2005 Bankruptcy Law Changes Have Worked to Detriment of Credit Card Companies

The irony is rich, even if the consequences to both credit card issuers and borrowers are painful.

Many readers no doubt know that the October 2005 bankruptcy law changes were a long sought, hard lobbied for win for credit card companies. It considerably restricted access to Chapter 7 bankruptcies which allow borrowers discharge the debt once they liquidation of existing assets, save those exempted by the state, and divides the proceeds among creditors, including credit card issuers. Debtors who are above median income in their state are most likely to have to file for a Chapter 13 bankruptcy. In Chapter 13, the borrower has to repay debts over five years. In addition, before 2005, the judge determined, based on information provided by the debtor, what a reasonable repayment plan would be. The new standard is based on IRS living standards, which a cousin who is a bankruptcy attorney described as “draconian” (for instance, the food budget per month for an adult individual is $200).

MBNA estimated that passage of the bill would enable it to collect an additional $100 per month per bankrupt, which would increase its profits $85 million a year.

So what did these credit card issuer do with their new enhanced rights? Emboldened, they went out and lent more to near-deadbeats, confident they could extract blood from turnips.

They are now reaping what they have sown. And part way through the post, there is a little whopper too.

From Christian Weller at Credit Slips:

Credit card companies are suffering from record default rates. In the fourth quarter of 2008, credit card companies charged off – declared as uncollectible – a whopping 6.3 percent of their debt. Aside from a fluke spike in the data in the first quarter of 2002, this was the largest charge-off rate since the Federal Reserve began collecting these data in 1980.

Interestingly, these record setting losses for credit card lenders come after the punitive changes to the bankruptcy code were supposed to weed out the “deadbeat” borrowers and lead to lower default rates….

The credit card quality continued to deteriorate for a number of reasons. First, credit card lenders happily filled the void left by less access to mortgages starting in early 2006….Credit card lenders expanded their business when everybody who had paid any attention knew that the overall credit quality was already deteriorating.

Second, people borrowed money because they had to. The argument that all forms of household debt, including credit cards, were caused by irresponsible borrowers has never jibed with the data. For instance, data from the Federal Reserve’s Survey of Consumer Finances show that families became less accepting of debt for conspicuous consumption over time…..

Third, credit card companies milked every last dollar out of their preferred customers, the so-called “revolvers” – people who carry a balance and make some payments. Higher interest rates, increased fees, and fewer perks were typically in store for these card holders when defaults surged. The only problem with this strategy is that it will lead to an acceleration of credit card default, especially in a recession. Still, a number of credit card companies are raising their fees, cutting back on perks associated with their cards, and raising interest rates right now, even though consulting firms already estimate that the average chare off rate could go as high as 8 percent to 9 percent this year. Apparently, bilking the customer in the current quarter beats making sure that the customer can still pay the bills next quarter.

Some lenders, though, are trying to clean their balance sheet by getting rid of a selection of risky borrowers, such as American Express with its announcement to pay certain borrowers $300 if they pay off their balance and close their accounts before a specific date. They are probably not doing this out of the goodness of their hearts. Rather, having a lot of bad debt out there could cost them a hefty chunk of change. American Express already disclosed a net charge off rate of 8.7 percent in February 2009. A substantial amount of credit card debt, though, is securitized. When the excess returns on the securitized funds – earnings for investors – shrink far enough because of a rise in defaults, the investors can ask for more cash from the credit card lender or, in extreme cases, demand their money back. The term liquidity crunch probably does not aptly describe what this would mean for credit card companies.

Yves here. That makes the idea of squeezing customers, as outlined in the paragraph above, even nuttier, if you drive them into default and trigger a clawback. However, at least when American Express shut down its business credit line programs entirely, our understanding is that they actually lowered monthly payments (payments, not interest) for most of their customers. That suggests, as Weller intimates, they may be close to the triggers on some of their securitizations. Back to the post:

The worst part of this crisis is that it was foreseeable. For decades, credit card companies have layered fees and excessive interest rates on their borrowers. Instead of addressing the consequences of high, complex, poorly understood credit card costs, though, the high default rates were simply explained away by declaring defaulting borrowers as deadbeats. Now that there won’t be another round of bankruptcy reform that could be sold as salvation, credit card lenders will have to come to terms with the fact that their practices were actually detrimental to their own financial health.

