Federal Reserve Bank of Philadelphia
Research Department
Why Credit Cards Played a Surprisingly Big Role in the Great Recession
2021 Q2
7
T
welve years after the Great Reces-
sion, one of the biggest economic
disasters of the modern era, econ-
omists still debate exactly what led to its
persistent declines in employment and
output. The basic narrative is clear: The
collapse of the housing price bubble
destroyed swaths of wealth, and the
ensuing credit crunch within the nancial
system tightened borrowing constraints
on rms and households, depressing
consumption and investment across the
Why Credit Cards Played
a Surprisingly Big Role in
the Great Recession
By Lukasz Drozd
Economic Advisor and Economist
.
The views expressed in this article are not
necessarily those of the Federal Reserve.
When economists and policymakers try to understand how a credit
crunch within the financial sector aects consumers, they usually
don’t think of the credit card market. They should.
economy. But this basic narrative raises
further questions. Which was more
important, the destruction of wealth or
the tightening of borrowing constraints?
How much of the decline in output was
directly caused by these initial shocks, and
how much by the subsequent, domino-
like propagation mechanisms? What were
these propagation mechanisms? Finally,
what does the Great Recession teach us
about the macroprudential regulation of
credit markets?
Photo: ideabug/iStock
8
Federal Reserve Bank of Philadelphia
Research Department
Why Credit Cards Played a Surprisingly Big Role in the Great Recession
2021 Q2
laws for the credit card industry altogether.
Recognizing an opportunity for additional
tax revenue, South Dakota and Delaware
were the rst states to raise their usury
laws’ ceilings on interest rates. Credit card
issuers did not wait long to relocate their
operations to these lender-friendly states,
and to this day their major oces can
be found in Wilmington, DE (for exam-
ple, JPMorgan Chase), or Sioux Falls, SD
(for example, Citibank). To retain their
nancial institutions, other states began
loosening their usury laws as well, and
today many states have no limit on credit
card interest rates.
Following the Marquette decision, credit
card borrowing steadily rose, notably
crowding out nonrevolving consumer
credit and gradually turning America
into a credit card debtor nation (Figure ).
What fueled this expansion—especially in
the s—was the steady spread of credit
card lending among lower-income and
riskier households. Credit card debt
per household relative to the annual me-
dian household income roughly doubled
every decade until the nancial crisis,
topping percent for a household with
The Rise of Credit Card Debt
Until the s, credit cards were a form
of store credit, limited to purchases of
goods and services from a single issuing
merchant and too inconvenient to become
a major source of credit for households.
It was the success of the rst general-
purpose charge card, issued by Diners
Club in the early s, that inspired Bank
of America to combine a credit line with
a charge card and oer BankAmericard,
the rst general-purpose credit card.
By the s, more than million such
cards were in circulation. Bank of America
began licensing its BankAmericard to
other banks that were issuing credit cards,
eventually spinning o BankAmericard as
a separate company called Visa.
But the revolution in payment technol-
oy did not spur a revolution in lending
right away. In the s and s, credit
cards were mainly used as a payment
instrument, and borrowing on credit cards
did not take o until the s. What
delayed the growth of credit card lending
was the combination of high ination and
usury laws that capped interest rates.
With a tight cap on interest rates, and with
ination driving up the cost of funds for
lenders, credit card lending struggled
to make a prot in the s. In fact, by
the end of the decade, due to a double-
digit spike in ination, many credit card
lenders found themselves on the brink
of collapse.
The credit card industry was saved
in , when the U.S. Supreme Court, in
Marquette National Bank of Minneapolis v.
First of Omaha Service Corporation, ruled
that if the interest rate cap in the state
where the bank is chartered is higher
than in the state where it oers its product
(in this case, a credit card), that bank may
charge a rate subject to the higher cap.
In other words, the court allowed a bank
to “export” its interest rate cap to other
states, which in the case of First of Omaha
meant that the company could issue
a credit card in Minnesota and charge an
interest rate in excess of Minnesota’s com-
paratively low cap of percent.
The broader implication of the Su-
preme Court ruling, however, was that, by
creating competition between states to
attract bank headquarters, it not only
relaxed usury laws for lucky issuers—such
as First of Omaha—but dismantled usury
Economists are still answering these
questions, but one of their key insights is
that severed access to credit played a big
role.
This insight has spurred renewed
interest in mapping the exact mechanisms
that drove the tightening of credit to
rms and households across dierent
markets, and in these mechanisms’ macro-
prudential ramications.
When economists and policymakers try
to understand how a credit crunch within
the nancial sector aects consumers,
they usually don’t think of the credit card
market. Historically, credit card borrowing
has been small, and credit card debt
involves a soft long-term commitment of
lenders to terms—an arrangement known
to be more stable and less prone to credit
supply disruptions than other forms
of debt—so it’s not obvious how, to the
detriment of borrowers, tightening of
credit conditions within the nancial
system could severely contract available
credit, force early debt repayments, or
unexpectedly hike interest payments on
outstanding credit card debt.
