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Credit cards you swipe or tap and a store lets you walk out with a coffee. It feels almost like magic. But what's actually happening when you do that? What is this little piece of plastic that lets us spend money we might not have? It turns out a lot happens between tapping your card and getting a coffee, and how that came to be has a fascinating history.
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Ask the obliging bank of America for a jar of soothing instant money.
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M O N E Y It goes back to a surprise on the doorsteps of a small town in California back in 1958. I'm Soni Kassam and this is 1440 explores. We're on a mission to uncover the essential knowledge that explores, explains your world. Stay with us.
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Americans love credit cards. More than 80% have at least one. Credit card debt in the US surpassed a trillion dollars in the past few years, and about a third of all purchases are made with plastic. In my life, I buy nearly everything with a tap. I recently went to sign up for a new card and I had a lot of decisions to make. Did I want cash back or points? Would I pay an annual fee? And the issuer had to make a lot of judgment calls about me. How likely am I to pay them back? How much money would the bank front me? All? That's because a credit card is basically an instant loan. It lets you spend money you don't have. Not yet at least. Instead, your bank covers the cost and you promise to pay them back later. If you settle up in full by the due date, no problem. But if you don't, interest kicks in and suddenly that free money isn't so free anymore. It's different from a debit card, which pulls money straight from your bank account. There's no borrowing here. I Think the best way to peek under the hood is to just use my card. So come along with me. So here I am at the coffee shop. I really want a matcha latte. All right. I'm walking into my local coffee shop. Could I do a grande iced matcha latte? Mocha iced matcha latte? Yes please. And pulling out my card. Now, in the top left corner is the name of the bank that issued it. We'll call it 1440 Financial for the sake of the story. In the bottom right is a logo for another company. Let's say this one says Visa. But it could just as easily have been a MasterCard logo. Or maybe American Express or Discover. Okay, I'm about to tap my 1440 visa on the little point of sale system at the register. Do I just tap it? Yeah. And in less than a second the screen flashes approved. That's it. I take my coffee and go easy, right? Thank you so much. It looks easy, but in those milliseconds a lot has happened. Let's go inside the card reader and see how we get from tap to latte. Imagine inside there's a tiny runner ready to run a relay race. Lets call him Charger. The tapping of my card, that's Charger's starter pistol. He takes off. His first stop, the coffee shops bank. This bank, let's call it Coffee bank takes a look at my card. It has a Visa logo on it. So it tells Charger, run to Visa. They'll tell you what to do next. And so Charger takes off again at the speed of light, heading toward Visa. Now this is one of the first things you need to know. Visa is not a bank. It's a network that connects different banks. Think of it like a highway where each off ramp leads to a different card issuer. You could take the Visa highway or the MasterCard highway in this case, Coffee bank tells Charger to take the Visa highway to my bank, 1440 Financial. When Charger arrives at 1440 Financial, he shouts, hey, Sony is trying to buy a coffee for $5.50. Is this okay? My bank tells Charger to wait outside while it pulls up a full record of my financial life. In a nanosecond it does some investigating. Do I pay my bills on time? How much of my credit have I used? Which card is this? That'll determine the fees the coffee shop will have to pay. And does this transaction look suspicious? If anything seems off? Maybe I'm buying coffee in a city I don't normally visit. My bank might flag the purchase for Fraud. But today, everything looks fine. And so, just like that, poor Charger bolts all the way back to the coffee shop. And just as the clock is about to strike one second since Charger took off, he hands the green flag to the coffee shop cash register. And at that exact moment, the screen flashes approved. I pick up my coffee and walk out the door. But get this, no actual money has moved yet that high speed Sprint. It was just to give a yes, a permission to buy the coffee. 1440 Financial. My bank hasn't paid the coffee shop yet. They've just promised to do so. My available credit drops by $5.50. But the real money that won't move until tonight while I'm fast asleep. And not only that, the coffee shop will have to pay fees for all of this. The wild part is the coffee shop won't know exactly how much the fee is until later. Here's what happens that night, the coffee shop's bank sends all of its transactions from the data Visa, which includes my little purchase. Visa then tells my bank 1440 financial time to pay up for Sony's $5.50 coffee. And by the way, Visa also takes a small network fee for all this trouble, about a fraction of a percent of the transaction. And then 1440 financial sends real money to the coffee shop, but not before deducting something like 2 to 4% for their processing costs and of course, profit more on that fee later. In this case, 1440 Financial has fronted me the $5.50. It's essentially a free loan until my statement hits at the end of the month. At that point, if I pay the full amount back, I I don't pay any interest. If I only make a minimum payment, the bank starts charging me high interest. And if I don't pay anything, they'll charge me interest and hit me with some big fees. Used wisely, the system works pretty well. I get the convenience of not having to carry a lot of cash. I can wait a few weeks to actually pay for things I've bought, and maybe I'll earn some great points I can use for travel. The bank still makes some money from me, something like 3% of every transaction. The store pays that, and perhaps I pay them an annual fee. If I carry a balance though, my bank starts really making money. The average interest rate on credit cards is around a whopping 22%. So if I don't pay back the $5.50 coffee in 10 years, it'll have cost me nearly 50 bucks. So how did we get here? Was it always this Zippy this fast? Not quite. Let me take you back to the early 50s. This is a world without credit cards.
