Put It on My O-Card

The case for government-backed credit cards.

Should the government back credit cards?

On the list of villains of the economic crisis, credit card companies are rising faster than their own rates. So after President Obama met Thursday with CEOs from Visa, Mastercard, and American Express, he stated his disapproval loud and clear. “The days of any-time, any-reason rate hikes and late-fee traps have to end,” he said. Meanwhile, the House passed a “Credit Cardholders’ Bill of Rights” that would limit unfair lending practices. The Senate version is even harsher—it would prohibit interest rate hikes for no reason and would put restrictions on marketing cards to people under 21. There may even be a provision for hanging CEOs by their thumbs.

But instead of cracking down on companies that treat their customers poorly, why doesn’t the government just offer a credit card of its own? After all, government regulation may help, but it’s unlikely to solve the problems of the credit industry—namely, spiraling interest rates coupled with rising defaults. Obama likes to talk about constructive alternatives. Why not offer an O-card? With his face on it?

The idea isn’t crazy. In Germany and France and Iceland and India, state-owned banks issue credit cards. One difference between those lenders and private banks is that interest rates are lower, since profit isn’t the state’s chief goal. (Europeans also have a different relationship with credit cards, using them to make routine payments rather than rack up debt.) Government-issued credit cards could also help consumers avoid those small but numerous charges that add up over time, from ATM fees to annual fees to interchange fees.

Nor does the notion freak out economists. “It’s not something I’d be sitting here and saying” in normal circumstances, says Tahira K. Hira, a professor of finance at Iowa State University. “But some of the rates are so astronomically high, it’s becoming impossible to manage for individuals.” Phillip Uhlmann of Tufts University says, “I think a government system might offer a cleaner type of business, more easily understood by consumers.”

Wait, what are we saying? Surely we don’t want the government lending directly to individuals. That way lies socialism.

Maybe so, but we’re already there. Think of all the different things the state finances. It backs home mortgages through quasi-government-owned Fannie Mae and Freddie Mac. It offers student loans through its direct-loan program, providing billions of dollars to help kids pay for college. Uncle Sam will even chip in to help you buy a car—it gave auto financer GMAC a $5 billion bailout last December.

If we’re already backing loans for the three biggest life expenses—homes, college, and cars—what’s missing? Consumer and business credit. Consumer spending accounts for almost 70 percent of GDP. The average American household carries $8,700 in credit card debt. And just as the financial crisis swallowed the housing market, it seems to be eyeing the credit card industry. Purchases are way down. Credit card companies are slashing credit limits. Others are offering special deals: If you’re the wrong kind of customer, American Express will give you $300 to close your account.

Creating a government-sponsored lending agency—a Fannie Mae for credit cards—would rein the whole system in. For one thing, it would offer lower rates than the usual 18 percent. The government could charge, say, 8 percent interest and still turn a profit. It would include none of the usual hidden fees or surprise charges. (In 2007, penalty fees were $7.5 billion, cash advance fees were $5.6 billion, annual fees were $4.6 billion, and interchange fees were $23.6 billion.) And while the credit card industry spent $34 billion on marketing in 2007, the government would avoid that expense entirely. The card would theoretically be accepted everywhere, because merchants would know Obama is good for it.

The caveat: You’d have to be supercreditworthy to get a card. The government doesn’t want to have borrowers behind on payments; if they defaulted, taxpayers would have to pick up the tab. (Fannie Mae and Freddie Mac had higher standards than other lenders, too.) But that would be preferable to the current system, which punishes people for even minor slip-ups, like paying at the wrong time of day or buying stuff at the wrong store.

The government system could even serve as a refinancing option for troubled card-owners. If you currently pay 18 percent interest on a $10,000 balance, you could refinance a chunk of that under the government credit program. That would serve as a sort of bailout for credit card companies—they’d have fewer customers default, and at the same time customers would pay lower rates.

So how would the government get into the credit card business? It has two main options. It could start from scratch outside the existing system. That would mean creating a bank or other lending entity, reaching out to individual merchants, and building a network of borrowers from the ground up. Or it could simply become an issuer. That means it would offer cards through an existing company like Visa or Mastercard. In that scenario, you could use the card everywhere right away. The government could still establish its own interest rates and terms of use, but it might have less flexibility than it would as an independent lender.

One way to attract borrowers would be to link the credit cards to a cause—like an affinity program, but for government. Every time you buy something, a small percentage would go to wind-farm construction, say, or clean-coal research, or school computers. The government could also do something creative like dipping into the Social Security money pool. If it lent that money to creditworthy Americans, it could make a killing.

There is a risk that a public credit card would undercut the competition. It would by definition have a triple-A rating, since the government could guarantee its own loans, while other lenders would be in the low single-As at best. The state therefore couldn’t be too cavalier about wooing customers from other companies. It would also have to avoid freeloaders who don’t intend to pay back their government-backed loans.

But a little competition would be a good thing, since it would force companies to re-examine their lending practices. And instead of straight regulation, this would be—you listening, Newt?—a market-based solution.