But, as I will explain, by the credit
card market had grown enough to have
a notable impact on aggregate consump-
tion demand. More importantly, by
a large fraction of credit card debt was
de facto short-term debt. In particular, by
many credit card borrowers were
reducing their interest rate payments by
moving balances from card to card to take
advantage of the then-ubiquitous zero-
promotional credit card oerings.
After Lehman Brothers collapsed in mid-
, triggering a credit crunch within
the nancial sector, the zero- oers
that had sustained the low cost of credit
card debt vanished from the market, lead-
ing to a massive and, for many borrowers,
unexpected interest rate hike on expiring
promotional debt. As I will argue, this led
such borrowers to cut their consumption
so they could repay debt early, which
contributed to the decline in consumption
demand during the Great Recession.
Policymakers should keep an eye on
promotional lending, and perhaps even
reserve a permanent spot for credit cards
in their macroprudential policy consider-
ations. The - crisis reminds us that
credit card borrowing remains fragile.
0%
5%
10%
15%
20%
25%
1984 1990 1995 2000 2007
Sources: Board of Governors of the Federal Reserve
System U.S., G. Consumer Credit, Total Revolving
Credit Owned and Securitized, Outstanding [],
retrieved from , Federal Reserve Bank of St. Louis;
https://fred.stlouisfed.org/series/REVOLSL, September
, . U.S. and Census Bureau, Current Population
Survey, March and Annual Social and Economic
Supplements, and earlier.
FIGURE 1
Credit Card Borrowing Rose to
Prominence in the 1990s…
Credit card debt per family as a percentage
of median annual family income, 1984–2007
Federal Reserve Bank of Philadelphia
Research Department
Why Credit Cards Played a Surprisingly Big Role in the Great Recession
2021 Q2
9
the progress in credit scoring technoloy.
The overhaul of the
U.S. personal bankruptcy regulations in the Bankruptcy Reform
Act of , which made discharging credit debt in court far easier,
and the overall increasing demand for debt by U.S. house-
holds were two other factors that contributed to the growth of
borrowing on credit cards on the demand side.
By the s, credit card companies were making more money
from credit card lending than from merchant or interchange
fees. (Merchant or interchange fees are the fees paid by merchants
on each transaction settled using a credit card.) By , of
billion in the credit card industry’s total revenues, interest reve-
nue (that is, revenue earned from nance charges) amounted to
billion, with lending-related penalty fees and cash advance fees
contributing another . billion. In comparison, merchant
fees contributed just billion to revenue. Even after subtracting
billion in costs and default losses, lending, though a more
costly part of the business, still came out on top in . These
numbers did not change dramatically until , and lending
maintained its prominent role.
At that point, with its trillion
in debt outstanding, credit card lending had grown big enough
to aect the entire economy.
at least one card by early .
Since much income growth over
the last several decades has occurred among the top percent
of earners, and these earners do not borrow on credit cards as
much, the median rather than the mean household income
provides a better picture of how important credit card lending
had become for the majority of households.
For low-income
households, credit cards often replaced far more expensive
options, such as “loan sharks” or payday lenders, and so the
growing availability of credit card debt has importantly contri-
buted to the “democratization of credit” in the U.S. (Figure ).
Although the Supreme Court ruling enabled the industry to
grow, it was, according to economic research, the convenience
of credit card debt and the rapid progress in information tech-
noloy that drove the unprecedented, decades-long expansion
in credit card borrowing. Information technoloy aected both
the direct costs of lending and indirect costs associated with
debt collection—a less visible but equally important pillar
that sustains unsecured lending.
By reducing lending costs that
creditors must cover to break even, technoloy increased the
aordability of credit card debt, fueled borrowing, and even
had a somewhat counterintuitive eect of increasing default risk
on a statistical dollar of outstanding credit card debt despite all
2007
2007
2007
2007
2007
2004
2002
1998
1995
1992
1989
1989 1989
1989 1989
First income quintile
Second income quintile Third income quintile
Fourth
income
quintile
Fifth
income
quintile
Shades indicate isolines of (fixed)
levels of credit card debt per family
Share of families with at least one card
Card debt per cardholding family 1989=100
27% 35%
500
400
300
200
100
0
45% 55% 65% 75% 85% 95% 100%
FIGURE 2
...and Contributed to the Democratization of Credit in the U.S.
Growth of credit card borrowing by income quintile, 1989–2007
Source: Board of Governors of the Federal Reserve System, Survey of Consumer Finances ().
10
Federal Reserve Bank of Philadelphia
Research Department
Why Credit Cards Played a Surprisingly Big Role in the Great Recession
2021 Q2
The Origins of “Zero”
As the credit card market became saturated in the late s
and early s, competition for customers intensied.
Balance transfers and promotional-rate oers proliferated
as the leading marketing tools.
