Credit Cards and the Great Recession: The Collapse of Teasers Lukasz - - PowerPoint PPT Presentation

Credit Cards and the Great Recession: The Collapse of Teasers

Lukasz A. Drozd1 Michal Kowalik2

1Federal Reserve Bank of Philadelphia 2Federal 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

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

Key stylized facts we build on

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

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

What We Do

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

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

What We Do

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

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

What We Do

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

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

Literature: Empirics

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

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

Literature: Theory

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Intentionally left blank.

Outline

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Data description and summary results Mechanisms: contract theory of promo offers Quantitative model Quantitative analysis and results

Outline

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Data description and summary results Mechanisms: contract theory of promo offers Quantitative model Quantitative analysis and results

Data description and sources

1The 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.

2The 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

• 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

• f 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

Credit card market prior to the crisis

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

• 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 debta [%] 35 Promo debt with 670+ FICO to total debt [%] 43 Promo debt with at least 50% APR discount to promo debtb [%] 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

aDebt are credit card balances carried over for at least one billing cycle, hence 2008Q1 effectively starts in Feb. bPromo 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. cThe 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.

Credit card market prior to the crisis

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

• 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

Credit card market prior to the crisis

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

• 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

Collapse in promo activity

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

• 4. Promo activity collapsed during the crisis.

(BT decline consistent with 70% decline in solicitations.)

0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 2007 2009 2011 2013 2015 2017 Year Promo debt as a fraction of total debt 45%

NBER recession

Promo debt as a fraction of total debt for FICOs 670+ (2008q1) 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 2007 2009 2011 2013 2015 2017 Year Annual balance transfers to total debt 74% Annual promo balance transfers to total debt

NBER recession

(2008q1)

Deleveraging (all banks)

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

• 5. Collapse in promo activity coincident with deleveraging.

10% 13% 15% 18% 20% 1996 1999 2002 2005 2008 2011 2014 2017 Card debt per adult to median income Year

NBER Recession

32 percent decline 0.4 0.42 0.44 0.46 0.48 0.5 0.52 0.54 2006 2008 2010 2012 2014 2016 Year Card debt to consumer credit less student loans 16 percent decline

Deleveraging (all banks)

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

• 5. Collapse in promo activity coincident with deleveraging.

50 60 70 80 90 100 110 120 130 140 150 Mortgage HE Revolving Auto Loan Credit Card

credit card market peak in 2009Q1 = 100

Year

Orthogonality to mechanical composition

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

• 6. Decline in BT orthogonal to measure risk composition of consumer pool.

50 60 70 80 90 100 110 120 130 140 150 Mortgage HE Revolving Auto Loan Credit Card

credit card market peak in 2009Q1 = 100

Year

Outline

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Data description and summary results Mechanisms: contract theory of promo offers Quantitative model Quantitative analysis and results

Environment

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Life-cycle setup with continuum of consumers and a large number of lenders: Consumers: face random income (and access to market) borrow from lenders to smooth consumption can default on debt at a fixed utility cost (stigma) Lenders: have unlimited access to funds at exogenous cost of funds r extend unsecured open ended credit lines to consumers compete in the market in Bertrand fashion (max U s.t. zero pf)

Consumer preferences

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Borrowers discount the future hyperbolically and are naive about it: Preferences as of current period t u(ct) + ηβ[u(ct+1) + βu(ct+2) + β2u(ct+3) + ...] Actual preferences in future period u(ct+1) + ηβ[u(ct+2) + βu(ct+3) + ..]

