Credit Cards –
Financing the American Dream
Ranil Gunasekara
Currently, the credit card has achieved the status as a household necessity more
than a luxury item. Whether we use it at a restaurant, grocery store or to purchase
anything online, we reach for our credit card to conveniently make the payment. The last
time I traveled to Washington D.C., I used my credit card to buy the plane ticket online,
to check-in at the airport and to buy the metro pass to get to my uncle’s house. I
only used cash on that trip when I bought a hot dog from the roadside vendor. The use of
credit cards is so popular that if you ask your friends to change a $20 bill that most of
them will not have the cash with them.
Though
there are a few risks involved in the use of credit cards, with some discipline and
caution we can benefit immensely by using this simple and cheap mode of credit to finance
our American dream. I will be discussing the history, operation, cultural impact which
includes credit cards being a status symbol and helping Americans increase their
purchasing power, as well as the negative effect of the use of credit cards.
In the early 1900’s the myth of not living beyond your
means was slowly diminishing with the growing urban culture, which was moving towards
consumer capitalism. Consumer credit comes in many ways (Manning 105-108). Loans were the
original form of credit extended to consumers as people bought only assets (land and
houses) on credit, but after World War I, more and more people began buying consumer goods
on store credit, which was extended to people with jobs so that they were able to pay back
the store when they received their wages. By the end of World War II consumer credit was
given a shot in the arm with the advent of the credit card.
Between the wars ingenious, individuals who received store
credit started extending the credit they received to the other customers. This practice
was mostly used when buying medicine where the customers who could not afford the medicine
due to the lack of available funds used the credit line extended to a person who
authorizes this transaction. Later the customer would pay the person with store credit the
amount owed plus interest.
The Diners Club credit card -- recognized as the first credit
card to be accepted at multiple businesses in many major cities -- was inspired by the
above practice. Frank McNamara, the original majority shareholder and president, used this
idea and with the support of his friends Alfred Bloomingdale and Ralph Snyder started the
credit card business. Originally the card was geared towards sales people and businessmen
to receive credit at restaurants and was known as the Diners Club credit card. The company
received seven percent (7%) for the “business that the restaurant would not have
received otherwise”. The company got
thirty (30) days credit from the business while the customer got 30 days credit from the
company (Mandell 1-5).
By the early 1950’s many banks started the practice of
issuing credit cards. On August 16, 1966, a
group of banks established the Interbank Card Association (ICA), which later became
MasterCard International. The Interbank Card Association was an association of credit card
issuers who established committees to run the credit card operations of the banks by
establishing rules and guidelines for running the organization. In 1968 the Interbank Card
Association started went global and has become one of the two most widely used credit card
brands globally (“The MasterCard Story”).
The other present day leader in credit cards, Visa, began in
1956 as a part of Bank of America. Bank of America was active in California and in 1966
formed the BankAmericard Service Corporation, and issued licenses to banks outside of
California to issue credit cards. In 1970 BankAmericard Service Corporation, to compete
with the Interbank Card association, transfered control and ownership of the BankAmericard
program to the banks that issue the cards forming the National BankAmericard Inc. After
expanding overseas in 1974 under its subsidiary International Bankcard Company (IBANCO),
BankAmericard changed its name to Visa U.S.A. and International Bankcard Company to Visa
International in 1976 in order to appeal to the international market
(“History”).
American Express and Diners Club credit cards are known as
specialty cards as they are mainly geared towards the travel and entertainment industry,
while Visa and MasterCard are multipurpose credit cards. MasterCard and Visa are card
associations, a group of credit card issuers and acquirers working together, while
American Express and Diners Club are individual companies which now operate globally.
There are two main parts in a credit card operation: the issuer, who is the company that
issues credit cards to cardholders; and the acquirer, the company that services the
businesses that accept credit cards. Both these companies have to be a member of the same
card association in order to function. Most businesses prefer to deal with acquirers who
are members with both MasterCard and Visa as these are the most popular credit cards
offered, and as it is easier to deal with one company than dealing with many acquirers.
A credit card is basically a line of credit that presents many
benefits to a person such as an increase in buying power, payment flexibility and access
to cash. When cash is withdrawn or a purchase is made, the available credit decreases.
Depending on how payments are made, partially or in full, the amount of the credit
available is either partially or fully restored. For example, if your initial line of
credit is $500 and you buy $50 worth of groceries with your card, you will have $450 left
over that may be used. When you receive your monthly bill, you can pay it off in full, pay
just the minimum amount required or any amount in between (Evans 27). However, it's
important to be aware that just paying the minimum amount will typically cover only your
interest charges and will not reduce your outstanding balance. In other words, you will
have to pay more than the minimum required whenever possible. After setting up your
budget, you will have a much better idea of how much you can spend on purchases with your
credit card each month. The issuer depends on the interest and annual fees (at present
issuers are less dependent on annual fees as many companies offer cards without annual
fees) paid on credit cards for profit (Shepherdson).
