Ebay Advertiser (2:56)

I don't know.

Jill Wiesenthal (2:56)

I find credit cards to be a weird business. Like I don't really know what Visa does relative to say, the bank that issues a Visa card, et cetera. I don't know how they slice the. I don't know anything about credit cards.

Tracy Alloway (3:06)

It's a very opaque business, for sure. And it's a weird business, I would say, like it's competitive, but also it's like not that much, you know, like everyone's kind of doing the same thing in many ways. So we should talk about it. It's also, I imagine, kind of sticky in the same way that deposits at banks are sticky. We spoke with Joe Abate about that a while back.

Jill Wiesenthal (3:26)

So some people cycle through them a bunch and stuff like that. And there's so much credit card advertising. I don't know what's good or bad or whatever. Look, I use my credit card as a payments card because I don't really. I don't carry a balance from month to month, so I don't, I don't know, I think about interest rates or whatever. I pay it off at the end of every month because I just basically use it for payments, et cetera.

Tracy Alloway (3:47)

So.

Jill Wiesenthal (3:48)

So I just don't know much about them. But they're a huge major consumer financing source.

Itamar Drexler (3:52)

Yeah.

Jill Wiesenthal (3:52)

And everyone's talking about fintech and BNPL and all these other things and stablecoins and all this other stuff and it's like. Yeah, but the big one. Who's talking about the big one. Credit cards.

Tracy Alloway (4:01)

Well, that's the thing. So points have become a bigger attractant, I guess, to credit cards. And so people are spending more with their credit cards and carrying a bigger balance, which means that the rate that you're paying on the credit card is actually more important potentially than something like your mortgage rate.

Jill Wiesenthal (4:18)

Totally. Well, very pleased to say we do in fact have the perfect guest, someone we've had on the podcast before. I think last time we were talking about Red Q, which is bank lending in the 70s. I like his work because he goes back to the simple things like, let's just talk about how this works. Let's talk about how this works because I think we move on too quickly without sort of understanding the basics. Maybe there are stones left unturned. Literally. The perfect guest, Itamar Drexler. He is a finance professor at Wharton and he was the co author of a fairly recent paper sort of looking at the question of why Are credit card rates so high? Because if you actually do borrow from them, sometimes the rates like 20 something percent seems way higher than any other sort of lending. So. Itamar, thank you so much for coming back on odd lots.

Itamar Drexler (5:03)

Thank you very much. It's really nice to be back. Thank you for having me.

Jill Wiesenthal (5:05)

When I was doing some prep for this episode, there is not a ton of actually like fresh academic work on the credit card industry. There's not a ton of papers, but it's this huge space. Why did you see a reason to, to go back and revisit the sort of basic simple question of looking at interest rates on credit cards?

Itamar Drexler (5:25)

Yeah, so my interest is usually like we talked about when I was here last time, is monetary policy, macro and a lot of banking. And I had some students who are co authors now on this paper a couple of years ago want to talk about fintech because fintech is a very popular topic. And then I was thinking, well, how do we analyze fintech and what's the potential room for fintech to grow? And if we don't really understand how the dominant incumbent players, the credit card banks work? And then we look at this and I was very surprised to see something kind of simple, which is that the return on assets for credit card banks are just way higher than the average bank. So bank ROAs are typically, you know, one 1.2%. They move a couple basis points. Very exciting. Credit card banks ROAs. And you know, most banks are not just credit cards, so it's actually even higher than this are in the three and a half, often 4%. So I was very shocked by this. Okay, how come it's so high when it's so hard to squeeze out a couple basis points? And then one of the reasons is just they charge really high rates. Like, okay, how do they get away with this? You know, what is going on here? Just very simple question about how to decompose that rate into the pieces and kind of what's left over at the end.

Tracy Alloway (6:36)

In the spirit of starting at basics, walk us through the revenue that credit card issuers or credit card banks are actually earning. The different types and who the players are in the system.

Itamar Drexler (6:47)

Yeah. So let's separate first into two categories. One are people who revolve their balance. And that's what most of the paper is about because I think that's the more interesting part and there's more details and it's kind of the banking part of it. And there are actually a lot of people who revolve. Often I find people are surprised to hear this, but about 60% of the credit card users actually revolve, so. Meaning that they don't pay in the grace period at the end of the month. And so they're hit with these very high usually interest charges. And then the other part are what people call transactors. So they're the kind that do pay during the grace period. So they're not paying interest. Okay. So for the revolvers, there's again multiple parts. So you pay interest on the balance that you have. But before then, there's the part which applies both to the transactors and revolvers. When you swipe the card, then there's immediately a percentage taken. People call it the swipe fee. And that is split up into a bunch of pieces. The ones that I used to be aware of, that most people are aware of is the card network like Visa, MasterCard, Amex. There was Discover, which is now part of Capital One. And that's. There's a whole menu, but basically it's like 15, 20 basis points.

Jill Wiesenthal (7:58)

Okay, okay.

