American Express: Another Example of How Fees Skew Credit Decisions

A clever post by Elizabeth Warren at Credit Slips keys off, of all things, a discussion by mystery writer Lisa Scottoline about her experiences with American Express and reward programs generally.

Scottoline gives a colorful recap of her inattentiveness about paying on time and its predictable impact on her credit record (“My FICO score was equal to my weight”). Warren zeroed in on a fact that I must admit I was unaware of: that American Express charges higher merchant fees on business credit cards than on personal ones. (I had always thought those merchant fees, which vary by type of vendor and can be as high as 3%, were already rapacious. Foolish me to be so unimaginative as to think that 3% was the ceiling). And as Warren illustrates, the higher fees of course mean that Amex is more generous with credit to business cardmembers than with personal ones.

Now of course, readers can argue that this is simply a sound credit practice; Amex is charging more to weaker prospects. But the charges aren’t being paid by the credit user, but the poor merchant selling to him. This not only distorts credit decisions but is also in effect a subsidy from one type of business to another.

From Credit Slips:

But the part that caught my eye was that she couldn’t get a real, grown-up American Express card, but she could get and use a big-time American Express Business Card. Same Lisa, same income, same FICO, but Business Barbie Lisa can have a card that Regular Paycheck Lisa can’t get. Why would that be so?

Surely American Express doesn’t think that small business owners are less risky than employees. (If they do, we have a couple of bankruptcy books to sell them showing that entrepreneur bankruptcies occur at about twice the rate of employee bankruptcies.) Surely they can’t think that someone’s credit score improves just because she renames herself Lisa Inc. (If they do, let the re-naming begin.)

Could the AmEx policy be the byproduct of merchant discount fees? If personal cards carry, for example, an average of 3% merchant discount fees, but small business cards carry 5% discount fees, then lenders would be more inclined to cast their nets more widely in the card-issuing phase of the credit cycle. It would also explain why I get an offer a week for a credit card for my small business–despite the fact that most of my income is salaried. It isn’t just AmEx. It seems that everyone is pushing “business cards.”

If credit decisions are pushed along by differential merchant discount fees, it is further evidence of Adam Levitin’s work on the credit distortions created by merchant discount fees. It not only affects cross-subsidization in the credit market, it also expands the total amount of credit available by forcing the merchants to pay fees that will make marginal credit decisions more profitable for the issuer. It also gives a new twist on John Armour’s questions about supporting–cross-subsidizing?–business start up.

Next time Lisa lays down her Lisa Inc AmEx card, will a merchant cough up a big discount fee? Lisa Inc as buyer may not care, but the small business start up on the selling end of the deal may care a lot.