How Credit Cards Work, Part 1

As you might have read the last few weeks, in light of the ongoing banking crisis a number of banks are floating the idea that they might begin to charge consumers once again for the use of their credit cards. It's not a totally unreasonable idea, as the credit card is a service of great utility to the consumer. Most banks used to charge for them; the fees fell away when some banks removed them to draw in more customers. On the other hand, today such a move is yet another way in which the banks are attempting to pass the costs of their mistakes onto ordinary Americans.

In any case, the conversation has made me wonder about the whole business of credit cards: What are they? And what makes them profitable? So, over the next few days I thought I'd give some of what I've learned. Consider it a sequel to my 3 Part Series on How a Bank Works.

So, first of all what is a credit card? Well, it's the equivalent of those blank checks your credit card company sends you from time to time. When I use my credit card I am basically taking out a loan: the bank fronts the money for the purchases I make, and I am responsible for paying the bank back, with interest.

The idea of the credit card started in the 1920s as a service offered by individual companies to their patrons, like a JC Penney Card or Gap Card today. After World War II, these services became much more widespread, though it still wasn't until 1959 that a bank, Bank of America, began to offer cards themselves, and then only in California until 1966.

All of which is to say, while credit and loans are older than the Bible, the modern use of the credit cards is a relatively recent phenomenon.

The ancient equivalent of credit.

Today, the use of credit will shock you. In 1999, 1.2 TRILLION dollars was charged on credit. Married to the fact that somewhere between 50 and 70% of people don't pay their complete balance each month, it becomes even more clear, it's not just the banks that have dramatically overextended themselves. The National Debt aside, our 340 plus million Americans themselves owe BILLIONS of dollars.