CREDIT CARDS

CREDIT CARDS introduce financial flexibility into modern consumers' lives. For those who always pay off their balances, credit cards eliminate the need to carry cash or obtain check-cashing approval. For those who carry a balance, credit cards allow acquisition of goods and services that cannot be paid for in full when purchased.

The twenty-first century extent of credit card use may be new, but its function is not. Before 1900, American families obtained "book credit" from merchants who allowed the same financial flexibility now provided by credit cards. But urbanization and the chain store movement rendered the old system of book credit infeasible.

The first step on the road to credit cards was development of store-specific metal charge cards in 1928. These cards continued the system of extending credit to favored customers. Clerks no longer needed to assess customers' creditworthiness; any one with a charge card received store credit.

Oil companies moved into credit cards as a way of building a customer base. As automobiles increased in popularity in the 1920s and gasoline stations proliferated, oil companies gave loyal customers paper "courtesy" cards that could be used at any of their stations. Balances were paid in full monthly. In 1939, Standard Oil of Indiana made a startling move when it mailed 250,000 unsolicited cards. By 1940, over 1 million cards circulated. In the 1950s, gas companies moved to embossed aluminum charge cards in the size still common in the early 2000s.

Early charge cards did not possess the key feature of modern credit cards: revolving credit, which allows card-holders to pay balances over time while simultaneously charging new amounts. Wanamaker's Department Store in Philadelphia moved toward a revolving charge account in the late 1930s when it gave customers four months to pay off a balance. This was not truly revolving credit, however; new charges were prohibited until the previous balance was paid. William Gorman introduced true revolving credit to department store cards in the 1940s, first at the L. Bamberger & Co. department store in Newark, New Jersey, and in 1947 at Gimbel Bros. of New York.

In all these cases, the card issuer's goal was to boost sales of the issuing company. Indeed, due to bad debts and fraud, the credit operations often generated a loss.

Universal Cards

Universal cards, by contrast, are intended to earn a profit for the issuing company. There are two types of universal cards: travel and entertainment (T & E) cards, and bank-cards. The distinction between the two types of cards—evident in their genesis—had all but disappeared by 2000. T & E cards were issued by private companies. Diners Club led the way in 1950. The brainchild of theater producer Alfred Bloomingdale, his friend and head of Hamilton Credit Corporation, Frank McNamara, and McNamara's attorney, Ralph Snyder, Diners Club was initially a card for New York City businessmen to use at local restaurants. Cardholders paid an annual fee; merchants paid a fee of up to 7 percent of charges. Their local success led quickly to the establishment of Diners Club in Los Angeles and Boston, and by the late 1950s across the United States. American Express, whose name was affiliated primarily with traveler's checks, and Carte Blanche, a card established by the Hilton Hotel Corporation, were the other two widely used T & E cards; both were introduced in 1958.

Bankcards were issued by commercial banks, institutions that had traditionally been wary of lending to consumers. In the 1920s, for example, when automobile fi-nancing was booming, bankers shied away, taking the very need to borrow as evidence of a family's lack of credit-worthiness. But the Great Depression showed bankers the error of their ways. Despite high unemployment, consumers paid off their loans. Banks began to move into automobile financing after World War II and into credit card operations in the 1950s.

Bankcards, begun when cross-country travel was unusual and interstate banking was illegal, were initially regional operations. Bank of America, of San Francisco, introduced its Bank Americard in California and surrounding states in 1959. That same year, Chase Manhattan Bank, of New York City, introduced its Chase Manhattan Charge Plan (CMCP). After a ten-day grace period, card-holders paid interest on unpaid balances. Merchants paid up to 6 percent of amounts charged.

Bank Americard thrived but CMCP failed. The difference is attributed in part to accounting practices—CMCP charged its cost of funds and advertising to its credit card operations but Bank Americard did not—and partly to Bank of America's extensive California network of branch banks. Bank Americard went national in 1966. In response, a number of other banks formed the Inter-bank Card Association, later the provider of Master Charge. Bank Americard changed its name to Visa in 1976; Master Charge became Master Card in 1980.

