Warning: Credit Card Practices Can Be Detrimental to Your (and Their) Health

Here is another example from the list of “things that we saw coming, but nobody cared.”  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. Apparently, things did not work out as planned.

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, as my colleague Tim Westrich and I documented in a report for the Center for American Progress last year. 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. Also, irresponsibility cannot explain why the growth rate in debt abruptly changed after 2001. Interest rates after all fell much more slowly in the 2000s than in the 1990s. And finally, people would have to plaster the walls of their homes with plasma screen TVs, have a different iPod for every day of the year, and rent out storage units for all of their new designer wardrobes to explain the enormous additional debt that families have taken on.

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.

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.

Comments

[Patches]

You know, I have been seeing a lot of that lately. I am consistently seeing people saying "Well we used to be able to afford the payments until they all raised the interest rates and our minimum payments went up". "Now we have to file bankruptcy". I have been seeing more and more of those types of debtors in office. The kicker is that many have NEVER missed a credit card payment, like EVER! Now they can no longer afford the minimum payments. I think that is the major contributing factor for these people I am seeing that have these above "median" incomes, way above! I didn't put two and two together until your post. Enlightening! TY!

[Ditech Home Loans]

Credit card company policies could slow the housing recovery, and consumer spending, because of the new fico formula that penalizes credit scores when accounts are closed, or credit limits are reduced.

[Fraud Guy]

And remember, this is in addition to the interchange premium that MC & Visa added to their "bonus" cards in order to defray the costs of the perks that they give to those customers.

So they're increasing costs to consumers, businesses, and the taxpayers. A lovely trifecta.

[mara]

Don't forget the evil mechanism of the Universal Protection Clause, whereby if you're late (even a day) on your BofA card, then Chase miraculously can raise your rates too--in fond anticipation of your insolvency. So I guess their entire M.O. would be to drain it out of the customers the fastest and let the other cc corp's be damned.
And don't get me started on FICO. Even a company doing a query will minus 5 points from your score, even if it's w/o your approval. If you personally close an account, or decide you only need 5k, not 10k of credit, you're dinged even though you thought you were being responsible.

[Patches]

Did you hear that ole' "Fair Issac" will stop selling FICO scores to consumers?

[Twitter Credit Card Offers]

Nowadays you're lucky if you can get a new credit card.

Not only the bar has been raised, the credit card issuers are closing more accounts faster than opening a new one.

They are on the defensive to prevent further losses in the current uncertainty economy.

People with good credit may suddenly unable to pay because of umemployment.

[Pat Regnier]

Can you say more about the SCF data and what it suggests about attitudes toward debt for conspicuous consumption? That's interesting

[wamucards]

I'am very sad about collapsed Washington mutual credit card. My FICO score was lost sine that time!!

[Linda Golden]

Wow, these posts say it all. I've spent the last 2 weeks trying to wrap my head around the fact that Bank of America closed my CC account (w/o my knowledge) and my term loan account because I called them to find out if they would work out a plan that would lower my monthly payments since my husband was laid off in Feb. I have never paid late or less than the minimum monthly payment. I even offered to pay 5,000 on the 12,000 I owed on the loan, and they said there was nothing they could do. They offered adding an additional year onto the loan which might lower the monthly ($370.00) payment $30.00 or so. I declined and said I would get back to them. Later that day I received a message that the woman I spoke with had tried to call me. I called back and was informed that my account had been closed. Then yesterday I received 2 letters saying my account(s) had been closed. I again called to speak to them and was informed my CC account was closed also. I did not realize my AAA credit card was underwritten by BOA so they decided I was now a risk and closed my accounts. So, trying to do the right thing just seems stupid right now. Shame on me for letting these piranha's know anything. So don't believe it when your told "call the creditor's" they will work with you. They will NOT. They are so afraid (after the 30 billion bailout) of not getting paid they will ruin your credit immediately.

[Fraud Guy]

Linda,

And sometimes telling them doesn't work at all.

Last year (tailing over from 2007), my wife and I were hit hard; I had lost my job and was unemployed for 1 day shy of 6 months; she was trying to reenter the workplace, and we ended up losing our previous home to foreclosure after 2 years of trying to sell, taking a $150K hit.