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31 comments

  1. Anonymous

    credit card lenders will have to come to terms with the fact that their practices were actually detrimental to their own financial health.

    There’s this thing called denial. It’s worked for years for the Republican party.

  2. Anonymous

    It couldn’t be happening to a more deserving bunch of greedy bastards. It is a bitch when the best laid plans of fascism come back to bite you on the butt.

    psychohistorian

  3. Anonymous

    A wish I still hold deep in my heart is that I had paid off my student loans with my credit cards, made payments as I could and then when my son’s health issues happened i’d have finished off the balances and gone BK in 2005. Unfortunately I paid the student loans on income sensitive, increased the interest and time line, charged up medical bills (we had insurance) and went bk in 05. I was current on every single cc when I filed. So I went into bk w/60K in debt. Walked out bk still with 30K owed to student loans. Not right…

  4. Anders

    Typos:

    Banktuptcy => Bankruptcy

    "once they liquidation of existing assets" => "once they liquidate existing assets"

    "these credit card issuer" => "these credit card issuers"

    Nitpick:
    lobbied for => lobbied-for
    (while it may not be entirely correct, it makes the sentence flow easier from "were a …" to "… win" – additionally, shouldn't it be "was a …"?)

  5. Anonymous

    I’m a good credit customer of Citibank. Bottom line is, I don’t trust them. I’m not going to run credit card balances and I’m much less likely to use my card at all. So if others feel the same, does this not increase the proportion of bad credit balances at these banks leaving banks with unprofitable credit card customers? I think so.

  6. john bougearel

    Wow, the real and best takeaway from this admission by Amex that they will pay “certain borrowers $300 if they pay off their balance and close their accounts before a specific date” is that their business model don’t work no mas!

    I love it! The usurious bastards can’t take the risk (heat). Oh sure, in a pro-cyclical credit creation boom the model works perfectly. In a counter-cyclical debt deleveraging bust, its “Risky Business part II.”

    Tom Cruise will have to star in the remake of this movie. Poor In the original movie, Tom (Joel) discovered his mom’s “crystal egg” had been stolen by the prostitute (Lana) he hired. In the remake of the movie it is the prostituted borrowers who were “hooked on the credit creation boom” who have stolen Amex’ crystal egg.

    The credit card companies have now been out-pimped! Addicted borrowers and pimps hooked on credit tend to “go all in” they lever up as far as they can go. They do not stop at mom’s crystal egg. While Tom Cruise is enjoying a nice time with the prostitute on the Chicago El, her pimp goes back to Joel’s house and burglarizes the whole damn house. Joel returns home to an empty house. All the furniture in the house had been stolen, gutted.

    This is akin to AMEX coming home to discover an empty vault. The vault has been gutted. Now they have to negotiate with their addicted borrowers to get their money back, and just like in the movie, they have to negotiate to buy the credit that they extended to the risky borrowers back.

    In the original movie, it all ended well, with only a crack in mom’s crystal egg, and a wisecrack from Joel who quipped that if Lana wants to keep seeing him, that it will cost her!

    The metaphor is rich with irony

  7. Heavy Armor

    The Bankruptcy Bill of 2005 is akin to a turbo-powered car that the mechanic (Credit Card Comps) decides to modify by turning up the boost (payments, fees, collections, etc) and getting rid of the blowoff/dump valve and closing the wastegate (Bankruptcy Protections for the consumer). The end result is one that increases horsepower (short-term profit), but will eventually blow the engine (the company itself) to smithereens.

  8. Anonymous

    I have a BAC credit card with a very high limit. I use the card every month and rarely carry over a balance. I have almost all of my money in cash and no real estate. I am really pissed about all of these bailouts. I want to run up $40K on the card and then stick them with it. Do I have to declare bankruptcy or can I just default and then pay them back half in a workout? Thx.

