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.