Consumer preferences

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Borrowers discount the future hyperbolically and are naive about it: Preferences as of current period t u(ct) + ηβ[u(ct+1) + βu(ct+2) + β2u(ct+3) + ...] Actual preferences in future period u(ct+1) + ηβ[u(ct+2) + βu(ct+3) + ..] ⇒ Consumers overestimate how fast their future self will pay down debt

Lending protocol

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Credit line is: F ≤ R - promo rate, R - step-up rate, L - pre-authorized credit limit

Lending protocol

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Credit line is: F ≤ R - promo rate, R - step-up rate, L - pre-authorized credit limit Borrowers can switch by refinancing with a new lenders (without recall)

Lending protocol

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Credit line is: F ≤ R - promo rate, R - step-up rate, L - pre-authorized credit limit Borrowers can switch by refinancing with a new lenders (without recall) Incumbent lenders continually reprice under CARD Act of 2009 restriction: Rates cannot be raised above R (can be lowered) Cannot slash credit limits below debt

Lending protocol

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Credit line is: F ≤ R - promo rate, R - step-up rate, L - pre-authorized credit limit Borrowers can switch by refinancing with a new lenders (without recall) Incumbent lenders continually reprice under CARD Act of 2009 restriction: Rates cannot be raised above R (can be lowered) Cannot slash credit limits below debt Refinancing subject to a friction: Even when consumer refinance she continues to pay interest for a ρ fraction of the next period

Timing

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Period t Period t+1 Consumers Lenders

1. Markov random variable s resolves all uncertainty within the period (income; arrival

• f offers)

3. Consumer decides whether to accept market

• ffer M or reject and stay with the incumbent

with no recall 5. Consumers strategically decides whether to repay and chooses consumption c and current borrowing b accordingly 2. Lending market opens: Consumer receives m arket offer M and repriced offer from incum bent I 4. Incumbent lenders reprice again rest of the period Initial endogenous state is Debt , Credit line …

Consumer problem: refinancing decision λ

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Consumer first chooses whether to refinance or stay by solving: V η

t (C, B, s) = max λ=0,1 Uη t (Mη t (C, B, s), Iη t (C, B, s; λ), B, s; λ)

where Mη

t (C, B, s) is market offer

Iη

t (C, B, s; λ) is incumbent’s repriced offer

(Note: λ = 0 if refinancing option not available under s. )

Consumer problem: default decision δ

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Consumer strategically plans default by solving: Uη

t (Cη M, Cη I , B, s; λ) = max δ=0,1 Uη t (Cη M, Cη I , B, s; λ, δ)

where Cη

I := Iη t (C, B, s; λ) = (F η I , Rη I , Lη I ) repriced contract from incumbent

Cη

M := Mη t (C, B, s) = (F η M, Rη M, Lη M) market offer (active or inactive)

(Note: λ = 0 if market offer inactive. )

Consumer problem: consumption c and borrowing b

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Consumer chooses consumption and current borrowing by solving: Uη

t (Cη M, Cη I , B, s; λ, δ) = max (c,b)∈Γ{u(c) − χ(s)δ+

ηβEs[δV 1

t+1(C−1, 0, s′) + (1 − δ)V 1 t+1(λC1 M + (1 − λ)C1 I , b, s′)]}

subject to budget constraint given by c ≤ Yt(s) − B + b − (1 − δ)

• λF η

M + (1 − λ)(ρF η I + F η M)

• b+

b ≤ (1 − λ) min{Lη

M, Lη I } + λLη I

where C−1 = (r−1, 0, 0) exogenous seed contract.

Consumer problem: consumption c and borrowing b

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Consumer chooses consumption and current borrowing by solving: Uη

t (Cη M, Cη I , B, s; λ, δ) = max (c,b)∈Γ{u(c) − χ(s)δ+

ηβEs[δV 1

t+1(C−1, 0, s′) + (1 − δ)V 1 t+1(λC1 M + (1 − λ)C1 I , b, s′)]}

subject to budget constraint given by c ≤ Yt(s) − B + b − (1 − δ)

• λF η

M + (1 − λ)(ρF η I + F η M)

• b+

b ≤ (1 − λ) min{Lη

M, Lη I } + λLη I

where C−1 = (r−1, 0, 0) exogenous seed contract.

