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Hello and welcome to another episode of the Odd Lots podcast.
I'm Jolle Wisenthal and I'm Tracy Alloway.
Tracy, are you good about like frequent flyer miles and hotel rewards and cash back and using your credit card to get like good seats at the US Open like all the dining? Are you good about maximizing that stuff?
Nope, I am not.
I'm trying to be better, you know, I'm finally signing up to a bunch of frequent flyer programs and things like that. But in general, I am not a points strategy. Some people get really into it.
Now.
I do not have a very busy life. I do not have mental energy towards, you know, maximizing points or learning about the newest cars. It's like, oh's this card worth a four hundred dollars fee because I can get upgraded to Platinum faster this year. I do not want to think about that stuff. I'm not that interested. But I get the impression that means I'm probably paying for someone who is or something like that, or maybe you know, I'm paying these fees on my credit cards or these
interchange fees, et cetera. Maybe I'm leaving money on the table by not doing it.
I don't know.
I find credit cards to be a weird business, Like I don't really know what visa does relative to say, the bank that issues a visa card, et cetera, to know how they slice them. I don't know any about credit cards.
It's a very opaque business, for sure, and it's a weird business. I would say, like it's competitive, but also it's like not, you know, like everyone's kind of doing the same thing in many ways, so we should talk about it. It's also, I imagine, kind of sticky, in the same way that deposits at banks are sticky.
We spoke with Joe Obote about that a while back.
So I don't cycle through them a bunch and stuff like that. And there's so much credit card advertising. I don't know what's good, bad or whatever.
I know.
Yeah, Look, I use my credit card as a payments card because I don't really I don't carry a balance from month to month, so I don't I don't know, I think my interest rates or whatever. I pay it off at the end of every month because I just basically use it for payments et cetera. So I just don't know much about them, but they're a huge, major
consumer financing source. Yeah, and every want to talk about fintech and BNPL and all these other things and stable coins and all this other stuff, and it's like, yeah, but the big one. Who's talking about the big one? Credit cards?
Well that's the thing.
So points have become a bigger attractant, I guess, to credit cards, and so people are spending more with their credit cards and carrying a bigger balance, which means that the rate that you're paying on the credit card is actually more important potentially than something like your mortgage rate.
Totally well pleased to say. We do, in fact have the perfect guests. Someone we've had on the podcast before. I think the last time we were talking about red Q, which is main lending in the seventies. I like his work because he goes back to the simple things like let's talk about how this works. Let's talk about how this works, because I think we move on too quickly without sort of understanding the basics. Maybe there are stones left unturned.
Literally.
The perfect guest Itamar Drexler. He has a finance professor at Warden and he was the co author of a fairly recent paper sort of looking at the question of why are credit card rates so high? Because if you actually do borrow from them, sometimes the rates are like twenty something percent. Seems way higher than any other sort of lending. So itamar Thank you so much for coming back on odd lots.
Thank you very much. It's really nice to be back. Thank you for having me.
When I was doing some prep for this episode, there is not a ton of actually like fresh academic work on the credit card industry. There's not a ton of papers, but it's this huge space.
Why did you.
See a reason to go back and revisit the sort of basic simple question of looking at interest rates on credit cards?
Yeah, so my interest is usually like we talked about when I was here last time's monetary policy, macro and out of banking and had some student to our co authors now on this paper a couple of years ago, I want to talk about fintech because fintech is a very popular topic. And then I was thinking, well, how do we analyze fintech and what's the potential room for fintech to grow if we don't really understand how the
dominant incumbent players the credit card banks work. And then we look at this and I was very surprised to see something kind of simple, which is that the return on assets for credit card banks are just way higher than the average bank. So bank ROAs are typically you know, one one point two percent, they move a couple basis points are very exciting. Credit card banks ROAs and you know, most banks are not just credit cards, so it's actually even higher than this, are in the three and a
half often four percent. So it's very shocked by this. How come it's so high when it's so hard to squeeze out a couple basis points. And then one of the reasons is just they you charge really high rates, Like okay, how did they get away with this? You know what is going on here? Just very simple question about how to decompose that rate into the pieces and kind of what's left over at the end.
In the spirit of starting at basics, walk us through the revenue that credit card issuers or credit card banks are actually earning, the different types and who the players are in the system.
