Putting the Screws on Credit Card Debtors

Today Bank of America joined a number of other credit card issuers in raising credit rates for borrowers who carry a balance. These are not credit card holders who have failed to pay on time, or who have any history of credit problems. Many of them even pay more than the minimum balance each month.

But they do have the misfortune of carrying a balance on their credit cards, putting them among the more than 50% of families who don't or can't pay off their credit card balances each month.

The average balance per open credit card -- including both retail and bank cards -- was $1,157 at the end of 2008. That's up from $1,033 at the end of 2006, a growth of nearly 11 percent in two years. (Source: Experian marketing insight snapshot, March 2009).

Even though credit card borrowing fell in February 2009, the number of credit card holders defaulting on their debt has continued to rise in the very same month. According to Reuters, “U.S. credit card defaults rose in February to their highest level in at least 20 years, with losses particularly severe at American Express Co (AXP.N) and Citigroup (C.N).” Incidentally American Express is the company that recently gained notoreity by paying low-charging customers to close their accounts, and Citigroup has been one of the most aggressive in raising rates.

Recently Congress has considered legislation to stop some of the credit card companies' practices that hurt consumers most:

Suddenly raising interest on accumulated balances
Raising rates across all credit cards held by a borrower because of a late payment made on one card
Charging for payments made over the internet or phone

The bad news for consumers is that these changes will not take place until 2010, and in the meantime, credit card companies are doing everything possible to wring out what they can in fees and interest rate increases while they still can.

To be fair, credit card companies are facing their own limitations on how much they can lend in a financial system where banks are leery even of lending to one another. Since the recession has dragged on, and unemployment has escalated, credit card companies have little way of knowing which of today's “good” customers may be tomorrow's defaulting customers because of escalating job losses. As a result, “Meredith Whitney, one of Wall Street's best known and most bearish bank analysts, estimates that Americans' credit card lines will be cut by $2.7 trillion, or 50 percent, by the end of 2010 -- and fewer Americans will be offered new cards.”

Some of those who pay off their balances every month and enjoy good credit may feel scant sympathy for those who are facing higher rates because they still carry credit card balances. But it's hardly a secure position when even good borrowers are losing their home equity lines and finding other sources of credit drying up.

If credit card companies continue to squeeze those who are paying them on a regular basis, particularly by lowering their credit limits and injuring their creditworthiness, they risk worsening the already weak consumer spending that generates a substantial portion of the United States' gross domestic product (GDP).

What looks like fiscal prudence now could also backfire on credit card companies when the economy begins to rebound, as many consumers may choose to get rid of their cards rather than pay the higher fees and interest rates.

For example, “Tamara Smith of Burlington, Vt., got a notice from Bank of America that her 7.9% rate will increase to nearly 13%. She immediately called the bank and opted out of the change. That means she keeps the 7.9% rate on her roughly $2,000 balance, but can't use the card for new purchases without having the higher rate apply to her entire balance,” (“BofA to Boost Rates on Cards with Balances,” The Wall Street Journal, April 9, 2009).

Credit card companies may find a short-term profit boost in these actions, but as more consumers move from credit to debit cards or even to cash, they may find little reason to return to the companies that tried to ditch or gouge them. And credit card companies may find it much harder to woo back the American consumer in good times when they have treated the consumer so badly when times were bad.

Pay Now or Pay More Later: What Can We Really Do about Toxic Assets?

For those of you who still think a “tarp” is something to cover up ugly debris, the government's TARP (Troubled Asset Relief Program) program actually does reflect the literal sense of the word quite well. Although the TARP has been an ever evolving work-in-process since it was first conceived by Hank Paulson in the last days of the Bush Administration, one aspect of it has not changed. TARP still represents the government's best efforts to help the financial industry contain a mountain of largely uncollectible debt. Yet months after the first attempts to bail out the banks, we still don't know just how toxic their "troubled assets" really are.

If you are wondering why the Feds and the Treasury and SuperObama can't just clean up the mess, it's worth taking the better part of an hour to listen to this week's public radio program, This American Life. NPR's Adam Davidson and TAL's Alex Blumberg have produced some of the best reporting to date on the banking crisis (See “Giant Pool of Money” and “Another Frightening Show about the Economy”.)

The most recent segment, “Bad Bank,” explains why we American taxpayers may have no choice but to pay “as much as we can” to redeem debts that bankers made to people with lousy credit and no credible means to pay back their loans. As a researcher from Deutsche Bank, Joe Lavorgna, wrote bluntly in a recent report: “Ultimately, the taxpayer will be on the hook one way or another, either through greatly diminished job prospects and/or significantly higher taxes down the line.” Mr. Lavorgna goes on to suggest that the government should "estimate the highest price it can pay for the various toxic assets on financial institution balance sheets," and then then cough up the funds even at taxpayer expense.("Taxpayer Beware: Bank Bailout Will Hurt").

