think is, well,
must be that most of the remainders is a charge offs, right, defaults,
And that's not true. So you can find that pretty easily.
So the average charge off rate on the revolvers, okay,
so when you look at it, let's say you look
it up online, you'll see kind of, you know, relative
(08:56):
to the whole balance sheets includes both groups, and like
you're saying, by definition, transactors don't borrow, so they can't default.
That kind of makes it go down a little bit.
But the majority our revolvers, So if we kind of
clean that out, then on average in our sample it's
five point seventy five percent of bounces are charged off,
So it's not trivial by any means. That's a high number.
(09:17):
But again we were talking about eighteen percent spread, so
if you think, oh, it must be about eighteen percent
charge us, it's not even close. And it's like never
been that high, So you might think, well, maybe it's
just that's on average, but sometimes it'll spike to be
ridiculous numbers it does spike, but not for very long
periods of time. So the bottom line is it's a
substantial chunk of it, but not even close to a
(09:38):
majority of it. So you know people default, but they
don't default that much.
Speaker 4 (09:42):
Can I ask one more question on APR and the
average there? Did you observe any trend over time? Like
did the rate actually get higher as time went on?
Speaker 5 (09:51):
So that's something we haven't spent a lot of time
on in this paper. But the answer to your question
is this is obviously yes. So if you look at it.
I think what can be found online is again it's
I think there's something a little misleading there, but that
has trended up pretty strongly. I think not as much
as somebody you know goes to their computer and looks up.
I'll say, Fred from the Call reports, what is the
average APR? It looks crazy. It looks like it's gone
(10:13):
up ten percent. It's gone up. We're gonna get to
the bottom of like exactly how much I think it's
gone up substantially since ten years ago. Let's say that
trend is clear. I don't think it's as much as
it looks like there, but yeah, it's been going up.
Speaker 4 (10:26):
Actually, okay, so you've established default rates for credit cards,
and as you said, like this business is about volume, right,
so is there an argument to be made that maybe
if the world, you know, falls apart, then you have
lots and lots and lots of consumers who are defaulting,
but you know, potentially at a low rate of the total.
(10:47):
But the volume makes it meaningful for banks.
Speaker 5 (10:50):
I mean, we are already looking at as a percentage
of assets, so that kind of like valuates, it takes
it all into consideration. I think the question, like in
our minds was at first, you know, maybe in a crisis,
something extreme happens. In a sense, it does, but this
is already the average default rates so usually it's lower,
and then you kind of include this in there, so
(11:11):
we'll talk I guess a little bit about risk premium,
which it turns out to be very clear here and important,
but it's you know, just the average default rate is
what it is, so it's not in expected defaults again
they're it's surprising. But at the same time, if you
just look at where banks actually suffer default losses in
an average year, not a crisis year, something like fifty
percent of banks default losses are actually coming from credit cards.
(11:33):
The thing is is that they're not surprising, they're not
unexpected losses. They're kind of the expected, but it's still
really big. And the reason for that is even though
credit cards only take up about five percent of banks
balance sheet, the charge offs or the defaults on average
bank assets is very low. I mean, you know, we
have this impression of banks as being these like crazy,
like risk taking lunatic to actually, I think the right
(11:56):
way to look at them is that their average asset
is extremely boring and low risk. They do take a
lot of leverage, which is only possible because the average
asset is extremely boring and low risk. But even after
all that, their amount of defaults is not really that high.
So if your average asset has about forty basis points
average charge off and this thing has over five percent,
(12:16):
then even if it's only five percent of the balance sheet,
it can act like it's fifty percent of the charge of.
Speaker 2 (12:36):
Other forms of consumer borrowing. Right, Like, people are very
assiduous about making their car payments making I don't know
if up until recently, until recently, but historically the perception
was people really prioritize car payments, right because that's essential
to live and you can't have your car repossessed. Home
mortgages obviously for obvious reason. I imagine that a stretched
(13:01):
household will miss credit card payments are more inclined to
if they're going to have to miss a payment, it's
going to be there versus some of these other popular
areas are borrowing.
Speaker 5 (13:11):
Totally, so the other ones are secured, and this is unsecured.
So in that sense, this is an actual asset that's
kind of risky and interesting for my vantage point, and
that it's unsecured lending to normal people. All the rest
of the stuff is secured, Like homes are obviously very important,
collateral cars pretty much so the rates on those are
(13:32):
much much lower. In these, they're nowhere near you know,
the spread, there's nowhere near as juicy. I mean, when
I teach students, we go through, like you know, the
hierarchy of borrowing that the vast majority of borrowing is secured.