Yeah, so let's separate first into two categories. One are people who revolve their balance, and that's what most of the papers about it I think that's the more interesting part and there's more details, and it's kind of the banking part of it. And there are actually a lot
of people who revolve often. I find people are surprised to hear this, but about sixty percent of the credit card users actually revolve, so meaning that they don't pay in the grace period at the end of the month, and so they're hit with these very high usually interest charges. And then the other part are what people call transactors, so they're the kind that do pay during the grace periods,
so they're not paying interest. Okay, So for the revolvers, there's again multiple parts, so you pay interest on the balance that you have. But before then there's the part which applies both to the transactor and revolvers. When you swipe the card, then there's immediately a percentage taken. People call it the swipe fee, and that is split up into a bunch of pieces. The ones that I used to be aware of that most people are aware of is
the card network like Visa, MasterCard, Amex. There was Discover which is now part of Capital One, and that's there's a whole menu, but basically it's like fifteen twenty basis points. Okay, okay, it doesn't sound like a lot, but there's like ten trillion dollars of purchases between debit and credit cards. Turns out when you take twenty basis points of ten trillion dollars kind of adds.
Up nice business if you can get it.
It's really nice. Actually, be surprised that usually Visa and JP Morgan are the two most valuable financial services firms. They change who's number one, So Visa's, you know, been worth over six hundred billion dollars. It's a lot, yea and MasterCards is gigantic too, so there's that. Then the majority of that swipe fee, the majority of that remain there, actually goes to the bank that issued the card to
the consumer. So that's called interchange fee. And again they don't make this like very easy to tell, but in our data it's a little over one point eight percent on average. I think it's largely been trending up over time slowly. So the bank gets that, it actually gets the vast majority of that, and then they pay your rewards and things. From that, a lot of that goes to just pass through to the rewards and things, and
they keep a small portion of it for themselves. But the big part of their business where most of the money comes from that we analyze here is all these people that revolved. They pay an interest rate, and that interest rate now is on average twenty three percent, which is just like a shockingly high number. I mean, I guess I've seen that. It just when you work on assets and like, you know, think the kind of things you guys talk about bonds and bonds pay you know whatever,
five percent investment grades spread is not even eighty basis points. Now, on top of it, high yield spreads under three percent, Like, how the hell do we get to twenty three percent?
When you hear this number twenty three percent and you think about the fact that credit card users can be decomposed into transactors and revolvers, my first instinct would be, well, the transactors are very on the ball. They're like, not credit risks. I've always been just a transactor. I've never revolved.
How much of that increase spread can just be explained by likelihood of default from the revolvers, which I presume are perhaps a little more you know, financially precurious and maybe less financially sophisticated.
Right, So I think, if like me, you didn't know much about this, your assumption. If I think, if you ask most financial economists, the first thing they would think is, well, must be that most of the remainders is a charge offs, right, defaults, And that's not true. So you can find that pretty easily.
So the average charge off rate on the revolvers, okay, so when you look at it, let's say you look it up online, you'll see kind of, you know, relative to the whole balance sheets includes both groups, and like you're saying, by definition, transactors don't borrow, so they can't default. That kind of makes it go down a little bit. But the majority our revolvers, So if we kind of clean that out, then on average in our sample it's five point seventy five percent of bounces are charged off,
So it's not trivial by any means. That's a high number. But again we were talking about eighteen percent spread, so if you think, oh, it must be about eighteen percent charge us, it's not even close. And it's like never been that high, So you might think, well, maybe it's just that's on average, but sometimes it'll spike to be ridiculous numbers it does spike, but not for very long periods of time. So the bottom line is it's a substantial chunk of it, but not even close to a
majority of it. So you know people default, but they don't default that much.
Can I ask one more question on APR and the average there? Did you observe any trend over time? Like did the rate actually get higher as time went on?
So that's something we haven't spent a lot of time on in this paper. But the answer to your question is this is obviously yes. So if you look at it. I think what can be found online is again it's I think there's something a little misleading there, but that has trended up pretty strongly. I think not as much as somebody you know goes to their computer and looks up. I'll say, Fred from the Call reports, what is the average APR? It looks crazy. It looks like it's gone
up ten percent. It's gone up. We're gonna get to the bottom of like exactly how much I think it's gone up substantially since ten years ago. Let's say that trend is clear. I don't think it's as much as it looks like there, but yeah, it's been going up.
Actually, okay, so you've established default rates for credit cards, and as you said, like this business is about volume, right, so is there an argument to be made that maybe if the world, you know, falls apart, then you have lots and lots and lots of consumers who are defaulting, but you know, potentially at a low rate of the total. But the volume makes it meaningful for banks.