The Marquette ruling, by
unifying regulations, set the stage for massive, nationwide
mail-marketing campaigns and permitted lenders to realize
economies of scale in marketing and processing. By the
end of the s, an ever-increasing volume of mail-in oers
dened the credit card industry, and does so to this day.
In the mid-s, Providian Financial Corporation
became the rst issuer to drop a seemingly unprotable
oer into people’s mail: a credit card with a zero on
balance transfers. This oer allowed consumers to transfer
their outstanding balance from any other credit card
account into their new Providian account (just like any
other balance-transfer oer) and pay no interest for an
introductory period. The bank could prot later only if
consumers for some reason did not repay debt after the
promotional rate expired, or if they violated the “ne
print” of the contract, triggering a penalty rate reset.
At the time, Providian had a highly protable credit
card business and was on the forefront of the industry’s
expansion to low-income customers.
The new market
looked promising but risky: Lower-income customers had
lower balances and were more likely to default, making it
dicult for credit card companies to cover the xed costs
of opening and operating their accounts. Such conditions
normally necessitate higher interest rates, but high interest
rates may also discourage borrowing, leaving lenders
exposed to default losses and bringing too little interest
income on borrowing to make a prot.
Litigation against Providian in the late s, which led
to the credit card industry’s largest Oce of the Comp-
troller of the Currency () enforcement action, oers
a unique glimpse into how the company approached the
marketing of credit cards and what led it to oer zero
. This evidence suggests that behavioral psycholoy
rather than competition was the key factor behind the
invention of “zero.”
For example, in one of internal memos to Providian’s
top executives that became public in the course of litigation,
Andrew Karr—the founder of Providian, its , and later
a strategic adviser to the company—described in this way
how the company planned to prot on subprime custo-
mers: “Making people pay for access to credit is a lucrative
business wherever it is practiced…. Is any bit of food too
small to grab when you’re starving and when there is no-
thing else in sight? The trick is charging a lot, repeatedly,
for small doses of incremental credit.”
The memo con-
rmed that the company was indeed concerned that raising
interest rates to compensate for higher lending costs might
backre, and it explained why its marketing stratey was
aimed at mitigating this issue by obscuring the true cost of
debt from borrowers—as the litigation showed.
Karr later echoed the content of this memo in a rare
interview by explaining that he suggested zero promotional
rates to Providian executives because seeing “zero” leads
borrowers to “believe what they want to believe,” which
one can infer he saw as being conducive to increased bor-
rowing by consumers even if competition ensues.
Providian paid a hefty price for its aggressive practices
in the early s, but the litigation was about the com-
pany’s deceptive practices, not the products themselves,
and zero lived on to become the hallmark of the credit
card industry in the s.
Providian’s approach may not
be representative of the industry as a whole, but recent
research shows that behavioral psycholoy provides a good
explanation for the widespread use of zero .
The Behavioral Economics of Zero APR
Zero- oers challenge standard economic theory
featuring rational consumers. When Boston Fed economist
Michal Kowalik and I studied a standard model of credit
card lending in which lenders can oer any introductory
promotional rate to (rational) borrowers, we found that,
under standard economic theory, rates should fully price
in the risk of default and the cost of funds, resulting in at
interest schedules and few introductory promotions.
Although the model can generate introductory promotion-
al oers when the default risk of a borrower is expected
to decline sharply, such occurrences are rare, and under
plausible conditions the model does not even come
close to accounting for the large volume of such oers
in the data.
The key reason is that rational consumers are best
served by prices that closely reect the true resource cost
of lending them money—which, among other items, in-
cludes the compensation to the lender for bearing the risk
that the borrower may default under some circumstances
(default risk premium).
In particular, when the price of
credit is too low for a period of time, as is the case with
a promotional introductory oer, credit card customers
borrow too much: The benet that accrues to them exceeds
the cost implied for the lender by the fact that the customer
may default on this amount later on. Rational borrowers
realize that this cost must eventually be passed onto them
because lenders must break even, and for this reason they
prefer at schedules. The key virtue of a competitive market
is that competition between lenders drives down prices to
a common break-even point, which implies that, to attract
customers, lenders must oer the product that best suits
the customer.
So why do we keep nding zero- oers in our mail-
boxes? Research in behavioral economics may have the
answer. This research suggests that zero may indeed
let people “believe what they want to believe.”
The best-known piece of evidence supporting this theory
comes from an inuential albeit unpublished study by
University of Maryland economists Lawrence M. Ausubel
and Haiyan Shui. In collaboration with a major credit
card issuer, Ausubel and Shui performed a unique study
of credit card marketing that involved an experiment of
Federal Reserve Bank of Philadelphia
Research Department
Why Credit Cards Played a Surprisingly Big Role in the Great Recession
2021 Q2
11
simultaneously mailing several dierent oers to tease out
customer bias for promotional introductory oers. In
cooperation with the issuer, the researchers tracked the
activity on the accounts after the oers were accepted.
To assess the customer’s choice, they also calculated the
interest rate payments the customer would have faced
had they chosen a dierent oer.