Consumer problem: consumption c and borrowing b

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Consumer chooses consumption and current borrowing by solving: Uη

t (Cη M, Cη I , B, s; λ, δ) = max (c,b)∈Γ{u(c) − χ(s)δ+

ηβEs[δV 1

t+1(C−1, 0, s′) + (1 − δ)V 1 t+1(λC1 M + (1 − λ)C1 I , b, s′)]}

subject to budget constraint given by c ≤ Yt(s) − B + b − (1 − δ)

• λF η

M + (1 − λ)(ρF η I + F η M)

• b+

b ≤ (1 − λ) min{Lη

M, Lη I } + λLη I

where C−1 = (r−1, 0, 0) exogenous seed contract. Lemma Lη

M never binds and Lη I can be assumed tight without loss.

Consumer problem: consumption c and borrowing b

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Consumer chooses consumption and current borrowing by solving: Uη

t (Cη M, Cη I , B, s; λ, δ) = max (c,b)∈Γ{u(c) − χ(s)δ+

ηβEs[δV 1

t+1(C−1, 0, s′) + (1 − δ)V 1 t+1(λC1 M + (1 − λ)C1 I , b, s′)]}

subject to budget constraint given by c ≤ Yt(s) − B + b − (1 − δ)

• λF η

M + (1 − λ)(ρF η I + F η M)

• b+

b ≤ (1 − λ)Lη

M + λLη I

where C−1 = (r−1, 0, 0) exogenous seed contract. Lemma Lη

M never binds and Lη I can be assumed tight without loss.

Lender Problem: Market offer M

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

The equilibrium market offer solves: Mη

t (C, B, s) = argmax Cη

M

Uη

t (Cη M, Cη I , B, s)

subject to ΠM

t (Cη M, Cη I , B, s) = 0

where Cη

I is equilibrium repriced offer (simultaneous game).

Lender Problem: Incumbent’s repriced offer I

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

The equilibrium repriced offer solves: Iη

t (C, B, s; λ) = argmax Cη

I

ΠI

t (Cη M, Cη I , B, s; λ)

subject to Rη

I ≤ R,

F η

I ≤ R,

Lη

I ≥ B

and Uη

t (Cη M, Cη I , B, s; λ) ≥ Uη t (Cη M, Cη I , B, s; λ)

where Cη

I = (R, R, B) and Cη M is equilibrium repriced offer.

Lender profit function Π

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Omitted.

Equilibrium

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Recursive equilibrium comprises consumer’s policy functions cη

t , bη t , δη t

lender pricing policies Mη

t , Iη t

and consumer and lender value functions V η

t , Uη t , ΠI t , ΠM t

such that they are consistent with consumer problem and lender problem.

Outline

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Data description and summary results Mechanisms: contract theory of promo offers Quantitative model Quantitative analysis and results

Assumptions

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Three-periods T = 3 (can generalize to any finite T) Two-state income process: Y (s = 1) := Y > Y (s = 0) = Y / Extremely convex cost of defaulting χ(s = 1) = ∞, χ(s = 0) = 0. Cost of funds normalized to zero

Equivalent problem of geometric consumers η = 1

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Transformed problem solves: max

(F, ˆ R,L)∈Θ

U(F, ˆ R, L) where U(F, ˆ R, L) := max

b1≤L,b2

u1(c1) + β(1 − p)[u2(c2) + β(1 − p)u3(c3)] c1 := ¯ Y − B + b1 − Fb+

1

c2 := ¯ Y − b1 + b2 − ˆ Rb+

2

c3 := ¯ Y − b2 and subject to Π(F, ˆ R, L) = (F − p)b+

1 + (1 − p)( ˆ

R − p)b+

2 = 0.

Equilibrium contract for geometric consumers η = 1

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Proposition If local monotonicity holds: F = p = R, L is nonbinding, and the consumer does not refinance.

Equilibrium contract for geometric consumers η = 1

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Proposition If local monotonicity holds: F = p = R, L is nonbinding, and the consumer does not refinance.

