The Bad Debt of Tomorrow
Next up around the corner, it seems, will be a wave of credit card defaults which, like mortgages, have been packaged and securitized and God only knows if the risk models that the owners of the securities are workign from are actually any good. In light of recent events, one suspects the answer is no. Hilzoy has this interesting chart:
The basic credit card business model is pretty bizarre. With a mortgage, the bank lends out money. In exchange, they charge interest on the loan. There’s a risk of default, but the basic business model is that you’re hoping most of your customers pay their bills on time. With credit cards, though, you don’t make any money off people who pay their bills on time. You’re hoping your customers won’t pay what they owe you, thus letting you start tagging them with the high interest rates and sundry penalties. But of course you don’t want your customers to default either. It’s a delicate balance. But the risk with a delicate balance is that you fall off.
46 Responses to “The Bad Debt of Tomorrow”
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October 21st, 2008 at 10:57 pm
“With credit cards, though, you don’t make any money off people who pay their bills on time.”
You mean paying the full balance within the grace period? People can accumulate a nice chunk of debt, then pay the minimum on time every month, and end up paying triple what they charged. That seems like making money for the CC company to me.
I have also dealt with credit card companies that are fairly forgiving, and don’t jump at the chance to nail you when you inadvertently miss a bill if you call up and explain it. The ruthless MBNA model is not the universal credit card company model.
October 21st, 2008 at 10:59 pm
Matt:
Credit card companies make money off of businesses that accept credit cards; typically, credit card companies earn 1% to I believe even 5% on purchases made with the card, paid for by businesses. That is why some marginal, small businesses, do not accept credit cards.
I believe though that the main profit center for credit card companies are those individuals that run a balance but never pay it off. And someone defaulting is bad news; I know individuals who will be harasses by debt collectors for outstanding credit card debt, but who will then threaten to declare bankruptcy. Usually, the debt collectors will get nervous and start stating how thing “can be worked out.”
October 21st, 2008 at 11:06 pm
With credit cards, though, you don’t make any money off people who pay their bills on time. You’re hoping your customers won’t pay what they owe you, thus letting you start tagging them with the high interest rates and sundry penalties.
You’re confusing people who miss payments with people who maintain balances but make the payments on time. It’s the latter group that drives most credit card profits.
October 21st, 2008 at 11:10 pm
Look where the lines start to diverge: right after George Bush, Jr. implored Americans to go out and shop after 9-11. Thanks, Worst President Ever.
October 21st, 2008 at 11:15 pm
Great Blog post. I am going to bookmark and read more often. I love the Blog template
October 21st, 2008 at 11:18 pm
While the divergence appears to start at Q4 2001, that could easily be and would be seen as noise except for the later huge increase in 2003. What happened in 2003 to cause people to being acquiring huge amount of cc debt?
October 21st, 2008 at 11:41 pm
Some of the above comments are conflating how ‘the banks’ make money with how Visa et al make money.
Visa is the one who gets the cut of the transaction.
Capital One, MBNA etc, get the interest and late fees.
But, the mortgage industry during the bubble did it’s share of running up surcharges and penalties. Heck it still does it to try to tack on as many penalties as they can get away with. The main difference between the mortgage guys and the credit card guys is that the former made their fortune by charging money on the front end too, by loading up on a bunch of junk fees (and some legit ones)
I think one would find that all the money lending industry, no matter what the variation, always try get the ‘delicate balance’ of trying to extract as much ‘interest’ as possible (through straight up % or with extra fees) while attempting to make sure they don’t lose their principal. And I’m pretty sure all facets of the money lending industry are in deep kimchi if they start having to write off a great deal of principal.
October 21st, 2008 at 11:42 pm
Another meaningless chart. What’s the bottom line supposed to represent? Total wages? Average wage? Median wage? Why is wage the relevant indicator rather than income or assets or a combination of them? And what’s the distribution of the credit card debt? The last Survey of Consumer Finances by the Federal Reserve found that more than half of all credit card holders had no outstanding balance at all, and that for the minority that did have a balance the median amount was only $2,200.
October 21st, 2008 at 11:51 pm
Two thoughts:
1 – keep in mind that credit card borrowers are like indentured servants now – the bankruptcy law changes mean they are indebted for life with no escape except repayment.
2 – I honestly don’t know, but I always assumed that CC companies also acted in bank-ish ways by deploying capital they don’t have for other uses on the assumption that the A/R would eventually come in. It’s probably a pretty predictable revenue stream under ordinary circumstances.
October 22nd, 2008 at 12:18 am
Mixner,
Why don’t you go find the answers to all these questions and then report back to us about how those answers undermine the claims that have been made. You are currently only waving your hand in that direction while dismissing the chart as worthless. In other words, quit your whining and bring some arguments and evidence.