Surprisingly, customers on average chose what the
rational model would deem a “wrong” oer. More
importantly, they were not simply accepting oers at ran-
dom, possibly ignoring the oered terms; to the contrary,
customers were attracted to oers that minimized their
immediate interest payments, even if choosing such oers
cost them more later. Ausubel and Shui concluded that
consumers fail to accurately predict their future behavior,
which leads them to erroneously think that they are pick-
ing the best oer.
In particular, Ausubel and Shui have demonstrated that
the results of their experiment are consistent with naiveté
hyperbolic discounting—the leading theory of consumer
myopia put forth by Harvard economist David Laibson and
earlier shown successful in addressing several puzzling
observations in consumer credit markets. According to this
theory, borrowers have an idealistic view of their future
self, incorrectly believing that their future self will have
almost no debt and pay no interest. This idealistic view
leads them to underestimate the burden of the interest-
rate hike associated with the expiration of an introductory
oer. As a result, they prefer introductory oers and under-
estimate the signicance of these oers’ high reset rates.
Ausubel and Shui also found that this theory ts the
data well for parameter values consistent with earlier work
with this model. By assuming the same parameter values,
Michal Kowalik and I showed that this theory can explain
the widespread use of zero in the U.S. credit card
market, where competitive lenders are free to design the
credit card oers they send to consumers.
Of course, the fact that the leading theory of consumer
myopia may explain the U.S. credit card market doesn’t
imply that the entire population is prone to zero- oers.
It may be that credit card customers who did not accept
a zero- oer in the Ausubel and Shui study are the ratio-
nal ones and only the overoptimistic found promotional
oers particularly attractive, leading to selection bias among
study respondents. Their nding only shows that there are
enough customers prone to these oers to drive promo-
tional lending.
The Makings of a Perfect Storm
Before my work with Kowalik, surprisingly little was known
about the prevalence of promotional oerings in the U.S.
credit card market and their eect on the functioning of
the market. Data provided by the three credit bureaus lack
interest rates, and their data are the most comprehensive
commercially available source of information about credit
market activity in the U.S. Without interest rate data, we
can’t study promotional activity as carefully as we would
like, and consequently we did not know much about it.
In our work, for the rst time, we could uncover evidence
of the widespread and intricate use of promotional lending
owing to the availability of regulatory account-level
data covering the majority of the general-purpose credit
card accounts in the U.S. right before the nancial
crisis—a data set large and detailed enough to character-
ize promotional lending in the economy as a whole.
Although we suspected some use of introductory oers to
reduce interest rate payments, what we found surpassed
our expectations.
By , the credit card market was essentially in the
grips of zero- oers, with a vast amount of credit card
debt being de facto short-term debt and prone to disrup-
tions during crises. In particular, as of the rst quarter
of , we found that percent of credit card debt held
on general-purpose credit card accounts was on pro-
motional terms with rates close to zero, with an average
yearlong expiration of the promotional terms. Among
prime borrowers with a good credit history (that is, a credit
score above ), the percentage was even higher:
percent. When we factored in a typical fee of percent for
transferring funds at the time, and a rate on the pro-
motional debt near zero, promotional accounts provided
an average discount of about percentage points from the
average reset rate on those accounts—and a similar discount
vis-à-vis the average interest rate paid on nonpromotional
credit card debt. This was true for both the prime segment
and the whole market, which shows that promotional debt
importantly contributed to making credit card debt
aordable to borrowers.
Crucially, balances that fed promotional accounts before
the crisis were mainly transfers of debt from other accounts—
as opposed to debt accrued from purchases using the new
card.
This nding implies that consumers were not only
using promotion on a massive scale but also moving
funds to reduce the interest rate paid on their credit card
debt, something we corroborated by showing that some
borrowers were chaining promotional cards to extend the
duration of promotional rates. As for the market as a whole,
this observation is key, since it implies that at the onset
of the Great Recession the aordability of credit card debt
hinged on an uninterrupted ow of promotional oers.
Three percent on zero may not sound like enough
for lenders to be able to break even, but lenders too could
prot on the promotional oers, since they attract borrow-
ers who later may have to pay the reset rate on the account
when they are unable to switch to a new card or when their
rate resets early because they violated the contract’s “ne
print.” Basic economic theory implies that lenders put up
with this behavior precisely because they could break even
and borrowers preferred such oers.
As explained earlier,
a competitive market leads to the outcome that best suits
the borrowers, and the evidence suggests that promotional
oers suited them best.
12
Federal Reserve Bank of Philadelphia
Research Department
Why Credit Cards Played a Surprisingly Big Role in the Great Recession
2021 Q2
county relative to other counties. This we did see, indicating
that the nancial sector’s credit crunch was in part responsible
for the declining share of promotional balances.