  9. Tom Stone

    Be aware that if you have been issued a corporate card you have almost certainly personally guaranteed it.Thus is your firm issued you an AMEX corporate card,you used it solely for business and your firm goes BK,YOU are on the hook for all the charges personally.

  10. Anonymous

    These drug-pushers are reaping what they have sown.

    For a generation credit card companies extended tens of thousands of dollars of unsecured credit to individuals and small business proprietors based solely upon a now-deemed-notoriously unreliable FICO score.

    These issuers were not “bankers.” At no point was any debtor asked to provide a financial statement, a tax return or a W-2 to verify capacity to service the credit extended.

    As such, credit cards became the original “liar loans.”

    Consolidation in the industry, to among a few greedy institutions, now is detonating their balance sheets and capital positions as, belatedly, they discovered open, available, unsecured lines of credit, sometimes of more than one hundred thousand dollars, to borrowers about which the issuers knew NOTHING but a number between 350 and 850.

    This is banking malpractice, and yet another example of how regulation failed to envision, much less criticize or prevent, this disaster in the making.

    Credit card companies made, in retrospect, very bad business decisions. They now must face the consequences and reap what they have sown.

  11. DownSouth

    Thanks a million for this post, Yves.

    There is a concerted right-wing effort taking place to paint negative sterotypes and demonize those who can’t pay their credit card debt or their mortgage, laying not only 100% of the blame for the economic crisis at their doorstep, but all manner of other economic and social evil as well.

    This is yet one more aspect of the the “Personal Responsibility Crusade” and the “Ownership Society” championed by right-wingers beginning in the early 80s.

    I found this jewel the other day that I believe just about says it all:

    Conservatives are promising to fundamentally change the American political landscape by transforming those with little stake in society into the motivated owners of Wall Street stocks, health insurance accounts and homes. As it turns the blue-collar wage earner into an investor, the Bush administration’s proposal for Social Security reform…is the beginning of this revolution. It’s also what Democrats fear most: new legions of Republican voters marching to the tune of individualism, choice and ownership — not entitlement…

    It’s odd that the so-called party of the working classes, women and minorities — all demographics statistically less likely to invest their money — is seeking to deny major portions of its voting bloc the chance to become part-owners in American companies. Instead, Democrats would rather citizens be wholly dependent on the period scheme that is Social Security and the party’s politics of entitlement.

    http://www.yaledailynews.com/articles/view/13693?badlink=1

    Thanks again for providing some great empiracal information with which to hold the line against the economic royalists.

  12. DownSouth

    This also is germane:

    To the Personal Responsibility Crusade, strong families are built on good personal decisions. If a family can’t afford to have kids, it shouldn’t. If it gets into hot water, it must be its own fault. But the stories and statistics we’ve explored show just how unrealistic this view is. People sometimes do make bad choices, but how can that explain the millions of middle-class families straining to make ends meet?… And what answers does it offer to those strained families when the bottom suddenly falls out?

    –Jackob S. Hacker, The Great Risk Shift: The New Economic Insecurity and the Decline of the American Dream

  13. Anonymous

    May I share an RBS (Royal Bank of Scotland– recently bailed out by the Brits)story? I’ve a stellar FICO, had an RBS card for over 7 years, with never once a late payment. OK, I’d had some old RBS convenience checks laying around that RBS sent me last fall- with an expiration date of 3/15/09.
    Interestingly, when I recently deposited one of the checks in my bank, RBS returned it, claiming that “just by coincidence” they’d closed my account the day before, as a “protection” to me, since the last activity on the card was in Feb.’08.
    When I asked the RBS supervisor since when do CC co’s close 7 year old accounts with a customer in excellent standing– without any notice whatsoever to said customer– I got a very fishy story that “oh we did send you notice” (get this!) “on the day we closed your account”.
    My “read” on this is that RBS may be looking for ways to avoid honoring its own convenience checks, sent out 6 months ago in “palmier” days. And as I’m a “deadhead” who pays my baslance in full each month, they’d like to “cull” people like me.