October 22nd, 2008 at 1:28 am
What percentage of the credit card debt number includes balances from people like me and my husband – those who use their credit cards frequently, but also pay them off in full every month and thus pay no interest? If people like that have increased their usage – more and more small purchases are made on credit cards – that could account for some of the increase. I still don’t think that it can possibly account for the bulk of it, but I do wonder why kind of correction factor that would introduce. The label “credit card debt outstanding” suggests that that is an adjusted number, but I can’t find any confirmation.
It’s also still worth the credit card companies’ time to have people like myself use them even if I’m not their favorite type. Because they get a cut from the merchants regardless and every once in a while a missed payment generates them an absurdly large fee.
October 22nd, 2008 at 1:47 am
http://libertarianrepublican.blogspot.com/2008/10/daniel-hemel-resident-of-oxford-england.html
Winnebago Alum Daniel Hemel supposedly commits voter fraud. Surely this has you written all over it…
October 22nd, 2008 at 1:48 am
Why don’t you go find the answers to all these questions
Because I’m not the one who posted the chart.
You are currently only waving your hand in that direction while dismissing the chart as worthless.
Do please explain what value you think the chart has. You don’t even know what the bottom line represents, do you?
In other words, quit your whining and bring some arguments and evidence.
You’re a child throwing a temper tantrum, D.
October 22nd, 2008 at 1:58 am
0.) Thanks, Joe Biden; just be glad you’ve got the Palin-a-rounder to make you look like an human being by comparison.
1.) Maybe it’s not as serious a problem, given that there’s no underlying collateral to be massively devalued…unless you count “ability-to-pay’on the part of a job-deficient populace….
October 22nd, 2008 at 2:44 am
oh mixner, don’t play such stupid little games. really, it’s like you’re not even trying.
the chart means exactly what it looks like it means: in the face of stagnant real wages, people have been using credit (as well as tapping HELOC and in other ways extracting equity from their homes) to sustain (or even improve) their standard of living.
when you see a sudden jump like this, it shows that there’s going to be a problem: real wages aren’t going to suddenly improve.
making this potentially worse, as with mortgages, we now have separated originator and servicing by securitizing credit card receivables, so if there is indeed a problem, it could pop up in all kinds of odd corners of the economy, based on who is holding the securitized receivables and how they will have to be marked to market.
there’s nothing mysterious here: for example, i’m not sure what the bottom line represents specifically, but i know what it represents intellectually because there’s no absence of available information to demonstrate the stagnation of real income.
as for the distribution of credit card debt, for crissake, you answered your own frickin’ question (i’m going to assume you looked up the information accurately): half of the households have more than $2200 in credit card debt.
meanwhile, as the link would have told you if you had bothered to click through and read, there’s some $950B of credit card debt. if i assume (incorrectly) that each of 120M households has 1 credit card, then the average credit card debt is $8,000. to pursue this simple (but good enough) analysis, if the median is $2200, then the other half of the households have an average debt of $13,500.
undoubtedly credit cards are more concentrated, so the numbers will be different, but as warren buffett says, i’d rather be approximately right than exactly wrong.
and approximately right is that of course we will see record levels of credit card default, but unlike historic credit card defaults, this one will have futher ripple effects due to the securitization of credit card debt.
how can this not be obvious to you?
October 22nd, 2008 at 2:58 am
Not really totally true – it is possible to run a profitable credit card business off interchange and merchant fees alone, although I agree that’s not really the point of a cards operation. But I don’t think it’s quite so pernicious or strange a business practice to assume that a credit card (ie, a payment card with an attached line of credit) is going to be used to get credit. And it’s perfectly possible to run a profitable credit card operation which doesn’t depend on late fees and penalty charges; in general, the dominant players try to avoid this sort of business practice as it hurts the brand in the long term, and it’s the marginal players that go in for the sketchy stuff. In Germany, almost everyone does in fact use their credit card as a debit card, and the credit card business there is economically viable, though not wonderfully profitable.
October 22nd, 2008 at 4:41 am
I eagerly await the Republicans’ explanation of how this is all the CRA’s fault….
October 22nd, 2008 at 5:00 am
I’ve been thinking about this too. The way debt should work is that its used to increase your income. You use debt to start a business, the business generates profits, the profits are used to pay off the debt with interest. In theory, student loans should work this way because it increases the graduate’s chances of getting a higher paying job (this is happening less and less each year in practice). You can kind of argue that a loan to buy a house will work this way too because the house will appreciate in value.
But credit card debt is used mostly to purchase items to be consumed, not to generate profits, so it doesn’t fit this model.
What credit cards really replicate, or should replicate, is the installment plans from your grandparent’s era. If you don’t have the cash for something, you can charge it, then pay off the debt in small amounts over time from your salary. Credit cards have also become necessary for buying things over the phone or internet, and there are a few items such as airline tickets that you have to buy that way.
The next change of bankruptcy law should limit credit card debt to some multiple of a person’s income. People have to declare their income to the government each year in April so I think this is practical. There should be some protections built in if a person’s income goes down through no fault of their own, maybe lowering interest rates on credit card debt in recessions with large layoffs.