Of course, other factors may have also contributed to the
decline in the availability of promotional credit card oers, and
our research design does not allow us to quantitatively assess
the relative importance of those factors. The most straightfor-
ward reason is that lenders might have discontinued promotional
oers because they themselves feared a recession-related spike
in defaults on credit card debt due to falling incomes and employ-
ment. Credit card debt is unsecured, which is one reason why
default rates spike during recessions. By reducing credit during
a recession, banks can avoid losses from rising defaults.
Connecting the Dots
The second half of was a turning point for credit card
borrowing overall.
Credit card debt, despite rising steadily for
decades, fell markedly relative to median household income and
other types of consumer debt (Figure ). In our work, Kowalik
and I have hypothesized that the decline in credit card borrow-
ing relative to the previous trend was driven by the collapse of
promotional oerings, which then led credit card customers to
either default on debt more frequently or make early debt repay-
ments, contributing to the decline of aggregate demand during
the Great Recession.
It’s dicult to assess exactly
how much the collapse in pro-
motional oerings contributed
to the decline in credit card
The Perfect Storm
The September collapse of Lehman Brothers, by triggering
a panic within the nancial sector, set the stage for a perfect storm
in the credit card market. Starved for liquidity, and expecting a
recession that would harm consumers, the nancial sector tight-
ened the supply of credit to rms and households, whereupon
many credit card borrowers suered because of their heavy
reliance on the constant ow of promotional oers to reduce
interest payments.
The data show that preapproved and prescreened promotional
balance-transfer oers had fallen more than percent by mid-
(Figure ), suggesting that many credit card borrowers who
had previously hoped to transfer balances onto a promotional
account might have had trouble getting a new card during the
crisis.
Consistent with the decline in mail-in oers, promotional
balance transfers dived, falling percent by early (Figure
). Not surprisingly, the fraction of promotional debt began to
decline, bottoming out in at about half of its precrisis value
of percent. This was true for all accounts in our sample as well
as just those with a good credit history (Figure ).
Kowalik and I further investigated to what extent the deterior-
ating nancial health of the lenders might have driven the decline,
which is a proxy for the impact of the crisis on each individual
lender’s nancing conditions. We analyzed how the county-level
credit card lender health index, which we constructed, correlates
with the decline in the share of promotional debt and balance
transfers in each county. If a credit card issuer has a large
presence in a U.S. county, and if its nancial health worsens
more than that of creditors in other counties, we should see
a larger decline in balance transfers and promotional debt in that
FIGURE 3
Recession Brought an End to the
Abundance of Zero-APR Oerings…
Number of mail-in preapproved credit card solicitations
with a promo balance transfer oer, in millions,
2007–2013
FIGURE 4
…Promotional Balance Transfers
Collapsed…
Promotional balance transfers as a percentage of
credit card debt outstanding, annualized, 2008–2013
FIGURE 5
…and the Share of Promotional
Card Debt Began to Shrink…
Promotional credit card debt as a percentage of credit
card debt outstanding, all accounts and accounts
with at least a 670 credit score, 2008–2013
Source: Federal
Reserve, .
Source: Mintel Compremedia
Inc., Direct Mail Monitor Data.
Source: Federal
Reserve, .
0
2,000
4,000
6,000
8,000
10,000
12,000
Jan
2008
Jun
2009
Oct
2013
Jan
2008
Jun
2009
Oct
2013
0%
10%
20%
30%
40%
50%
Jan
2008
Oct
2013
0%
10%
20%
30%
40%
50%
Credit score
670+
All accounts
Jun
2009
See How Chaining of Zero-
APR Oers May Amplify
a Recession.
Notes: The sample
includes six largest banks,
eight banks in total; gray bar
indicates recession.
Note: Gray bar
indicates recession.
Notes: The sample
includes six largest banks,
eight banks in total; gray bar
indicates recession.
Federal Reserve Bank of Philadelphia
Research Department
Why Credit Cards Played a Surprisingly Big Role in the Great Recession
2021 Q2
13
FIGURE 6
... which Turned the Decades-Long
Borrowing Boom into a Bust
Actual and model-predicted credit card debt per
adult as percentage of median personal income,
2001–2014
FIGURE 7
The COVID-19 Recession Had
a Similar Eect on Balance
Transfers…
Promotional balance transfers as a percentage of
credit card debt, annualized, 2018–2020
FIGURE 8
... and the Share of Promotional
Debt Also Began to Shrink
Promotional credit card debt as a percentage of credit
card debt outstanding, all accounts and accounts
with at least a 670 credit score, 2018–2020
Sources: Board of Governors of the Federal Reserve System, G. Consumer Credit, Total
Revolving Credit Owned and Securitized, Outstanding [], , Federal Reserve Bank
of St. Louis; https://fred.stlouisfed.org/series/REVOLSL. U.S. and Census Bureau, Current
Population Survey, March and Annual Social and Economic Supplements, and earlier.
Source: Federal Reserve System, .
Notes: The data in Figure pertain to a smaller sam-
ple of eight banks and are not directly comparable to
data in the figure; gray bar indicates recession.
Source: Federal Reserve System, .