You have to think it's crazy for a bank to
come to somebody with the medium or lower credit score
and say here have the line of credit of like
five ten thousand dollars and you can default on it.
(13:54):
You don't get shot for that. It's it's part of
the law, it's part of the game.
Speaker 1 (13:58):
Yeah.
Speaker 4 (13:59):
I was reading an art from life in nineteen seventy
where they were talking about how credit cards are becoming
a big thing, and oh my god, these credit card
companies are just mailing out applications to Americans. It's like
giving sugar to diabetics. That was their analogy, speaking of
unsecured versus secured. I'm also looking right now at a
website that claims to have invented the first credit card
(14:23):
that's based on your stock portfolio, So borrowing against your.
Speaker 3 (14:26):
Stock portfolio with the card. I gotta say, the card
does look pretty nice. It's made of glass. Maybe that
tells you something intentional metaphor yeah, exactly.
Speaker 4 (14:36):
Okay, So if it's not about risk premiums, if the
rate isn't compensating for something like default, could it be
compensating for all the points and benefits that customers are accruing.
Speaker 5 (14:48):
So it's not just compensation for expected default. I want
I want to separate them from the risk premium. The
risk premium is kind of the competition for unexpected default,
which turns out to be pretty big here. But let's
go back and talk about the point and stuff. So
I find that people are more excited to talk about
points than anything. The term rewards was really a marketing flourish.
So yeah, So in total number of dollars this interchange was,
(15:12):
I mean, again you have to look at fine exact numbers,
but for credit cards alone, I think it was over
one hundred and fifty billion dollars. So, like the GDP
of a medium sized country gets transferred as interchange, and
we find that about eighty five percent of that gets
transferred through as rewards, you could wonder, I think it'd
be natural to say, what is the point of this?
(15:32):
Why charge people one point eight percent and then pass
through one point five to seven percent as rewards? Where well,
at least some people like I guess you and I
Joe don't pay that much attention. I think I have
enormous amounts of United Miles I'm never going to use
because I have to actually travel to whatever place to
use them. So why is that? I mean, I think
(15:52):
a good economic question, and people have tackled this. I
do think it creates a very strong network effect, so
you are not actually seeing a charge for this. It's
the retailer that has to eat it, and if you
do not use a card that gives rewards, you're not
going to get in most cases a lower price. So
there's a whole series of litigation and fights over the
years amazing about what retailers can do to discriminate prices
(16:17):
based people who using cards and hurt And I thought
a couple of years ago. The last couple years, I'm
seeing more restaurants give you back a percentage or not
charge you a percentage if you didn't do that. But
it's a little bit beyond my legal expertise to sometimes
understand these because for the longest time, I think you
could give people a discount, but you couldn't do a searcharge.
There was some like legal discrimination between those things. And
(16:38):
as a result, people mostly don't pay attention to that
kind of thing, and so you really want to stay
inside the network and it kind of keeps you there.
Even if at the end it would be a total
pass through, it still helps for them to keep this business.
Speaker 2 (16:52):
You know, it's interesting. There's this crypto company. Have you
heard of a Blackbird. Yeah, it's a crypto thing and
they have a bunch of restaurants. You sign up and
you're like pay in a coin. I don't know exactly
how it works, but I think that they have to
in some way because in theory would be nice, like
maybe we'll get a little bit in the stable coins.
It's like a payments rail in the future or in
this conversation, and think it would be a nice way
(17:13):
to like circumvent this. But even they, I think implicitly
have to reinvent the rewards model to do it. Maybe
you get premium seeds or you get reservations, et cetera.
In order to sort of like bootstrap a new network,
you start end up having to reinvent a lot of
the rebates and the benefits, et cetera that come up
the old network. Maybe we'll get into crypto a little
(17:35):
bit more, but talk to us a little bit more
then about like the persistence of this spread that can't
fully be explained by defaults.
Speaker 5 (17:44):
Yes, so the default, like I said, is like a
little under six percent, then I'll just I'll mention it.