If this sounds like a holdup note, both the reporters on this story and the economists and bankers they interview agree, it is. The banking industry after all its greed and excesses is basically telling us, “Pay up now, or just pay more later.”

But as one expert in banking crises from the Columbia University School of Business points out, this aspect of the financial crisis is not really new. According to Professor David Beim, history shows that governments have always bailed out the banks because societies can't function without them. He cites the example of a banking crisis in 37 AD that had the Roman emperor galloping back to the capital posthaste with bags of money to give to the bankers who had created the problem by making bad loans. Sound familiar?

Professor Beim notes that this has happened over and over and over again, only not on such a global scale. We'd be in great shape, relatively speaking, if the U.S. were merely Indonesia or Argentina. The IMF could intervene, take over the bad banks, clean things up, and the global economy would keep chugging along nicely. But take a behemoth like the United States with its Bank of America and Citigroup, which together hold over a quarter of all the money in the U.S. banking system, and we face a dilemma of a different order of magnitude.

The problem is compounded by the continuing belief that such dire outcomes “can't happen here” and by the anger of the American public who are still telling politicians to let the bankers take it on the chin even though it could propel the United States into a economic crisis that would make make the Great Depression pale by comparison.

Yet by far the scariest part of this reporting on the state of “bad banks” does not come from tales of people losing jobs or homes or life savings, but rather from a simple graph. According to David Beim, this is the hard data that shows we are not simply facing a housing crisis or a credit crisis but something much deeper and more systemic.

The graph shows that for much of postwar history, the collective debt of the American consumer has always been a mere fraction of our gross domestic product (GDP), usually hovering around 30%, sometimes rising to 50%, but in the last ten years, rising faster and until it reaches a point where the indebtedness of the American people equals GDP. That means 100% of what we owe is equal to 100% of all the goods and services we produce.

That has only happened twice in the last hundred years: in 1929 and now. As a nation we are literally out of room to borrow because we don't have the assets to borrow against. From this perspective, the problem of banks' toxic assets, intractable as it seems to be, is just the tip of the iceberg. We have all been victims of our own collective greed and our collective indifference to consumer borrowing run amuck.

So what can we do? Well, according to the experts we don't have many choices. Thanks to the fiscal irresponsibility of the past decade, we have a war we've borrowed to pay for, and a financial system that deregulation has helped send into a tailspin. And we, as consumers, have gone along for the “free” ride that is proving to be a costly fantasy trip.

We can pay now, or pay more later. And no amount of outrage or denial will change that.

Consumer Debt - The Next Credit Crisis?

Consumer Debt: The Next Credit Crisis?

Economists and public policy researchers have been saying the same thing for years. Americans cannot go on spending the U.S. economy into continued prosperity and themselves into hock. And yet recent history seems continually to thumb its nose at these gloom and doom prophesies.

First, it was the combination of a bull stock market and low interest rates that made it seem as if one could borrow forever, invest in the latest hot stocks, and make money.

Then home equity lines and rising housing prices turned the family homestead into a convenient piggy-bank, not just for actual home improvements, but for new cars, vacations, and paying off credit card balances that had gotten a little out of hand.

Now the market has been down for four straight months, the values of homes are falling, and people are finding that their net equity may be zero or worse, they may actually owe more on their mortgage than their home is worth.

So far most pundits have focused on the crisis in the housing market as the most significant aspect of this economic downturn, but there are worse scenarios ahead to keep you up at night.

Consumer spending accounts for a substantial amount of the U.S. gross domestic product; it counted for as much as 72 percent of GDP as recently as April 2007. Yet in February of 2008 consumers turned in their weakest spending performance in 17 months, suggesting that this key component of the U.S. economic engine is also slowing down significantly. If you think of the average American consumer as the “little engine that could,” imagine what the economic impact will be if that consumer turns into the “little engine that can't any longer.” Few public officials want to acknowledge that we may be in a recession now, but a fall-off in consumer spending may make recession inevitable and not necessarily the mild contraction everyone keeps hoping for.

At the same time, many U.S. credit card holders are finding themselves deeper and deeper in debt, amounting to nearly $1 trillion as of 2007. And what are credit card companies doing to help the American consumer? They're shortening the time to pay, increasing fees for late payments, piling on the fine print of their contractual agreements and laughing themselves all the way to the bank.

