Compound interest or compound returns are fascinating. If you’re reading this, you don’t need to be told why. Time combined with money put to work can and does result in staggering leaps of wealth. If you’re confused, look up Warren Buffett’s net worth when he was 53 and 63, versus 93.
The profound impact of compounding on Buffett’s fortune is something that the regulators inside the Consumer Financial Protection Bureau (along with a “junk-fee” hating President Biden) ought to consider. In particular, they might think about it amid their attempts to force credit card companies to reduce the amount they charge for late payments on outstanding balances. At present the amount is $32, but the CFPB is in hot pursuit of regulation meant to push the number down to $8.
At first glance, it all sounds so wise. $32 surely seems so excessive, and perhaps aggressive. Let’s bring the number lower. Cardholders will be happier, as will card issuers be in a better state as a consequence of fewer calls from unhappy card members. The customer is always right, and all that…
Unfortunately, good policy rarely emerges from first glances. Second and third looks make it possible for us to gaze beyond the cosmetics of feel-good ideas. In particular, credit card companies have owners also known as investors. And if governmental decrees limit the ability of credit-card companies to make money off of credit-card issuance, the losers will be those investors.
As we see with wealth put to work, the tried and true path to wealth creation is paved with compounding. Better yet, returns that may seem small in the near term can compound into very large returns over the long term. It’s just a reminder that investment capital is expensive precisely because the potential for outsize investment returns is so great. Every dollar counts, so if governmental decrees limit the amount of dollars investors can earn, so do they limit the long-term value of the investment. Investors have options if so.
Importantly, there’s more. A lot more. When credit card companies finance the transactions of their cardholders, they don’t just lend the cardholders money. More realistically, they lend the money of return-hungry investors who are willing to fund credit-card transactions in return for the interest-bearing income streams that can be had from cardholders paying off the debts run up on credit cards.
In which case, stop and imagine what it does to their returns if cardholders are delinquent in paying back what they owe. Every dollar once again counts given the high cost of investment mistakes, which means those who finance credit-card debt must be compensated for any failure by cardholders to pay back what they owe.
All of which requires a crucial third glance at the seemingly innocuous efforts by the CFPB to lower the charges levied on late payers. It just seems so right for all concerned, until it’s remembered that not only is investment capital expensive, but investment errors are prohibitively costly. Think yet again the impact of time on money.
What this hopefully conveys to the mildly sentient is that there aren’t price controls as much as there are shortages. And if the political class is able to secure price controls in the form of substantially reduced late-payment fees levied on cardholders, it will as a rule substantially reduce credit availability for high-risk, and occasionally late-paying borrowers. While they won’t endure seemingly nosebleed late fees, they won’t simply because they won’t have credit cards to begin with.
It’s all pretty basic, and it’s basic for the same reason that wealth creation and accumulation is basic for those who recognize time and reasonable returns on their savings over time are the path to impressive wealth gains. This being the case, the costs of return sapping capital commitments are immense. And since they are the cost of a regulatory war on “junk fees” and/or late fees is enormous, and should be stopped.