So defaults that do spike in bad times. So we estimate,
using kind of the cross section of different Fyco scores,
how much extra compensation you get as you go to
lower and lower Fyco scores in terms of extra APR
net of the defaults. So we estimate that the risk
(18:04):
premium there is accounting for about similar sized piece. So
there's a risk preum about five percent on average, which
is much smaller. For let's say you're an eight hundred
FICHO borrower, there's not that much risk premium. But if
you're a six hundred Fyco borrower, the risk preum goes
up to, like, you know, nine percent. So I think
it's means something very important. I think the person who's
borrowing there may not realize that they are paying a
(18:27):
very large risk bemum. So if you're a low Fyco
borrower and you aren't going to default like you know
you're not, you're paying a very high risk premium. And
that is because other people default in bad times. Even
if you do think you're going to default. Sometimes I
think one should realize how much of a risk premium
you're actually paying for this. So but now let's go
back to something else before we maybe talk more about
(18:49):
that is the other pieces of this. So we talked
about interchange and rewards. It's not zero. They do earn
a little bit from it. Most of the transactors what
they make off transactors. Is that difference because transactors spend,
you know, recurringly a lot. Borrowers tend to kind of
accumulate and they don't have that much more room to
spend because they've borrowed. So that's not a big portion
of the revenues there. Then there's fees that's another couple
(19:10):
percent is actually making the puzzle worse. And then the
part that turned out to be really big that surprised
us is operating expenses, of which marketing you mentioned, this
turns out to be really big, and.
Speaker 3 (19:23):
Yeah, this is the thing that I don't get.
Speaker 4 (19:25):
So there is so much marketing for credit cards, and
as I said, like they're all kind of similar in
many ways. And I remember this was often the blockage
for new entrants from the fintech space trying to get
into this business. I remember talking to Lending Club about
this back when they were a thing. They were spending
so much money on mail advertisements, and I just don't
(19:46):
get why that's the primary acquisition channel and why it
seems to be so important to the business model.
Speaker 5 (19:52):
It's a really interesting question. Maybe the answer would be,
like people listening this will be like I knew that,
which is the reason you do it. Because it works,
which means which I wish. I mean, this goes back
to Joe's question. I think you can see we look,
we do this analysis there that if you spend more
on operating expenses, which I think largely means additional marketing
(20:12):
because the actual operational side of this apparently is very expensive.
But there's big differences across these guys in operating expenses,
and I don't think it's because their systems are like
much more and we actually see no relation between that
and defaults. So it's once you control for fighters. So
it's not about screening people for better borrowers. But what
it is it's an effective, apparently at the margin, customer
acquisition strategy. So think the following thought process. You could say, well,
(20:35):
why don't somebody just cut all this marketing out and
just charge a lower rate and that'll get people.
Speaker 3 (20:41):
Yeah, that's that's your acquisition advertising, right.
Speaker 5 (20:45):
Apparently it doesn't work. So so people are not are
not rate sensitive, which is a recurring theme I'm starting to,
you know, learn when we talked about we talk about
banks and bank deposit rates. People are They're not completely
insensitive obviously, but they're not that sensitive to the rates
get paid, and they're not that sensitive to the rates
that get charged on this, so there are actually this
(21:05):
is a surprising thing. The CFPP has a spreadsheet, well,
when there are people still working there. They used to
have a spreadsheet that they updated with essentially every single
card there is and what the rate on it. And
all the cheapest cards are credit unions, and they're significantly cheaper,
much cheaper than your average credit card. But I'm sure
almost nobody's accept their customers have heard about them, and
(21:26):
it's because they don't advertise much. And so you say, well,
if their rates are so cheap, why don't people go there.
It's like they haven't heard about them and they don't
care that much about the rate. Is my inference from this.
So the more you pay for marketing and operating expenses
and the data, the higher is the average amount you're
able to charge this for very funny.
Speaker 2 (21:43):
Does some of the stuff repel the brain of the
academic economists, No, for real, like this idea that the
borrower wouldn't be raided sensitive, the idea that we're actually
paying more to be advertised to et cetera. Because this
is their cost, the idea that their lower cost options
out there and all we have to do is search
for them and they're available.
Speaker 4 (22:03):
Like well, also for macro economists specifically, right, because we
talk about benchmark rates and the importance of how those
feed into the economy, and here we are talking about
the credit card rate, which is actually potentially more important.
Speaker 2 (22:16):
Like I'm serious though, Like rates are high because to
some extent consumers just aren't paying attention to them, et cetera.