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Every Friday night, Julia's job is to compare the grocery prices of our neighborhood stores.
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Eisenhower is president, the economy is booming, and let's say you want a new dishwasher, but you don't happen to have a massive pile of cash handy. So how easy is this purchase going to be?
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It's going to be a kind of big deal.
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This is Sean Venatta. He's a senior lecturer in financial history and policy at the University of Glasgow, and he's written a number of publications on credit cards.
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I'm the author of Plastic Banks, Credit Cards, and the End of Financial Control.
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So back to our dishwasher purchase.
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You're going to sit down with the credit manager at your local appliance store. They might have questions about your income. They might call the local credit bureau to find out about you. But any large purchase is going to be similar to how it would be if you're buying a car today, meaning.
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You had to get a separate loan for each purchase on credit. Every single transaction was painstakingly approved through personal relationships, phone calls, filling out forms, and then a whole lot of waiting until a 1950s version of a Tech Disruptor, if you will, came along and changed everything in a somewhat unlikely place.
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The afternoon mail comes, and the world changes in Fresno.
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Fresno, a small city in California. It's 1958. All of a sudden, bank of America.
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Just mailed out, like, 60,000 envelopes. And in each envelope was a piece of plastic.
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The people of Fresno had never seen anything like it.
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You can charge almost anything almost anywhere. The BankAmericard gives you instant credit. And so when you open up the envelope, you're getting this piece of plastic with your name with your account number embossed on it. You know, there's no, like, private personal information to activate the card. You just sign it, right? It is this kind of revolution where it's not just that you have a store card and you're using this card in one store. You can go across Fresno with one mailing.
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Bank of America changes the world. Credit is no longer something that banks arrange with merchants and that merchants then painfully, slowly give out on a person, by person basis, like when we tried to buy that dishwasher in 1950. Now, credit is a mass consumer product offered and marketed to consumers. This worked because bank of America was so big, it could ensure that wherever its Fresno customers went, the card was accepted.
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And this took off your wallets never empty with BankAmericard.
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They called it the BankAmericard. And at first, total chaos. Fraud ran wild. People stole cards, and over 20% of cardholders just never paid. Delinquencies were six times higher than the old school. Go to the bank loan system, a disaster. But then it caught on. Stores loved how it boosted sales. Customers realized they could buy now and worry about paying later. And bank of America, they doubled down, expanding across California. But then even that starts to feel limiting. So why not think bigger?
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In the mid-1960s, bank of America decides to take its card plan national by licensing it to large banks across the country. So then you can use a BankAmericard in New York or Miami. And so that's really where we get. What we now have is these nationwide credit card networks that link different banks together.
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So basically, at this point, bank of America is both the bank issuing the card and. And the network, the highway, remember, connecting all the other banks, that gives it a lot of power. All the other banks issuing cards have to pay bank of America, their competitor, to use its network. And that doesn't make other banks particularly happy.
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And what happens is, like as the bank of America network comes online, it's just not functioning very well. It doesn't function well because bank of America is both and an issuer in the network and controls the network. So they have a kind of conflict of interest in how it's being operated.
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It's a bit like if General Motors was also the owner of all the highways in America. This doesn't sit quite right with the other carmakers or in our case, the other banks. So these banks who all have to use the BankAmericard network start to rebel. In particular, one banker starts to rebel with a great name.
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This guy D. Hawk. He worked for a bank in Washington State that enrolled in the BankAmericard program. And so there's a rebellion of these banks, which Hawk is kind of leader of, and they convince or sort of coerce bank of America to separate the network from the bank. It's a coup. Basically.
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The real kind of dramatic Moment comes in 1976 when BankAmericard changes its name to Visa. That's why BankAmericard is becoming Visa, the.
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Most widely recognized card in the world. And so that's kind of this moment when it really separates and becomes its own thing, where the network as a kind of entity is really distinct from the banks that are participating.