In the late 1960s, bankcard companies sought to increase their customer base by mailing unsolicited cards. While they were successful in achieving their immediate goal, financial losses and fraud investigations soared. Although the number of actual fraud cases was low, many people feared they would be liable for charges on stolen cards. Responding to public outcries, in 1970 the Federal Trade Commission (FTC) banned the mailing of unsolicited credit cards.

Customer complaints were not limited to the unsolicited card mailings. The FTC's intervention in 1970 was followed by the 1972 congressional passage of the Fair Credit Billing Act, subsequently revised several times. Its eventual 1974 enactment included provisions covering both billing practices and disputes regarding defective merchandise. The final version of the Equal Credit Opportunity Act (ECOA) enacted in March 1977 prohibited the use of gender, race, national origin, and marital status as criteria for evaluating credit card applications, and required that unsuccessful applicants be notified in writing of the reasons the application was rejected. With ECOA, married women were first allowed to hold credit in their own names and to establish their own credit history independent of their husbands'. In March 1979, the Financial Institutions Regulatory and Interest Rate Control Act of 1978 became effective, including provisions protecting the privacy of credit card users.

Revenue from interest charges was often limited by state usury laws—laws establishing limits on interest rates. In the late 1970s, interest rates paid by banks to obtain funds rose so high that many states raised or completely eliminated their usury ceilings, allowing banks in some states to increase their credit card finance rates to as much as 24 percent. Customers seemed indifferent to interest rate increases. When other interest rates fell in the 1980s, bankcard companies kept credit card rates high: credit card finance rates averaged 17.3 percent in 1980 and 18.2 percent in 1990, during which time the prime rate banks charged their best business customers fell from 15.3 percent to 10.0 percent.

Extent of Use

The growth of credit card use in the United States since 1970 has been dramatic. In "Credit Cards: Use and Consumer Attitudes," an article published in the September 2000 issue of the Federal Reserve Bulletin, author Thomas Durkin reports thirty years of credit card statistics based on the Survey of Consumer Finances, a household survey conducted every three years by the Federal Reserve Board. In 1970, 16 percent of households held at least one bank credit card; by 1998, 68 percent of households did so. Only 37 percent of families with a bankcard carried a balance in 1970, but 55 percent did so in 1998. For those carrying a balance, the average balance, adjusted to 1998 dollars to eliminate the influence of inflation, was $839 in 1970 and $4,073 in 1998.

The likelihood of having a credit card rises with income: in 1998, only 28 percent of families in the lowest fifth of the income distribution had a bank credit card, while 95 percent of those in the highest fifth did. Families in the highest income bracket are more likely to pay off their credit card bills each month than are families in all other income brackets: 55 percent of families in the top fifth of the income distribution pay off their cards each month, but only 40 percent of families in the bottom four-fifths of the income distribution do so.

David Evans and Richard Schmalensee, in Paying with Plastic (1999), reported that outstanding credit card balances relative to income have risen since 1983, rising most dramatically for young adults. Credit card balances as a percentage of household income were 3 percent in 1983 but 50 percent in 1995 for 18-to 24-year-olds. The fourfold increase for households in the 25 to 49 age bracket, from 10 percent in 1983 to 41 percent in 1995, pales by comparison.

The 1990s rise in credit card debt went hand in hand with a drop in personal saving. Increased availability of credit cards might have led consumers to spend more than their incomes, accounting for the drop in saving. But the 1990s rise in the stock market increased wealth and led consumers to spend rather than save; perhaps families simply chose the convenience of charging rather than paying with a check or cash. Whichever causal story is correct, the rise in spending, drop in saving, and rise in credit card use in the last fifteen years of the twentieth century are certainly correlated.

BIBLIOGRAPHY

Durkin, Thomas A. "Credit Cards: Use and Consumer Attitudes, 1970–2000." Federal Reserve Bulletin 86, no. 9 (Sept. 2000): 623–634.

Evans, David S., and Richard Schmalensee. Paying with Plastic: The Digital Revolution in Buying and Borrowing. Cambridge, Mass.: MIT Press, 1999.