Note: Gray bar indicates recession.
2001 2008 2014
15%
17%
19%
18%
16%
21%
23%
24%
22%
20%
25%
Data
Model Prediction:
Recession and
Zero-APR crisis
Model Prediction:
Just recession
to the same ratio in the data. This ratio
is an imperfect proxy for consumption-
depressing factors other than declining
income, which may be a product of
the recession itself and not a trigger. We
estimated that, according to our model,
peak-to-trough, the decline in the availa-
bility of promotional oerings contributed
to about a quarter of the decline in this
ratio from through .
The COVID19 Crisis:
A Silent Alarm?
Fast-forward to and both balance-
transfer activity and zero- oers have
not rebounded to their respective
levels (Figure ), which has made the
credit card market more stable. We do not
know why the decline has persisted for
so long after the recession, but the most
prosaic explanation may be the right one:
Having had a bad experience with zero
, borrowers avoided such oers after
the Great Recession. Nonetheless, promo-
tional activity and balance transfers did
not disappear and may rise again in the
future, which raises the question: How
has promotional credit card lending fared
during the more recent - crisis?
borrowing or consumption demand. In
the data, both the collapse in oerings
and the decline in borrowing or con-
sumption involve changes that triggered
the recession and changes that were the
product of the recession. For example,
such a decline may have been partly due
to a hike in defaults on credit card debt
triggered by job losses during the Great
Recession, which was part of a feedback
mechanism rather than the trigger.
To isolate the contribution of the with-
drawal of promotional oers, Kowalik and
I used an economic model of the credit
market that replicates what happened
during the Great Recession. Using the
model, we asked, what would have hap-
pened had fairly priced promotions held
steady during the recession?
The results we found were troubling.
According to the model, there would have
been no decline from the precrisis trend
in the ratio of median personal income
to credit card debt per adult. Indeed, the
ratio would have gone up (Figure ).
But was the collapse in promotional
oerings enough to aect consumption
demand across the economy? To nd out,
we also compared the model’s ratio of ag-
gregate consumption to disposable income
Note: Model predictions
are approximate due to
minor dierences in data
formatting and sources.
For detailed analysis, see
my work with Kowalik
().
Feb
2018
Oct
2020
Feb
2020
0%
10%
20%
30%
40%
50%
Feb
2018
Oct
2020
Feb
2020
0%
10%
20%
30%
40%
50%
All
accounts
Credit
score
670+
14
Federal Reserve Bank of Philadelphia
Research Department
Why Credit Cards Played a Surprisingly Big Role in the Great Recession
2021 Q2
How Chaining of Zero-APR Oers May Amplify a Recession
Here is how credit card borrowers chain
promotional zero- oers: First, they
charge purchases on their zero- credit
card. Then, before the card’s new, higher
base rate kicks in, they apply for another
zero- card and transfer the debt to the
new card. In eect, they are extending
the duration of the promotional interest rate.
For economists, there is nothing unusual
about “chaining” of promotional credit card
oers. It’s just another instance of borrowing
via rolling over short-term debt obligations—
a widespread practice across the economy.
However, this type of borrowing is known
to be vulnerable to disruptions of the credit
supply and may trigger or contribute to
a recession, which is why it is monitored
and regulated as part of macroprudential
policies. (See Endnote for an explanation
of macroprudential regulation.)
Here is how it happens. Consider a situation
where a borrower takes out a long-term
loan and borrows for two periods from Bank
A using two dierent strategies. In the first
situation (Case I), debt does not become due
until Period , and Bank A cannot request
funds early. In the second situation (Case II),
the borrower “chains” lenders by repaying
Bank A with funds borrowed from Bank B
in Period . Both cases lead to the same
outcome when credit flow is uninterrupted:
The borrowers borrow in the first period
and repay in the third, eectively borrowing
funds for a duration of two periods. But the
second case (Case II) is vulnerable to a credit
supply disruption and the first is not. Say, for
example, that in Period , banks decide not
to lend as much, so that the borrower in Case
II has a hard time finding another lender
(Figure ). This borrower will be forced to
repay debt early and cut down on their
spending on purchases of goods and ser-
vices. Alternatively, the borrower, unable
to make the payment, will default on their
debt, in which case Bank A will be hurt and
will possibly reduce the credit supply to
other customers, which will hurt their con-
sumption (or investment). In both situations,
if banks, amid a recession, withdraw funds
from the market to reduce their losses, they
may amplify that recession due to reduced
consumption or investment demand.
Case I
Long-term
Lending
Case II
Chain
Lending
Case I
Long-term
Lending
Case II
Chain
Lending
Bank B loans to
Borrower for one
period, which
Borrower uses to
repay Bank A
and Borrower
spends on goods
and services
But What Might Happen If the Credit Supply Is Disrupted in Period 2?