• 1. Allocation satisfies MRT = MRS in high state MRT = −(1 − p) while MRS = −(1 − p)β u′(c2)

u′(c1) ,

which implies: u′(c1) = βu′(c2).

• 2. Consumer’s Euler equation dictates F = 0 :

(1 − F )u′(c1) = β(1 − p)u′(c2)

• 3. Binding L also implies F = p.

Equilibrium contract for hyperbolic consumers η < 1

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Proposition If local monotonicity holds in the ex ante problem at F = p = R, L slack, then F < p < R.

Equilibrium contract for hyperbolic consumers η < 1

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Proposition If local monotonicity holds in the ex ante problem at F = p = R, L slack, then F < p < R.

• 1. Allocation satisfies MRT = MRS in high state MRT = −(1 − p)

bη 2 b2 while

MRS = −(1 − p)β u′(c2)

u′(c1) , which implies:

u′(c1) = βu′(c2) b2 bη

2

.

• 2. Consumer’s Euler equation dictates F = 0 :

(1 − F )u′(c1) = β(1 − p)u′(c2)

• 3. Binding L also implies F = p.

Numerical example

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

0.1 0.2 0.3 0.4 1 0.95 0.9 0.85 0.8 0 APR

• Refinancing

1 No refinancing 0.1 0.2 0.3 0.4 0.5 0.6 1 0.95 0.9 0.85 0.8

• 0 APR

Refinancing 1 No refinancing

Figure: A numerical example: Equilibrium contract as a function of η (β = 1).

Notes: The figure illustrates equilibrium contract for a range of values of hyperbolic discount factor η, assuming Yl = 1/2, Yh = 1, B = 1, ρ = .5, p = .1, β = 1 and u(c) = log(c). F is restricted to be non-negative. The shaded area indicates when refinancing occurs on the equilibrium path. The right panel shows the wedge between ex ante and ex post borrowing that creates incentives to set promotional terms.

Outline

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Data description and summary results Mechanisms: contract theory of promo offers Quantitative model Quantitative analysis and results

Parameterization

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Log-utility, hyperbolic discount from Ausubel and Shui (2005): η = 0.81 Cost of defaulting is parameterized by χ0: χ(y) = χ1 max(y − χ0, 0). Income of a working age in economy state ω = {R, E} is: yt(ω) = etktzt(ω) where yt - agent’s income at age t et - deterministic age-dependent income profile kt - a 3 state discrete i.i.d. process zt(ω) - 6x6 state Markov process that depends on ω Individuals start life at the age of 24 years, retire at the age of 65 year, and die at the age

• f 80 years and period length is l (parameter we calibrate)

Demographics simulated starting from 2010 population structure and using death probability tables and .9 population growth

Calibration

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Table: Data targets and calibrated values of jointly selected parameters. Data Model

• A. Targeted moments
• 1. Credit card debt of card holder to median personal income [%]

22 22

• 2. Net charge-off rate [%]

4 4

• 3. Average duration of promo offers [months]

12 12

• 4. Average step up rate on promo accounts [%]

17 20

• 5. Average rate on credit card debt [%]

12 12

• B. Jointly calibrated parameters

Discount factor β 0.926 Cost of defaulting χ0 0.867 Period length l [months] 20 Refinance delay ρ 0.4 Lender cost of funds r 0.07

• C. Preset parameters

Hyperbolic discount factor β 0.81 Income process (see Online Appendix and supp. files)

Model Validation

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Classification of promo accounts in mapping model onto data: 0% 20% 40% 60% 80% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% As a fraction of accounts with F<R [in %] Promo discount size: 1‐F/R [in %] Classified as promotional in the model

Model Validation

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Model does remarkable job matching moments we did not target:

Table: Data targets and calibrated values of jointly selected parameters.

