Tuesday, February 24, 2009

There's Something Happenin' & U Don't Know What It Is, Do You, Mr. Cardholder

The credit card industry's explanation for the failure of smart cards to emerge in the United States is well known. To be economically viable, the industry has argued, smart cards must provide substantial cost savings. In Europe, they were justifiable because they significantly reduced fraud losses through point-of-sale PIN authentication. In the US, however, cheaper telecommunications costs enabled the card systems to guard against fraud almost as successfully through magnetic stripe point of sale authorization. The system worked through complex algorithms that enabled card issuers to identify and block potentially fraudulent transactions. I was personally saved from fraudulent transactions on a couple of occasions as a result of these systems. Although recently, one card company blocked some of my own legitimate transactions because my wife had tried to buy a plane ticket to Europe using the card. Perhaps they are becoming overly cautious.
In addition to tightening their fraud protections, the New York Times recently reported that the largest card issues may be using similar systems to monitor the credit worthiness of their own cardholders. These issuers review hundreds of data points, including home prices in the cardholder's area, the type of mortgage lender used, and whether small-business cardholders work in a distressed industry. Although the most significant factor continues to be overall debt in comparison to financial resources, some issuers may be incorporating spending patterns into their credit worthiness algorithms.
According to the Times, American Express "has been looking at how you spend your money, searching for patterns or similarities to other customers who have trouble paying their bills." When the indicators are bad, cardholder credit lines are reduced. AmEx recently sent letters to cardholders, explaining that "[o]ther customers who have used their card at establishments where you recently shopped have a poor repayment history with American Express." The letters, however, failed to identify the problematic merchants.
Initially, AmEx defended the practice. “We’re just doing this to manage risk,” an AmEx spokeswoman is quoted as saying, "customers who make transactions with certain merchants tend to have a higher proportion of credit issues or a higher probability of default.” When approached by Times columnist Ron Lieber, however, AmEx claimed that it had stopped using spending patterns to predict credit losses and never actually based decisions on a cardholder shopping at a particular merchant. Last year, however, sub-prime lender Computer Credit was shown to have looked at merchants including marriage counselors, tire retreaders, pool halls, pawnshops, and massage parlors in considering whether to lower its customers' lines of credit. The curious message may be that changing your spending patterns in response to economic conditions -- say by having your tires retreaded instead of buying new ones or buying tools at a pawn shop rather than Sears -- may lead to an overall reduction in your available credit.

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