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To recap, thanks to, or more like forced by D. Hawk, bank of America spins off its network. Now, instead of a bank controlling the payment network. We get two distinct players. One banks like Citibank, Wells Fargo and Capital One that issue cards and lend the money. And two networks like Visa and MasterCard, which came up around the same time that process transactions and make sure money moves between banks. And here's the thing, that basic setup hasn't really changed since the 1970s. Banks issue the credit networks route the payments quick. Side note, there are two exceptions, American Express and Discover, who are both lenders and run their own closed networks. So every time you tap your card, you're stepping into a system designed decades ago, though today it's operated at lightning speed. That part of the story In a Moment.
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1440 started in 2017 with a simple to deliver fact driven, impactful news to smart, curious readers. Today, our audience of over 4 million is made up of engaged news consumers who want more than just the headlines. They want to understand the why and the how. Yet finding high quality resources to go deeper beyond this podcast, of course, has never been more difficult. The best work, from videos to long form journalism, is too often buried beneath countless pages of clickbait and low quality AI generated content. That's why we created 1440 topics. Our staff hand curates only the best content and organizes it into a single place for you to explore.
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Explore.
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We've done the hard work so you can spend more time learning about alternative investments, hurricanes, ancient Rome, and so much more. Continue learning at join140.com 1440Topics separating what's worth your time from the rest of the Internet.
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So far, we've seen how credit cards were born, how they work, and how they spun off networks like Visa and MasterCard. Up to this point, this has been a story of American innovation, a story of faster payments, of no more waiting weeks for approvals or filling out stacks of paperwork just to buy a dishwasher. But while this has made buying things easier, it's also had a big effect on a lot of people's finances.
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Part of what the card system enables is high interest consumer debt. And that does create, I think, a lot of damage for households that find themselves in high interest credit card debt.
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And that brings us to credit card interest rates. This is the cost you pay if you don't pay off your balance in full every month. And here's the kicker. Roughly half of Americans don't. Which means for millions of people, every swipe, every tap, every unpaid balance gets more expensive by the day and by how much.
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Current credit card interest rates on average are like 23%.
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That's almost three times the current mortgage rates, twice the rate of a car loan. Turns out these rates weren't always this high.
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Consumers are using state law, are limiting credit card interest rates successfully through the 1960s and 1970s.
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But then in the mid to late 70s, something shifts. Courts rule that credit card companies can ignore other states interest rate limits as long as they obey the laws in their own home state. So what do the banks do?
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They move the actions of the most aggressive firms, Citibank in particular, by relocating to places like South Dakota and Delaware where there are no state interest controls, which then enables them to charge any interest rate they want.
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And remember, by Now, Visa and MasterCard have built nationwide credit networks. So even if the bank is in Delaware or South Dakota, its customers are everywhere. Which means no matter where they live, they're subject to Delaware's or South Dakota's rules. That's still the system we have today.
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I think Delaware and South Dakota did great, great for themselves, right? These are states that were really struggling with agricultural depression, with deindustrialization. They saw in finance a source of good, well paying jobs, and so they took the chance. But what it means is that we live in a system where the states with the fewest people and the most banks end up deciding interest rate policy and kind of consumer well being for the rest of the country. So credit cards are one of the most profitable lines of business for the biggest banks. And that's because, you know, they're able to charge whatever interest rates they want.
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Okay, so from what we've learned, interest is the big one. But it's not the only way banks make money off credit cards. Even if you pay your balance in full every month, there are other fees lurking in the background. These are smaller than interest, but still adding up over time. One, the annual fee. Some cards are free, but for the privilege of having a premium card, you could owe anything from say $95 to nearly $700 per year for lounge access and fancy perks you may or may not use. Two, late payment fee. Miss a deadline and Boom, something like $35 is gone. Not interest, just a penalty for being forgetful. And three, maybe a foreign transaction fee, a 3% toll just for daring to buy a croissant and Paris. None of these hit as hard as high interest rates, but together they guarantee the bank always gets paid one way or another. Okay, before we wrap up, there's one last fee we need to talk about. But don't worry, this one isn't coming out of your pocket. At least not directly. It's actually a mix of different fees. But for simplicity, let's call it the merchant's fee and pay attention. Because this fee is the reason credit card rewards and points exist. To understand how it works, let's go back one last time to that coffee shop at the top of the show. Could I do a grande iced matcha latte? Iced matcha latte? Yes, please. You remember when I tapped my card and charger sprinted across the network from the coffee shop to my bank and back? And later that night, while the coffee shop owner and I were fast asleep, 1440 Financial paid the coffee shops bank. Okay, so that $5.50 for my fancy coffee, if you recall, it didn't exactly come from me. I won't pay up from my checking account until the end of the month when my statement arrives. That's 30 days from now. But from the coffee shop's perspective, waiting isn't an option.
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Even if I trust Sony completely, I don't want to wait 30 days for her to pay me. I want to get paid now, right? And so I'll take a 4% hit to get paid immediately. But it is mostly about like the merchant not wanting to take the credit risk and wanting to have the money quickly.
