There's no magic number for late fees — or is there?

Bloomberg News

The Federal Reserve, as we all know, is on a mission to tamp down inflation and has been for some time. That mission, as we also all know, is not to eliminate inflation entirely — that would be impractical — but instead to rein it in to an acceptable level of price growth, namely 2%. 

The reason why the Fed has zeroed in on 2% — as opposed to 1% or 5% — is fundamentally arbitrary. I don't need to recount the whole story here, but back in the 1980s New Zealand was struggling to tame inflation and set upon the 2% target because 1% was too low for the central bank to achieve and 3% seemed like an unacceptably high target for the central bank to settle for. Other central banks followed their lead, and that's how 2% evolved into the universal inflation target — essentially, because it looks about right.

But just because something is arbitrary doesn't mean it's meaningless. Why are there nine innings in baseball? Why is printer paper 8.5 inches by 11 inches? Why do waiters place forks on the left of a plate instead of the right? The answer is because in all of these cases, what matters is not the policy itself but the ability of the policy to be good enough that it can be universally applied. In other words, what's magic about the number is that it's a number that everyone can live with.

The Consumer Financial Protection Bureau has embarked on a much-vaunted quest to take down pointless and excessive "junk fees" in banking — a move that even got a shout-out in the President's State of the Union address earlier this year. More specifically, CFPB director Rohit Chopra has initiated a proposal to cut credit card late fees to $8, a move that has left banks and credit unions apoplectic, with some even warning that if the rule is finalized, it could undercut banks' ability to extend credit to precisely the kinds of vulnerable customers that the reduction in late fees is meant to protect.

To be sure, banks doth have a tendency to protest too much when it comes to regulators clamping down on fee income. As the Credit Card Accountability Responsibility and Disclosure Act, or CARD Act, was being debated in 2009, banks fought the law. But after the law won, they learned to live with it, and meanwhile consumer credit card penalties declined dramatically and without any apparent correlative decline in credit issuance. 

But there's also reason to suspect that banks aren't just crying wolf this time. The nature of credit card revenue is that it tends to go up in good times and be dramatically offset by losses in bad times. When a bank offers unsecured consumer credit, there's a limited number of ways for the bank to hedge its potential losses. The dirtiest tricks — like surprise fees or retroactive rate increases — are no longer allowed under the CARD Act. If the government allows only a small fraction of today's late fees, it makes some sense that banks might conclude that the best way to offset losses is to not extend credit in the first place — except to those who don't need it.

Regulation and compliance

Banks, credit unions outraged by CFPB's $8 credit card late fee plan

May 24, 2023 9:00 PM

I don't know if that is true of the $8 figure, in no small part because individual banks' exact margins on credit card revenue are totally opaque to the public — but, at least theoretically, known to the regulator. The CFPB said in its February report outlining its methodology that it analyzed Y-14 data to arrive at the $8 figure, but banks — especially small banks and credit unions — have said the agency's analysis is flawed, and are champing at the bit for the opportunity to make their case in court. Given the current makeup of the Supreme Court — where any such case will inevitably land — banks like their odds.

I sincerely doubt, considering the high profile that the CFPB and White House have given this particular regulation, that such bluster will alter the shape of the final rule. They may even consider an unfavorable court ruling to be a political victory, proving that Democrats wanted to cut your late fees but the banks and the mean old Supreme Court said no. It is also possible — indeed, nearly certain — that Rohit Chopra knows quite a bit about credit card issuers' bottom lines that I don't.

But if the CFPB insists that $30 is unnecessarily high to serve as a deterrent to late payment and banks insist that $8 is too low to offset credit losses — and there's no real way of proving it one way or the other — the tactical decision may be to just finalize the rule at $19 and be done with it. Yes, banks want to sue the CFPB to beat the rule, but suing costs money, too. And yes, the CFPB wants to show that it's getting tough on bank fees, but reducing them by more than a third is no small victory. 

Is $19 an arbitrary number? Of course it is. But it's also right in the middle of two other arbitrary — and unacceptable — numbers. That's good enough to give it the magical ability to make a lot of pain and uncertainty go away.