Jose D. Roncal
Last fall we wroteConsumer Debt in the U.S., an extensive report on the state of credit debt in the U.S. We’ve also written about the credit crunch in our bookThe Big Gamble. There is valuable background information in these reports, but with so many recent changes in the news, we thought it was time to give you an update.
What has changed?
The severe economic downturn has changed the rules about those little plastic cards we carry in our wallets: credit-happy consumers have curtailed their binge spending, government regulators are tightening the standards, and credit card companies are having to re-evaluate their business models and soon will have to be more transparent about their practices.
The reasons for the decline in credit card use are all interlinked. First, credit card issuers got hit with a rising default rate—up to 8% or double the figure in 2006. That caused companies to set stricter standards making it harder for borrowers to get additional credit. At the same time consumers have become more cautious about taking on more debt because of concerns over job loss, declining home values and evaporating retirement funds.
We are all too familiar with these facts, but there’s one aspect in this picture that isn’t reported much: securitized credit card debt. That means packaging and selling credit card debt just like Wall Street did with mortgage-backed securities. For a little refresher on what that means, see our report entitledGet Ready for Another Crisis: The Coming Credit Card Debt Meltdown, especially on the third page under the subhead: Under the radar: Packaged credit card debt.
The securitized debt backed by credit card receivables was a whopping $915 billion industry. Who bought this debt? Pension funds and institutional investors, among others. When banks package and sell card debt, they pass some of the default risk along to investors. Yet, banks were pocketing much of the profit from rate and fee increases on those accounts. Imposing higher fees on more accounts—without an equal rise in risk—means banks were raising revenue at investors’ expense.
Securitization was a major impetus for banks to expand penalty fees and rates in recent years. This increased the default rate and led to big losses for investors. It eventually unraveled the whole game—just as delinquencies in the housing market brought down the $900 billion market in mortgaged-backed securities.
These practices had been a major platform in the financial infrastructure and helped set the pace for widespread use of credit cards. But the current financial collapse has made it impossible to securitize credit card debt.
Since 1958, back when the first credit card was issued, the industry has grown to nearly $1 trillion in revolving outstanding credit on more than 700 million U.S. credit card accounts. At the same time, the savings rate was on a steady decline.
But in May of this year, the savings rate hit a 15-year high of 6.9%, due in part to the one-time federal stimulus checks mailed in 2008, and partly due to consumer fears we’ve already mentioned.
As we look forward, we think the future for the credit card industry will depend on what happens in the broader economic picture. Access to credit will increase a bit as the recession eases, but the mind-set of the borrower may be harder to change. The renewed compulsion for the lost art of frugality and the urge to beef up savings accounts are natural responses after having suffered through the shock of loss. But since up to 70% of the U.S. economy hinges on consumer spending, this renewed penchant for saving could actually create a drag on the recovery.
On the upside, the increased savings could eventually be used to fund new innovative startups, create new jobs and stimulate a surge of economic growth—though that’s more of a long-range outlook.
In the short-term, credit cards and debt are probably not going away. The simple and habitual swipe of a plastic card makes transaction processing faster and more convenient. The growth surge may be over, but credit cards are still ubiquitous.
Meanwhile, the reforms set by the Obama administration could bring a little relief when they go into law in February 2010. The Credit Card Accountability, Responsibility and Disclosure Act is designed to end some of the deceptive tactics that credit card companies have been using for years. Since the average balance on close to half of all Americans is more than $7,000, the changes could benefit many consumers.
What are the changes?
|•||Billing statements will have to reveal exactly how long it would take to pay off the balance if the cardholder only makes minimum monthly payments.|
|•||Statements will be mailed 21 days before due date rather than 14 days.|
|•||There must be a 45-day advance notice of any changes to terms and conditions.|
|•||No rate increases will be permitted on existing balances unless consumers are at least 60 days late, or the initial rate was a promotional rate that has expired, and this scenario would still be required the 45 day notice as shown above.|
|•||Promotional rates will have to be valid for 6 months.|
|•||No more payment processing fees, such as surcharges for paying by telephone.|
|•||Can no longer impose penalties for late payments to another card company.|
|•||Payments will be applied to the portion of the balance with the highest rat|
These changes will undoubtedly ease the burden for those with high debt. But creditworthy cardholders who are prudent and live within their means—”deadbeats” in industry parlance, because they generate negligible fee revenue—these customers will become the new targets of the industry and could see perks disappear and the imposition of, or a hike in, annual fees.
If these are the new rules, we have to ask, ” In a society where paying with plastic has become a necessity rather than a luxury, can fees on all of our debit card transactions be far behind?”
If you found this article helpful, visit www.financialspeculation.com to claim your own copy of Jose Roncal’s popular FREE REPORT, “12 Keys to Smart Speculating in Tough Times.” It’s chock full of valuable insight on how to rebuild your nest egg. While you are there, check out “The Big Gamble: Are You Investing or Speculating?” See for yourself why Donald Trump has called it “a great read!”