It used to be that credit card companies made most of their money on the interest owed by consumers who didn't pay off their balances in full each month; those who do pay the full amount monthly are referred to “deadbeats” by these companies. But increasingly, credit card companies are making far more money off the fees they charge. According to RK Hammer, a bank-card advisory firm, card issuers took in $13 billion in fees [in 2006], not counting $12 billion in late fees (Kiplinger, February 22, 2007).

You may feel like you're the only one who ignores the the fine print on your credit card or those supplemental “changes to your account” that you get with your monthly bill, but don't feel stupid or lazy because you just can't take the time to figure out what your contract with your credit card issuer really means. Professor Elizabeth Warren of Harvard's law school gave her third-year law students the exercise of figuring out what the fine print on an average credit card really meant, and they found it far more challenging than they expected. If Harvard law students cannot figure this out, how can the average consumer be expected to understand the fine print, especially if it includes language like “we reserve the right to change the terms of this Agreement at any time”?

Although Congress has periodically investigated these abuses and even wrung their hands over the way credit card companies take advantage of the most vulnerable consumers, it has done little to prevent them. That may finally be about to change with the introduction of legislation by Senator Carl Levin and Representative Carolyn Maloney who have put forward a cardholder's bill of rights. This bill would require such consumer protections as a ban on collecting interest for amounts already paid, timely notice of changes in interest rates, and the ability to cancel a card if rates suddenly rise. Professor Warren has also advocated for a Financial Product Safety Commission to regulate the industry, which so far has largely operated on its own terms.

These are useful first steps. But in the meantime, consumers should follow the old Latin adage: caveat emptor, or let the buyer beware, whenever they are tempted to open a new credit card account to get an extra 10% off the next purchase, or get money back on their gas purchases, or any other seeming “freebie.” In most cases, you're better off using your debit card and not paying the annual fee or any other “hidden” fee in your credit card contract. If you do want a credit card, try getting one through your local credit union or savings and loan, where you can talk to a real human being if you run into any kind of trouble.

Credit card users should also realize that in a troubled economy they hold far more power than they might think. If the U.S. economy depends so heavily on consumer spending to stay healthy, now is the time for U.S. consumers to exercise their voting and lobbying power by letting Congress know they want a level playing field for credit card holders, and at least enough regulation to ensure that someone who borrows a little money to buy a dishwasher or a stereo system is not paying many times the value of that purchase by falling into the credit card trap.

If the U.S. wants to avoid the next credit crisis, it needs to take a pro-active approach to consumer credit card debt and not wait for the housing bubble to be followed by a wave of credit defaults and bankruptcies as consumers fall back on the plastic as their last resort for making ends meet.

Saving Wall Street - Failing Main Street

Saving Wall Street; Failing Main Street

The headlines just seem to get gloomier with each passing week of 2008. Housing prices keep falling, gas prices rise, and consumer confidence is at a five-year low.

But where are the tax-payers' efforts being directed? Not at the average consumer or at the home-owners no longer able to keep up with adjustable-rate mortgages. Instead millions of dollars of government credit has been extended to keep banks lending money to one another and to bail out investment firms like Bear Stearns.

The extension of credit makes sense in an environment where banks are suddenly distrustful of one another and how much more bad debt will surface as the full extent of the sub-prime mortgage crisis becomes known. One can even make the argument that arranging the shot-gun marriage of Bear Stearns and JP Morgan Chase can be justified if it helped to contain a sudden run, not just on Bear Stearns but other firms with similar investments.

However, since it is not merely the U.S. Government, but ultimately U.S. taxpayers, namely you and me, who are financing these transactions, it also makes sense to ask what are the risks and benefits for us? UC-Berkeley public policy professor and commentator, Robert Reich, points out that when the British government bailed out one its largest failing banks it took shares of stock so that British taxpayer would reap the gains if the shares became sufficiently valuable. In the case of the JP Morgan-Bear Stearns deal, U.S. taxpayers are essentially providing a kind of corporate welfare, in which they lose if the JP Morgan acquisition proves a bust, but if the acquisition pays off, JP Morgan shareholders win and U.S. taxpayers still lose. Why voters tolerate this kind of lose-lose situation over and over again as the government steps in to handle various financial bubbles from the savings and loan scandal to the current credit crisis is a mystery.

Capitalism is supposed to be a zero-sum game, but in the current U.S. political and economic system, it's a rigged game where individuals can lose but corporations and corporate bankers always seem to come out ahead. Conservative politicians have always argued that what is good for business is good for the average American, but recent economic developments increasingly call that into question, and the increasing burden of business bailouts on the American taxpayer may finally bring these issues to the foreground for debate in the upcoming election.