  14. Merry-will-go-round

    DownSouth: Thanks for the link at your post and your thoughts! If you do some more digging, the cognitive dissonance may be somewhat resolved. Understanding is less about analyzing value differences conservatives and liberals and more about analyzing neoliberal values shared by both conservatives and liberals. You might enjoy searching on David Harvey and Michael Hudson on the Internet.

  15. Mannwich

    This was all to predictable and predicted. Pigs feeding at the trough didn’t know when to stop.

    The irony of this is rich. I’m not amused but it’s rich.

    Bottom line is these companies want most of the U.S. to serve in debt slavery their whole lives with fees layered on fees, etc. etc. People are now waking up to this fact. Might be too late though.

  16. zak822

    Are people getting rid of their credit cards instead of just hoping they don’t get hammered by the card companies?

  17. Anonymous

    “Do I have to declare bankruptcy or can I just default and then pay them back half in a workout? Thx.

    This is probably not quite the right forum for your question – you’ll probably get much more detailed help and a variety of opinions elsewhere. There are many personal finance forums for this.

    But, yes, you can negotitate your unsecured debt if you choose to default. You’ll need to spend a lot of time on the phone dealing with cold hearted bastards. It might take weeks or months of calls, but when they see you are serious about not giving ground they will negotiate. Cutting 30%-60% of your debt is a reasonable thing to aim for, but DO NOT underestimate the time and aggravation involved. You may also scar your credit report, although this is also negotiable.

    Avoid the credit card repair companies, they are BS. There are a few good books out there – look at Amazon and read reviews.

    (And yes, I did negotiate ~$8k of CC debt to ~$5k, with a ding on my credit, now healed by time.)

    Good luck!

  18. Anonymous

    Just hought to add the above programe was aired in Nov 2004, a good bottom to top video, fetures Warren too.

    Grosse Pointe….would the regulars please watch and comment.

  19. Anonymous

    I have been advocating a credit card payers strike since the TARP was first announced last year.

    This is probably the only nonviolent path of resistance the public has to the leeches off of their necks and out of their wallets.

    I think if the cardholders refuse to pay the card it will inundate the civil courts and credit raters with case paperwork and tell the scum in Congress we the people are done screwing around with Bagman- Biden, Dodds and his band of unknown staffers in Treasury, Geithner, Rubin, Summers et al. It will be the only way to get relief and revised usury laws because Congress will have to deliver something else besides bag.

    Collectively if everyone’s credit scores go down it will still be relative. Using your card payment as cash for your purchases, it will probably be the only way we get money circulating again. TARP and the rest of the alphabet soup hasn’t and isn’t going to do it.

    With the kind of financial heat we could put on these bastards perhaps we can get the fraud and “Bezzle” exposed and prosecuted. Maybe, just maybe, we would even get RICO dusted off and used. I really don’t thing the bastards in Congress really want to have to go back to working for a living.

    It could happen if we make it. There’s some “hope” yet and it ain’t coming from St.Obomba .

    Comments please.

    Buzz Meeks

  20. Anonymous

    Thanks for a great post, Yves.

    May I recommend this book: "Maxed Out – Hard Times, Easy Credit, and the Era of Predatory Lenders" by James D. Scurlock (ISBN: 1-4165-3251-X). Excellent read. It was published in 2007.

    The book is available at your friendly Borders, B&N, or Amazon.com for only 24 fiat U.S. dollars. But make sure you charge it to your AmEx BEFORE you declare bankruptcy and have all your credit card debt erased forever.

