This Is Why Credit Card Interest Rates Are So High

SPEAKER_2 (0:02)

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Joe Weisenthal (0:18)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Joe Weisenthal.

Tracy Alloway (0:23)

And I'm Tracy Alloway.

Joe Weisenthal (0:24)

Tracy, are you good about like frequent flyer miles and hotel rewards and cash back and using your credit card to get like good seats at the US Open, like all the, or dining? Are you good about maximizing that stuff?

Tracy Alloway (0:38)

Nope, I am not. I'm trying to be better. I'm finally signing up to a bunch of frequent flyer programs and things like that. But in general, I am not a point strategist. Some people get really into it.

Joe Weisenthal (0:50)

I know. I do not. I have a very busy life. I do not have mental energy towards, you know, maximizing points or learning about the newest cards. Like, oh, is this card worth a $400 fee because I can get upgraded to platinum faster this year? I don't want to think about that stuff. I'm not that interested, but I get the impression that means I'm probably paying for someone who is or something like that, or maybe, you know, I'm paying these fees on my credit cards or these interchange fees, et cetera. Maybe I'm leaving money on the table by not doing that. I don't know, 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 them. I don't know anything about credit cards.

Tracy Alloway (1:32)

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.

Joe Weisenthal (1:42)

Yeah.

Tracy Alloway (1:42)

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 Abbate about that a while back.

Joe Weisenthal (1:52)

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.

Tracy Alloway (2:00)

Yeah.

Joe Weisenthal (2:01)

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 think what interest rates or whatever. I pay it off at the end of every month because I just basically use it for payments, etc. So I just don't know much about them, but they're a huge major consumer financing source. And everyone's talking about FinTech and BNPL and all these other things and stable coins 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 (2:27)

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.

Joe Weisenthal (2:44)

Totally. Well, very pleased to say we do, in fact, have the perfect guest. Someone we've had on the podcast before. I think the last time we were talking about Reg 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 to quickly without understanding the basics. Maybe there are stones left unturned. Literally, the perfect guest, Itamar Drechsler. He is a finance professor at Wharton, and he was the co-author of a fairly recent paper 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 lending.

Itamar, thank you so much for coming back on Odd Lots.

Itamar Drechsler (3:29)

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

Joe Weisenthal (3:31)

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 go back and revisit the sort of basic simple question of looking at interest rates on credit cards?

Itamar Drechsler (3:52)

Yeah, so my interest is usually, like we talked about when I was here last time, 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, I 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, if we don't really understand how the dominant, incumbent players of 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 1, 1.2%.