The Frontal Cortex

Credit Cards and the Brain

David Brooks’ column today is filled with some depressing financial facts:

Between 1989 and 2001, credit-card debt nearly tripled, soaring from $238 billion to $692 billion. By last year, it was up to $937 billion, the report said.

State governments aggressively hawk their lottery products, which some people call a tax on stupidity. Twenty percent of Americans are frequent players, spending about $60 billion a year. The spending is starkly regressive. A household with income under $13,000 spends, on average, $645 a year on lottery tickets, about 9 percent of all income.

Fifty-six percent of students in their final year of college carry four or more credit cards.

What’s interesting to me is the way credit cards take advantage of some innate flaws in the brain. When we buy something with cash, the purchase involves an actual loss – our wallet is literally lighter. Credit cards, however, make the transaction abstract, so that we don’t really feel the downside of spending money. Brain imaging experiments suggest that paying with credit cards actually reduces activity in the insula, a brain region associated with negative feelings. As George Loewenstein, a neuroeconomist at Carnegie-Mellon says, “The nature of credit cards ensures that your brain is anaesthetized against the pain of payment.” Spending money doesn’t feel bad, so you spend more money.

Consider this experiment: Drazen Prelec and Duncan Simester, two business professors at MIT, organized a real life, sealed-bid auction for tickets to a Boston Celtics game. Half the participants in the auction were informed that they had to pay with cash; the other half had to pay with a credit card. Prelec and Simester then averaged the bids for the two different groups. Lo and behold, the average credit card bid was twice as high as the average cash bid. When people used their Visa or Mastercard, their bids were much more reckless. They could no longer constrain their desire, and so they spent way beyond their means. (Prelec and Simester entitled their paper: “Always Leave Home Without It”.)

This is what’s happened to the American consumer over the past few decades. We’ve spent our way into a deep financial hole. At this point, the credit card companies need us to keep on spending, which is why they sent out 5.3 billion solicitations in 2007. That means the average American adult got fifteen credit card offers in the mail.

Comments

  1. #1 yttrai
    June 10, 2008

    I’d love to see how debit cards rank – same as credit, or closer to cash, or halfway between?

    (This from someone who has a debit card but not a credit card, but neither do i pay cash for anything over about $20 often.)

    And this is an N of one, but reading your article and imagining paying for something with a credit card gave me panic related physiological responses – adrenaline, heart beating faster, i felt afraid. I don’t get that with cash.

  2. #2 Tony P
    June 10, 2008

    And what happens to the credit card companies when people stop using the cards? They go out of business. There needs to be a push to get people to live within their means.

  3. #3 RyanG
    June 10, 2008

    I second the request for debit cards. They would help narrow down whether these spending habits are because of not physically paying for it, or because of not paying until next month.

  4. #4 Suzanne
    June 10, 2008

    I wonder how much of the increase in credit debt is actually consumer spending and how much of it the banks and credit card issuers have added on in late fees, overlimit fees, etc. I read recently that in some cases consumers would be ahead by taking out a payday loan from the loan sharks instead of using credit cards.

  5. #5 Rachael
    June 10, 2008

    yttrai:
    >>And this is an N of one, but reading your article and imagining paying for something with a credit card gave me panic related physiological responses – adrenaline, heart beating faster, i felt afraid. I don’t get that with cash.

    Make that an n of two. I positively despise credit, and even when I earned 14k a year, I never got myself into any debt that lasted longer than my next statement. Why buy something I don’t have the money for? That is stressful

    TonyP
    >> There needs to be a push to get people to live within their means.

    I agree with the sentiment but not the reality, TonyP. Living outside of our means is an ugly part of American culture. My political beliefs lie along these lines: it is much easier (and more appropriate) to regulate financial industries than it is to expect/hope/teach people financial savvy. The only way this problem will change is when the government cracks down on the glutted credit card companies (we are all starting to pay the consequences now as our economy slows and the average citizen falls into massive debt)

  6. #6 dave
    June 10, 2008

    Interestingly, I decided quite some time ago that I prefer making small purchases with cash, for precisely this reason (but without studies to back it up) – having the cash leave my hands forces me to be aware that I *am* spending money. (I also try to make exactly one visit to the bank machine per week, so I know how much my cash spending adds up to. That sometimes scares me.)
    (For if anybody’s trying to collect data here: Larger (almost always planned) purchases go on the debit card; I don’t have a credit card – at this point that’s mostly because I’m being contrarian, but I did go out of my way to not get one before I had a full-time income, since a big part of my money management strategy is “make it hard to spend money I can’t afford to spend”.)