I mean, we are already looking at as a percentage of assets, so that kind of like valuates, it takes it all into consideration. I think the question, like in our minds was at first, you know, maybe in a crisis,
something extreme happens. In a sense, it does, but this is already the average default rates so usually it's lower, and then you kind of include this in there, so we'll talk I guess a little bit about risk premium, which it turns out to be very clear here and important, but it's you know, just the average default rate is what it is, so it's not in expected defaults again
they're it's surprising. But at the same time, if you just look at where banks actually suffer default losses in an average year, not a crisis year, something like fifty percent of banks default losses are actually coming from credit cards. The thing is is that they're not surprising, they're not unexpected losses. They're kind of the expected, but it's still
really big. And the reason for that is even though credit cards only take up about five percent of banks balance sheet, the charge offs or the defaults on average bank assets is very low. I mean, you know, we have this impression of banks as being these like crazy, like risk taking lunatic to actually, I think the right way to look at them is that their average asset is extremely boring and low risk. They do take a lot of leverage, which is only possible because the average
asset is extremely boring and low risk. But even after all that, their amount of defaults is not really that high. So if your average asset has about forty basis points average charge off and this thing has over five percent, then even if it's only five percent of the balance sheet, it can act like it's fifty percent of the charge of.
Other forms of consumer borrowing. Right, Like, people are very assiduous about making their car payments making I don't know if up until recently, until recently, but historically the perception was people really prioritize car payments, right because that's essential to live and you can't have your car repossessed. Home
mortgages obviously for obvious reason. I imagine that a stretched household will miss credit card payments are more inclined to if they're going to have to miss a payment, it's going to be there versus some of these other popular areas are borrowing.
Totally, so the other ones are secured, and this is unsecured. So in that sense, this is an actual asset that's kind of risky and interesting for my vantage point, and that it's unsecured lending to normal people. All the rest of the stuff is secured, Like homes are obviously very important, collateral cars pretty much so the rates on those are much much lower. In these, they're nowhere near you know,
the spread, there's nowhere near as juicy. I mean, when I teach students, we go through, like you know, the hierarchy of borrowing that the vast majority of borrowing is secured. You have to think it's crazy for a bank to come to somebody with the medium or lower credit score and say here have the line of credit of like five ten thousand dollars and you can default on it. You don't get shot for that. It's it's part of the law, it's part of the game.
Yeah.
I was reading an art from life in nineteen seventy where they were talking about how credit cards are becoming a big thing, and oh my god, these credit card companies are just mailing out applications to Americans. It's like giving sugar to diabetics. That was their analogy, speaking of unsecured versus secured. I'm also looking right now at a website that claims to have invented the first credit card that's based on your stock portfolio, So borrowing against your.
Stock portfolio with the card. I gotta say, the card does look pretty nice. It's made of glass. Maybe that tells you something intentional metaphor yeah, exactly.
Okay, So if it's not about risk premiums, if the rate isn't compensating for something like default, could it be compensating for all the points and benefits that customers are accruing.
So it's not just compensation for expected default. I want I want to separate them from the risk premium. The risk premium is kind of the competition for unexpected default, which turns out to be pretty big here. But let's go back and talk about the point and stuff. So I find that people are more excited to talk about points than anything. The term rewards was really a marketing flourish.
So yeah, So in total number of dollars this interchange was, I mean, again you have to look at fine exact numbers, but for credit cards alone, I think it was over one hundred and fifty billion dollars. So, like the GDP of a medium sized country gets transferred as interchange, and we find that about eighty five percent of that gets transferred through as rewards, you could wonder, I think it'd be natural to say, what is the point of this? Why charge people one point eight percent and then pass
through one point five to seven percent as rewards? Where well, at least some people like I guess you and I Joe don't pay that much attention. I think I have enormous amounts of United Miles I'm never going to use because I have to actually travel to whatever place to use them. So why is that? I mean, I think a good economic question, and people have tackled this. I do think it creates a very strong network effect, so
you are not actually seeing a charge for this. It's the retailer that has to eat it, and if you do not use a card that gives rewards, you're not going to get in most cases a lower price. So there's a whole series of litigation and fights over the years amazing about what retailers can do to discriminate prices based people who using cards and hurt And I thought a couple of years ago. The last couple years, I'm seeing more restaurants give you back a percentage or not
charge you a percentage if you didn't do that. But it's a little bit beyond my legal expertise to sometimes understand these because for the longest time, I think you could give people a discount, but you couldn't do a searcharge. There was some like legal discrimination between those things. And as a result, people mostly don't pay attention to that kind of thing, and so you really want to stay inside the network and it kind of keeps you there.
Even if at the end it would be a total pass through, it still helps for them to keep this business.