Itamar Drexler (7:59)

Doesn't sound like a lot, but there's like $10 trillion of purchases between debit and credit cards. Turns out when you take 20 basis points of $10 trillion, kind of adds up.

Tracy Alloway (8:09)

Nice business, if you can get it.

Itamar Drexler (8:10)

It's really nice, actually. Be surprised that usually Visa and JP Morgan are the two most valuable financial services firms. They change who's number one. So Visa's, you know, been worth over $600 billion. It's a lot.

Jill Wiesenthal (8:24)

Yeah.

Itamar Drexler (8:24)

And MasterCard's gigantic too. So there's that. Then the majority of that swipe fee, the majority of the remainder actually goes to the bank that issued the card to the consumer. So that's called interchange. Again, there's. They don't make this, like, very easy to tell, but in our data, it's a little over 1.8% on average. I think it's largely been trending up over time slowly. So the bank gets that. It actually gets the vast majority of that. And then they pay your rewards and things from that. A lot of that goes to just pass through to the rewards and things. And they keep a small portion of it for themselves. But the big part of their business, where most of the money comes from, that we analyze here, is all these people that revolve, they pay an interest rate. And that interest rate now is on average 23%. Wow. Which is just was like a shockingly high number. I mean, I guess I've seen that it just when you work on assets and like, you Know, think the kind of things you guys talk about. Bonds and bonds pay, you know, whatever 5% investment grade spread is not even 80 basis points. Now on top of it, high Yield spreads under 3%. Like how the hell do we get to 23%?

Jill Wiesenthal (9:30)

Yeah. When you hear this number, 23%.

Itamar Drexler (9:34)

Yeah.

Jill Wiesenthal (9:35)

And you think about the fact that credit card users can be decomposed into transactors and revolvers.

Itamar Drexler (9:41)

Right.

Jill Wiesenthal (9:42)

My first instinct would be, well, the transactors are very on the ball. They're like not credit risks. I've always been just a transactor. I've never revolved how much of that increased spread can just be explained by likelihood of default from the revolvers, which I presume are perhaps a little more financially precarious and maybe less financially sophisticated.

Itamar Drexler (10:07)

Right. So I think if, like me, you didn't know much about this. Your assumption, if I think if you ask most financial economists, the first thing they would think is, well, it must be that most of the remainder is charge offs. Right, Defaults. And that's not true. So you can find that pretty easily. So the average charge off rate on the revolvers, okay, so when you look at it, let's say you look it up online, you'll see kind of, you know, relative to the whole balance sheet, so includes both groups. And like you're saying, by definition transactors don't borrow, so they can't default. That kind of makes it go down a little bit. But the majority are revolvers. So if we kind of clean that out, then on average in our sample, it's 5.75% of balances are charged off. So it's not trivial by any means. That's a high number. But again, we were talking about 18% spread. So if you think, oh, it must be about 18% charge offs, it's not even close. And it's like never been that high. So you might think, well, maybe it's just that's on average. But sometimes it'll spike. To be ridiculous numbers, it does spike, but not for very long periods of time. So the bottom line is it's a substantial chunk of it, but not even close to a majority of it. So, you know, people default, but they don't default that much.

Tracy Alloway (11:16)

Can I ask one more question? On APR and the average there, did you observe any trend over time? Like, did the rate actually get higher as time went on?

Itamar Drexler (11:25)

So that's something we haven't spent a lot of time on in this paper. But the answer to your question is this is obviously yes. So if you look at it, I think what can be found online is again it's, I think there's something a little misleading there. But that has trended up pretty strongly I think. Not as much as somebody, you know, goes to their computer and looks up. I'll say. Fred from the call reports, what is the average APR? It looks crazy. It looks like it's gone up 10%. It's gone up. We're going to get to the bottom of like exactly how much. I think it's gone up substantially since 10 years ago. Let's say that trend is clear. I don't think it's as much as it looks like there, but yeah, it's been going up actually.

Tracy Alloway (12:00)

Okay, so you've established default rates for credit cards and as you said, like this business is about volume, right? So is there an argument to be made that maybe if the world, you know, falls apart then you have lots and lots and lots of consumers who are defaulting, but you know, potentially at a low rate of the total. But the volume makes it meaningful for banks.

Itamar Drexler (12:24)

I mean we are already looking at as a percentage of assets. So that kind of like valuates it takes it all into consideration. I think the question like in our minds was at first, you know, maybe in a crisis something extreme happens. In a sense it does. But this is already the average default rate. So usually it's lower and then you kind of include this in there. So we'll talk I guess a little bit about risk premium which turns out to be very clear here and important. But it's, you know, just the average default rate is what it is. So it's not an expected default. Again there's, it's surprising. But at the same time if you just look at where banks actually suffer default losses in an average year, not a crisis year, something like 50% of banks default losses are actually coming from credit cards. The thing is, is that they're not surprising, they're not unexpected losses. They're kind of the expected, but it's still really big. And the reason for that is even though credit cards only take up about 5% of bank's balance sheet, the charge offs or the defaults on average bank assets is very low. I mean now we have this impression of banks as being these like crazy like risk taking lunatics. Actually I think the right way to look at them is that their average asset is extremely boring and low risk. They do take a lot of leverage which is only possible because the average asset is extremely boring and low risk. But even after all that their amount of defaulters is not really that high. So if your average Asset has about 40 basis points, average charge off, and this thing has over 5%, then even if it's only 5% of the balance sheet, it can act like it's 50% of the charge up.