Do counter people who think, no, there must be something,
There must be some variable you're missing, because we're rational
and we would take out the lower rate.
Speaker 5 (22:29):
I want to talk to people like you're saying, I
haven't really held up the chance, because you know, when
you pitch this to a finance audience, not macro people,
and I have a finance president, then they're more open.
I mean, credit cards is the thing in finance. People
like credit cards. But I think the interaction with macro
and monetary is really interesting, so it doesn't bother me.
I think it's interesting. I mean, I think it's kind
(22:51):
of bad that a lot of people who are usually
not in the best shape are essentially adding six percent
rate to their credit card because they're paying for the
advertising that they responded to. But you know that's you know,
you could get it if you didn't respond to the advertising,
responded to the rate, they would do that instead, but
they don't, So you know, think about you know, you
guys often talk about the FED lowering or hiking rates.
(23:13):
At the risk of sounding heretical here, I am not
a huge believer that consumers at all are very sensitive
to these changes in the policy rate and the FED
funds rate, even though the standard model works through their
inner temporal consumption savings decision. I think most of the
events is very weak that they care about that. And
then the credit card, I think on top of that
(23:33):
is really makes this clear because if you're paying twenty
three percent and you are the kind of person that
wants to borrow, I mean, obviously because you've borrowed, how
much is a half of percent going to matter to you?
If the FED hikes plus you could have been getting
a much cheaper rate anyway, and that didn't compel you
to go looking for it. So I think it kind
of puts a big question mark over whether that's really
(23:55):
the channel, which which is a lot of people have
said that, but it's still kind of the main way
with those things.
Speaker 4 (24:01):
Can we talk a little bit more about competition and
why doesn't someone just come in with a lower rate
and disrupt the entire business.
Speaker 5 (24:09):
Let's give you another example, personal lines of credit. These
were all new things to me. I find this. I
think where you've put retail people with the financial sector,
you actually get a lot of explosions. They're like weird stuff.
So that's the place where sort of academics should go looking,
and many do, but it's not the place where I
kind of having worked at like hedge fund market maker,
ever thought about these things you want to think about,
like the fancy people, like the people who are sophisticated
(24:31):
do all the math, but they kind of cancel each
other out. Where the real fireworks are is when you
get into the retail sector. And if you look at
personal lines of credit from the same companies at the
same FICO, they're substantially cheaper, plus you get all the
money up front. That's something it's still very puzzling that
there is almost no marketing there. You don't get marketed
a lot on personal lines of credit, and the people
(24:52):
who discover them do use them to consolidate these debts
and pay them off in one shot at a lower interester.
It's a very I think, very logical thing to do
don't do, but I mean, just to get back to
I think we see them over and over and you're
talking about BNPL and stuff. This idea of how do
you acquire customers in what role the rate actually has
there is just keep seeing it. It's like a movie.
(25:14):
I've seen this before. It's more effective at the margin
than lowering the rates, and it explains a lot. I
think of how the finance sector interacts with retail, which
is not just like canceling out. So that's the issues, Like, oh, well,
they spend five percent of assets on marketing, then they
add five percent to the cost. I guess there's no
harm in that. Well not really, because what people have
(25:35):
done is paid the five percent in order to get
the marketing. So if you really like the commercials, you
should be really happy. But I don't think most people
would sign up for that.
Speaker 4 (25:59):
I'm just I've still stunned that the advertising actually works,
because like, I get the mail and I just throw
it out without looking at it.
Speaker 3 (26:06):
Maybe I should be looking at it.
Speaker 4 (26:08):
On the disruption front, you mentioned BNPL, and we've done
at least one episode on it. We should probably do
more at some point. Is that the big disruptor, you know,
if they're plugged into websites and some of them are
getting rewarded for being plugged into those websites by retailers,
then they bypass the high acquisition costs. And presumably it
(26:29):
can still acquire customers because you see them everywhere online.
Speaker 5 (26:33):
So I do think that has a lot to do
with what their angle is, is it gets in front
of you in that way. I listened to a recent
episode of Yours. I think you guys were talking about BNPL,
SOO I wasn't going back to a much earlier episode.