You know, it's interesting. There's this crypto company. Have you heard of a Blackbird. Yeah, it's a crypto thing and they have a bunch of restaurants. You sign up and you're like pay in a coin. I don't know exactly how it works, but I think that they have to in some way because in theory would be nice, like maybe we'll get a little bit in the stable coins. It's like a payments rail in the future or in this conversation, and think it would be a nice way
to like circumvent this. But even they, I think implicitly have to reinvent the rewards model to do it. Maybe you get premium seeds or you get reservations, et cetera. In order to sort of like bootstrap a new network, you start end up having to reinvent a lot of the rebates and the benefits, et cetera that come up
the old network. Maybe we'll get into crypto a little bit more, but talk to us a little bit more then about like the persistence of this spread that can't fully be explained by defaults.
Yes, so the default, like I said, is like a little under six percent, then I'll just I'll mention it. So defaults that do spike in bad times. So we estimate, using kind of the cross section of different Fyco scores, how much extra compensation you get as you go to lower and lower Fyco scores in terms of extra APR net of the defaults. So we estimate that the risk premium there is accounting for about similar sized piece. So there's a risk preum about five percent on average, which
is much smaller. For let's say you're an eight hundred FICHO borrower, there's not that much risk premium. But if you're a six hundred Fyco borrower, the risk preum goes up to, like, you know, nine percent. So I think it's means something very important. I think the person who's borrowing there may not realize that they are paying a very large risk bemum. So if you're a low Fyco borrower and you aren't going to default like you know you're not, you're paying a very high risk premium. And
that is because other people default in bad times. Even if you do think you're going to default. Sometimes I think one should realize how much of a risk premium you're actually paying for this. So but now let's go back to something else before we maybe talk more about that is the other pieces of this. So we talked about interchange and rewards. It's not zero. They do earn a little bit from it. Most of the transactors what they make off transactors. Is that difference because transactors spend,
you know, recurringly a lot. Borrowers tend to kind of accumulate and they don't have that much more room to spend because they've borrowed. So that's not a big portion of the revenues there. Then there's fees that's another couple percent is actually making the puzzle worse. And then the part that turned out to be really big that surprised us is operating expenses, of which marketing you mentioned, this turns out to be really big, and.
Yeah, this is the thing that I don't get.
So there is so much marketing for credit cards, and as I said, like they're all kind of similar in many ways. And I remember this was often the blockage for new entrants from the fintech space trying to get into this business. I remember talking to Lending Club about this back when they were a thing. They were spending so much money on mail advertisements, and I just don't get why that's the primary acquisition channel and why it seems to be so important to the business model.
It's a really interesting question. Maybe the answer would be, like people listening this will be like I knew that, which is the reason you do it. Because it works, which means which I wish. I mean, this goes back to Joe's question. I think you can see we look, we do this analysis there that if you spend more on operating expenses, which I think largely means additional marketing because the actual operational side of this apparently is very expensive.
But there's big differences across these guys in operating expenses, and I don't think it's because their systems are like much more and we actually see no relation between that and defaults. So it's once you control for fighters. So it's not about screening people for better borrowers. But what it is it's an effective, apparently at the margin, customer
acquisition strategy. So think the following thought process. You could say, well, why don't somebody just cut all this marketing out and just charge a lower rate and that'll get people.
Yeah, that's that's your acquisition advertising, right.
Apparently it doesn't work. So so people are not are not rate sensitive, which is a recurring theme I'm starting to, you know, learn when we talked about we talk about banks and bank deposit rates. People are They're not completely insensitive obviously, but they're not that sensitive to the rates get paid, and they're not that sensitive to the rates that get charged on this, so there are actually this is a surprising thing. The CFPP has a spreadsheet, well,
when there are people still working there. They used to have a spreadsheet that they updated with essentially every single card there is and what the rate on it. And all the cheapest cards are credit unions, and they're significantly cheaper, much cheaper than your average credit card. But I'm sure almost nobody's accept their customers have heard about them, and it's because they don't advertise much. And so you say, well, if their rates are so cheap, why don't people go there.
It's like they haven't heard about them and they don't care that much about the rate. Is my inference from this. So the more you pay for marketing and operating expenses and the data, the higher is the average amount you're able to charge this for very funny.
Does some of the stuff repel the brain of the academic economists, No, for real, like this idea that the borrower wouldn't be raided sensitive, the idea that we're actually paying more to be advertised to et cetera. Because this is their cost, the idea that their lower cost options out there and all we have to do is search for them and they're available.
