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.
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.