    Vinny GOLDberg

  21. Anonymous

    These bloodsuckers have the U.S. government up to its eye balls in debt already, and aimed for the average American as well. They aimed to enslave your and my sons and daughters. They thought their stupid FICO scores are so scary, we’d all just buckle under and keep paying 30% interest and countless fees for the rest of our miserable lives. Oh, I’m sooooooo scared now. Riiiiiiight! I say let’s screw them. Let’s all go on permanent repayment strike. Better yet, let’s all pull a MOWA on them (Max Out, Walk Away). They already got their money from the TARP. They already maxed out on our tax money, on our social security funds, on our inexistent social medicine, on our failing education. They already stole form yours and my sons and daughters. Let’s bring this house of cards down. Let’s rebuild this society anew.

  22. mmdonner

    what most of the posts above miss, i think, with the haha ‘they deserve what they get the bastards” is that they will get bailed out after sucking all they can from the card users….
    users will pay twice…as card holders and as taxpayers.
    card companies will survive just fine and pay big salaries and bonuses as well no doubt.
    they will purchase CDSs to cover or somehow do just fine. you can take that prediction to the bank.
    Michael

  23. Anonymous

    Going all the way back to Alan Greenspan, he regards the US worker as absolutely replaceable.

    During 8 years of George W Bush, his dimwit US Labor Secretary Elaine Chao rarely met the minimum jobs creaiton target in the US. Elaine Chao enjoys a media blackout. Her name was never mentioned in the US Labor Department monthly jobs report.

    I would love to hear both Alan Greenspan and Elaine Chao testify as to how middle class Americans are going to pay credit card debt.

    Former US Senator Elizabeth Dole and current Senator Richard Burr both voted for the 2005 reform at the same time North Carolina was hemorrhaging jobs. I wrote Elizabeth Dole about the discrepancy. Her reply was that credit card companies planned to increase the font size on the fine print to make it easier to read. Elizabeth’s defeat was announced early in the evening on November 4.

  24. Anonymous

    mmdonner: what most of the posts above miss, i think, with the haha ‘they deserve what they get the bastards” is that they will get bailed out after sucking all they can from the card users…. users will pay twice…as card holders and as taxpayers.

    That is precisely why I say let’s all pull a MOWA on them. Let’s Max Out, and then Walk Away from our debt. The only thing they can do is ruin your credit, which will fix itself after 7 years. Besides, this stupid credit rating system is likely to end after this crisis anyway.

    That is the only way we can recoup the money these bankster criminals are stealing from our tax coffers. Remember: MOWA is the new economic model for 2009 and beyond. You will need the money to feed your families, to pay for health insurance, to fill up your tank. So, MOWA everybody!

    Ron

  25. run75441

    The biggest issue with much of this is Congress itself. They are out of touch with their constituency of which 40% are either poor or living in poverty. In June of 2005, I wrote this letter to my Congressman in answer to his blather. Mikie Rogers is a hack.

    Dear Mr. Rogers:

    I apologize for not answering your attached response earlier than now. Wide bipartisan support does not grant the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act legitimacy or make the flawed attempt to fix an issue, requiring no fix whatsoever, correct either. To set the record straight, in Michigan all Democratic Congressmen voted against the bill while all Republicans voted for it. I am sure you know this already or at least the staffer who wrote your answer knows this factoid.

    The federal government has become the debt collector of record for the financial industry sharks (such as MBNA, Visa, Ford Motor Credit, etc.) as detailed in this new act. Since the financial industry has been experiencing record profits I hardly think Congress needs to incur another $400 million in deficit spending to help them out when this money can be more aptly spent on helping to fund federally mandated programs in Michigan such as “No Child Left Behind”, “Individuals with Disabilities Education Act (IDEA).”, “The Help America Vote Act”, “Medicaid,” or potentially help Michigan reduce the highest unemployment rate in the nation by attracting new industry to it. These under funded federally mandated programs have cost Michigan ~$3.3 billion dollars from 2001 through fiscal 2005 as reported by the CBPP, a centrist think tank. Please help your state and its people out sir!

    In reviewing your comments, I would add the following:

    “In fact last year 1.4 million people filed for bankruptcy that is more filings than during the Great Depression.”