Like well, also for macro economists specifically, right, because we talk about benchmark rates and the importance of how those feed into the economy, and here we are talking about the credit card rate, which is actually potentially more important.
Like I'm serious though, Like rates are high because to some extent consumers just aren't paying attention to them, et cetera. Do counter people who think, no, there must be something, There must be some variable you're missing, because we're rational and we would take out the lower rate.
I want to talk to people like you're saying, I haven't really held up the chance, because you know, when you pitch this to a finance audience, not macro people, and I have a finance president, then they're more open. I mean, credit cards is the thing in finance. People like credit cards. But I think the interaction with macro and monetary is really interesting, so it doesn't bother me.
I think it's interesting. I mean, I think it's kind of bad that a lot of people who are usually not in the best shape are essentially adding six percent rate to their credit card because they're paying for the advertising that they responded to. But you know that's you know, you could get it if you didn't respond to the advertising, responded to the rate, they would do that instead, but they don't, So you know, think about you know, you guys often talk about the FED lowering or hiking rates.
At the risk of sounding heretical here, I am not a huge believer that consumers at all are very sensitive to these changes in the policy rate and the FED funds rate, even though the standard model works through their inner temporal consumption savings decision. I think most of the
events is very weak that they care about that. And then the credit card, I think on top of that is really makes this clear because if you're paying twenty three percent and you are the kind of person that wants to borrow, I mean, obviously because you've borrowed, how much is a half of percent going to matter to you? If the FED hikes plus you could have been getting a much cheaper rate anyway, and that didn't compel you
to go looking for it. So I think it kind of puts a big question mark over whether that's really the channel, which which is a lot of people have said that, but it's still kind of the main way with those things.
Can we talk a little bit more about competition and why doesn't someone just come in with a lower rate and disrupt the entire business.
Let's give you another example, personal lines of credit. These were all new things to me. I find this. I think where you've put retail people with the financial sector, you actually get a lot of explosions. They're like weird stuff.
So that's the place where sort of academics should go looking, and many do, but it's not the place where I kind of having worked at like hedge fund market maker, ever thought about these things you want to think about, like the fancy people, like the people who are sophisticated do all the math, but they kind of cancel each other out. Where the real fireworks are is when you
get into the retail sector. And if you look at personal lines of credit from the same companies at the same FICO, they're substantially cheaper, plus you get all the money up front. That's something it's still very puzzling that there is almost no marketing there. You don't get marketed a lot on personal lines of credit, and the people who discover them do use them to consolidate these debts and pay them off in one shot at a lower interester.
It's a very I think, very logical thing to do don't do, but I mean, just to get back to I think we see them over and over and you're talking about BNPL and stuff. This idea of how do you acquire customers in what role the rate actually has there is just keep seeing it. It's like a movie. I've seen this before. It's more effective at the margin than lowering the rates, and it explains a lot. I think of how the finance sector interacts with retail, which
is not just like canceling out. So that's the issues, Like, oh, well, they spend five percent of assets on marketing, then they add five percent to the cost. I guess there's no harm in that. Well not really, because what people have done is paid the five percent in order to get the marketing. So if you really like the commercials, you should be really happy. But I don't think most people would sign up for that.
I'm just I've still stunned that the advertising actually works, because like, I get the mail and I just throw it out without looking at it.
Maybe I should be looking at it.
On the disruption front, you mentioned BNPL, and we've done at least one episode on it. We should probably do more at some point. Is that the big disruptor, you know, if they're plugged into websites and some of them are getting rewarded for being plugged into those websites by retailers, then they bypass the high acquisition costs. And presumably it can still acquire customers because you see them everywhere online.
So I do think that has a lot to do with what their angle is, is it gets in front of you in that way. I listened to a recent episode of Yours. I think you guys were talking about BNPL, SOO I wasn't going back to a much earlier episode.
But I don't think the economics of the BNPL beyond that aspect of it, are that different from the credit cards, and there still is very high operating and acquisition cost if you look at like BNPL companies also then don't really make money, and so I think they're still in
that stage where they're building up to it. And you mentioned lending club bunding club didn't make money now it did not, It didn't, so because I think you want to grab these juicy customers but they respond to the marketing and just to go even back to that, so Amex is one of It's really hard to find aggregate marketing numbers across companies, but from lists I've seen, Amex might even be it's definitely, I think a top ten marketer in the whole country. It might even be in
top five. I'm not sure, along with some of the It spends over six billion dollars a year on marketing. And this is not including the lounges and all this, which has been like articles about how everybody's like investing like millions of dollars in these lines. That's that's a separate category. And Capital one spends over four billion dollars
a year. So I looked it up, and amics is bigger than Nike and Coke and marketing, and you think of like those being the ones that got to be like the gigantic ones, and Capital one's about as big.