  7. #7 pushmedia1
    June 10, 2008

    “This is what’s happened to the American consumer over the past few decades. We’ve spent our way into a deep financial hole.”

    Evidence?

    Counter-evidence, “The percentage of people who had negative net worth was about the same in 1962 as it was in 2000, the latest census year.”

  8. #8 Sofia Kim
    June 10, 2008

    Credit card debt is on its all time high with today’s economy. Hopefully people can obtain the help they need to get out of debt. Thanks for the article!

  9. #9 dawn
    June 10, 2008

    I think this is all pretty interesting. I would love to see this aspect of incurring debt addressed: “living beyond your means” seems to suggest a certain amount of discretionary spending. What if food, rent and transportation are “beyond your means”? I’ve heard anecdotes about people increasingly turning to credit to pay for utilities/basic bills. And how much of that is due to the increased ease of signing up for automatic bill payments online with a credit card?

  10. #10 Big Daddy
    June 10, 2008

    Did you even get the point of Brooks’ column? It was about the Protestant Ethic, and values, not brain flaws. Dude, an undergraduate degree, even with a fancy Rhodes scholarship, must be such a drag sometime. Sixty-two scholars signed onto something called “debt culture” and the best you’ve got is some brain imaging experiments. Pretty pitiful.

  11. #11 pushmedia1
    June 10, 2008

    dawn, people are not “living beyond their means”. If you don’t believe me, follow the link I gave above.

    Credit card debt has increased by a lot in last couple of decades, but that’s mostly because its replaced other sources of revolving credit (installment plans, etc). Even still a majority of people don’t carry CC debt at all and most people that do hold CC debt are middle class (not poor). See here. Indebtedness in general has also increased in the last generation or two, but that’s largely due to increases in home ownership and the introduction of mortgage tax incentives.

    One way to think of the long run trend is that people stopped paying rent and started paying off credit cards. This means the typical person today owns a home and enjoys a higher standard of living (as they have access to more credit) in exchange for a higher indebtedness.

    In any case, the increase of indebtedness doesn’t necessarily mean people are “living beyond their means”. Would you rather own nothing and owe nothing or own a $500k house and have $400k in debt?

    I don’t mean to high-jack the thread, Jonah, but I think you’re seeing a problem where there isn’t one (and its a common mistake to make and I feel compelled to point it out).

  12. #12 The Healthy Librarian
    June 11, 2008

    Great post–love reading about the science behind everyday behavior.

    As children of parents who grew up in the depression my husband & I “learned” the behavior of paying off the credit card bill every month. The credit card companies hate us & keep raising our limit.

    I remember so well having to add up my groceries as I shopped (before calculators) with a primitive little plastic counter–because I’d die of embarrassment if I didn’t have enough cash to pay for what I was purchasing.

    It took many years for grocery stores to even accept credit cards.

    Nowadays I don’t even get a “payslip” for what I earn. Not only does it go straight into my checking account–but I have to log on to a web site to see what I got paid. They could make a big mistake & I’d never know, if I failed to check up on it.

    Wow–no wonder people get into so much trouble.

  13. #13 Jeffrey Kittay
    June 11, 2008

    I had a housekeeper working for me for years — lovely lady, but she admitted that she could not handle spending the little money she had — she always overspent. Through some quirk of mailing lists because of some mail she once received at my address, I started getting some of her junk mail. She was CONSTANTLY solicited to sign up, never mind her credit rating. This is like offering vodka to minors. All the heightened consciousness in the mortgage bust about the ethics of offering easy credit to those who can’t afford it or can’t handle it should immediately shift to these questionable marketing practices by the credit card industry.

  14. #14 Sarah
    June 12, 2008

    Sorry for the sidetrack, but what is a neuroeconomist exactly? “The nature of credit cards ensures that your brain is anaesthetized against the pain of payment” sounds like something a psychologist or neuropsychologist could say.

  15. #15 rosy4
    July 10, 2008

    The topic credit cards and the brain is one of the interesting that the way way credit cards take advantage of some innate flaws in the brain. When we buy something with cash, the purchase involves an actual loss

    rosy
    _________________________________________________________

    Credit Card Debt

  16. #16 Rosa Gregorio
    November 16, 2011

    Looking forward to reading more. Great blog post.Really looking forward to read more. Much obliged.