President Bush’s new (and DOA at the House) $3.1 trillion dollar budget projects that, by September 30, 2008 — the end of the current Federal fiscal year — the shortfall over revenues will be $410 billion. The House majority party is salivating over the choice chops of political fodder this provides in an election year, while at the same time patting themselves on the back for delivering a $150 billion stimulus package to the economy, which does nothing to stimulate the economy. Because this stimulus spending is short term, the package outlay translates dollar for dollar directly to the deficit. (To be fair, the President has signed off on this package also in the spirit of true bipartisanship — lookout taxpayer!)

I consider myself somewhat prudent in that while I have a mortgage, the P&I seldom exceeds $1000 a month (it’s an ARM and thus varies with LIBOR); I don’t have any outstanding credit card debt — I am a transactor rather than a revolver; and I have some investments and savings.

The Federal Reserve has reduced interest rates in the last few months by almost 2 points. This is to bolster the economy (as perceived through the lens of the equities and bond markets). The markets have rallied, and then sunk as the impact is absorbed and evaluated. Democrats in Congress are talking about not being able to ‘afford extending the Bush tax cuts‘ and not being able to ‘afford the revocation of the AMT‘. They are also talking about expanding many programs.

What does this all mean to me?

My ARM resets every February based on the preceding six months LIBOR so the reduction of the Fed rate is likely to have little impact on my P&I. Additionally, since the LIBOR has lately decoupled from the Fed rate there is no guarantee that any Fed action will lower LIBOR. Credit card issuers adjust their loan rates monthly, usually based on 10-12% over the Fed rate, so that they can maintain a good net interest margin. However, since I am prudent and have no revolving card debt, I obtain no benefit from this. Since the rate goes down, so does the interest accrued to my meager savings and money market accounts. Current savings rates are less than the CPI so in terms of dollar denominated spending power, the value of my savings actually decreases.

One effect of the cuts manifests in the dollar’s value compared with other currencies. The dollar has achieved new lows. As a result, dollar denominated commodities such as oil and grain, have increased in terms of price. The value of a barrel of oil is the same or slightly rising (due to demand) but the value of the dollar is falling meaning that you need more of them to buy that barrel. Consequently, gasoline is hovering near $3.00 per gallon and can only rise as demand picks up again. Consequence to me: I have to pay more to get to work and back to buy fuel. I have to spend more of my pay to keep my house heated in the winter and to pay for electricity.

Policy decisions in Congress, particularly with the ethanol alternative fuel initiative, have also had their effect. These efforts are a derivative effect to mitigate the higher oil prices. Subsidies to ethanol producers — again an expense supported by taxes — have driven corn prices higher. Basic grain products have increased in price, cattle feed and thus meat has increased in price, and since corn syrup is used in about everything, most other processed foods have increased in price. Consequences to me: inflation.

One of the reasons that is used to support the package is that the liquidity of the financial markets is being reduced. The reason for that is simple — bankers don’t have a good feel anymore for what an asset is worth, and consequently are reluctant to lend money against that asset. Multiple levels of risk diversification haven’t quite worked out as planned. While I am a fan of and support securitization, the packaging of asset and mortgage backed securities with credit enhancements and credit default swaps constituted building a house of cards. Young financial engineers with little experience in the downside of things spun up an edifice of risk that is still in the process of toppling. But the Fed has already provided an answer to the liquidity problem through its discount window where banks are assured of obtaining the capital they need. The stimulus package doesn’t affect this. By viewing the economy entirely through the lens of the financial market, rate cuts only reinforces risky behavior. The Fed action is predicated on the premise (unsubstantiated) that whatever affects the markets eventually affects the general economy.

Finally, it seems as if Congress doesn’t learn anything. If anything was clearly demonstrated by the Bush tax cuts, it was Laffer’s theorem that there is an optimum taxation rate to provide maximum revenue. Since the stimulus package will increase the deficit, the inevitable result will be a call for an increase in taxes. The result of that will be a slowdown of the economy, a decrease in tax revenue, which will result is still higher deficits. Plus, the effect will flow down to the States and their revenue streams. All of the ‘good’ and ‘beneficial’ programs will be strained and States and Cities will attempt to make up the shortfall. Consequence to me: My take-home pay decreases as my fed taxes increase. My property tax component which is now slightly less than my P&I amount will exceed it and I will absorb more of the burden of government.

The reason that the market has blipped higher and then reset is that investors collectively know these things. This non-stimulus stimulus package offers no long term market or economic benefit. This package and the rate cut itself is a profligate renunciation of fiscal prudence. The current set of policies rewards the behavior the current Congress rails about: the lack of savings of US citizens; an excessive burden of credit card debt; highly leveraged mortgages; overreliance on oil.