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Jill Wiesenthal (16:23)

Forms of consumer borrowing, right? Like people are very assiduous about making their car payments. Yes. Making. I don't know if.

Tracy Alloway (16:30)

Well, up until recently.

Jill Wiesenthal (16:32)

Up until recently. But Historically, the perception was people really prioritize car payments. Right. Because you. That's essential to live and you can't have your car repossessed. Home mortgages, obviously, for obvious reasons, I imagine that a stretched household will miss credit card payments, are more inclined to. If they're going to have to miss a payment, it's going to be there versus some of these other popular areas of borrowing.

Itamar Drexler (16:58)

Totally. So the other ones are secured and this is unsecured. So in that sense, this is an actual asset that's kind of risky and interesting from my vantage point, in that it's unsecured lending to normal people. All the rest of the stuff is secured. Like, homes are obviously very important collateral. Cars, pretty much. So the rates on those are much, much lower than these. They're nowhere near, you know, the spread. There's nowhere near as juicy. I mean, when I teach students, we go through like, you know, the hierarchy of borrowing, that the vast majority of borrowing is secured. You have to think it's crazy for a bank to come to somebody with a medium or lower credit score and say, here, have a line of credit of like 5, $10,000, and you can default on it. You don't get shot for that. It's. It's part of the law. It's part of the game.

Jill Wiesenthal (17:44)

Yeah.

Tracy Alloway (17:45)

I was reading an article from life in 1970 where they were talking about how credit cards are becoming a big thing and oh, my God, these credit card companies are just mailing out applications to Americans. It's like giving sugar to diabetics. That was their analogy. Speaking of unsecured versus secured, I am also looking right now at a website that claims to have invented the first credit card that's based on your stock portfolio. So borrowing against your stock portfolio with a card, I gotta say, the card does look pretty nice. It's made of glass. Maybe that tells you something.

Itamar Drexler (18:20)

Unintentional metaphor.

Tracy Alloway (18:21)

Yeah, exactly. Okay, so if it's not about risk premiums, if the rate isn't compensating for something like default, could it be compensating for all the points and benefits that customers are accruing?

Itamar Drexler (18:34)

So it's not just compensation for expected default. I want. I want to separate that from the risk premium. The risk premium is kind of the compensation for unexpected default, which turns out to be pretty big here. But let's go back and talk about the points and stuff. So I find that people are more excited to talk about points than anything. The term rewards was really a marketing flourish. So. Yeah. So in total, number of dollars. This interchange was, I mean again you have to look at find exact numbers but for credit cards alone I think it was over $150 billion. So like the GDP of a medium sized country gets transferred as interchange and we find that about 85% of that gets transferred through as rewards. You could wonder, I think it'd be natural to say what is the point of this? Why charge people 1.8% and then pass through 1.57% as rewards where well, at least some people like I guess you and I Joe don't pay that much attention. I think I have enormous amounts of United miles I'm never going to use because I'd have to actually travel to whatever place to use them. So why is that? I mean I think it's a good economic question and people have tackled this. I do think it creates a very strong network effect. So you are not actually seeing a charge for this. It's the retailer that has to eat it. And if you do not use a card that gives rewards, you're not going to get in most cases a lower price. So there's a whole series of litigation and fights over the years. Amazing about what retailers can do to discriminate prices based people who using cards and aren't. And I thought a couple years ago or the last couple years I'm seeing more restaurants give you back a percentage or not charge you a percentage if you didn't do that. But it's a little bit beyond my legal expertise to sometimes understand these because for the longest time I think you could give people a discount but you couldn't do a surcharge. There was some legal discrimination between those things and as a result people mostly don't pay attention to that kind of thing. And so you, you really want to stay inside the network and it kind of keeps you there. Even if at the end it would be a total pass through, it still helps for them to keep this business.

Jill Wiesenthal (20:38)

You know it's interesting, there's this crypto company. Have you heard of Blackbird? Yeah, it's a crypto thing and they have a bunch of restaurants. You sign up and you like paying a coin. I don't know exactly how it works, but I think that they have to on some way because in theory it'd be nice like maybe we'll get a little bit into stable CO as like a payments rail in the future or in this conversation and think it'd be a nice way to like circumvent this. But even they just I think implicitly have to Reinvent the rewards model to do it. Maybe you get premium seats or you get reservations, etc. In order to sort of like bootstrap a new network, you start end up having to reinvent a lot of the rebates and the benefits, etc. That come with the old network. We will get into crypto a little bit more. But talk to us a little bit more then about like the persistence of this spread that can't fully be explained by defaults.