Though originally credit card merchants had to call their
acquirer for voice authorization (credit-authentication requests from merchants and
provides the merchants with a payment guarantee) for transactions over the floor limits
(maximum transaction amount without authorization), at present with the advancement of
technology and the usage of credit cards increasing most merchants have been given Point
of Sale (POS) machines which get authorizations by reading the data on the magnetic stripe
of the card and transmitting them to the issuer via the acquirer and the credit card
association. A transaction on the internet requires the card number, expiration date and
the security code on the signature panel of the card (if the card is a MasterCard or Visa)
in place of swiping the card. Then the same authorization process as above takes place.
The following diagram from the New York State Dept. of Taxation
and Finance demonstrates on how the authorization process takes place (“Credit Card
Authorization”).
This diagram
also indicates a significant difference between the specialty cards (American Express and
Diners Club) which are companies that have all the records of customers stored centrally,
while the multi purpose card (Visa and MasterCard) associations have the records stored at
the individual issuer.
Generally at the end of the day the business forwards the days total credit card
transactions to the acquirer (through the Point of Sale terminal) to the acquirer. Then
the acquirer pays the business the total minus the commission (which is the profit for the
acquirer). The acquirer transmits the total of all sales done by all the businesses to the
card association which sends it to the individual issuers, who remit the money to the
acquirer via the card association.
In 2004 the United States (US) Census Bureau has projected that
twenty six percent (26%) of consumer payments made in 2005 will be in the form of credit
cards, up from fourteen point five percent (14.5%) in 1990 (“Banking, Finance, and
Insurance” Table 1181). Seventy two percent (72%) of the families in America having
credit cards in 2001 shows that credit cards have become one of the most popular means of
making purchases, offering consumers convenience, status (especially in the 1980’s)
and an increase in buying power to live the American dream (“Banking, Finance, and
Insurance” Table 1186).
The credit card was introduced for the convenience for patrons
as well as businesses. When extending store credit, businesses preferred a mode of payment
where they were sure of payments while not having the responsibility of collecting debts
and maintaining in store accounts while extending credit. For consumers the credit card
was a line of credit which was convenient as they did not have to maintain accounts at
different stores, but could have a centralized account with a credit line which can be
used at multiple stores.
Another convenience of the credit card is that it eliminates the
hassle of carrying large amounts of cash or a checkbook around. The credit card also
eliminates the necessity of frequently going to the bank (now the Automated Teller
Machine) regularly as well as the risk associated with having your cash or check stolen.
In 1995 an estimated eight hundred and fifty million dollars ($850,000,000) of cash was
stolen in eighty four thousand (84,000) robberies (Evans, 30). Since 2000 most of the
credit card companies have come up with a policy of the cardholder having zero percent
(0%) liability in the case of an unauthorized transaction (“History of Firsts”).
This eliminates the risk to the cardholder of any transactions done in the case of the
card being stolen.
The mail order industry and the e-commerce industry have
benefited immensely from the booming credit card industry. Credit cards are the most
popular payment mode in these types of transactions. Paypal (a major online card acquirer)
processing transactions worth over twelve point two billion dollars ($12.2 billion) in
2003 (“Annual Report 2003”) demonstrates that credit cards are the most popular
mode of payment when it comes to online transactions. On the other hand the e-commerce
revolution has boosted the credit card industry by creating a market where credit card
usage becomes the primary payment method.
With global travel becoming easier, the credit card adds another
convenience by not having to carry traveler’s checks or foreign exchange. If the
cardholder wants currency in a foreign country he can use an Automated Teller Machine and
withdraw cash. At present a person can go to nearly any country in the world with nothing
but a credit card as a mode of payment. This adds to all the other conveniences that the
credit card offers.
To stimulate the credit card market, American Express introduced
the Gold card, in 1966. This idea did not reap the intended results till the 1980’s
when Visa and MasterCard launched their own Gold cards. The Gold cards offered lower
interest, higher credit limits, and other benefits while requiring a higher membership
fee. Still the main appeal of the Gold card was something more intangible, status. In 1982
a top executive of a New York brokerage firm admitted, "If you want to know the
honest truth, I have a Gold card because of the status.... I use it because it looks
neat” (Shepherdson). The prestige was the typical attraction to the Gold card during
this period. Soon, with the wide spread
issuance of the Gold card the opinion about began to change; it was not prestigious enough
to have a Gold card anymore. The Gold card’s image depended on it being exclusive,
not the lower interest rate. To combat this American Express came out with the Platinum
card which was solely geared towards patrons who charge more than ten thousand dollars
($10,000) a year. In 1985 the annual fee for the Platinum card was two hundred and fifty
dollars ($250) which went up to three hundred dollars ($300) by 1989. The Platinum card
offered a host of personal services like free personal assistance in emergencies during
international travel and offers to exclusive parties such as the Tony awards parties
(Shepherdson).
Another innovative idea brought in the 1980’s by the two
major card associations, MasterCard and Visa, were the affinity programs. This program
allowed clubs, charities and professional associations to have there name on the credit
card. The affinity cards, which are known as “co-branded cards” helped people to
be recognized with the organizations that they were associated with where by carrying
them. In 1998 MBNA, the largest issuer of co-branded cards had more than four thousand
five hundred (4500) affinity card programs (Evans 74).
