Wall Street History

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Wall Street History

12/17/2004

The Credit Card Industry

**Next WSH...December 31**

A few weeks ago PBS’ “Frontline” had a fascinating story on the
credit card industry. Sounds like a dry topic, doesn’t it? Well,
its genesis, the modern era that is, may not be that familiar to
some of you so I thought I’d take a few snippets from the
program and splice them together.

But first, a quiz

1. How many credit cards does the average American family
have?

2. Nearly 144 million Americans have general-purpose credit
cards. Approximately how many of them pay off their bill ‘in
full’ each month?

3. Approximately how many Americans pay only ‘the minimum’
payment required each month?

4. What is the credit card debt carried by the average American
family?

Answers below.

Walter Wriston, chairman and CEO Citicorp / Citibank for 17
years.

Q: What was the world like before credit cards, and why did
Citibank get involved in credit cards?

Wriston: Well, the world was partitioned, and after the debacle
of the Great Depression in the 1930s, a group of restrictive laws
were passed, the net of which was that Citibank, for example,
was prohibited from opening any offices outside the five
boroughs of New York. And so the world (had) 30,000 banks in
1930, and by 1946, there were about 15,000 banks, and today
there are somewhere in the order of 6,000 or 7,000. Because
each one was partitioned the object of the exercise on a credit
card was to find a way to serve customers outside of the
prescribed market area by the statutes, and so the driving force
behind it was to create a delivery system for financial products to
people across the country.

We bought a piece of Carte Blanche in ’65 or so, and then the
Bank of America started a credit card called Bank Americard,
and Citibank started one, and the wonderful name was the
Everything Card. It was a regional card and one day I was
invited by a Midwestern bank to come out and talk to their board
about whatever the issue was in those days, and walking home
that night about midnight, the chairman of the bank said to me,
“Citibank’s pretty smart, but if you’re pumping gas in Palo
Alto (Calif.) and you see Everything Card, you never heard of it,
you’d throw it on the ground.” And so he said, “If you want to
succeed in the business, you have to have a national name.” He
was right. The next morning I picked up the phone and called
Dick Cooley, who is the chairman of Wells Fargo, and he (had)
just started a thing called MasterCard. And I said, “Dick, I want
to join.”

We mailed out 20 million cards across the country I remember
going to St. Louis and just about being stoned by the local
banker. One of them said to me: “You sent my wife a credit card
with a $1,000 credit line. What are you doing in my market?”
And I said, “Where is it written that this is your market?” But
out of that huge mailing and so forth, the momentum was created
that produced what is now Citigroup (and) now has
approximately 142 million cards in more than 40 countries. So
that’s what the early start was like, long before we understood
the use of statistics for credit losses and all that sort of thing .

Q: And what was the reason behind going to South Dakota?

Wriston: Well, it was very simple. We were going broke.

If you are lending money at 12 percent and paying 20 percent,
you don’t have to be Einstein to realize you’re out of business.
So the state of New York had this usury law, so we went to the
governor and said, “We have to stop the business because we’re
losing money for our shareowners.” We said: “Look, we want to
continue our credit card, but we can’t do it because we’re losing
too much money. And all you have to do is lift the usury ceiling
to some reasonable amount and we’ll stay here.” And they said:
“Aha! You really won’t move. We’re not going to do
anything.” So we went there three times and the legislature
refused to do (budge).

So we made a study of the five states that had either no usury law
or very high amounts. One of them was Hawaii, and that was too
far away; one of them was Missouri; one of them was South
Dakota .So there was a Supreme Court decision called
Marquette v. First of Omaha Services Corporation (1978) which
said that you could export the interest rate from the state from
which the credit card was issued .So we went out to South
Dakota and the governor there was Bill Janklow (who has had
some recent problems you may have heard about). And we said,
“Look, we’ll bring a couple of thousand jobs out here.” And the
local bank said, “Well, you’ll compete with us, and we can’t
stand that.” And so we said: “Well, we’ll open a limited
national bank in which we will not compete with the local banks,
and we’ll put the facility in an inconvenient place for customers,
and we’ll pay different interest rates than you guys, and you can
be happy. All we want to do is use it to issue cards.”

And so after about a year and a half of negotiation, the
comptroller of the currency issued us a charter of a limited
national bank of South Dakota. And we went out and built a
facility out there which is now the largest employer in the state
of South Dakota. And that was the start, and they exported the
interest rate that would make a profit for the bank right across the
country.

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Bill Janklow, governor of South Dakota from 1979 to 1987 and
from 1994 to 2003.

Q: Do you remember how it is that credit cards came to your fair
state?

Janklow: Let me set the time for you, because I think that puts it
in perspective. Interest rates were going into orbit. They were
climbing all the time. The cost of money was getting more and
more expensive. South Dakota had laws – when I came to the
governor’s office – on what you could charge to borrow. In
other words, there was one interest rate by law that they could
charge for new cars, another one for used cars less than five
years old, another one for used cars more than five years old. If
you went to a bank, if you went to the consumer-loan
department, they could by law charge you rates of interest that
couldn’t be charged by the mortgage department or another
department at the bank

The marketplace exceeded all of those numbers at that point in
time, and what I’m trying to say is, we may have a law that said
you could charge 9 percent, but money cost 11 percent, so banks
weren’t loaning money. It stopped credit. In this city, Sioux
Falls, there were only five houses, seven houses built in 1981.
That’s all. There were only seven housing permits, because
nobody could afford the financing for a home .