Wait, a personal line of credit, Yeah, that's just a good classic is the product. I've never looked into one of those. An unsecured loan from the bank.
It's an unsecure line.
But this is just like classic bank borrowing. I go to the bank, guys, they can um borrow some money.
Surprisingly that the I mean you can make you can look it up even like it's so easy to look it up. They offer you it's a relatively large amount compared to a credit card, and you put in your fight. Oh, they give you a rate. The rate's almost for sure always lower than the credit card. I don't get it either, but you know, you know, and.
One could use these to payoff of all.
That's mostly what people do, which they should. I had a journalist ask me about this, and I was like, this is a great idea, Like I should look this up and talk about this. I mean, there's no you know, how do you explain this spread? I mean, I think largely it's got a lot of this less of this retail focus to it. But yeah, it's the same companies too. If you go to amex MS lineup credit Discover offers a discovered line of credit capital one capital one line of credit. It's the same thing.
It's so strange, this whole conversation.
It edges into some frankly like slightly uncomfortable territory in my opinion, because you write, because especially when you characterize something, it's like you're kind of end up paying a lot for them to advertise to you, and you apparently like the advertisement because that's you responded to it, et cetera. Like you edge into this territory where it's like these are not like it must be not the most sophisticated base, right, It's like, why do Nigerian email scams have all kinds
of typos, et cetera. And the theory is because they want to select for people who will be foolish enough to respond to them, because if you go down the chain, they don't want you to be too savvy and asking questions. So like, let's just get all the savvy customers out of the way who would instantly recognize a scam email, and then you like get there. It's right, Like it's a little.
Saying that the Nigerian princess don't pay you back.
I'm just saying like it seems like there's a filtration process going on where you end up with the base of revolvers where all this money is made, where it's clearly not that because otherwise they would be doing the personal line of credit or not doing these things, or looking for that credit union credit card.
Well, I'll say something about marketing, and I mean we all do respond that. You know, you guys are you guys are very not elitist here and every anti elitist. So marketing is just a huge industry. Is As a finance person, I'm like, we do have a marketing department at the business school, and I'm like, wow, there's a reason because you look at let's say you look at Alphabet and Meta. Meta's revenues are almost one hundred percent from marketing, and Google's are like close to eighty percent.
We're talking hundreds of billions of dollars a year and all the very sophisticated stuff. And at the end, it's to sell, you sell, you advertise.
It works and I've I've certainly been taken I get taken in by marketing all the time.
Just say.
One of the thing is I think the reason that because the ros here are high, when we decompose this at the end, it sort of does most If you take the alpha of this, think of this as alpha relative to the average bank asset. We get that it's about of percent, So how do you get down two percent? So the risk premium here is quite big. We compare
it to the risk premium on bonds. You have to compare it to high old corporate bonds, and it looks similar for all but the lowest FIICO bonds versus let's say triple C rated bonds, where the lowest FYCO seems to have a big chunk the risk cream over and above the bonds. I'd actually see the bonds look low relative to that because it's the risk premum on credit cards that kind of rises linearly and it's the bonds that kind of don't. But for the not so bad credits,
it's pretty similar risk premium to highyield bond market. So that sense doesn't look it's big, but it doesn't look crazy, but it should, say you know, Goldman, I think they when they got in before they got into credit cards and it did not work out, it's apparently it is competitive in that sense. I think they were eyeing this and saying this is a good business. You see the highest roe's by far of all the you know, if you go look through the banks ten k's, you know,
some of them break this out. I think JP Morgan for example, and you see like that's got the highest roe by far, that it's bigger than the you know, all the other parts of the bank. So I think they were thinking that now it got into it paid very high operating costs and had higher defaults than other ones that didn't obviously did not work out because they turned away from it.
Do you see any signs of rates eventually coming down? It sounds like it's probably not going to be through competition or new entrance like FinTechs. But could it be something like regulation. I have vague memories of the Credit Card Act doing something on this front, but could it be something.
Like that the Credit Card Act? There are tons of papers on it when it came out, mostly limited your ability to increase rates on existing borrowing, and it sort of put caps on all kinds of fees and charges, and then people were looking for whether banks would move that to something else. I think in the long run the answer is yes. I don't know if they move
that or just something else. But I mean, so far rates if you could just plot it on fred even though I think it's like a little bit distorted, it's been going up and up, I mean before it starts going down because I got to stop going up. So they're in pretty strong position. But there is this by now pay later, there were lending club kind of things
A largely crashed and burned, and payments in general. I mean, you know these companies for payments are huge is because there is this you know PayPal A these guys, this is just to take off a little bit off the top of this swipe fee and then we're gonna get to the interest rates on this borrowing. I mean, I think that there is constantly like movement in this space, but it has not been to drive down things, driven up acquisition costs more than just driven down the actual rates.