Borrower repays
Bank A in Period 3
$
$
$
PERIOD 1 PERIOD 2 PERIOD 3
Borrower repays
Bank B in Period 3
$
Option 1
Reduce spending on goods and services to
repay Bank A’s loan early
Because the Borrower does not need a loan
in Period 2, the outcome is the same.
Bank A loans to Borrower
for two periods to spend
on goods and services
$
Bank A
Bank A loans to Borrower
for one period to spend
on goods and services
$
Bank A
Bank A loans to Borrower
for one period to spend
on goods and services
$
Bank A
$
$
$
$
If Bank B rejects the loan application, Borrower has
two options that will both be recessionary:
Option 2
Default on loan repayment, forcing Bank A to
reduce loans to other borrowers and hurting
creditworthiness in the economy
Borrower
spends on
goods and
services
FIGURE 9
Chain Lending and How It Might Amplify a Recession
Federal Reserve Bank of Philadelphia
Research Department
Why Credit Cards Played a Surprisingly Big Role in the Great Recession
2021 Q2
15
The answer to this question is important because it
helps us address another question: How vulnerable is
promotional lending during a recession not triggered
by a nancial crisis?
Credit markets fared well during the crisis, but as
for promotional credit cards, the data from the
rst half of are troubling because it suggests that
promotional oerings might have been similarly
depressed, and the overall impact of this development
was lower because the starting volume was lower.
In particular, the data for the rst half of show
a modest percentage point decline in the share
of promotional debt, which fell from about percent
prior to the Great Recession to about by October
(Figure ). Worryingly, the decline in promo-
tional balance transfers is almost as striking as during
the Great Recession, falling by over percent peak
to trough, albeit from a volume that is less than a third
of that at the onset of the Great Recession (Figure ).
As more data become available, we will be able
to examine this crisis more closely, but the early
indication is that promotional credit card borrowing
is vulnerable during recessions that do not involve
a nancial crisis.
Conclusion
The nancial crisis taught us that the prolifer-
ation of zero on balance transfers can threaten
economic stability. The - crisis reminds
us that a signicant fraction of debt still originates as
promotional transfers, and nothing prevents that
fraction from rising again. At the very least, then, the
volume of zero- debt and balance transfers should
be carefully monitored. The credit card market is
now large enough to aect the whole economy, and
policymakers should keep it in mind when they craft
their regulatory agendas.
Laissez faire theory holds that, if both sides of
a market transaction decide to use a particular credit
instrument, this credit instrument is likely socially
benecial, and the government shouldn’t regulate it.
But the research points to the role of awed human
psycholoy in the rise of zero- oers, and this
should raise concerns about the application of the
laissez faire principle. What’s also worrisome is that
the way lenders break even falls outside of the con-
tract. For example, consumers may get hit with the
reset rate when they cannot nd another oer, or
when they violate the contract’s “ne print,” thus
exposing themselves to an imminent and unexpected
rate hike on debt. The contract doesn’t specify how
much they will pay for borrowing—a departure from
how most loan contracts are written. Such an arrange-
ment is conducive to abuse and predatory practices.
Notes
1 Macroprudential regulation of credit markets is
an approach to regulation guided by the principle
of mitigating risks to the financial system
and the economy as a whole. Stress testing
of banks to ensure their resilience in times of
distress is an example of macroprudential
regulation implemented in the aftermath of the
Great Recession by the Dodd–Frank Wall Street
Reform and Consumer Protection Act of .
2 For an accessible discussion, see the Econo-
mic Insights article by my colleague Ronel Elul.
See also the work by Gilchrist, Siemer, and
Zakrajsek; Mondragon; and Aladangady. The
study by Mian and Sufi initially suggested
a modest role for credit markets.
3 The annual percentage rate () refers to
the annual rate of interest charged to borrow-
ers for carried-over balances after the credit
card statement closes. In a zero- oer, the
credit card holder pays no interest on charges
to their credit card for an introductory period.
Thereafter, a new kicks in for the outstand-
ing balance and all future charges.
4 Usury laws govern the maximum amount of
interest that can be charged on a loan.
5 High levels of fraud and defaults also con-
tributed to low profits during this early period.
See Evans and Schmalensee (page ) for
more details.
6 According to the court's unanimous opinion,
the National Bank Act of created a path
toward a national consumer lending economy.
7 See Livshits, MacGee, and Tertilt; Drozd and
Serrano-Padial; and Athreya, Tam, and Young
for detailed analyses of the growth of credit
card borrowing in the U.S. Jaromir Nosal and
I provide an analysis of how a decline in the
fixed cost of lending leads to an expansion in
access to lending.