But I don't think the economics of the BNPL beyond
that aspect of it, are that different from the credit cards,
(26:54):
and there still is very high operating and acquisition cost
if you look at like BNPL companies also then don't
really make money, and so I think they're still in
that stage where they're building up to it. And you
mentioned lending club bunding club didn't make money now it
did not, It didn't, so because I think you want
to grab these juicy customers but they respond to the
marketing and just to go even back to that, so
(27:16):
Amex is one of It's really hard to find aggregate
marketing numbers across companies, but from lists I've seen, Amex
might even be it's definitely, I think a top ten
marketer in the whole country. It might even be in
top five. I'm not sure, along with some of the
It spends over six billion dollars a year on marketing.
And this is not including the lounges and all this,
which has been like articles about how everybody's like investing
(27:38):
like millions of dollars in these lines. That's that's a
separate category. And Capital one spends over four billion dollars
a year. So I looked it up, and amics is
bigger than Nike and Coke and marketing, and you think
of like those being the ones that got to be
like the gigantic ones, and Capital one's about as big.
Speaker 2 (27:55):
Wait, a personal line of credit, Yeah, that's just a
good classic is the product. I've never looked into one
of those. An unsecured loan from the bank.
Speaker 5 (28:05):
It's an unsecure line.
Speaker 2 (28:06):
But this is just like classic bank borrowing. I go
to the bank, guys, they can um borrow some money.
Speaker 5 (28:10):
Surprisingly that the I mean you can make you can
look it up even like it's so easy to look
it up. They offer you it's a relatively large amount
compared to a credit card, and you put in your fight. Oh,
they give you a rate. The rate's almost for sure
always lower than the credit card. I don't get it either,
but you know, you know, and.
Speaker 2 (28:29):
One could use these to payoff of all.
Speaker 5 (28:31):
That's mostly what people do, which they should. I had
a journalist ask me about this, and I was like,
this is a great idea, Like I should look this
up and talk about this. I mean, there's no you know,
how do you explain this spread? I mean, I think
largely it's got a lot of this less of this
retail focus to it. But yeah, it's the same companies too.
If you go to amex MS lineup credit Discover offers
a discovered line of credit capital one capital one line
(28:52):
of credit. It's the same thing.
Speaker 3 (28:54):
It's so strange, this whole conversation.
Speaker 2 (28:57):
It edges into some frankly like slightly uncomfortable territory in
my opinion, because you write, because especially when you characterize something,
it's like you're kind of end up paying a lot
for them to advertise to you, and you apparently like
the advertisement because that's you responded to it, et cetera.
Like you edge into this territory where it's like these
(29:18):
are not like it must be not the most sophisticated base, right,
It's like, why do Nigerian email scams have all kinds
of typos, et cetera. And the theory is because they
want to select for people who will be foolish enough
to respond to them, because if you go down the chain,
they don't want you to be too savvy and asking questions.
(29:38):
So like, let's just get all the savvy customers out
of the way who would instantly recognize a scam email,
and then you like get there. It's right, Like it's
a little.
Speaker 5 (29:46):
Saying that the Nigerian princess don't pay you back.
Speaker 2 (29:50):
I'm just saying like it seems like there's a filtration
process going on where you end up with the base
of revolvers where all this money is made, where it's
clearly not that because otherwise they would be doing the
personal line of credit or not doing these things, or
looking for that credit union credit card.
Speaker 5 (30:05):
Well, I'll say something about marketing, and I mean we
all do respond that. You know, you guys are you
guys are very not elitist here and every anti elitist.
So marketing is just a huge industry. Is As a
finance person, I'm like, we do have a marketing department
at the business school, and I'm like, wow, there's a
reason because you look at let's say you look at
(30:27):
Alphabet and Meta. Meta's revenues are almost one hundred percent
from marketing, and Google's are like close to eighty percent.
We're talking hundreds of billions of dollars a year and
all the very sophisticated stuff. And at the end, it's
to sell, you sell, you advertise.
Speaker 2 (30:42):
It works and I've I've certainly been taken I get
taken in by marketing all the time.
Speaker 1 (30:47):
Just say.
Speaker 5 (30:48):
One of the thing is I think the reason that
because the ros here are high, when we decompose this
at the end, it sort of does most If you
take the alpha of this, think of this as alpha
relative to the average bank asset. We get that it's
about of percent, So how do you get down two percent?