Our current mortgage ended up a recurring 30 days late, but we were trying to pay our property taxes, and couldn't come up with it. We advised our bank, and have still been trying to work with them to allow us to catch up. They let the taxes go to auction, where we have 2 1/2 years to redeem, and they were sold for about 7%. After the auction, the bank redeemed the taxes at the higher rate, and now wants them repaid upfront or within a year, which would nearly double our current mortgage payment.

I asked them why they didn't bid on the tax auction at 0% (as lowest bid wins)--I don't know.
I asked them why they are forcing repayment in a shorter time frame--because we can.
I asked them why they are only taking steps to increase our payments--because if you are only 30 days late, we have to.
I asked them if they have other programs to reduce payments--yes, but if you are over 60 days late, then we can consider them.
Wouldn't that put me in default, and at risk of foreclosure or needing to pay all payments in arrears--Yes.
Do you think I should play chicken with you on my house--No.
Can I get an outline of your programs to determine if it worth the risk of going 60 days delinquent--No, then you might game our system.

Oh, I'm gaming the system....

Someone once said that life is like playing a game of cards in the dark, while blindfolded with a dealer who's always smiling. I think the dealer is the financial system.

[OSR]

"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."

Not so fast there, sunshine. Consequences are only for suckers and citizens. For everything else, there's TARP.

[mark t]

That is a very good post. I think a national usury law would go a long way toward shoring up the finances of average americans, AND, compared to mortgage modification laws that would compromise principal and facilitate windfalls, a national usury law would aid those who strive to pay back the amount they borrow and thus would reduce moral hazard and also be perceived as more just.

[elementaryfinance]

I think the recession is going to teach everybody that leverage is a dangerous thing in the hands of people who are not as financially savy as they should be. Leverage is a more complex financial instrument than people believe.

[Henry]

If you cant afford it don't use no damn credit cards
Credit is used for an emergency or to make more money like a business not buy dumb things you don't need now the government is buying all our bad debt from the banks using our money to free up the credit markets so we can get some more bad debt, this is some bullshit.....save your money.

[Patches]

Believe it or not Henry, you can make money by buying bad debt. There is not much in this world you can buy without financing. Cars, Homes even TVs. What we have here it the classic "Catch 22". Without credit cards and actually owing on them, you would be hard pressed to receive a decent interest rate on your Mortgage. So unless you want a 8-15 percent interest rate on your mortgage you would have needed to build your credit through some means. Your older credit cards give you the best boost on your credit score. (which they will be no longer selling us consumers) I agree we need to save more. Definitely! Now they say you should not have used more than 30% on any one credit card.

Do you remember what Prez Bush said after 911? To fight terrorism he wanted us to go out and "SHOP"! The system is rigged yo! If you have never had a credit card or even charged on one a Mortgage Company will never give you a decent interest rate or a Mortgage for that matter. They have credit scores on us that we don't even know about or can ever know about! AND ITS LEGAL to keep it (the calculations of those scores) from us. If we knew how the scores were calculated we could "game the system", so they say. Rigged bro, rigged!

[Margo]

A national usury law is a great idea. Also people need to be given time to pay their bills and not be penalized by outrageous rate increases if the check does not get to the company on time. I had to pay $10. more using my checking account because if I used the mail my credit card payment would be late. The laws are written for lenders and the banks not consumers. Likewise the Bankruptcy Law needs to be rewritten because it against working moms and people that get sick. Joe "The Banker's Boy" Bidden, Hiliary Clinton and I think Schurmer from NY were two or three of the Democrats that voted for that bill to pass. There were nine Democrats that voted for the bill. Does anyone know who they are?

[Alessandro Machi]

I have started a protest against JP Morgan / Chase bank and their belief that they can raise the monthly minimum payment from 2 percent to 5 percent while giving the consumer no recourse.

Please check out the protest at http://www.Daily-Protest.com

[Sanja]

Warning: Do not apply for US Airways Dividend Miles Credit Card, If you are one day late with payment, they'll rise your interest to almost 30%!

[Alessandro Machi]

Speaking of US Airways and their parent company American Airlines. American Express closed thousands of frequent flyer mile credit card users who had LOTS of miles saved up.

The customers lost those miles. Then American Airlines suddenly was able to "reallocate" frequent flyer miles to CitiBank for lower interest rates on a big loan they were or are negotiating.

Wow is all I can say. http://dailypuma.blogspot.com/2009/04/breaking-news-amex-and-citibank-have.html