Itamar Drexler (21:30)

Yeah, so the default, like we said, is like a little under 6%. Then I'll mention it. So defaults do spike in bad times. So we estimate using kind of the cross section of different FICO scores, how much extra compensation you get as you go to lower and lower FICO scores in terms of extra APR net of the defaults. So we estimate that the risk premium there is accounting for about similar size piece. So there's a risk premium about 5% on average, which is much smaller for let's say you're an 800 FICO borrower, there's not that much risk premium. But if you're a 600 FICO borrower, the risk premium goes up to like, you know, 9%. So I think it means something very important. I think the person who's borrowing there may not realize that they are paying a very large risk premium. So if you're a low FICO borrower and you aren't going to default, like, you know you're not, you're paying a very high risk premium. And that is because other people default in bad times. Even if you do think you're going to default sometimes I think one should realize how much of a risk premium you're actually paying for this. So but now let's go back to something else before we maybe talk more about that is the other pieces of this. So we talked about interchange and rewards. It's not zero. They do earn a little bit from it. Most of the transactors, what they make off transactors is that difference because transactors spend, you know, recurringly a lot of borrowers tend to kind of accumulate and they don't have that much more room to spend because they've borrowed. So that's not a big portion of the revenues there. Then there's fees. That's another couple of percent is actually making the puzzle worse. And then the part that turned out to be really big that surprised us is operating expenses of which marketing you mentioned this turns out to be really big. And if you.

Tracy Alloway (23:10)

This is the thing that I don't get there is so much marketing for credit cards and as I said, like they're all kind of similar in many ways. And I remember this was often the blockage for new entrants from the fintech space trying to get into this business. I remember talking to Lending Club about this back when they were a thing and they were spending so much money on mail advertisements. And I just don't get why that's the primary acquisition channel and why it seems to be so important to the business model.

Itamar Drexler (23:39)

It's a really interesting question. Maybe the answer would be like people listening to this will be like, oh, I knew that. Which is the reason you do it, because it works. Which means, which, by which I mean this goes back to Joe's question. I think you can see we look, we do this analysis there that if you spend more on operating expenses, which I think largely means additional marketing because the actual operational side of this apparently is very expensive. But there's big differences across these guys in operating expenses. And I don't think it's because their systems are like much more and we actually see no relation between that and default. So it's once you control for fico. So it's not, not about screening people for better borrowers. But what it is, it's an effective, apparently at the margin customer acquisition strategy. So think the following thought process. You could say, well, why don't somebody just cut all this marketing out and just charge a lower rate and that'll get people.

Tracy Alloway (24:28)

Yeah, that's, that's your acquisition advertising. Right.

Itamar Drexler (24:31)

Apparently it doesn't work. So, so people are not, are not rate sensitive. Which is a recurring theme I'm starting to, you know, learn when we talk about, we talk about banks and bank deposit rates, people are, they're not completely insensitive, obviously, but they're not that sens to the rates they get paid and they're not that sensitive to the rates I get charged on this. So there are actually, this is a surprising thing. The CFPB has a spreadsheet. Well, when there are people still working there, they used to have a spreadsheet that they updated with essentially every single card there is and what the rate on it. And all the cheapest cards are credit unions and they're significantly cheaper, much cheaper than your average credit card. But I'm sure almost nobody except their customers have heard about them. And that's because they don't advertise much. And so, and you say, well if their rates are so cheap, why don't people go there? It's like they haven't heard about them and they don't care that much about the rate is my inference from this. So the more you pay for marketing and operating expenses in the data, the higher is the average amount you're able to charge for.

Jill Wiesenthal (25:28)

That's really funny. Does some of this stuff repel the brain of the academic economist? No, for real. Like this idea that the borrower wouldn't be rate sensitive, the idea that we're actually paying more to be advertised to, etc. Because this is their cost. The idea that there are lower cost options out there and all we have to do is search for them and.

Tracy Alloway (25:48)

They'Re available like, well, also for macroeconomists specifically.

Palantir Advertiser (25:53)

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Tracy Alloway (25:53)

Because we talk about benchmark rates and the importance of how those feed into the economy. And here we are talking about the credit card rate, which is actually potentially more important.

Jill Wiesenthal (26:02)

Yeah, like I'm serious though, like, rates are high because to some extent consumers just aren't paying attention to them, et cetera. Do you encounter people who think, no, there must be something, there must be some variable you're missing because we're rational and we would seek out the lower rate.

