Tuesday, April 19, 2011

Credit-Card Affinity Agreements and a Free Society

Probably Would Disapprove Credit Cards, Like Any Good Nanny

Over at Conglomerate, Eric Gerding, a respected Professor of Corporate Law, apparently disapproves agreements between universities and credit card companies creating so-called affinity cards, whereby universities help companies market such cards to students and alumni, in return for a portion of the earnings that such cards produce. Gerding plainly does not like such arrangements, and he urges readers to examine a database created by the Federal Reserve that reports on the terms of such deals, including what payments universities have received, how many cards have been issued pursuant to such arrangements, and the identity of the card issuer. (For instance, a search of the database will reveal that the Duke University Alumni Association received $1.375 million from Chase Bank, USA N.A., that there are over 8,000 cards issued pursuant to the Duke/Chase Affinity program, and that 4 such cards were issued last year.) Congress required the Fed to create the database in the so-called Credit Card Accountability, Responsibility and Disclosure Act of 2009, and the Fed in turn required companies with these programs to turn over such information, without providing the companies with compensation for the time and effort spent complying with this request.

Here is the substance of Professor Gerding's critique:

"These [affinity] agreements allow issuers to create 'affinity' cards, that is credit cards branded for a particular university (Go Heels!) and marketed towards the students and alumni of that university. It is a familiar business model: if you want to get students hooked on debt, start dealing at the playground. To get inside the schoolyard, cut the principal in on the action. Universities can earn over a million each year with these deals. Check out how much your alma mater has made from deals with credit card issuers at this nifty searchable database."

Unlike Professor Gerding, I see no problem with the existence of such affinity agreements. Moreover, in my view, the 2009 Act's requirement that the Fed and credit card companies spend real resources compiling (and presumably updating) such a database is a waste of society's scare resources at best and at worst an effort to distort the competitive process of credit card issuance.

Let me explain.

1) We live in a free society. In free societies adults may enter voluntary agreements, including agreements to obtain credit cards and borrow money. Indeed, individuals leave the state of nature and form civil society in part to empower the community to enforce such voluntary agreements, which make individuals' property more valuable and help them acquire more.

2) College students and alumni are adults. As such they are free to marry (or not) join the army, enter college or drop out, eat three meals a day (or not), exercise regularly (or not), etc. They are even free to obtain credit cards and borrow money, if they choose to use such cards in this way.

3) While credit cards empower their holders to borrow, they do not require them to do so. Instead, such cards reduce the cost of transacting, e.g., allow consumers to avoid carrying large sums of cash (which can otherwise earn interest in a bank account, for instance). There is no reason, a priori, to deprive college students of these benefits or, for that matter, the option to use a credit card to borrow.

4) There is no logical basis for concluding that such affinity agreements, which are simply creative methods of distribution, produce harm. The market for issuance for credit cards is relatively unconcentrated. The largest issuer (Chase) has a 19 percent share of the issuance market, the second largest (Bank of America) has a 16 percent share, the third largest (CITI) has a share of 12 percent, the fourth largest (Amex) has a share of 9 percent, and the fifth largest (Capital One) has a share of 6 percent. Issuers ranked between 6 and 14 have shares of between 6 percent and 1 percent. Thus, the so-called Herfindahl-Hirschman index --- the sum of the squared market shares of industry participants --- for this industry is less than 1,000. Counts and the antitrust enforcement agencies would consider the market unconcentrated and thus not susceptible to an exercise of market power, whether unilaterally or via lawful coordinated interaction. (See e.g. Department of Justice and Federal Trade Commission Joint Merger Guidelines here.) (Of course, express collusion between market participants would be a felony.)

5) No one forces students or alumni to sign up for affintity cards. If such cards provide onerous terms, then consumers can simply turn to providers of non-affinity cards that provide better terms. Moreover, non-standard agreements such as exclusive dealing contracts, tying contracts, and various other restraints that arise in unconcentrated markets are presumptively beneficial, given that the proponents of such agreements have expended real resources negotiating and enforcing them in an environment in which the acquisition or maintenance of market power is not plausible. There is no reason to apply a different presumption to so-called "affinity agreements." While such agreements give the issuer that is a party to them the chance to convince a consumer to sign up for the affinity card, such consumers have numerous credit card options and may even choose payment vehicles other than credit cards. Duke, for instance, has 140,000 alumni. Fewer than 9,000 have a Duke affinity card, and some of those who do presumably have other cards as well.

6) Given the absence of any plausible theory of harm (the concentration statistics listed above are public), the statutory requirement to create a database results in a waste of resources. Moreover, the requirement imposes costs on those firms that employ such (presumptively efficient) agreements, thereby disadvantaging those firms simply because they have employed a successful marketing device. Cynics might guess that Congress imposed this requirement at the behest of credit card issuers that do NOT employ such arrangements, who are seeking to raise the costs of their rivals by forcing them to comply with onerous regulatory requirements.

7) To be sure, the cost of compliance with this particular regulation is modest. The American credit card industry will survive. Still, the rationale for the requirement and the purported concern for the welfare of (adult) college students and college alumni on which it rests reflect Nanny-like paternalism that is inconsistent with the precepts of a free society. Moreover, even if no single regulation can, by itself, hamper a business numerous regulations taken together can do so, just as numerous Lilliputian ropes held down Gulliver.