Banks Clamp Down Harder on Credit Card Borrowers

An article in Business Week, and a related discussion on the blog Credit Slips, highlight a new and nasty trend: banks are refusing to give overstretched borrowers who negotiate repayment plans through credit counselors the interest rate breaks they once did.

In the old days, banks would reduce interest rates on balances due, sometimes to zero, to customers who worked out a repayment plan via not-for-profit credit counselors. But now the creditors have taken a page from Scrooge:

Until recently issuers often agreed to ratchet down interest rates permanently, to as low as 0%, for those working with credit counselors. That has been a critical concession, says the industry, since it makes monthly payments more affordable and helps ensure the principal is getting paid down. But now some credit-card companies are balking. Discover Financial Services, (DFS) counselors contend, won’t cut rates below 17.9% for clients, while Capital One Financial (COF) is holding firm at 15.9%. At least 5 of the 13 largest issuers are offering smaller breaks on rates than they did five years ago, according to a study by the Consumer Federation of America….

Some companies are still willing to deal. JPMorgan Chase (JPM) announced a year ago it would cut rates to 0% for consumers who agree to a formal debt-management plan. Bank of America will drop to the low single-digit level or even to 0% in some instances.

Meanwhile, counselors are fretting that they aren’t getting paid for their services as they did in the past. The credit counseling agencies historically have collected 15% of the total debt that’s paid off. Today banks are forking over less than 8%, notes the National Foundation for Credit Counseling, the umbrella group for 1,500 counselors. That money goes to fund operations, so counselors worry they may have to skimp on services given the cutbacks….

Why are credit-card companies clamping down? Some analysts suspect issuers are increasingly worried about losses. Card issuers reported $38 billion in bad loans last year. Columbia Law School professor Ronald Mann gives another reason. He says banks have taken a closer look at the data and determined that most individuals will keep paying their debts even if lenders don’t lower the rates as they have in the past. “Higher rates maximize the recovery,” says Mann.

The counselors see the world differently. In the current credit crunch, more borrowers are turning to their programs. The NFCC worked with 2.7 million individuals last year, a nearly 30% jump from 2006. Without the usual rate breaks, counselors think more people will fall behind on their payments. That could lead to an uptick in bankruptcies. A study by Visa Inc. (V) found that 50% of consumers who dropped out of credit counseling programs declared bankruptcy. Says Dillenbeck: “If we don’t have good concessions, we have little power to help people.”

Now just as banks were shortsighted on the growth phase of the credit card business, giving accounts to anyone with a Social Security number and a pulse, so to are they being in the contractionary period.

Credit card issuers have ascertained they can squeeze more from customers. Hhhm. And over what period did they gather that data? By definition, given the time it takes banks to implement new policies (and for them to be noticed by the press), the most recent it could have been is through the end of 3Q 2007, more likely end of 2Q 2007.

In other words, in an economy that still had some growth, before home prices were tanking in lots of markets.

There is a fine balance in workouts between taking enough from the borrower and taking too much. If you the lender try to extract more than can be had, it produces failure and leads you to incur more costs (in having to renegotiate the debt again) that if you had come up with a realistic number the first time.

But the credit card issuers seem newly confident that they can extract more. I have a sneaking suspicion that this conclusion comes from their experience under the new bankruptcy law (which went into effect October 2005) than with a credit-crunch induced desire to wring more cash from every available source (although the latter means they will be very reluctant to reverse this policy until it is conclusively shown to be a turkey) .

Recall that the new bankruptcy law imposes draconian repayment standards on those who don’t qualify for a Chapter 7 bankruptcy (if you have a home you want to keep, or your income has been above the median in your state, you are probably barred from Chapter 7). And worse, the budgets almost assuredly haven’t been adjusted for the recent uptick in food and gas costs. I was told that a person in Manhattan was expected to eat for $200 a month. The other budget assumptions are that stringent. And not surprisingly, nearly all the bankruptcy filings post 2005 have qualified for Chapter 7.

So the banks assume the deck is stacked in their favor, anyone going to a counselor must not be able to avail themselves of Chapter 7, and they can therefore put the screws on them.

The banks are badly overplaying their hand. We’ll see largely sympathetic media coverage of people hurt by this change in posture. And we have regime change coming in DC. Banks are becoming wards of the state; their ability to demand that the bankruptcy law stay intact when they need to be put on life support, is slim. While frontal revocation of the new bankruptcy law may entail too much high drama, it can be quietly gutted via exemptions here and there.

Elizabeth Warren of Credit Slips has some further observations:

This has at least three implications for the short term future of the economy:

First, family debts are tied to each other. If fewer consumers can get any relief, more counseling plans will fail. That means more bankruptcies, and, while they are at it, more consumers discharging other debts such as medical bills. More consumers will also take a second look at whether it makes sense to give back the car for which the loan far exceeds the value. This is also the time to look at the home mortgage and think about whether trying to make the payment after a reset is worthwhile. Don’t get me wrong: this won’t affect millions, but, at the margins, a credit card squeeze on interest rates will push more people to give up altogether–and that will affect returns for other lenders as well.

Second, the race is on. If Discover won’t lower rates, Citi will quickly figure out that a customer’s limited funds are going disproportionately to a competitor. Time for Citi to get tough–and so on.