Itamar Drexler (26:16)

I want to talk to people like you're saying, I haven't really had the chance because when you pitch this to a finance audience, not macro people, and I'm a finance person, then they're more open. I mean, credit cards is a thing in finance. People like credit cards. But I think the interaction with macro and monetary is really interesting. So it doesn't bother me because I think it's interesting. I mean, I think it's, it's kind of bad that a lot of people who are usually not in the best shape are essentially adding 6% rate to their credit card because they're paying for the advertising that they responded to. But, you know, that's, you know, you could get, if you didn't respond to the advertising, responded to the rate, they would do that instead, but they don't. So, you know, think about, you know, you guys often talk about the Fed lowering or hiking rates. At the risk of sounding heretical here, I am not a huge believer that consumers at all are very sensitive to these changes in the policy rate and the fed funds rate. Even though the standard model works through their intertemporal consumption savings decision, I think most of the evidence is very weak that they care about that. And then the credit card, I think on top of that really makes this clear. Because if you're paying 23% and you are the kind of person that wants to borrow. I mean, obviously because you've borrowed, how much is a half a percent going to matter to you if the Fed hikes? Plus you could have been getting a much cheaper rate anyway, and that didn't compel you to go looking for it. So. So I think it kind of puts a big question mark over whether that's really the channel which, which is. A lot of people have said that, but it's still kind of the main way we talk about those things.

Tracy Alloway (27:47)

Can we talk a little bit more about competition? And why doesn't someone just come in with a lower rate and disrupt the entire business?

Itamar Drexler (27:56)

Let's give you another example. Personal lines of credit, these were all new things to me. I find this, I think where you've put retail people with the financial sector, you actually get a lot of explosions. They're like weird stuff. So that's the places where sort of academics should go looking and many do. But it's not the place where I kind of having worked at like hedge fund market maker, ever thought about these things. You don't think about like the fancy people, like the people who are sophisticated, do all the math, but they kind of cancel each other out. Where the real fireworks are is when you get into the retail sector and if you look at personal lines of credit from the same companies at the same fico, they're substantially cheaper. Plus you get all the money up front. This is something I. It is still very puzzling that there is almost no marketing there. You don't get marketed a lot on personal lines of credit. And the people who discover them do use them to consolidate these debts and pay them off in one shot at a lower interest rate. It's a very, I think, very logical thing to do that people don't do. But I mean, just to get back to. I think we see over and over and you're talking about BNPL and stuff, this idea of how do you acquire customers and what role the rate actually has there is. I just keep seeing it. It's like a movie. I've seen this before. It's more effective at the margin than lowering the rates. And it explains a lot, I think, of how the finance sector interacts with retail, which is not just like canceling out. So that's the issue. It's like, oh, well, they spend 5% of assets on marketing, then they add 5% to the cost. I guess there's no harm in that. Well, not really because what people have done is paid the 5% in order to get the marketing. So if you really like the commercials, you should be really happy. But I don't think most people would sign up for that.

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Itamar Drexler (30:44)

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Tracy Alloway (31:47)

I'm just. I'm still stunned that the advertising actually works because like I, I get the mail and I just throw it out without looking at it. Maybe I should be looking at it on the disruption front. You mentioned BNPL and we've done at least one episode on it. We should probably do more at some point. Is that the big disruptor? You know, if they're plugged into websites and some of them are getting rewarded for being plugged into those websites by retailers, then they bypass the high acquisition costs and presumably can still acquire customers because you see them everywhere online.

Itamar Drexler (32:21)

So I do think that has a lot to do with what their angle is, is it gets in front of you in that way. I listened to a recent episode of yours. I think you guys were talking about bnpl. Assume I wasn't going back into a much earlier episode. But I don't think the economics of the BNPL beyond that aspect of it are that different from the credit cards. And there still is very high operating and acquisition cost. If you look at, like, BNPL companies first, most of them don't really make money. And so I think they're still in that stage where they're building up to it. And you mentioned Lending Club. Lending Club didn't make money.

Tracy Alloway (32:56)

No, no, it did not.

Itamar Drexler (32:57)

It didn't. So. Because I think you want to grab these juicy customers, but they respond to the marketing. And just to go even back to that. So Amex is one of. It's really hard to find aggregate marketing numbers across companies, but from lists I've seen, Amex might even be. It's definitely, I think, a top 10 marketer in the whole country. It might even be in top five. I'm not sure. Along with some of the. It spends over $6 billion a year on marketing. And this is not including the lounges and all this, which is. There's been, like, articles about how everybody's, like, investing, like, millions of dollars in these lines. That's a separate category. And Capital one spends over $4 billion a year. So I looked it up, and Amex is bigger than Nike and Coke and marketing. And you think of, like, those are being the ones that are got to be like, the gigantic ones. And Capital One's about as big a.

Jill Wiesenthal (33:44)

Personal line of credit. That's just a good classic. What is that product? I've never looked into one of those.

Itamar Drexler (33:50)

I haven't.

Jill Wiesenthal (33:51)

Is that an unsecured loan from a bank?

Itamar Drexler (33:53)

It's an unsecured loan, but this is.

Jill Wiesenthal (33:54)

Just like classic bank borrowing. I go to the bank, I say, can I borrow some money?

Itamar Drexler (33:58)

Surprisingly, you can look it up. Even, like, it's so easy to look it up. They offer. It's a relatively large amount compared to a credit card. And you put in your fico, they give you a rate. The rate's almost for sure. Always lower than the credit card. I don't get it either, but. But, you know, I, you know.

Jill Wiesenthal (34:17)

And one could use these to pay off revolving.