Here is my table of consequences:

Result/Effect Prudent Man Profligate Consumer
Gasoline Prices Screwed Screwed
Leveraged Mortgage Not Applicable Bailout
Savings Reduced Value Say What?
Food Prices Higher Higher
Credit Card Payments No Effect Lower
Risky Financial Behavior No Effect Rewarded
Income Taxes Increased Likely Exempt
Property Taxes Increased Dude! I rent.

So!

Never one to bitch without offering a solution, here is what we need to do:

  • Actually limit federal and state spending. Cut agency staff and eliminate costly programs which do not perform. Insure each agency has a performance metric upon which future funding is based.
  • Stop adding new entitlement classes to existing entitlements of Medicare and Social Security. Take a close look at the implementation to insure that the program is not driving UP the cost of health care.
  • Eliminate tax deductions on corporate contributions for employee health care.
  • Increase the Fed Rate by 3 full points. The market will take a dive. So the next day …
  • Announce the elimination of the AMT (and follow through) and make a permanent tax rate of 10% ($20,000 < Income < $250,000) and 22% (Income > $250,000).
  • Completely eliminate capital gains tax.
  • Eliminate corporate income tax. (This is just another tax on the consumer , since it’s passed through).

Basically, fix the tax problem and all other problems will fall into line. There is a reason why formerly Communist countries have gone to flat taxes and low rates.

In what appears to be continuing series in credit card malfeasance, I would like to preface by saying that it applies to one issuing bank/card marketing company and not necessarily to all such entities. However; card marketing companies are like lemmings — where one goes, they all follow, so I wouldn’t be surprised that what I describe here could be happening elsewhere.

The story starts in the typical manner: an offer letter shows up in your mailbox for a credit card. It may have a low teaser rate or may be an affinity card with your favorite sports symbol on it (“The Chief”). You decide that you will send it in. It says your rate may be “as low as” 3%. “As low as” means that if you pay all your bills in gold boullion, pay them before they are due, and add on every enhancement offered, you get the 3%, otherwise you pay the 24% like everyone else. What happens is that to generate a marketing list, card marketers go out to the credit bureaus with a set of criteria (say FICOs between 650 and 680) and get a list of names and addresses—the “pre-pull”. They make the offer and for those who return the business reply envelope, they do a post-pull and then give you the rate that the credit risk model says you deserve, taking into account allowances for things like the current interest rate margin (profit).

Now typically, (here is the cross-sell again), these offers for a credit card come packaged with a lot of enhancements like a) lost and stolen card protection, b) travel rewards, c) extended warranties, or d) discounts. These may be via opt-in/out boxes or actually packaged together. So when the application is sent in, you may be signing up for “enhancement products” on the card if you don’t read VERY carefully.

A recent trend I’ve noticed is for credit cards to be offered at a checkout counter. Now this is actually a good marketing strategy — using your existing relationships with a customer. This shift is occurring as marketing professionals scour for new ways to reach you. Five years ago, the direct mail response rate was 1.3%. The last time I looked it was .04%. Since it costs postage, printing, processing charges, etc. to send an offer, the CPA or cost per booked account is is getting larger and larger. If you are at a checkout counter at a store and the clerk says something like “Do you know you can get a 10% discount if you use The “Store Branded” Master Card —would you like one?” — well, that is pretty enticing.

So you apply for the credit card. This usually takes the form of a “take-one” application in industry parlance. In the particular case in mind, you fill out the application form, including your SSN, and hand it to the checkout or customer service person who enters the data into “The Program”. The application sails away to the issuing bank, who owns The Program, and they run the post-pull and model and presto, you have a credit card, often within minutes. The stores even have a card-not-present payment option to allow you to use it right away. The CPA for this type of offer is much lower than shotgunning direct mail out to the general population, which happens to own an average of five credit cards anyway. And even with the 10% discount giveaway added, the CPA is less than traditional direct mail marketing methods.

What about those enhancement products? On the form I obtained, in order to sign-up for an enhancement, you have to either sign a blank that says you want the product, or sign that you decline the product. This set of required signatures is, however, on another panel of the application tri-fold. I asked what happens if you ignore the blanks and turn in the application without signing either accept or decline? “The Program” won’t accept the application without one or another. [Note the positive reinforcement of the cross-sell opportunity rather than default to a no-sell.]