Third, the news is bad on every front. Employment is down and defaults on home mortgages, car loans and credit cards are up. The consumer can’t pull the load, and the lenders who made huge profits off those consumers over the past decade or so are facing big losses. The idea that a one-shot stimulus will get us out of this mess seems more fanciful every day.

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  1. Francois

    My oh my!
    Seems that the banks and credit card companies are sending an advance invitation to the new President and Congress to hit them really hard with new regulations.

    How stupid can these people can be? Do they really think that lobbying money can forever stall long overdue reforms of their business practices? When was the last time they check the electoral map for 2008? Haven’t they notice the large number of their “natural allies” scheduled for retirement or is serious danger of being swept away during the next election?

    They’d do well to remember that they can operate only thanks to the State. And there are a few bills in Congress that are just awaiting the best moment to considerable tighten the screws on them.
    And in a recession climate, it’ll become extremely difficult for any politician to side with the credit card industry without jeopardizing their seat.

  2. Anonymous

    Just a question from a fairly naive European saver,

    What the hell is the use of credit in the US?

    This country has been the richest of the world for roughly over 50 years. It did not invent capitalism (UK did) but made it democratic stuff and “middle class” stuff. Great achievement.

    The US has suffered none of the major wars its partners have made and suffered. It still has signicant soil resources of all kinds.

    So whhy the hell do US people need capital injection for daily life? This is beyond my comprehension.

    That makes absolute no sense except if :
    – the real equity position of the US is not as described in books,
    – the country has a view to take undue and unfair advantage of the dollar reserve role… And default on it.

  3. Yves Smith

    Anon of 4:07 AM,

    A good question, and it deserves a longer answer, but I am afraid I will have to be brief. The US, UK and Australia all suffer from high consumer borrowings and low savings. This is something of a cultural phenomenon.

    Two main causes: stagnant average wages (you now have most married women working, which was unheard of in the 1950s, and it appears to be largely to support household incomes rather that out of a feminist impulse to have a richer life) and more tolerant social attitudes towards debt (combined, of course, with more access to debt).

    America is a terribly plutocratic society; many people feel compelled to keep up with their neighbors. For instance, my attorney, who has become a good friend, has a child in private school. That is already a big chunk of her household’s discretionary income. When the kid wants a new iPod or a new laptop because his friends in school have them, she feels compelled to buy it, even though she really should be reining in her spending (she is the bigger earner, but her husband works too, full time). It’s partly because she works so hard (she leaves the house at 7 AM and is seldom home before 9 PM) she feels guilty. The spending is a compensation mechanism.

    Dunno if that helps….

  4. Anonymous

    So why the hell do US people need capital injection for daily life?

    I’ll take a stab at this. Many observers have described the US as evolving in the direction of a winner-take-all society, in which the distance between the top of the socioeconomic ladder and the bottom and middle rungs has been increasing over time.

    The decline of manufacturing and the rise of financial services in the US and the resulting shift in income distribution over the last couple of decades are part of this story, but it is also a broader cultural phenomenon, seen in non-economic areas where a social darwinian ethos at the micro level has taken hold.

    Any middle class parent in the US with school age children can tell you horror stories about how competitive is it today, at school, in sports, and even in social organizations like the Boy Scouts which in theory promote an ethos of cooperation and group solidarity.

    Given access to an apparently limitless supply of per capita debt, US consumers have been using credit as a social escalator and/or safety net to deal with these darwinian pressures, because the message that our culture has been sending out loud and clear is that there are winners and losers, the former go on to bigger and better things, and the latter are trampled underfoot. If max’ing out my VISA/HELOC/etc is what it takes to ride the up escalator rather than the down escalator, well so be it, I can always pay it off when I get to the top. That’s what the average US consumer has been thinking.

  5. Anonymous

    Here’s a simpler view of rampant consumption.

    Current middle aged families were raised into a consumption system of “entitlements” or what some call the “ME” generation. They were raised to assume they could have any and everything they asked for in life. If one did not have $$, credit would suffice. Now there’s a problem paying back all of those foolish loans. Couple that with the point made earlier regarding enormous expansion of dual income families and their associated guilt driven need to buy everything for their little ones and you can envision why we’ve evolved into our credit generated consumable bubble economy. Test first, lesson later. We’re now about to learn about poor fiscal habits in a BIG way.

  6. CathyG

    I think it’s more about grotesquely skewed income inequality than it is about senses of entitlement. There’s a great lecture available on this subject by Robert Reich at:

    Since the 1970’s, so much of this great nation’s great wealth has been funneled to the richest 1% that everyone else has had to run faster and faster just to stay in place.

    Sending women to work bought us some breathing room. Having fewer children bought us some more. We quit saving and got another short respite. Finally, the only way that the bottom 90 to 95% of the country could postpone a serious drop in the standard of living was to use home equity and credit and hope and pray that things would somehow get better before the bills came due.

    Well, dang it, it didn’t turn out that way. I wonder what’s next – rescinding of child labor laws?

  7. Anonymous

    “There’s a great lecture available on this subject by Robert Reich”

    A typical left wing screed.

    Quitting saving does not give people “breathing room.” It paints them into a corner.

    The other commenters have it right. People believe they have an entitlesment to things they can’t afford.

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