Itamar Drexler (34:19)

That's Mostly what people do, which they should. I had a journalist ask me about this and I was like, this is a great idea. Like I should look this up and talk about this. I mean, there's no, you know, how do you explain this spread? I mean, I think largely it's got a lot of this. Less of this retail focus to it. But yeah, it's the same companies too. If you go to Amex, you can Amex line of credit. Discover offers a Discover line of credit. Capital One and Capital One line of credit. It's the same thing.

Tracy Alloway (34:42)

It's so strange, this whole conversation.

Jill Wiesenthal (34:45)

It edges into some frankly, like slightly uncomfortable territory, in my opinion. Because you. Right, because especially when you characterize something as like you're kind of end up paying a lot for them to advertise to you and you apparently like the advertisement because that's. You responded to it, et cetera. Like, you edge into this territory where it's like, these are not like it must be though, not the most sophisticated base. Right. It's like, why do Nigerian email scams have all kinds of typos, et cetera? And the theory is because they want to select for people who will be foolish enough to respond to them. Because if you go down the chain, they don't want you to be too savvy and asking questions. So like, let's just get all the savvy customers out of the way who would instantly recognize a scam email and then you like get there. It's right.

Itamar Drexler (35:34)

Are you saying that the Nigerian princes don't pay you? Because I think I might be in trouble.

Jill Wiesenthal (35:39)

Like, it seems like there's a filtration on where you end up with the base of Revolvers where all this money is made, who are just clearly not that financially savvy because otherwise they would be doing the personal line of credit or not doing these things or looking for that credit union credit card.

Itamar Drexler (35:54)

Well, I'll say something about marketing. I mean, we all do respond. You know, you guys are, you guys are very not elitist here. Every anti elitist. So marketing is a. Just a huge industry. Is. As a finance person, I'm like, like we do have a marketing department at the business school. And I'm like, wow, there's a reason. Because you look at, let's say you look at Alphabet and Meta. Yeah, Meta's revenues are almost 100% from marketing and Google's are like close to 80%. We're talking hundreds of billions of dollars a year and all the very sophisticated stuff. And at the end it's to sell you advertising.

Jill Wiesenthal (36:30)

It works. And I've, I've certainly been taken, I got taken in my marketing all the time.

Itamar Drexler (36:35)

Just say one, say one other thing is I think the reason that because the roas here are high when we decompose this at the end it sort of does most. If you take the alpha of this, think of this as alpha relative to the average bank asset we get that it's about a percent. So how do you get down to a percent? So the risk premium here is quite big. We compare it to the risk premium on bonds. You have to compare it to high yield corporate bonds and it looks similar for all but the lowest FICO bonds versus let's say triple C rated bonds where the lows FICO seems to have a big chunk the risk premium over and above the bonds. I'd actually say the bonds look a little low relative to that because it's the risk premium on credit cards that kind of rises linearly and it's the bonds that kind of don't. But for the not so bad credits it's pretty similar risk premium to high yield bond markets. So Netsense doesn't look, it's big but it doesn't look crazy. But I should say Goldman I think before they got into credit cards and it did not work out. So apparently it's, it is competitive in that sense. I think they were eyeing this and saying this is a good business. You see the highest ROEs by far of all the, you know if you go look through the banks, 10Ks, you know some of them break this out. I think JP Morgan for example and you see like that's got the highest ROE by far that it's bigger than the, you know, all the other parts of the bank. So I think they were thinking that and we got into it. They paid very high operating costs and had higher defaults than, than other ones that didn't obviously did not work out because they turned away from it.

Tracy Alloway (37:55)

Do you see any signs of rates eventually coming down? It sounds like it's probably not going to be through competition or new entrants like FinTechs. But could it be something like regulation? I have vague memories of the Credit Card act doing something on this front. But could it be something like that?

Itamar Drexler (38:11)

The Credit Card act, there were tons of papers on it when it came out. Mostly limited your ability to increase rates on existing borrowing.

Tracy Alloway (38:18)

Okay.

Itamar Drexler (38:19)

And did it sort of put caps on all kinds of fees and charges and then people were looking for whether banks would move that to something else. I think in the long run, the answer is yes. I don't know if they move that or it's just something else. But I mean, so far rates, if you could just plot it on Fred, Even though I think it's like a little bit distorted, it's been going up and up. I mean before it starts going down, it's got to stop going up. So they're in pretty strong position. But there is this buy now, pay later. They were lending club kind of things, although they largely crashed and burned and payments in general, I mean these companies for payments are huge because there is PayPal, all these guys. This is just to take off a little bit off the top of this swipe fee and then we're going to get to the interest rates on this borrowing. I mean, I think there is constantly movement in this space, but it has not been to drive down. I think it's driven up acquisition costs more than just driven down the actual rates.