Statistic (in percent % unless otherwise noted) Data Model Promo debt as a fraction of total debt 35 33 Annual balance transfers as fraction of debt 39 44 Average interest rate on promo debt (+3 in data) 7 6 Median interest rate on promo debt (+3 in data) 6 6 Share of revolvers among card users 59 60

Calibration of collapse of promo

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

10% 15% 20% 25% 30% 35% 40% 45% 50% 2007 2010 2013 2016 Model: recession + transition + collapse of promo Year fitted collapse of promo schock Promo card debt to total card debt Data Model: recession + transition Model: recession

NBER Recession

0.1 0.2 0.3 0.4 0.5 0.6 0.7 2007 2010 2013 2016 Model: transition + recession + collapse of promo Year Annual balance transfers to debt Data Model: transition + recession Model: transition

NBER Recession

Figure: Collapse of promotional activity: model via-´ a-vis the U.S. data.

Notes: The figure illustrates the decline in the share of promotional credit card debt to total debt (left panel) and the collapse

• f balance transfers (promotional balance transfers) as a fraction of debt. Solid lines correspond to the model and the dotted

line is the data. We consider three models that incrementally add shocks. The total contribution of the collapse of promo shock is the difference between green line with circles and the orange line with squares.

Quantitative results: Deleveraging

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

60 70 80 90 100 110 120 Model: recession + transition + collapse of promo Year 2007=100 Card debt per adult to median income Data Model: recession + transision Model: recession

NBER Recession

60 70 80 90 100 110 120 Model: recession + transition + collapse of promo Year 2007=100 Real card debt per adult Data (detrended) Model: recession + transition Model: recession

NBER Recession

Figure: Deleveraging on credit cards: model via-´ a-vis the U.S. data.

The figure illustrates deleveraging on credit cards relative to median income and in absolute terms (in data real value detrended using the 1996-2006 linear trendline). Solid lines correspond to the model and the dotted line is the data. We consider three models that incrementally add shocks. The total contribution of the collapse of promo shock is the difference between green line with circles and the orange line with squares.

Quantitative results: Charge-off rate

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

0% 2% 4% 6% 8% 10% Model: recession + transition + collapse of promo Year 2007=fitted Net chargeoff rate on card debt Data (all banks) Model: recession + transition Model: recession 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 2007 2010 2013 2016 Model: recession + transition + collapse of promo Year 2007=fitted Average APR on card debt Data Model: recession + transition Model: recession

NBER Recession

Figure: Charge-off rate and interest rate on card debt: model via-´ a-vis the U.S. data.

Note: The figure illustrates the net charge-off rate on card debt (fraction of debt defaulted on) and the average interest rate paid on credit card debt estimated using our account level dataset. Solid lines correspond to the model and the dotted line is the data. The charge-off rate is for all banks and comes from FRB. We consider three models that incrementally add shocks. The total contribution of the collapse of promo shock is the difference between green line with circles and the orange line with squares.

Quantitative results: Aggregate implications

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

80 85 90 95 100 105 110 115 Model: just transition + collapse of promo Year 2007=100 Real consumption per adult Data (detrended) Model: recession

NBER Recession

95 96 97 98 99 100 101 102 103 104 105 Model: just transition + collapse of promo Year 2007=100 Consumption to disposable income ratio Data

NBER Recession

Figure: Charge-off rate and interest rate on card debt: model via-´ a-vis the U.S. data.

Note: The figure illustrates the net contribution of the collapse of promo shock to decline in consumption in the model (orange line with squares). Solid lines correspond to the model and the dotted line is the data. The left-panel looks at total consumption and the right panel looks at consumption income ration (aka average propensity to consume). The orange line here refers to net added contribution of having promo shock (with transition) and isolates out this shock from recession and demographic changes.

Conclusions

Drozd and Kowalik Why Tease? The Role and Ramifications of Credit Card “Teaser” Rates

Credit card market played a quantitatively significant role in HH deleveraging A supply-driven shock likely at play: withdrawal of promotional offerings from the market The shock is sufficient to account for deleveraging in a consistent way, and has sizable implications on aggregate assuming Mian-Sufi demand driven view of Great Recession