With widespread usage of credit cards the glamour behind it
tended to decline. In the 1990’s consumers were attracted to credit cards more for
their convenience and the purchasing power it offered rather than a status symbol.
By increasing the amount of money that a person is able to spend
resulted in an increase in the buying power of an individual. Credit cards are a source of
easy credit which, unlike most loans, can be spent on various consumer goods. In a
consumer economy credit cards have become a major role player. Immaterial of the state of
the economy, credit cards are able to help stimulate the economy by increasing the money
supply. The move from conservative capitalism to consumer capitalism in the 1920’s
which brought in the need for credit for consumer spending has come a long way and has
seem to reached its pinnacle; with the widespread use of the credit card.
Modern day consumer capitalism and the credit card depend on
each other in many ways. Credit cards are used as a tool to give the consumer the ability
to spend money which in turn stimulates the economy. During the presidency of Jimmy
Carter, the credit card industry faced a downturn due to the economic policies such as
high interest rates and usury laws adopted by the federal government. But the economic
policy adopted by the later half of the Reagan administration which lowered interest rates
to stimulate the economy (Niskanen) was welcomed by the credit card industry as consumers
were encouraged to use credit cards because the interest rates were low.
Credit cards play a major role in the operation of small
businesses. As shown in the 1993 Survey of Small Business Finances, four in ten small
businesses use personal credit cards for business purposes while three in ten small
businesses use business credit cards. (Cole 638). Credit cards have benefited people not
only in the consumption of personal goods and services, but also provide revolving credit
in the operation of their own business which in turn helps them satisfy their goals in
living the American dream.
There is a growing trend of credit card usage among college
students. Marie O'Malley, Vice President Marketing, Nellie Mae supports this theory with
the statistical data collected by her organization which show that in 2002 eighty three
percent (83%) of the college students applying for student loans had at least one credit
card, up from sixty seven percent (67%) in 1998. Many students use credit cards to pay for
books and supplies needed for college, and even their tuition (O’Malley). With the
increase in purchasing power students can now afford extra luxuries which they would not
have been able to afford.
The convenience offered by the use of the credit card is not
without its share of negative effects. Some of the problems created are caused by the lack
of discipline of the cardholder and unforeseen economic hardships, while some are due to
criminals who have stolen either the cards or the card numbers.
Bankruptcy in America is at an all time high, mainly due to the
bad management of personal finances (“Influence of Total Consumer Debt on Bankruptcy
Filing Trends by Year 1980-2003”). Credit cards have been a factor of the rising
bankruptcy as it is a convenient and easy source of consumer credit; therefore contribute
largely to the personal debt of the consumer. A bad credit history limits a
consumer’s access to cheap credit. With the consumer credit ratings being used at
present, credit card issuers are trying to protect themselves when issuing cards by
charging high interest rates from individuals with a poor credit history. The high
interest rates turn makes it difficult for consumers who are used to spending beyond their
means to maintain their debt at manageable levels. The Bankruptcy bill 74-25 passed by the
Congress in April 2005 is geared towards curtailing defaulters who have habitually been
declaring bankruptcy to get out of debt (“Congress Passes Bankruptcy Reform
Bill”). This new bill will provide credit card companies the luxury of not having to
write off the debt of certain bankrupt customers in the company’s accounts
(“Senate OKs Bankruptcy Bill 74-25”).
Certain unforeseen economic situations such as a recession and
layoffs also contribute to the bankruptcy of individuals. This happens when individuals
already have a high amount of personal debt and do not anticipate any unforeseen events..
Identity theft has increased with the access to credit cards
increasing. By using the identity of a person with a good credit history, thieves tend to
obtain credit cards and use them to finance there personal lives. This issue has come in
to existence as a outcome of the credit card industry, but has become more and more
prolific with the online use of credit cards. With the advancement of technology and the
advanced security features used by internet acquirers such as Paypal and Verisign identity
theft due to the use of credit cards online has decreased (“Privacy Policy”).
The zero percent (0%) liability provisions of the credit card issuers makes identity theft
more of a hassle to the consumer rather than a financial liability (“History of
Firsts”).
Many credit card companies suffer losses in turnover due to
fraud. More and more credit card companies have started concentrating on preventing credit
card fraud. Even though the credit cards have many security features, criminals have
managed to work around them. The security features of a Visa card, which is similar to the
security features of other major credit cards is shown below (“Visa Card Security
Features”).
“Skimmed”
cards, which is the term given to fraudulent cards which has data of another card recorded
in the magnetic strip is a common method of credit card fraud. The increased awareness of
merchants who accept credit cards have brought down the use of “skimmed” cards
drastically (“Skimming in the rain”).
Since the 1980’s credit cards have become an essential part of our living the American dream, but they are not without a negative effect. The credit card industry which is relatively young has steadily grown and been able to stimulate and positively influence today’s consumer culture. The increasing acceptance of credit cards by businesses around the world as well as the increasing popularity of ecommerce, credit cards are fast becoming the most popular means of payment for goods and services received. With the credit card moving from a status symbol, to a day to day necessity for most people which has brought in many conveniences to our lives, we can be pretty sure that the credit card is here to stay.
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