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Well, it seems obvious … but nice to have it confirmed!

Why would you leave money in a checking or savings account while also carrying a credit card balance? Economists call this question the credit card debt puzzle. That’s because simultaneously holding both liquid assets and credit card debt seemingly makes no sense if the interest rates paid on deposit accounts are substantially lower than the interest rates charged on unpaid credit card balances — which they always are. In late 2021, the average rate paid was 0.06%, and the average rate charged was 16.13%.

And yet in 2019, according to a new Federal Reserve Bank of Boston working paper, 42% of the people surveyed carried — or “revolved” — credit card debt while maintaining some liquid assets, typically as a balance in their bank accounts. The paper was written by Boston Fed senior economist and policy advisor Joanna Stavins and Federal Reserve Bank of Atlanta payments risk expert Claire Greene.

The authors look at why consumers make such a choice. As indicated by the paper’s title, “Credit Card Debt Puzzle: Liquid Assets to Pay Bills,” Stavins and Greene show these “borrower-savers” left money in the bank to cover monthly bills and other necessary expenses including mortgage or rent. They find that more than 80% of borrower-savers’ bills (by value) were paid using checks, online bill payments, and other out-of-bank-account payment instruments.

“Even those consumers who carry costly unpaid credit card debt must keep a substantial balance in liquid assets to pay their bills,” the authors write. “Thus, the credit card puzzle is not a puzzle at all.”

There’s also this:

We use the 1979 National Longitudinal Survey of Youth to revisit what is termed the credit card debt puzzle: why consumers simultaneously co-hold high-interest credit card debt and low-interest assets that could be used to pay down this debt. Relative to individuals with no credit card debt but positive liquid assets, borrower-savers have very different perceptions of future credit access risk and use credit cards for precautionary motives. Moreover, changing perceptions about credit access risk are essential for predicting transitions among the two groups. Preferences and the composition of financial portfolios also play a role in these transitions.

… and this:

This article investigates the credit card debt puzzle. Simultaneously holding credit card debt and liquid assets is puzzling given the sizeable difference between interest rates of debt and assets. However, this behavior is common—about 31% of households in the 2016 Survey of Consumer Finances. The cost of co-holding may be justified if consumers anticipate future restrictions in credit or if they need to maintain liquidity. Other existing explanations for co-holding include impulsive spending and low financial literacy. This research reveals a new explanation for the credit card debt puzzle: consumers’ overconfidence of their financial knowledge. Using a Coarsened Exact Matching method, we found that overconfident consumers were 20%-40% more likely to co-hold credit card debt and liquid assets.

… and probably a lot of other material as well!

This entry was posted on Tuesday, August 9th, 2022 at 7:31 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.