Credit Cards and the Great Recession: The Collapse of Teasers Lukasz A. Drozd 1 Michal Kowalik 2 1 Federal Reserve Bank of Philadelphia 2 Federal Reserve Bank of Boston Nov, 2018 The views expressed in this paper are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Philadelphia, Federal Reserve Bank of Boston, or the Federal Reserve System. Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
Big picture question: Transmission of 2007 financial crisis to real economy Current view on the issue puts households and household credit in the spotlight (Mian, Rao and Sufi, 2013; Mian and Sufi, 2014) Was deleveraging a product of declining net worth or the effect of tightening of lending standards by distressed financial institutions? (Gilchrist Zakrajsek, 2017; Mondragon, 2015; Greenstone, Mas, Nguyen, 2012) Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
Big picture question: Transmission of 2007 financial crisis to real economy Current view on the issue puts households and household credit in the spotlight (Mian, Rao and Sufi, 2013; Mian and Sufi, 2014) Was deleveraging a product of declining net worth or the effect of tightening of lending standards by distressed financial institutions? (Gilchrist Zakrajsek, 2017; Mondragon, 2015; Greenstone, Mas, Nguyen, 2012) This paper: A detailed look at deleveraging on credit cards Document and explore a plausible mechanism for supply-driven deleveraging Show the mechanism consistent with deleveraging on credit cards Assess contribution to MS aggregate consumption-demand channel Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
Key stylized facts we build on Fact 1. Prior to the crisis many borrowers relied on promotional offers to, in effect, borrow for the long term on promo rates fact 1: 35%+ debt (43% prime) on 10pp+ promo discount s.t. expiration 12 months away fact 2: promo balance transfer volume ≈ flow of expiring promo debt Fact 2. Availability of promotional offers vanished in 2008, resulting in a collapse of balance transfer and almost 50% decline in the share of promotional debt by 2011 fact 3: cc solicitations and balance transfer volume fell by 70% fact 4: share of debt with promo flag declined by 50 percent by 2011 Fact 3. Collapse of promo activity coincident with deleveraging on credit cards fact 5: 32% peak-to-trough decline in credit card debt relative to trend from late 2008 onward fact 5: 20% peak-to-trough decline relative to consumer credit excluding student loans Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
What We Do Develop equilibrium theory of promotional pricing featuring hyperbolic discounting Inspired by evidence documented by Ausbel and Shui (2005) and Agrawal at al. (2015), showing consumers choose ex post suboptimal offers Consumers are myopic, but Gabaix and Leibson (2017), show a rational model with noisy information gives rise to “as-if” hyperbolic discounting Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
What We Do Develop equilibrium theory of promotional pricing featuring hyperbolic discounting Inspired by evidence documented by Ausbel and Shui (2005) and Agrawal at al. (2015), showing consumers choose ex post suboptimal offers Consumers are myopic, but Gabaix and Leibson (2017), show a rational model with noisy information gives rise to “as-if” hyperbolic discounting Show theory consistent with U.S. credit market prior to the crisis Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
What We Do Develop equilibrium theory of promotional pricing featuring hyperbolic discounting Inspired by evidence documented by Ausbel and Shui (2005) and Agrawal at al. (2015), showing consumers choose ex post suboptimal offers Consumers are myopic, but Gabaix and Leibson (2017), show a rational model with noisy information gives rise to “as-if” hyperbolic discounting Show theory consistent with U.S. credit market prior to the crisis Ask whether a withdrawal of promo offers account for deleveraging and related facts Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
Literature: Empirics Mian and Sufi (2010-IMF) Show reliance on credit cards across the U.S. counties prior to the crisis a strong predictor of the decline in auto sales after 2008 even when controlling for household leverage Brown, Haughwout, Lee, Van der Klaauw (2013), Demyanyk and Koepke (2012) Question importance of supply forces based on decline in credit in inquiries Our answer: inquiries a function of offers received, a primary tool of solicitation Agrawal, Chemisengphet, Mahoney, Stroebel (2015) Show evidence that CARD Act of 2009 was unlikely the culprit Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
Literature: Theory Intentionally left blank. Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
Outline Data description and summary results Mechanisms: contract theory of promo offers Quantitative model Quantitative analysis and results Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
Outline Data description and summary results Mechanisms: contract theory of promo offers Quantitative model Quantitative analysis and results Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
Data description and sources 1. Aggregate data from the Board of Governors of the Federal Reserve System , such as the stock of revolving debt (consumer credit - G.19) and net charge-off rate on credit cards for all banks 2. Supervisory OCC/Y14M account level micro-data focusing on general purpose credit cards from 6 largest credit card lenders tracked between 2008 and 2017, and eight in total, having an approximate market share of over 50 percent in 2007 (accounting for 30 percent of general purpose card credit card accounts) 1 2. Experian credit bureau data comprising of a representative panel of 200,000 credit records tracked between 2001 and 2013. 2 1 The data is on an account level with a monthly frequency and is provided by bank holding companies subject to DFAST. The sample before 2013 is limited to several largest banks and it comes from OCC merged data with Y14M reporting. We focus on this sample here. Data after 2013 covers a broader sample of banks. 2 The credit bureau data summarizes credit history of 200,000 credit market participants: the first 100,000 records are representative as of 2001 and the second one is representative as of 2013. We use observations from both panels. Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
Credit card market prior to the crisis 1. A large fraction of debt had promo status with a median duration of 12 months Statistic 2008Q1 1. Use of promotional debt: Promo debt to total debt a [%] 35 Promo debt with 670+ FICO to total debt [%] 43 Promo debt with at least 50% APR discount to promo debt b [%] 68 Median duration of promo spell (originated in 08) c [months] 10 Average duration of promo spell (originated in 08) c [months] 12 Median duration of promo spell (all accounts) c [months] 12 Average duration of promo spell (all accounts) c [months] 16 a Debt are credit card balances carried over for at least one billing cycle, hence 2008Q1 effectively starts in Feb. b Promo debt on low APR is the promo debt for which the promotional APR is lower than the step-up APR by at least 50 percent. c The spell is a number of months for which an account has a positive promotional balance, among accounts originated in 2008. We find equal median and higher mean for all accounts, which suggests accounts originated prior to 2008 had a longer promotional spell. Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
Credit card market prior to the crisis 2. Promo debt provided a major discount relative to non-promotional and step-up rates Statistic 2008Q1 2. Interest rates (in APR): Median promo APR [%] 3.5 Average promo APR [%] 4.3 Average promo APR with discount 50%+ debt [%] 2.6 Average non-promo APR [%] 15.5 Average step-up APR on promo accounts w/ debt [%] 17.3 Median step-up APR on promo accounts w/ debt [%] 16.0 Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
Credit card market prior to the crisis 3. A large volume of balance transfers sustained the stock promotional debt consistent with “chaining” of promotional offers to, in effect, borrow for the long-term Statistic 2008Q1 3. Refinancing and balance transfers: Balance transfers (BT) per annum to promo debt [%] 131 BT to promo cards to BT total [%] 92 BT to flow of promo debt nearing expiration (last quarter) [%] 104 Average transferred amount per BT [$] $4,290 Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates
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