Unrelated macro question. One of the reasons I like your work. They're sort of revisiting some of these like basic questions, which I think is useful. And of course when we talked to a couple of years ago, it was like, let's revisit some of what we thought we knew about the seventies and say if that inflation story is a
little bit different, just on the big macro question. These days rates where they are inflation sort of persistently warm, A lot of people are like, I got to talk about our star must be therefore higher than it otherwise would have been. What do you think we've learned? You know, we had this very fast rate gig cycle twenty twenty one through twenty twenty three. I would say many economists would have expected the unemployment rate to rise a lot more given that rate hike cycle it has.
And spending to go down, you're spending.
To go down, et cetera. But I personally am rarely satisfied by the stories that people tell about how in fact those raid hikes translated into lower inflation. Have you yourself sort of learned anything interesting in the last I don't know, three or four years, five years of this macro experiment that we have post pandemic.
I think it's a great topic in question. My inference was that the cycle. I'm in the group that thought that this was largely a supply shock issue. That COVID disrupted supply chains tremendously. I mean, we saw that, and I think if you look like the New York Fed has this index that they put together on supply disruptions, this predicted the trajectory of inflation with a three month lead very well. I think we had a period where we saw that there was increased employment and yet output
was going down. So usually when we talk about productivity and things, there's all these compositional issues. Do you fire at least productive people, so productivity goes up for mechanical reasons. But when you have more people being employed and yet outputs going down, as it did for several quarters, that can't be the reason. So I took away from it.
You know, there's harsh arguments about this, that this was largely supply driven, and how it relates to the seventies is our argument there, for different reasons, was that it was supply driven due to credit crunches and things. So I tend to think that a lot of the business cycle things and the inflations we've seen, like after wars, were often switching the kind of production that you do,
which is a supply thing. I'm very much in the supply camp, and I think the reason that employment held up and spending held up because I don't think that this was happening through decreasing demand and getting people fired and so forth. I think it was products, you know, components could ship again and so people could be more productive with the labor they had. So to me, I'm sure some people very very highly disagreed. To me, that looked like a pretty clear story.
So if you're at Jerome pal and you're worried about inflation going up, and I should just mention we are recording this.
On October twenty nine.
Yeah, FED, which is why we expect it to be a cut, right, but you know, inflation is still, you know, somewhat warm.
As Joe said, if you're worried about it, should you be looking at credit card rates versus you know, mortgage rates or benchmark rates or things like that. How should policy makers actually think about this problem between those?
I think mortgage rates that people you know do seem very much to respond to, it is a much bigger amount. Maybe they are more sophisticated sensitive. It lasts with you for a long time. I mean, I think that's much more important the shifts in those spreads for the macro economy than well, the credit card rates is just not much movement. I mean, they are literally tacked on top of the Fed Funds rates, so that's completely mechanical. Didn't
used to be the case thirty years ago. But the spread will move one for one with the Fed Funds, except when they expand it by issuing new cards and making rates hire. So I think the mortgage market's much more important for macro kind of stuff. I mean, I don't envy, you know, Pal's job. It's a very hard job. Now, I'm not sure. Last time was at the FED. I was in the elevator when he got in, but I didn't didn't want to bug in, so I didn't say anything to him. But I got to see him in person.
Drove our stars fake real good. Going back to you know, you're talking about fintech et cetera, I personally like, I actually think stable coins are going to be a very big deal. I do not necessarily think they're going to be a big deal for consumer transaction. It's not obvious to me. My guess is that they'll open up new transactions that we aren't thinking of right now, but not
for like buying coffee or buying you know whatever. But from your research, whether into cards, et cetera, how would that inform your or other fintech how would that inform your thinking about the trajectory of the stable coin industry.
It's stable coin. It's interesting, and I've heard you mentioned this kind of view, which I think is not and i'd considered I was thinking a lot about consumers. I'll say this, I think for me and something I talk to my co author's stable coin are they're like a puzzle in the sense that maybe not all stable coin, but the ones that have been around are kind of like a money market fund that doesn't pay you interest.
