Millennials play in the credit card casino
Amex and JPMorgan are the biggest winners from a closed financial system
by John Gapper
Kenneth Chenault knows how to play the game of life: the chairman and chief executive of American Express has received at least $370m during his 17-year tenure there. He was declared “the gold standard for corporate leadership”, by Warren Buffett, a long-time Amex investor, when he announced his departure.
Mr Chenault also knows when to take his chips off the table. The US credit card business, especially for high end cards such as Amex Platinum, is more competitive than it used to be. A points scramble has intensified since JPMorgan Chase launched its Sapphire Reserve card last year, with an annual fee of $450 and an initial sign-up bonus worth $1,500 in points.
His departure is an opportunity to ask questions about how card companies prosper, particularly in the US. The Supreme Court this month agreed to hear a case challenging Amex’s practice of barring merchants from steering customers towards cards that charge lower transaction fees. The ultimate question is who loses and who wins in what is an oddly structured market.
The traditional answer to the question is clear enough: people who pay for goods and service in cash lose, while card holders gain. As one study found, it involves “a regressive transfer from low income to high income consumers . . . amplified substantially by the practice of paying rewards”.
This is how the transfer works: companies such as Visa, MasterCard and Discover levy a charge on sellers of two per cent for each transaction (Amex’s average merchant charge is 2.4 per cent, which is why it tries to stop steering). Stores are barred by contract from charging card users more, so prices rise about 1 per cent for everyone, whether they pay by cash or card.
Some of the fees are channelled back by credit card companies to their customers in rewards and, since Discover launched the first cashback card in 1986, cash rebates averaging 1 to 2 per cent. Since rewards cards such as Amex tend to be held by people with prime credit scores, they gain most.
Recently, the market has become more like a game. The Sapphire Reserve card shook up Amex by offering top users superior rewards in return for a large annual fee. Those who play their cards right, earning triple points for travel and dining, can gain high returns. A Sapphire Reserve card holder could gain $7,950 net of fees over 10 years, Barclays analysts estimate.
This has sparked a contest among millennials with good credit, an aptitude for games, and time to plan their spending cleverly. Some apply for multiple cards to maximise rewards, unlike traditional users. “The question is not just how much disposable income you have but how much disposable time,” says Robert Harrow, an analyst at the research group ValuePenguin.
The contest has made life less comfortable for Amex, which had to raise its rewards by 21 per cent in the third quarter of this year. The total rewards paid by the top six US card issuers doubled to $23bn between 2010 and 2016, attracting more people to use credit. US credit card debt now exceeds $1tn, and Americans rate credit cards as their favourite payment method.
Like casinos, card issuers do not want their customers to master their games too well. Casinos frown on blackjack players who change the odds by counting cards, although it is legal. Both Amex and JPMorgan strive to prevent people signing up for cards for welcome rewards and later dropping them. Amex changed its terms this year to prohibit “abuse, misuse or gaming”.
The big winner is the house, as in any casino. Amex charged $18.7bn in merchant fees last year and paid out $6.8bn in rewards. Most card users are not single-minded enough to obtain the highest potential returns. Discover card holders can get 5 per cent cash back per quarter on $1,500 of purchases in some categories, but its average rewards rate is only 1.3 per cent.
Amex gains most from what it calls its “closed loop” — it issues cards and handles transactions. Its degree of control has similarities to Nintendo, which sells both consoles and games and this week raised sales projections for its Switch console. Complete control has its privileges: Amex’s US card business made a 35 per cent return on capital last year, far higher than investment banks.
The growth of super-prime cards has increased competition but it ultimately reinforces the credit card networks. The largest transfer of wealth is now from poorer cash buyers to millennial gamers but the latter have to work hard for their points and are rewarded in the currency of the card issuer.
While rewards have risen, little has affected where they come from — the US card market’s high transaction fees. Unlike the EU, which capped some transaction fees in 2015, the US relies largely on competition to minimise card purchasing costs and the price distortions that they create.
To judge by the profitability of Amex and others, competition is not working as well as it should. More of the “swipe economics” of transactions are being passed through to the most energetic users but there is room for reform in the market as a whole. The Supreme Court has work to do.
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