So the risk premium here is quite big. We compare
it to the risk premium on bonds. You have to
compare it to high old corporate bonds, and it looks
(31:09):
similar for all but the lowest FIICO bonds versus let's
say triple C rated bonds, where the lowest FYCO seems
to have a big chunk the risk cream over and
above the bonds. I'd actually see the bonds look low
relative to that because it's the risk premum on credit
cards that kind of rises linearly and it's the bonds
that kind of don't. But for the not so bad credits,
it's pretty similar risk premium to highyield bond market. So
(31:31):
that sense doesn't look it's big, but it doesn't look crazy,
but it should, say you know, Goldman, I think they
when they got in before they got into credit cards
and it did not work out, it's apparently it is
competitive in that sense. I think they were eyeing this
and saying this is a good business. You see the
highest roe's by far of all the you know, if
you go look through the banks ten k's, you know,
some of them break this out. I think JP Morgan
(31:51):
for example, and you see like that's got the highest
roe by far, that it's bigger than the you know,
all the other parts of the bank. So I think
they were thinking that now it got into it paid
very high operating costs and had higher defaults than other
ones that didn't obviously did not work out because they
turned away from it.
Speaker 4 (32:06):
Do you see any signs of rates eventually coming down?
It sounds like it's probably not going to be through
competition or new entrance like FinTechs. But could it be
something like regulation. I have vague memories of the Credit
Card Act doing something on this front, but could it
be something.
Speaker 5 (32:23):
Like that the Credit Card Act? There are tons of
papers on it when it came out, mostly limited your
ability to increase rates on existing borrowing, and it sort
of put caps on all kinds of fees and charges,
and then people were looking for whether banks would move
that to something else. I think in the long run
the answer is yes. I don't know if they move
that or just something else. But I mean, so far
(32:45):
rates if you could just plot it on fred even
though I think it's like a little bit distorted, it's
been going up and up, I mean before it starts
going down because I got to stop going up. So
they're in pretty strong position. But there is this by
now pay later, there were lending club kind of things
A largely crashed and burned, and payments in general. I mean,
you know these companies for payments are huge is because
(33:06):
there is this you know PayPal A these guys, this
is just to take off a little bit off the
top of this swipe fee and then we're gonna get
to the interest rates on this borrowing. I mean, I
think that there is constantly like movement in this space,
but it has not been to drive down things, driven
up acquisition costs more than just driven down the actual rates.
Speaker 2 (33:27):
Unrelated macro question. One of the reasons I like your work.
They're sort of revisiting some of these like basic questions,
which I think is useful. And of course when we
talked to a couple of years ago, it was like,
let's revisit some of what we thought we knew about
the seventies and say if that inflation story is a
little bit different, just on the big macro question. These
days rates where they are inflation sort of persistently warm,
(33:52):
A lot of people are like, I got to talk
about our star must be therefore higher than it otherwise
would have been. What do you think we've learned? You know,
we had this very fast rate gig cycle twenty twenty
one through twenty twenty three. I would say many economists
would have expected the unemployment rate to rise a lot
more given that rate hike cycle it has.
Speaker 3 (34:08):
And spending to go down, you're spending.
Speaker 2 (34:11):
To go down, et cetera. But I personally am rarely
satisfied by the stories that people tell about how in
fact those raid hikes translated into lower inflation. Have you
yourself sort of learned anything interesting in the last I
don't know, three or four years, five years of this
macro experiment that we have post pandemic.
Speaker 5 (34:30):
I think it's a great topic in question. My inference
was that the cycle. I'm in the group that thought
that this was largely a supply shock issue. That COVID
disrupted supply chains tremendously. I mean, we saw that, and
I think if you look like the New York Fed
has this index that they put together on supply disruptions,
this predicted the trajectory of inflation with a three month
(34:52):
lead very well. I think we had a period where
we saw that there was increased employment and yet output
was going down. So usually when we talk about productivity
and things, there's all these compositional issues. Do you fire
at least productive people, so productivity goes up for mechanical reasons.
But when you have more people being employed and yet
outputs going down, as it did for several quarters, that
(35:12):
can't be the reason. So I took away from it.
You know, there's harsh arguments about this, that this was
largely supply driven, and how it relates to the seventies
is our argument there, for different reasons, was that it
was supply driven due to credit crunches and things. So
I tend to think that a lot of the business
cycle things and the inflations we've seen, like after wars,
were often switching the kind of production that you do,
(35:35):
which is a supply thing. I'm very much in the
supply camp, and I think the reason that employment held
up and spending held up because I don't think that
this was happening through decreasing demand and getting people fired
and so forth. I think it was products, you know,
components could ship again and so people could be more
productive with the labor they had. So to me, I'm
(35:56):
sure some people very very highly disagreed. To me, that
looked like a pretty clear story.