Jill Wiesenthal (39:15)

Unrelated macro question. One of the reasons I like your work sort of revisiting some of these like basic questions which I think is useful. And of course when we talked to a couple years ago, it was like let's revisit some of what we thought we knew about the 70s and see if that inflation story is a little bit different. Just on the big macro question these days, rates where they are inflation sort of persistently warm. A lot of people are like, oh, talk about our star must be therefore higher than it otherwise would have been. What do you think we've learned? You know, we had this very fast rate hiking cycle 2021 through 2023. I would say many economists would have expected the unemployment rate to rise a lot more given that rate hike cycle. It hasn't. I don't know.

Tracy Alloway (39:57)

Or spending to go down.

Jill Wiesenthal (39:58)

Yeah, or spending to go down, et cetera. But I personally am rarely satisfied by the stories that people tell about how in fact those rate hikes translated into lower inflation. Have you yourself sort of learned anything interesting in the last, I don't know, three or four years, five years of this macro experiment that we have post pandemic?

Itamar Drexler (40:18)

I think it's a great topic and question. My inference was that the cycle. I'm in the group that thought that this was largely a supply shock issue that Covid disrupted supply chains tremendously. I mean we saw that and I think if you look like the New York Fed has this index that they put together on supply disruptions, this predicted the trajectory of inflation with the three month lead very well. I think we had a period where we saw that there was increased employment and yet output was going down. So usually when we talk about productivity and things, there's all these compositional issues. Do you fire the least productive people? So productivity goes up for mechanical reasons, but when you have more people being employed and yet outputs going down as it did for several quarters, that can't be the reason. So I took away from it. You know, there's harsh arguments about this, that this was largely supply driven and how it relates to the 70s is. Our argument there, for different reasons, was that it was supply driven due to, due to credit crunches and things. So I tend to think that a lot of the business cycle things and the inflation as we've seen, like after wars, were often switching the kind of production that you do, which is a supply thing. I'm very much in the supply camp and I think the reason that employment held up and spending held up because I don't think that this was happening through decreasing demand and getting people fired and so forth. I think it was products, you know, components could ship again and so people could be more productive with the, with the labor they had. So to me, I'm sure some people very, very highly disagree. To me, that looked like a pretty clear story.

Tracy Alloway (41:48)

So if you're Jerome Powell and you're worried about inflation going up, and I should just mention we are recording this on October 29th. Yeah.

Jill Wiesenthal (41:56)

So actually the Fed decision, there's going to be a, which is widely expected.

Tracy Alloway (41:59)

To be a cut. Right. But, but you know, inflation's still, you know, somewhat warm, as Joe said. If you're worried about it, should you be looking at credit card rates versus, you know, mortgage rates or benchmark rates or things like that? How should policymakers actually think about this problem between those.

Itamar Drexler (42:17)

I, I think mortgage rates that people, you know, do seem very much to respond to, it is a, a much bigger amount. Maybe they're more sophisticated, sensitive. It lasts with you for a long time. I mean, I think that's much more important, the shifts in those spreads for the macro economy than, well, the credit card rates. There's just not much movement. I mean, they are literally tacked on top of the fed funds rate. So that's completely mechanical. Didn't used to be the case 30 years ago. But the spread will move one for one with the fed funds rate, except when they expand it by issuing new cards and making rates higher. So I think the mortgage market's much more important for macro kind of stuff. I mean, I've seen, I don't envy pal's job. It's a very hard job. Now, I'm not sure. Last time I was at the Fed, I was in the elevator when he got in, but I didn't want to bug him, so I didn't say anything to him. But I got to see him in person.

Jill Wiesenthal (43:07)

Jerome, our star is fake. Going back to you, talk about fintech, et cetera. Personally, I actually think stablecoins are going to be a very big deal. I do not necessarily think they're going to be a big deal for consumer transactions. It's not obvious to me. My guess is that they'll open up new transactions that we aren't thinking of right now, but not for like buying coffee or buying, you know, whatever. But from your research, whether into cards, et cetera, how would that inform your or other fintech? How would that inform your thinking about the trajectory of the stablecoin industry?

Itamar Drexler (43:43)

Yeah, stablecoin. It's interesting and I've heard you mention this kind of view, which I think is not one I'd considered. I was thinking a lot about consumers. I'll say this. I think for me and some of the people I talk to, my co authors, stablecoin are. They're like a puzzle in the sense that maybe not all stablecoin, but the ones that have been around are kind of like a money market fund that doesn't pay you interest. That's how I would summarize them because. And that's why I think these are some like the most profitable companies ever, per employee, because they don't do anything. So if you give them a bunch of billion dollars, they just take the whole interest. There's some advertising there too, but not a tremendous amount compared to that. And people are happy with that. I don't really get it. But you know, now they've, like you mentioned, they've started to learn the sort of tricks of the trade. They're going to do rewards. It's better than paying people actual interest. You give them rewards. So from the point of view of consumers, it is kind of a mystery. I mean, I would love to start a money market fund and not pay anybody any interest. Economically, when you don't pay any interest on a dollar ever, you've taken the whole dollar. That's what the dollar does. It pays you interest. So the net present value of all the interest of a dollar is the dollar. So if they never pay you and you stay there forever, then if they have $8 billion, they've captured $8 billion again.