Mandell, Lewis. The Credit Card Industry: A History. Boston: Twayne Publishers, 1990.

Manning, Robert D. Credit Card Nation: The Consequences of America's Addiction to Credit. New York: Basic Books, 2000.

Nilson Report. Home page at http://www.nilsonreport.com.

Spofford, Gavin, and Robert H. Grant. A History of Bank Credit Cards. Washington, D.C.: Federal Home Loan Bank Board, 1975.

Martha L.Olney

See alsoFinancial Services Industry ; Installment Buying, Selling, and Financing ; Retailing Industry .

CREDIT CARDS

"Ill Just Charge It."

Ubiquitous words and phrases generally associated with the 1960s—"Don't trust anyone over thirty," "the Generation Gap," "the Establishment," "peace/' and "groovy"—capture only part of the decade. One important change during these years might best be depicted by the expression that revolutionized the way Americans bought things: "I'll just charge it." The burgeoning use of credit cards simplified the idea of buying now and paying later, thereby adding fuel to the economic boom already under way. Although various kinds of charge cards had been available for nearly fifty years, the credit-card industry took off in the 1960s.

Origins

Consumer credit in the form of installment-buying plans became prominent during the years following World War I. In order to encourage the purchasing of big-ticket items such as automobiles, washing machines, radios, and the like, companies in the 1920s allowed customers to spread the cost of their purchase over several months rather than making one lump-sum payment. With installment buying, more automobiles were on the road, and oil companies began issuing gasoline cards to customers permitting them to charge purchases at any of the firm's affiliated gas stations. The airline industry followed suit in the 1930s. American Airlines opened the credit door with its Universal Air Travel Plan (UATP). Beginning as a coupon book, UATP later developed into a credit card business. But these charge cards, much like the ones department stores were also giving out, could be used only at the issuers' establishments. The universal card, acceptable at many stores and shops for a variety of goods and services, awaited the creation of Diners Club.

Diners Club and the Others

Set up by Alfred Bloomingdale (the son of the department-store tycoon), Frank McNamara, and Ralph Synder, the Diners Club card was introduced in 1949. It was a universal, third-party card: that is, the Diners Club company acted as a middleman between the consumer and the merchant. The firm made money by charging customers for the card and charging merchants for using its services. Cardholders paid a monthly fee and were required to pay off their total balance each month. After several years operating in the field alone, Diners Club faced new competition in 1958. That year American Express, known for its traveler's checks, and Hilton Hotel's credit-card branch, Carte Blanche, each introduced universal credit cards. Later in 1958 the nation's two largest banks, Bank of America and Chase Manhattan, jumped into the growing credit-card industry.

Bank Americard and Master Charge

With Bank Americard, Bank of America created a universal revolving charge card—the cardholders were given the option of making a minimum payment, with the balance (with interest added) carried over to the next month's bill. In 1966 Bank of America decided to franchise its BankAmericard (the name was changed to VISA in 1976) across the country. In response several large banks formed another national card system known as the Inter-bank Card Association (Interbank purchased the rights to Master Charge in 1969 and changed its name to MasterCard in 1980). Once established, these two rival firms battled to place their respective credit cards in consumers' hands. The method was unsolicited mass mailings of credit cards. By 1970 there were millions of bank cards in circulation, and some predicted this plastic money would one day replace paper currency altogether.

Continued Growth

During the 1970s the number of credit cards in circulation more than doubled, with the charge volume increasing 1,400 percent. Growth continued into the 1980s: by 1985 VISA had 86.4 million cardholders to MasterCard's 64.9 million. Credit cards had truly transformed the way Americans bought things. By 1984, 71 percent of American families had at least one credit card, and from 1970 to 1986 the number of families carrying a bank credit card rose from 16 to 55 percent. As finance professor Lewis Mandell suggested, consumers had apparently taken the television commercial seriously and were "not leaving home without them."

Source:

Lewis Mandell, The Credit Card Industry: A History (Boston: Twayne, 1990).