Speaker 4 (36:00):
So if you're at Jerome pal and you're worried about
inflation going up, and I should just mention we are
recording this.
Speaker 2 (36:06):
On October twenty nine.
Speaker 3 (36:08):
Yeah, FED, which is why we expect it to be
a cut, right, but you know, inflation is still, you know,
somewhat warm.
Speaker 4 (36:16):
As Joe said, if you're worried about it, should you
be looking at credit card rates versus you know, mortgage
rates or benchmark rates or things like that. How should
policy makers actually think about this problem between those?
Speaker 5 (36:29):
I think mortgage rates that people you know do seem
very much to respond to, it is a much bigger amount.
Maybe they are more sophisticated sensitive. It lasts with you
for a long time. I mean, I think that's much
more important the shifts in those spreads for the macro
economy than well, the credit card rates is just not
much movement. I mean, they are literally tacked on top
(36:50):
of the Fed Funds rates, so that's completely mechanical. Didn't
used to be the case thirty years ago. But the
spread will move one for one with the Fed Funds,
except when they expand it by issuing new cards and
making rates hire. So I think the mortgage market's much
more important for macro kind of stuff. I mean, I
don't envy, you know, Pal's job. It's a very hard job. Now,
I'm not sure. Last time was at the FED. I
(37:13):
was in the elevator when he got in, but I
didn't didn't want to bug in, so I didn't say
anything to him. But I got to see him in person.
Speaker 2 (37:19):
Drove our stars fake real good. Going back to you know,
you're talking about fintech et cetera, I personally like, I
actually think stable coins are going to be a very
big deal. I do not necessarily think they're going to
be a big deal for consumer transaction. It's not obvious
to me. My guess is that they'll open up new
transactions that we aren't thinking of right now, but not
(37:39):
for like buying coffee or buying you know whatever. But
from your research, whether into cards, et cetera, how would
that inform your or other fintech how would that inform
your thinking about the trajectory of the stable coin industry.
Speaker 5 (37:55):
It's stable coin. It's interesting, and I've heard you mentioned
this kind of view, which I think is not and
i'd considered I was thinking a lot about consumers. I'll
say this, I think for me and something I talk
to my co author's stable coin are they're like a
puzzle in the sense that maybe not all stable coin,
but the ones that have been around are kind of
like a money market fund that doesn't pay you interest.
(38:17):
That's how I would summarize them, because and that's why
I think these are some like the most profitable companies
ever per employee, because they don't do anything. So if
you give them a bunch of billion dollars, they just
take the whole interest. There's some advertising there too, but
not a tremendous amount compared to that, and people are
happy with that. I don't really get it, but you know,
(38:39):
now they've, like you mentioned, they've started to learn the
sort of tricks of the trade. They're going to do rewards.
It's better than paying people actual interests. You give them rewards.
So from the point of view consumers, it is kind
of a mystery. I mean, I would love to start
a money market fund and not pay anybody any interest.
Life economically, when you don't pay any interest on a dollar, ever,
you've taken the whole dollar. That's what the dollar does.
(39:01):
It pays you interest. So the net present value of
all the interest of a dollar is the dollar. So
if they never pay you and you stay there forever,
then if they have eight billion dollars, they've captured eight
billion dollars.
Speaker 3 (39:12):
Again, nice business, if you yeah, that's a great business.
Speaker 5 (39:15):
It's it's weird, but it's a great business.
Speaker 3 (39:17):
What's your next research project?
Speaker 5 (39:18):
So I think from this credit card stuff, there's definitely
interesting things to think about, you know, how people default
and how much this marketing stuff affects them. From another
point of view is one of my co authors in here,
a former student of mine. We have a bunch of
work on adjustable rate mortgages and why they kind of disappeared.
So they used to be a big thing and they've
(39:40):
kind of disappeared, and I think we kind of understand why.
So that's uh, you know, there's been a lot of
discussion about that for mortgages. Why is the US in
one camp and many other countries in another camp? But
the US kind of used to be in the adjustable
mortgage rate camp at least pre crisis and stuff.
Speaker 2 (39:56):
I remember when the rate hike, when we started surging.