8 According to data from the Survey of Con-
sumer Finances (), the mean credit card
debt per household whose income is close to
the median (that is, between the th and
th percentiles of income) has been almost
identical to the overall mean credit card debt
per household between and . This is
not true for income. In the same data source,
income per household close to the mean was
lower by percent in and by percent
16
Federal Reserve Bank of Philadelphia
Research Department
Why Credit Cards Played a Surprisingly Big Role in the Great Recession
2021 Q2
19 Consider a situation in which a borrower is encouraged to draw an
additional dollar of debt because of a low promotional interest rate. Sup-
pose this borrower will default on this additional dollar of debt when they
lose their job. In a competitive market, the borrower must compensate
the lender by paying more interest in the future for the additional risk of
default because the lender must break even on average. In the model, the
additional benefit from the dollar when the borrower becomes unem-
ployed outweighs the cost of paying more interest when the borrower
keeps their job—an eect that makes introductory oers suboptimal for
rational borrowers.
20 The evidence that Ausubel and Shui found has been confirmed in
other studies, which point to similar biases in investing and saving
behavior. For example, in a closely related study, Agarwal et al. show
that credit card customers prefer low-annual-fee cards, even though
they end up later overpaying in interest in excess of the fee.
21 Promotional lending can be studied using proprietary account-level
data, but such data are typically not available at a scale that allows
researchers to see how borrowers transfer balances across accounts
and lenders. Prior to the Dodd–Frank Act, the was the only institution
we knew of that possessed an account-level data set covering a large
fraction of U.S. credit card accounts. The Federal Reserve System later
acquired this data set for its stress testing. The numbers reported in this
article come from this merged data set.
22 These data are collected by the Federal Reserve System under
Dodd–Frank to help the Fed conduct stress testing of banks. The data are
available for economic research conducted within the Federal Reserve
System, providing new insights into the inner workings of credit markets.
23 See figures in my work with Kowalik.
24 Our data does not allow us to calculate lender costs on the account
level, and it is not possible to precisely assess profitability of zero-
accounts. Initially, lenders do lose money on zero- accounts in the
data, but over time we did not find any indication that these accounts
are less profitable than comparable accounts.
25 Prescreened oers mailed out by credit card issuers are the main tool
of customer acquisition in the credit card market, so the number of mailed-
out solicitations is a reliable measure of the credit card industry’s hunger
for new customers. Evans and Schmalensee report that in the early s
about percent of credit accounts were initiated via prescreened oers.
26 Using a dierent approach, Keys, Tobacman, and Wang reach a similar
conclusion.
27 Credit card borrowing takes place when a credit card holder does
not pay back the balance in full after the credit card statement closes
and “rolls over” the outstanding balance to the next billing cycle
(partly or fully).
28 Consumption demand was an important factor in the Great Recession.
Mian and Sufi have shown that the decline in consumption was key to
explaining the fall in aggregate demand.
in the s. This shows that income is more concentrated at the top of
the income distribution than debt, and hence the burden of debt for the
majority of households is best captured by using median income instead
of mean income. For more details on the income growth among top earn-
ers, see the Economic Insights article by my colleague Makoto Nakajima.
9 See my work with Ricardo Serrano-Padial for more details on the con-
nection between debt collection and credit card lending.
10 See my work with Ricardo Serrano-Padial. “Default risk” measures
the fraction of debt that lenders expect will not be paid back because
some credit card borrowers may default, and debt may be deemed
nonrecoverable. Because credit card debt is unsecured, and debt can
be discharged in court, default risk is substantial on credit cards. One
measure of default risk is the so-called charge-o rate on a credit card
debt portfolio: the fraction of debt charged o the creditor’s books after
days of being delinquent during a period, net of any recovered and
previously delinquent debt over the same period.
11 See the article by James J. Daly. In their monograph, Evans and
Schmalensee report very similar numbers in the credit card market for
the preceding year.
12 In , Capital One became the first issuer to introduce a balance-
transfer oer.
13 Evans and Schmalensee report that, by the s, percent of
credit accounts were initiated via prescreened oers.
14 The company was known to use advanced (for that time) modeling to
thoroughly understand the behavior of its customers. See online post by
Andrew Becker.
15 The memos were published by the San Francisco Chronicle after a year-
long legal battle with Providian to make them public. Excerpts of the
released memos can be found in the Chronicle article by Sam Zuckerman.
16 The interview appears in the Frontline documentary “Secret
History of the Credit Card.” The documentary can be found at https://
www.pbs.org/wgbh/pages/frontline/shows/credit/.
17 Providian settled in for $ million after already reimbursing
customers at least $ million. The company was sold to Washington
Mutual in for approximately $. billion. Its credit card portfolio
at the time amounted to million card holders.
18 In the case of credit cards, the risk of default is significant given
the unsecured nature of credit card debt. Borrowers may default on un-
secured debt by filing for bankruptcy. Since the borrower does not have
to oer collateral as potential compensation to the lender, the lender is
at risk of never receiving payment on the principal amount owed. And,
even if the borrower does not file for bankruptcy, their (usually) small
amount of debt may make debt collection prohibitively costly for the
lender, leading to a widespread phenomenon of “informal bankruptcies.”
For more details, refer to my work with Ricardo Serrano-Padial.
Federal Reserve Bank of Philadelphia
Research Department
Why Credit Cards Played a Surprisingly Big Role in the Great Recession
2021 Q2
17
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