I think credit card reform is definitely going to pass which is (possibly) good news for millions of struggling Americans. However, as the New York Times points out, it may not be so good for people with good credit.

I’ll state up front that I am skeptical about the tone of the article, which has a bunch of hallmarks of a financial industry propaganda piece meant to dissuade people from supporting greater regulation. These types of articles have been appearing frequently, with the implicit message that the mega banks are powerless victims that will be forced — forced I tell you — to enact some undetermined rules that will punish Good People while completely cutting off borderline “worthy” borrowers if the government dares interfere with their practices.

That said, I think the predictions in the article are right on. In reality, it won’t be government regulation that causes the bulk massive credit contraction, an increasing of fees and less usage of credit cards by good borrowers, it will be a natural consequence of massive debt unleveraging that we are currently experiencing. People with good credit are going to pay much more in the future because the millions of people that were forced to pay 30% interest rates were just barely hanging on, and in many cases simply transferring the debt from one card to another. Now that things have changed and unemployment is rising so quickly, these high interest payers will instead default and saddle the companies with huge losses. These losses will cause the companies to raise interest rates on good borrowers, clamp down on credit for risky ones, cut back on rewards, and all the other aspects that the article implies will be the fault of new legislation. In essence, this “warning” from the banks seems like a way to justify future behavior and provide “evidence” for them to say “I told you so” in an attempt to get regulation repealed. Yves Smith at Naked Capitalism documents a similar piece seemingly every other week.

Still, the regulation will serve to accelerate these trends, and will therefore add more credit contraction pressure which will deepen the recession. It’s hard to tell whether the interest rate cap will actually help that many people in the short term: the biggest problem right now is unemployment, and without income the difference between 33% and 20% is marginal. In theory, it would help people over several years, especially when the economy starts growing again, but in reality most of the people with bad credit will just be cut off completely. Moreover, those people with good credit will stop using cards as much and cut down on revolving debt. The only group I can think of that will be helped a ton by the legislation will be those that have good credit but then have a major life event — like a health crisis or death in the family or small business failure — that they bounce back from. I wonder what percentage of people fall into that group.

So is the legislation a good or bad thing? Well I see it being at best a net neutral in the short term, and primarily will just accelerate existing trends. Therefore, it really depends on your outlook. If you believe that we are having a temporary credit crisis that will work itself out and we’ll resume growth shortly, then this front loading of credit contraction is a very bad thing that might stop that. If you believe as I (and nearly every person that I’ve read that predicted the crisis) do, as well as studies by the IMF, then the best course is to wipe the system clean of as much risky debt as possible upfront, and then start to rebuild on sounder footing. This bill would actually be very beneficial if the government decided to take the route of making all the banks write down their assets to real values, anticipating that it would cause millions of bankruptcies and temporary massive unemployment; followed by a quick expansion of new credit into new investment areas and low amounts of properly priced consumer credit that would be enough to help people supplement purchases but not so much that we’ll have our consumer-service economic monster again. In short, it hurts the existing paradigm but helps usher in a new one: something that is definitely not wanted by the status quo loving political and economic powers.

Update: Apparently the bill doesn’t include an interest rate limit. It seems to be more focused on curbing down on the unilateral fee and interest rate increases that the banks impose on prior balances. Now that is something I can get behind wholeheartedly. I’ve always thought it was ridiculous that they could arbitrarily change the rules on a contract.