On March 18 the Federal Reserve issued a 323-page release, purportedly aiming to render more precise, among other things, a provision of the Dodd-Frank Act that requires credit card issuers to consider "the ability of the consumer to make the required payments" in arriving at credit decisions for credit cards.
What is this nonsense?
In order for a bank to operate in a safe and sound manner, it must of course "consider" whether a prospective or current borrower will repay according to terms. That is true for any loan, credit cards included. And if a consumer lacks the "ability" to make the payments, then he will not make them. So, this provision of Dodd-Frank is, at absolute best, supererogatory — useless.
Has there been a particular problem of banks becoming unsound because they failed to consider ability to repay in opening or increasing limits on card accounts? Hardly. Cards did not cause the recent crisis, and card lending, particularly including subprime card lending, came through this true stress test with flying colors, despite massive unemployment of people who previously had plenty of income.
So, where's the beef?
The beef is apparently someone's weird notion that banks can and did make money by lending to people who could be seen in advance to be unable to pay. Or, maybe the idea was that banks were too stupid to see that they needed to "consider" ability to pay, but once compelled to consider it, they would make better lending decisions. Bizarre!
Ability to pay has something, but not much, to do with income. Payments on a card are usually only a very small fraction of income or household spending, and a customer who has been paying nicely on one card may pay it off with his new one — irrespective of his income. But the simple mind confuses "ability to pay" with "income."
Before Dodd-Frank, many card issuers weren't asking applicants to state their income on their applications. They had found that obtaining and using this unverified, "stated income" figure didn't enable them to make better underwriting decisions. No evidence has been cited showing that lenders who asked for stated income had lower losses as a result.
With Dodd-Frank implemented, most card issuers now include an income question in their applications. "Considering" this information can readily lead to another hit on bank earnings and the economy — by causing eminently creditworthy customers to be turned down. Credit officers will blame bank lawyers for this — unfairly.
Up to this point in the saga, there was uncertainty and compliance expense, based on no evidence at all of likely public benefit. But, bad enough was too good to be left alone.
Subsequently, and tardily, the Fed noticed that some card lenders were asking for "household income" rather than "income" on their applications. That was nothing new, and of course it wasn't caused by Dodd-Frank.
Nevertheless, another regulatory proceeding followed, one that supposedly ended by the time of the March 18 release.
Cutting through the verbiage, what we have now from the Fed is that as a lender you can ask for "income" from an individual applicant, who will interpret that however she or he likes — individual, household, pretax, after-tax income, whatever. You just can't ask for household income. This despite the fact that the Fed itself notes there may be little or no difference between the dollar amounts you get by asking applicants for income versus asking them for household income.
If the Fed were serious about this, it would have mandated that the applicant be asked for something like "individual income (excluding income of others in your household)." But it didn't mandate that. So, it got the squeal but not the pig. Why take this route?
My educated guess is that denying individual credit card accounts to nonworking adult household members — a violent disruption of current patterns of credit granting that would result in a substantial reduction in the overall availability of consumer credit for retail sales — was too much for the Fed to swallow. So, in its "clarified" regulation, the agency jumped through hoops to give lip service but no substance to the principle of requiring individual income. The rest of the industry now has to follow the central bank through these hoops.
The road not taken would have been even bumpier, if passable at all. Is a nonworking spouse's "allowance" not to be considered as income? Is it any less reliable than casual employment income? If an individual has a checking account showing regular deposits, aren't these deposits income? Are monthly payments from a reverse mortgage income?
It is possible now to conclude that this provision of Dodd-Frank, like many others, could never have produced benefit, only cost. The Fed has materially increased this cost by wading into the hot water and then jumping for a slippery rock.
Andrew Kahr is a principal in Credit Builders LLC, a financial product testing and development company. He was the founding chief executive of Providian Corp. and can be reached at