This, I presume, is meant to be a closed loop control but the customer service people are always busy and are under pressure to complete the application processing as quickly as possible. I asked if they ever just checked a box to get on with it —“No, That would be cheating” was the response. A particular person, of whom I have previously referred to in conjunction with credit cards, applied for a card in this manner, not signing up for the enhancement. She left both signature spaces blank. Strangely, the application, which was returned to her after the data entry procedure, had some handwriting which differed from hers. An accident?

I asked the checkout clerk, a young guy, if they received incentives for pushing credit cards. Yes they did. I asked whether they got cash incentives or the manager-will-beat-you less type. [My daughter , working in a department store as a clerk, was continually subjected to harassment for not meeting her ‘quota’ of store cards. She quit.] He laughed and said more like the second rather than the first.

At this point let me state that this is completely legal. The best marketing builds on existing relationships. The only caveat is that perhaps it’s not that good of an idea to have customer service clerks enter data under pressure and under incentives to meet application quotas. And further; it’s not a good idea to take applications and transfer data to their terminal where the customer really can’t view what is being requested in their name. Card processors do this by optical character recognition at high rates (and with low error rates) and leave out the human component. I also wonder where that application goes, the one with your personal data and SSN on it, after the data is entered into The Program.

That is how instant credit can work. Here is how typical direct mail applications work. The application arrives at card processing entity where the application is scanned, post-pulls are done, analysis run and card is priced (interest rate set). Plastic is generated and shipped to customer with sticky label that says “To activate card, call number 800-613-4395”. So far so good. Now the scam……

Let’s suppose that the customer, in an attack of buyer remorse, upon receiving his plastic decides that he doesn’t need another card, so he just cuts up the card. That is to say, the card is never activated.

20 days later he get a statement with a $29.00 or some such charge against his card. It might be for an extended warranty plan or a card protection plan, but the customer knows that he cut up and never activated the card. He disregards the statement. (Most likely he never opens it because he knows he doesn’t have that card.) After 30 days, the card gets hit with interest (e.g. 24%) plus $29 late fee. Balance is now $58.58. Second month passes — another interest and late fee. Balance is now $88.75. Account is deliquent 60 days, letter is sent. “Why is is this bank bothering me” — into the garbage. Another month, another late fee. Balance now $119.53, and so forth until you get a phone call. “I don’t owe you anything”. Suppose the card holder was sub-prime and they were given a credit line of $500. After a while, the accumulated balance exceeds the credit limit and they get both a late fee and an over-limit fee.

In the particular case I am speaking of, customers had run up balances of $1500 or more having never activated their card. Not to mention royally screwing their credit histories at the bureaus.

A regular merchant could never post a settlement against an unactivated card as this is a principle barrier against merchant fraud. But the issuing bank, who usually also runs either an enhancement business unit, or contracts for one, OWNS the cardholder masterfile. By masking out the activation character position in the master file by means of a COBOL program,they can run the enhancement sales orders against the master file and ‘force post’ the enhancement product sale. The pretense is that this is valid and legal because the customer indicated a desire to purchase the enhancement, even though the product is an enhancement against a non-active account.

Pretty good. Enhancement products can generate the highest profit margins at the bank, and drop right to the bottom line. Now if they could only convince the FTC and the lawyers litigating aginst them in class action suits.

While the 12AngryMen wax philosophic on the issues of our time, I thought it would be perhaps useful to forward a bit of knowledge to our dear readers. Let me preface this missive by stating that in a previous life, I developed banking and on-line software for a credit card marketing company. While the company I worked for was not above certain ethically challenged marketing efforts, I assure you that it never decended to the levels described herein. I know — my group wrote all of the applications. One has to, however, admit to a bit of grudging admiration for the deviousness inherent in this bit of subterfuge.

Usually I make purchases on-line using my card and a bit of software called Shopsafe which produces one-time cards with a specified expiration date and a specified credit limit. This is a practice I heartily recommend by the way. Unfortunately other members of my family are not so circumspect. The following is an analysis of what happened and how it happened.

Upon receiving a monthly statement, my wife reviewed the card statement and noticed a charge for $9.00 from a company called WLI.ReservationRewards.com. I immediately recognized the charge as an after-marketing or cross-sell result from some purchase made by my wife. A quick search revealed what I expected. The on-line site my wife visited was eBags.com (which happens to be listed on the previous link.) Intriqued, did a little CSI work and uncovered the logic and process involved. The following is a bit technical, but if nothing else, skip it to the recommendations at the end.