    The 1.4 million people going bankrupt quoted by you is a statistic for 2001 non-business bankruptcies. Actual non-business bankruptcies for 2004 were ~1.563 million down ~3.8% from 2003 which was 1.625 million. Since the Great Depression, we have truly become the ownership society that President Bush envisions and also long before this phrase was coined by him. In 2005, more people own cars, homes, vacation homes, boats, airplanes, 401ks, etc as a percentage of the population than during that period of time up to WW II called the Great Depression. Far fewer people during the Great Depression had assets worthy of going through bankruptcy and the cost of processing bankruptcy proceedings was expensive so they just walked away. The comparison of the Great Depression Bankruptcy rates to 2004 Bankruptcy rates is an apples to oranges comparison.

    “This explosion in bankruptcy filing cost every American family $400 last year alone.”

    Why would you cite unsubstantiated financial industry statistics from 1997 as put forth by the WEFA (financial industry organization) in 1998?? Both the G.A.O. and the C.B.O. have stated this loss number remains unsubstantiated by the financial industry and repeated requests for the basis of this number have not been answered. Why would you choose industry propaganda over the independent reports of your own organizations, the C.B.O. and the G.A.O.?

    “This common sense, bipartisan legislation restores personal responsibility to the bankruptcy process by requiring requiring filers to meet a basic means test, and prove they do not have the income to pay their debts before granting them bankruptcy protections.“

    Why is it so important to allow those who can have Asset Protection Trust Funds the continued capability of hiding their assets (homes, vacation homes, cars, boats, art, etc.) from the Bankruptcy Abuse Prevention and Consumer Act if they declare bankruptcy? Does this exclusivity for the wealthy make good, common sense? The “basic means test” does not determine who gets bankruptcy protection; however, it does determine who will be granted either Chapter 7 or Chapter 13 bankruptcy protection. It has been estimated by the A.B.I. that this act may capture an additional 3% of those abusing bankruptcy and an ~10% of the often cited $400 per consumer financial industry statistic. Common sense would dictate a better return. The previous law was doing the job.

    ”Additionally, this legislation provides special protection for farmers and people with extraordinary medical expenses.”

    This statement is not quit true for a couple of reasons. The bill offers protection for “on-going” and not “past” medical expenses. Because of the stigma attached to declaring bankruptcy, most people will not declare bankruptcy until it is too late. As reported by the A.B.I., the average citizen would sacrifice food, clothing, healthcare, and be late in paying bills rather than go bankrupt. People still do not like to go bankrupt. Illness, personal injury, loss of job (Michigan-highest unemployment), divorce are the most cited reasons for doing so with the fastest growing segment of the population doing so being the elderly. The caveat of “special protection” is limited in scope and its ability to protect, is untested in court, and still can be contested by a creditor and changed.

    There are many things that you as a Congressman can do for Michigan and its people rather than vote the main stream thereby punishing the very constituency voting you into office. As one issue, I have suggested the full funding of federally mandated programs as something that will bring relief to Michigan by reducing the strain on state funds used to supplement these programs as required by federal law. The under funding of these federal programs has seriously impeded Michigan’s ability to meet its responsibilities, attack its unemployment problems, and attract new industry. The Bankruptcy Abuse Prevention and Consumer Act plays against these issues and is not a good act.

    Thank you for your time and consideration.

    Sincerely,

  26. Anonymous

    ron, without success i’ve tried to re-find his ‘manifesto’, but an individual in spain began trying to promote that a few years ago. i believe he used his cc to help create a few shell companies, each of which was able to obtain its own line of credit while allowing him obtain still more on a personal basis…running personal indebtedness up to around half-million euros simply in order to default.
    pretty sure that he’s since been arrested.

  27. DownSouth

    Annonymous at 5:42 p.m.

    Thanks for the link to the PBS Frontline segment.

    It provides a historical framework and shows what happens when:

    1) Congress and the courts become captive to the banking industry and do away with usury laws

    2) Regulators become captive to the banking industry and abolish consumer protections.

    The deathhold that bankers have on our government must be broken.

Comments are closed.