I’d never heard of all this credit card stuff. I’d like to take credit
for it, but I had nothing to do with it. I received four
communications in one day. A former governor, Frank Farrar,
who served as governor for years and then went into banking and
had a lot of banks that he was involved in, he called me, and he
had been contacted through banking circles. The state Economic
Development Department contacted me and told me they had
been contacted by Citibank, and Citibank wanted to meet with
me .

We had a phone conversation, and a couple of days later a couple
of people came to South Dakota and they explained to me what
condition their bank was in .There was a New York state law
that said that if you bought goods and services, you could charge
15 or 18 percent, but if you had a cash advance, it was 12, so it
cost the bank more money to borrow money to loan you money
than you were paying in interest

Q: So why come to South Dakota?

Well, the government had passed a law in the 30s called (the
Glass-Steagall Act and it) was an attempt to keep big national
banks from taking over all the banking in America. The
trustbusters were involved in a lot of that back in the 30s, and so
they had passed legislation that said that a nationally chartered
bank cannot go across state lines into another state and practice
banking .

We had exceptions to that in the Great Plains, because our
money-center banks were really the Minneapolis banks. They
were the monolithic giants in this region. In those days it was
called Norwest Bank and First Bank (which) were in Montana,
Wyoming, North and South Dakota, Nebraska, Minnesota, Iowa
and Wisconsin .

So we were allowed to have a Minneapolis bank in South
Dakota .Then they passed an amendment called the Douglas
Amendment to the McFadden Act. The Douglas Amendment
said you could go across state lines if the state invited you
in And no state had ever invited because all the community
bankers made sure that no one would pass legislation inviting an
out-of-state bank in.

[Citibank wasn’t sure South Dakota or any other state would let
them in.]

There had been another Supreme Court decision (Marquette v.
First of Omaha). (This) decision said forget where the bank is
chartered; wherever the credit decision is made, in whatever state
locality the credit decision is made – the “lex loci” rule – that’s
the place where you can apply interest In other words, let’s just
say that if South Dakota had a 5 percent ceiling on interest, and
that’s where the decision was made, the bank couldn’t charge
more than 5 percent, even if they loaned the money to somebody
in Florida. But if South Dakota had a 25 percent ceiling, then
you could charge 25 percent, even to a loan in Florida .

I lived in a state where the economy was, at that time, dead. I
was governor of South Dakota at the only time in this state’s
history when the economy shrunk from one year to the
next .Our sales-tax collections actually took in less total money
one year than the previous year .I was desperately looking for
an opportunity for jobs for South Dakotans. To me, this wasn’t a
credit card deal; it was a jobs deal .

What Citibank got out of it they had 3 million total cards,
and (more than) 2 million of them were in New York, New
Jersey, and Connecticut, but they had rolled out a national
program and were mailing credit cards all over the country .

Credit cards saved Citibank through the early 80s and into the
90s, and gave them the opportunity to survive .

Those 3,000 jobs (Citibank brought) to Sioux Falls, based on our
population back then would have taken 300,000 jobs in New
York City to equal it at Citibank.

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[Wriston also had some interesting comments on the Depression
and today’s environment.]

The Great Depression, which came on in a failure of the Bank of
the United States in 1931 and so forth, and Roosevelt closed the
bank, was perpetrated – any scholar will tell you now – by the
fact that the Federal Reserve didn’t supply any liquidity. And so
(Federal Reserve Chairman) Alan Greenspan will tell you that;
(Fed Chairman from 1979-87) Paul Volcker will tell you that.
They did exactly the wrong thing. They refused to lend any
money to the banks, and it perpetuated 20 years of the
Depression. We had 18 million people unemployed in 1933.
And in 1939, after the whole New Deal, well, there’s still 18
million people unemployed because the Fed just did the wrong
thing.

Today when you have a crisis – take the last one, (which) was
Long-Term Capital Management, which was a hedge fund – they
made a bunch of bad bets, and the Fed put together a group of
lenders to bail them out. And whether that was right or wrong is
another issue. Monday morning the Fed flooded the market
with liquidity, and you don’t even remember that that was the
biggest bankruptcy in American history at that time So it isn’t
the question of the regulation. We tried all that. The question is,
how does the central bank supply liquidity in a timely manner if
there is a crisis?

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Credit Card Quiz Answers:

1. The average American family has 8 credit cards.

2. Approximately 55 million of 144 million Americans pay off
their bill in full each month.

3. Approximately 35 million pay only the minimum payment
each month.

4. The average American family carries approximately $8,000 in
credit card debt.

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Finally, here is some useful information.

--Even if you make your credit card payments on time, the credit
card bank can raise your interest rate automatically if you’re late
on payments elsewhere – such as on another credit card or on a
phone, car, or house payment – or simply because the bank feels
you have taken on too much debt.

This practice is called the “universal default” clause. The logic
behind it is that the bank is not being unreasonable in raising
rates when it has reason to believe that the risk of being repaid by
the customer has increased.

--There is no limit on the amount a credit card company can
charge a cardholder for being even an hour late with a payment.

--There is no federal limit on the interest rate a credit card
company can charge. That’s why, as above, the issuers choose
states such as South Dakota and Delaware that don’t have “usury
laws,” meaning there is no cap on the interest rate that is
charged.

Source: PBS.org

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I’m off on a trip to South America. Merry Christmas and I’ll
report back on December 31 with an article on year end.

Brian Trumbore

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