WLI contacts on-line companies with affinity and cross-sell agreements. Basically, no one in their right mind would sign up for this crap (My previous company sold similar enhancements. They had a 98% profit margin.) So in order to get sales, WLI has to make agreements with companies who sell stuff you actually want. They will cut a deal with the company—after you complete your transaction, link to our site for a cross-sell opportunity and we will split any sales with you 50-50. To the legimate company, this is a hell of a deal. Free money even. All you have to do is add some code pages to your web site and in return you get 50% of the till. A lot of profit for no effort.

What actually happens is that instead of linking to the site as a separate session, they link internally as another page in the same session. Why is this important? When you do a credit card transaction, any reputable company will attempt to protect your credit card data. They do this by establishing an SSL session to encrypt sensitive data on-line. Because of the stateless transactions on the HTTP protocol, it is sometimes necessary to store the card data in the event that a transaction does not run to completion. Card data are usually stored in cookies encrypted under the SSL symmetric key. Note that this is actually safe as this data is not usually stored on disk, and even if it is, it is encrypted with a 128 bit symmetric key. When the session ends, the data are automatically purged, and the data on disk is not accessible as the key is toast also. Visa and Mastercard rules state that card data should not be stored, and the CVV, the verification codes are NEVER to be stored. A lot of companies interpret this as stored on disk. So when you end your transaction, and leave your session, your card data is purged. Right? Not so fast!

Remember that the code the cross-sell company added doesn’t link in the normal sense but just continues with the session in an attempt to sell you some useless crap. By continuing the session, the application running (the cross-sell application, not the original on-line store) has access to the card data in the cookie. Most legitimate companies don’t think this through — the money is too good.

Now here is where the sneakiness gets involved. This has to be legal. That is to say, somewhere you have to say that you want to buy the product that they are selling. Further, they have to send you an acknowlegment. This can be immediate (print this page) or usually as a follow-on email. So what happens?

You get to the cross-sell page and see some gobbly-gook and decide this is bullshit and navigate away from the page. You are done with it and gone. Nope! Somewhere on the page there is a box which is checked that says “Send me this crap for $9.00 a month”. This is called opt-out and is a source of great consternation between marketing people and the FTA. [As an aside, organ donors in Europe have to opt-out to NOT become an organ donor, i.e., uncheck the box. In the United States, drivers have to opt-in to become an organ donor. The relative rates of donors in Europe is over 80% verses 20% in the United States. This is the power of opt-out and why marketeers fight for it so hard.] Clever web designers that they are, attempt to hide the opt-in box which of course is prechecked (making it, in effect, an opt-out). This could be buried in a mass of text, but typically is in a place that requires the user to scroll down to see it. A cursory glance at the page shows nothing so the user just navigates away from the page.

At this point the old javascript on-exit() script kicks in. Before the browser exists, it pulls the name, card information and everything that is required to create a new transaction from the cookie left behind by the legitimate store and posts a new form to WLI. Since this is a monthly charge, it sends all of the card data so that transactions can be recurring. This has two effects: 1) you are charged for something you don’t want, and 2) your card data is now on a server somewhere else protected by likely not very much security.

Actually, I am a step ahead of myself. Typically these deals come with a free 60 or 90 day trial period, after which the charges start to appear. To be legal they have to send an acknowlegment. Since you obviously can’t print the screen since you navigated away, they send you an email. (also grabbed from the cookie.) Unfortunately, this is a simple message couched in language such that there is no immediate charge
to catch your attention and usually with a subject line that guarantees that the email will be spam-canned immediately.

After 90 days, the more enterprising send you another email, also likely spam-canned, that let you know that the charges are about to begin and then they hit you up for the $9.00 per month. The other thing is that the fees are kept low so that they are likely to slip in under the radar in a long list of charges. Err what is that – a latte I charged at Starbucks? The billing statements are also listed as obscurely as possible.

A heck of a deal. Don’t bother calling the legitimate on-line store customer service. They are usually completely unaware that this is happening, and the marketing people are not about to draw it to anyone’s attention if they find out because their revenue stream has just jumped up.

As a service to readers I give the following advise:

  • Use Shopsafe or some similar software to generate one-time cards. Set the expiration date at minimum (usually 2 months from current date) and the limit at $5.00 over the current purchase (plus shipping and handling, etc.) Scams like this can’t work if the card is invalid (expired) at the end of the free-trial period, or if the absolute credit limit will be exceeded.
  • After you complete the transaction (the page will say this) and BEFORE YOU DO ANYTHING ELSE, close the browser. Kill it — and the session data. Then open a new browser to continue whatever you want to do. Never navigate away from a completed transaction page.
  • Read your credit card statements.

[Author’s Note: If there is sufficient interest and comments, I will be willing to expose more credit card ethically challenged activities. There are several interesting ones.]