Tracy Alloway (45:01)

Nice business if you can get it.

Itamar Drexler (45:02)

Yeah, it's a great business. It's weird, but it's a great business.

Tracy Alloway (45:05)

What's your next research project?

Itamar Drexler (45:07)

So I think from this credit card stuff there's definitely interesting things to think about. How people default and how much this marketing stuff affects them. From another point of view is one of my co authors in here, a former student of mine. We have a bunch of work on adjustable rate mortgages and why they kind of disappeared. So they used to be a big thing and they've kind of disappeared and I think we kind of understand why. So that's, you know, there's been a lot of discussion about that for mortgages. Why is the US in one camp and many other countries in another camp but the US kind of used to be in the adjustable mortgage rate camp up at least pre crisis and stuff.

Jill Wiesenthal (45:44)

I remember when the rate hike, when we started surging, there was this popular theory that monetary policy would have more teeth in countries like Canada, Australia, the UK because so many more households would be more sensitive to faster resets. Has that actually been borne out? It sounds great as like a theory intuitively that makes a lot of sense. I do, I guess Canadian unemployment has trended higher than American. But. But the inflation trajectories I think have been roughly the same in those other anglophone countries versus the US where they had, I don't know, like how strong effect was that, do you know?

Itamar Drexler (46:20)

I don't know exactly, but I don't get the impression that it was tremendously different. I think it has impacted consumers. One thing I should note though is there's two senses in which monetary policy can have an effect. One is that it makes people have to spend a lot of money on that. So it's expensive for them. But, but the other one is that here. And I don't think that's the effect we were going for, but people have just, you know, stopped taking out as many mortgages and don't move. It was a negative effect. I'm just not sure it's a anti inflationary effect. So it's like with you if you're going to have floating rate stuff and that's like the case with credit cards and it shouldn't affect the volume of it that much in terms of producing it. But it's kind of people, it's expensive for them and then on the fixed rate one they just stick to the old stuff and we don't, you know, mortgage credit's really dried up in a way, but it's not affecting the existing borrowers only to the extent that you don't want to move, which is actually a big deal.

Jill Wiesenthal (47:14)

Itamar Drexler, thank you so much for coming back on Odd Lot. It's always a treat. And next time you have a new report out, let's talk. Let's talk arms next time.

Itamar Drexler (47:22)

Okay, great. Thank you very much, Pat.

Jill Wiesenthal (47:36)

Tracy. I found that conversation to be fascinating, I have to admit. Like, yeah, like, credit cards are the sort of black box to me in many respects. I don't really understand the business because I don't actually use them for revolving purposes or borrowing against them. I don't think I quite realized how crazy the numbers are. And I certainly knew that there was tons of advertising, including direct mail on credit cards. But the idea that this is so substantial, that a big part of what people are paying for here is the advertising, that was all very novel to me.

Tracy Alloway (48:07)

It's very surprising. My main takeaway is that people, I guess, are not rational, at least when it comes to credit cards. Right. The marketing seems to work.

Jill Wiesenthal (48:15)

Yeah. Natoya. I'm not rational because I don't take advantage of all the points that I could and I don't, like, optimize the way I could. And when I, like, buy a plane ticket, only part of the time do I think about, is this the airline?

Tracy Alloway (48:26)

Well, you could also argue that it's rational to, like, factor in the time.

Jill Wiesenthal (48:30)

You spend on doing this. That's how I justify all of this money left on the table by saying, I make a rational decision.

Tracy Alloway (48:36)

My time is valuable.

Jill Wiesenthal (48:37)

Yeah, my time is valuable. It's. But, you know, if there are all these other borrowing products out there that are cheaper, etc. It does feel like someone must be able to come along and make a product. And yeah, that is. Lyft's gonna compete on Raid or you're gonna be able to borrow cheaper. I don't know. Maybe BNPL will achieve that. I don't know.

Tracy Alloway (48:56)

I'm gonna go take out a personal finance loan right now.

Jill Wiesenthal (48:59)

Go for it.

Tracy Alloway (49:00)

Shall we leave it there?

Jill Wiesenthal (49:01)

Let's leave it there.

Tracy Alloway (49:01)

This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

Jill Wiesenthal (49:06)

And I'm Jill Wiesenthal. You can follow me at thestalwart. Follow our guest, Itamar Drexler. He's Idrex. Follow our producers, Carmen Rodriguez at carmenarmon dash o' Bennett @dashbot and Kel Brooks at Kell Brooks. For more Odd Lots content, go to bloomberg.com oddlots we have a daily newsletter and all of our episodes and you can chat about all of these topics 24. 7 in our Discord, Discord, GG, Oddlauds.

Tracy Alloway (49:30)

And if you enjoy odd lots. If you like it when we talk about the very profitable business of credit cards, then please leave us a review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber and you enjoy getting benef and rewards, then please check out the Bloomberg Channel on Apple Podcasts. You can listen to all of our episodes absolutely ad free. Just find the Bloomberg Channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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