Do popular theory that monetary policy would have more teeth
in countries like Canada, Australia, the UK because so many
more households would be more sensitive to faster resets. Has
that actually been born out? It sounds great, it's like
a theory. Intuitively that makes a lot of sense, I do.
(40:18):
I guess Canadian unemployment has trended higher than American but
the inflation trajectories I think have been roughly the same,
and those other Anglophone countries versus the US where they hit.
I don't know, like how strong effect was that, do
you know.
Speaker 5 (40:32):
I don't know exactly, but I don't get the impression
that it was tremendously different. I think it has impacted consumers.
One thing I should note, though, is there's two senses
in which monetary policy can have an effect. One is
that it makes people have to spend a lot of
money on that, so it's expensive for them. But the
other one is that here and I don't think that's
the effect we were going for, but people have just
(40:53):
you know, stopped taking out as many mortgages and don't move.
It was a negative effect. I'm just not sure it's
anti inflationary effect. So it's like if you're gonna have
floating rate stuff, and that's like the case with credit cards,
and it shouldn't affect the volume of it that much
into of producing it, but it's kind of people. It's
expensive for them, and then on the fixed rate one
(41:15):
they just stick to the old stuff and we don't
you know, mortgage credits really dried up in a way,
but it's not affecting the existing bar wars, only to
the extent that you don't want to move, which is
actually a big deal.
Speaker 2 (41:26):
Drexler, thank you so much for coming back on odd low.
It's always a trade. And next time you have a
new report out, let's talking let's talk arms next time.
Speaker 5 (41:34):
Okay, great, thank you very much having me.
Speaker 2 (41:48):
Tracy. I found that conversation to be fascinating. I have
to admit, like, yeah, like credit cards are the sort
of black box to me in many respects. I don't
really understand the business because I don't actually use them
for revolving purposes or borrowing against them. I don't think
I quite realized how crazy the numbers are. And I
certainly knew that there's tons of advertising, including direct mail
(42:09):
on credit cards, but the idea that this is so
substantial that a big part of what people are paying
for here is the advertising that was all very novel
to me.
Speaker 3 (42:19):
It's very surprising.
Speaker 4 (42:20):
My main takeaway is that people, I guess are not rational,
at least when it comes to credit cards. Right, the
marketing seems to work.
Speaker 2 (42:26):
Yeah, no, totally. I'm not rational because I don't take
advantage of all the points that I could, and I
don't like optimize the way I could. And when I,
like buy a plane ticket, only part of the time
do I think about is this the airlines?
Speaker 4 (42:38):
Well, you could also argue that it's rational to like
factor in the time and spend on doing that.
Speaker 2 (42:43):
Sorry, I justify all of this money left on the
tech's right by saying I make it irrational. My time
is valuable, Yeah, my time is valuable. It's but you know,
if there are all these other borrowing products out there
that are cheaper, et cetera, it does feel like someone
must be able to come along and make a product.
Speaker 5 (43:02):
And yeah, that is, let's going to.
Speaker 2 (43:04):
Compete on raid or you're gonna be able to borrow achiever.
I don't know, maybe b NPL will achieve that. I
don't know.
Speaker 3 (43:08):
I'm going to go take out a personal finance loan
right now.
Speaker 5 (43:11):
Go for it.
Speaker 3 (43:12):
Shall we leave it there, let's leave it there. This
has been another episode of the Audthlots podcast. I'm Tracy Alloway.
You can follow me at Tracy Alloway.
Speaker 2 (43:18):
And I'm Jill Wisenthal. You can follow me at the Stalwart.
Follow our guest Itamar Drexler. He's at Idres. Follow our
producers Carmen Rodriguez at Carman Arman, Dashel Bennett at Dashbot,
and kill Brooks at Kilbrooks. More odd Lots content go
to Bloomberg dot com slash odd lots. We have a
daily newsletter and all of our episodes, and you can
chet about all of these topics twenty four to seven
in our discord discord do gg slash odd lots.
Speaker 4 (43:42):
And if you enjoy ad lots, if you like it
when we talk about the very profitable business of credit cards,
then please leave us a review on your favorite podcast platform.
Speaker 3 (43:52):
And remember, if you are a Bloomberg.
Speaker 4 (43:54):
Subscriber and you enjoy getting benefits and rewards, then please
check out the Bloomberg channel on Apple Podcasts. You could
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Speaker 3 (44:09):
Thanks for listening
Hosts And Creators
Joe Weisenthal
Tracy Alloway
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