That's how I would summarize them, because and that's why I think these are some like the most profitable companies ever per employee, because they don't do anything. So if you give them a bunch of billion dollars, they just take the whole interest. There's some advertising there too, but not a tremendous amount compared to that, and people are happy with that. I don't really get it, but you know, now they've, like you mentioned, they've started to learn the
sort of tricks of the trade. They're going to do rewards. It's better than paying people actual interests. You give them rewards. So from the point of view consumers, it is kind of a mystery. I mean, I would love to start a money market fund and not pay anybody any interest. Life economically, when you don't pay any interest on a dollar, ever, you've taken the whole dollar. That's what the dollar does. It pays you interest. So the net present value of
all the interest of a dollar is the dollar. So if they never pay you and you stay there forever, then if they have eight billion dollars, they've captured eight billion dollars.
Again, nice business, if you yeah, that's a great business.
It's it's weird, but it's a great business.
What's your next research project?
So I think from this credit card stuff, there's definitely interesting things to think about, you know, how people default and how much this marketing stuff affects them. From another point of view is one of my co authors in here, a former student of mine. We have a bunch of work on adjustable rate mortgages and why they kind of disappeared. So they used to be a big thing and they've kind of disappeared, and I think we kind of understand why. So that's uh, you know, there's been a lot of
discussion about that for mortgages. Why is the US in one camp and many other countries in another camp? But the US kind of used to be in the adjustable mortgage rate camp at least pre crisis and stuff.
I remember when the rate hike, when we started surging. Do popular theory that monetary policy would have more teeth in countries like Canada, Australia, the UK because so many more households would be more sensitive to faster resets. Has that actually been born out? It sounds great, it's like a theory. Intuitively that makes a lot of sense, I do.
I guess Canadian unemployment has trended higher than American but the inflation trajectories I think have been roughly the same, and those other Anglophone countries versus the US where they hit. I don't know, like how strong effect was that, do you know.
I don't know exactly, but I don't get the impression that it was tremendously different. I think it has impacted consumers. One thing I should note, though, is there's two senses in which monetary policy can have an effect. One is that it makes people have to spend a lot of money on that, so it's expensive for them. But the other one is that here and I don't think that's the effect we were going for, but people have just you know, stopped taking out as many mortgages and don't move.
It was a negative effect. I'm just not sure it's anti inflationary effect. So it's like if you're gonna have floating rate stuff, and that's like the case with credit cards, and it shouldn't affect the volume of it that much
into of producing it, but it's kind of people. It's expensive for them, and then on the fixed rate one they just stick to the old stuff and we don't you know, mortgage credits really dried up in a way, but it's not affecting the existing bar wars, only to the extent that you don't want to move, which is actually a big deal.
Drexler, thank you so much for coming back on odd low. It's always a trade. And next time you have a new report out, let's talking let's talk arms next time.
Okay, great, thank you very much having me.
Tracy. I found that conversation to be fascinating. I have to admit, like, yeah, like credit cards are the sort of black box to me in many respects. I don't really understand the business because I don't actually use them for revolving purposes or borrowing against them. I don't think
I quite realized how crazy the numbers are. And I certainly knew that there's tons of advertising, including direct mail on credit cards, but the idea that this is so substantial that a big part of what people are paying for here is the advertising that was all very novel to me.
It's very surprising.
My main takeaway is that people, I guess are not rational, at least when it comes to credit cards. Right, the marketing seems to work.
Yeah, no, totally. I'm not rational because I don't take advantage of all the points that I could, and I don't like optimize the way I could. And when I, like buy a plane ticket, only part of the time do I think about is this the airlines?
Well, you could also argue that it's rational to like factor in the time and spend on doing that.
Sorry, I justify all of this money left on the tech's right by saying I make it irrational. My time is valuable, Yeah, my time is valuable. It's but you know, if there are all these other borrowing products out there that are cheaper, et cetera, it does feel like someone must be able to come along and make a product.
And yeah, that is, let's going to.
Compete on raid or you're gonna be able to borrow achiever. I don't know, maybe b NPL will achieve that. I don't know.
I'm going to go take out a personal finance loan right now.
Go for it.
Shall we leave it there, let's leave it there. This has been another episode of the Audthlots podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.
And I'm Jill Wisenthal. You can follow me at the Stalwart. Follow our guest Itamar Drexler. He's at Idres. Follow our producers Carmen Rodriguez at Carman Arman, Dashel Bennett at Dashbot, and kill Brooks at Kilbrooks. More odd Lots content go to Bloomberg dot com slash odd lots. We have a daily newsletter and all of our episodes, and you can chet about all of these topics twenty four to seven in our discord discord do gg slash odd lots.
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