Jackie Ramos and the Issue of Fix Pay

Here’s an interesting story at Consumerist about Jackie Ramos, a Bank of America employee in the collections department, who was fired for giving too many people fix pay programs, and recorded a youtube video on it (Consumerist has a transcript).

Fix Pay is an interesting program. From Jackie’s video:

There is something we have in my department called a Fix Pay. Essentially it is a program that turns your balance into an installment loan. It stops all fees on the account, and it also closes your account. In order to get a Fix Pay, though, you have to qualify by answering a rather irrelevant set of questions, like how much you spend on groceries and how much your cellphone bill is. Day in day out I had to deny countless people who needed the program but didn’t qualify. Too often I would have to give them the spiel about, “I can’t accept you [into the program] because your disposable income is too negative,” and then they would just sit there on the phone and say, “Well, if I could afford to pay my bill, why would I need a program?”

When I first heard about Fix Pay type programs, I assumed banks would be rushing to take advantage of this kind of structure in this recession, as it kills a line of credit (most banks have been wanting to extend less credit), and turns a highly unlikely to get paid credit card debt by a distressed borrower into something manageable. And 6% at a point where Treasuries are at zero seems like a great money deal.

Now note what Jackie Ramos says here: people are too risky for fix pay, and that’s why they are being denied. The obvious problem is that if they are too risky at 6%, they are almost certainly too risky at 30% with fees.

We looked at some of the theory of where a credit card interest rate comes from before. The idea that it reflects your credit rating accurately seems false from a quantitative point of view. The best theory readers and I came up with was that it was a signal to pay off the balance right away.

That converges on another good theory I was unaware of, a “Sweat Box” theory, where the idea is just to try and get as much money as possible out of costumers upfront, and be indifferent about discharging the rest under bankruptcy later. Before I started crunching numbers, I had no idea how profitable that strategy would be, and thus how much sense it makes from a business point of view.

Numbers time: You work at a collections agency. Someone calls you with $2,000 in credit card debt; they are paying 30% interest from missing a payment, and they are having trouble making the minimum 3% payment, and are racking up a $50 late fee every other month. You are confident that they will default in X months, and not pay a penny of the remaining balance. You could give them a Fix Pay loan, which would be a 6% annual interest, no more fees, that they would pay off over 4 years with 100% certainty.

At what X, if it exists, is it more profitable to deny them the Fix Pay loan? And what is the remaining balance on the credit card? Here’s a quick google spreadsheet exercise, which shows (with an appropriate 3% cost of capital, or discount rate, as indicated in credit card literature), that in this example X is 22 months, with $1,250 on the balance. To make that clear, rather than having the consumer pay off the full loan over 4 years with 100% certainty at 6% and no fees, it’s more profitable to charge 30% interest and fees for 2 years and then simply forget about the $1,250 that is still on the balance when the consumer finally goes under. Anything more you could get out of them, in court or with a few more minimum payments, is gravy. [Edit: Numbers cleaned up after document missed one payment; even stronger conclusions, with 22 months instead of 24, and $1,250 instead of $1,205.]

This out-of-the-money-put on consumers is one thing that makes credit cards so crazy. Here is a conservative meme; put people who are in over there heads on credit card debt on a rational mechanism to pay it off. The credit line is cut as a penalty, and 6% is a high enough rate to make a profit for the business. Setting up a payment structure that makes the person responsible for paying off their entire balance in an orderly way gives good incentives to be a responsible user of credit going forward. And yet the ability of credit card companies, without any type of limits on fees or usury laws, to profit from sweating consumers and then forgetting about whatever is left when they are exhausted is so large, that creating innovations and aligning incentives to get people into these good behaviors goes right out the window. Instead the innovations and incentives run in the opposite direction.