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No waiting, no chasing me down, just getting paid immediately. That's one big benefit the credit card system offers the coffee shop. Think about it, 1440 financial. My bank takes on all the risk. They're the ones who have to chase me down and actually pay. Check that I'm not maxed out, or worse, that I'm not a fraudster posing as me. And for that security, as well as access to the huge universe of card users, the coffee shop is willing to lose some money. Okay, fine, a lot actually. Generally 2 to 4% of the transaction. That's the merchant's fee. Another benefit of cards is that cash the alternative, it's actually costly as well. Cash means counting and storing bills, worrying about theft and making bank deposits. It can be a nightmare. Alright, I promised you that this merchant's fee wasn't just some boring economics lesson. As promised, here's what that highly technical and buried fee often helps pay for the rewards of using the American Express card keep adding up. Every time you use the card, you can earn points that translate into a world of exciting rewards. That's right, credit card rewards.
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All of the kind of reward points, in theory are coming out of the discount fee. So if you use a rewards card often it costs the merchant more. But they don't have a choice whether or not to accept it. Because if they're in the Visa network, they have to accept all Visa cards, credit and debit rewards or not.
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The cash back, the miles, the points, they don't come out of thin air. They're funded by the fees that businesses pay every time you swipe. And the bigger the rewards, the higher the fee. That's why premium cards, the ones with lounge access and luxury perksalso, charge merchants the most. But there's a ripple effect. To make up for those fees, businesses often raise prices across the board, which means everyone pays more, even people who pay with cash. In other words, credit card rewards programs, which tend to benefit wealthier customers, are essentially subsidized by those who don't use credit at all. Some argue this is unfair to small businesses who operate on thin margins and have no choice but to accept cards, and unfair to lower income consumers who end up paying higher prices without reaping the benefits of points, miles and cashback. As for Sean Venatta, he's American, but he lives in Scotland now. And that's given him a window into Europe's very different credit card culture.
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Continental Europe is much more anti credit card. They developed a debit based card system instead of a credit based card system. And they really, I'd say, resisted. And even still, consumers tend to resist using credit cards for day to day payments in a way that Americans don't have any problem with.
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Turns out credit cards in the US play by a different set of rules, especially when it comes to fees. In fact, compared to the rest of the world, Americans pay some of the highest credit card fees anywhere. Take the merchant FEES in the U.S. these hover around 2%. In the European Union, they're capped at just 0.3%. And remember what we learned about rewards, they're funded by those fees. Which means in Europe, in much of the world, credit card rewards are a lot less flashy. But on the flip side, merchants aren't paying as much just to accept a card. And my final question for Sean, it's the last piece of the puzzle. The way banks measure and manage risk, not just on purchases, but on you as a borrower. And it all comes down to a single your credit score. Before modern credit scores, banks had, let's just say, some interesting ways of deciding if you were trustworthy.
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In the 1950s, your credit is in like a logbook. It's not just your payment information. It's like, are you sober? Are you faithful to your wife? All that kind of stuff is in there. And then as the banks are developing nationwide networks and trying to digitize finance. Credit bureaus are also doing the same thing.
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Today, your credit score isn't just a number. It's your financial reputation. And you want to know who the real power players are. They're FICO, VantageScore, and the three big credit bureaus, Equifax, Experian, and TransUnion. They track every payment, every balance, every late fee. And like it or not, banks, landlords, and even some employers are paying attention. A score over 800, you're golden around 740. Still great. Dip below 670, things start getting expensive. Because in a world built on credit, your score isn't just a number. It's the key to everything. So what have we learned? Every time we tap, swipe, or insert our cards, an entire system kicks into motion. One designed decades ago. A system where banks take the risk, merchants take the hit, and we, the cardholders, walk away feeling like we've won. And in a way, we have. Points, miles, cash back. But only because the system needs us to keep spending. Because at the end of the day, credit cards aren't just a convenience. They're a business. A very, very profitable one. So next time you buy a coffee, remember, you're not just making a purchase. You're stepping into a financial system designed to keep you spending. And now that you know the rules, you get to decide how to play. Thanks for listening to 1440 explores. I'm Soni Kassam. Make sure to follow the show and leave a review on Spotify, Apple or wherever you listen to your podcasts. And let us know what you think@podcastoin140.com while you're at it. Subscribe Start your learning journey with us at join140.com subscribe to our free daily and weekly newsletters on world affairs, business and finance, society and culture, and much more. 1440 explores is a production of rhyme media for 1440 media. This episode was produced by Nicolo Minoni. It was fact checked by Sanam Skelly. Our sound designer is Jay Cowett. The executive producer at Rhyme is Dan Bobkoff, and the executive producers at 1440 are me and Drew Steigerwald. See you next time.