October 22nd, 2008 at 5:20 am
The sad thing is that when Mixner tries, he usually does bring something to the argument.
Still looking for an answer to Ifv’s question. What on earth happened in 2003?
October 22nd, 2008 at 5:43 am
One of the reasons the subprime crisis caught so many people by surprise is that historically credit card delinquencies have been a very reliable leading indicator of mortgage delinquencies. So (many, but not all) people saw stable credit card payments and assumed that mortgages were fine for the moment as well. Of course that turned out not to be true – people ended up defaulting on their homes while paying off their credit card. Indeed, people were taking out mortgages to pay off their credit cards, rather than the other way round as in the past. To be honest, I’m stunned that credit cards have taken this long to suffer. I suppose it’s because employment held up fairly well (by the standards of the decade) until early this year.
“Still looking for an answer to Ifv’s question. What on earth happened in 2003?”
Well, it’s always foolish to attribute anything to a single factor, but the Fed Funds rate fell to 1% in June 2003, and that probably had something to do with it.
October 22nd, 2008 at 5:50 am
Alright, granted VISA, Inc. may not be representative of credit card companies generally…
And granted, the quarter Oct-Dec 2007 isn’t necessarily representative of the present circumstances…
But…
According to VISA’s form 10-Q, filed with the SEC, from Oct-Dec 2007, VISA, Inc. total revenues ($1,488Mil) are divided as follows: 1) Service Fees ($732Mil, 49.9%), 2) Data Processing Fees ($492Mil, 33.06%), 3) Volume and Support Incentives (-, yes negative, $250Mil), 4) International Transaction Fees ($381Mil, 25.6%), and 5) Other Revenues ($133Mil, 8.9%). This is REVENUE.
Post Tax Income (profit) for the same period was $422Mil or 28.36% of total revenue.
As I am not an accountant, I am not sure what, exactly, this means. But, for my argument we can make a couple of assumptions, all of which will lead to different conclusions and be defensible, at least somewhat…
Say “Service Fees” directly represent interest paid by VISA’s debtors. We can make the following arguments to appropriately disposed, reasonable people: 1) If revenue is equally distributed relative to profits, revenue from “Service Fees” (49.9% of revenue) is, nonetheless, NOT a majority of VISA, Inc. profit. 2) If Service Fees are supported by “Volume and Support Incentives” (aka Advertising?), then, technically, revenues, (Service Fees – Volume and Support Incentives, $732Mil – $250Mil) and, proportionally profits, are only equal to $482Mil (32.39% of revenue). 3) Furthermore, if we look at the company’s income statement, and we consider that “Selling/General/Admin. Expenses, Total” ($465Mil, 31.25% of revenue) includes the cost of employees’ salaries, power, water, food, business expenses, etc, and we remember that without these people the other revenues would be impossible, then again, proportionally to revenue, the profits from “Service Fees” are equal to: $482Mil – $465Mil = $17Mil, so that, technically, VISA, Inc. earns 1.1% (17Mil/1488Mil) of its profit from customers’ debts.
The point is, depending how you measure it, everyone could be right, except the people who say “the majority of credit card company profits come from interest payments.”
Maybe in bad times, like right now, credit card companies make most of their money on debt. But that’s sort of the point. They charge interest on money that they lend so that when people don’t immediately pay their debt back and when people are afraid to use their credit cards more generally, they still receive revenue.
October 22nd, 2008 at 5:54 am
sorry, that should be 1.1% of revenues and 17/422 = 4% of profits
October 22nd, 2008 at 6:38 am
Re: keep in mind that credit card borrowers are like indentured servants now – the bankruptcy law changes mean they are indebted for life with no escape except repayment.
Not true. If your income is less than half the median in your state you can still blow away all your debt in Chapter 7 just as before (and even pre-2005 individuals with too much income could not use Chapter 7). Chapter 13 is still available to everyone else, albeit with a longer payment period (five rather three years).
Re: in the face of stagnant real wages, people have been using credit (as well as tapping HELOC and in other ways extracting equity from their homes) to sustain (or even improve) their standard of living.
Question: if wages are merely stagnant why would they need credit cards to maintain their standard of living? Improve it, yes, but with a stagnant wage you should be able keep your standard of living the same.
Re: Credit cards have also become necessary for buying things over the phone or internet, and there are a few items such as airline tickets that you have to buy that way.
Debit cards work just as well for all those purchases. About the only thing I can think of where a credit card may be absolutely necessary is a car rental (some car rental agencies do take debit cards as well, but not all of them, and they usually require a very large deposit, which they are slow to refund)
Re: To be honest, I’m stunned that credit cards have taken this long to suffer.
The minimum payment on a credit card is usually very, very low, much lower than a house payment.
October 22nd, 2008 at 6:40 am
Walter Wriston the father of the modern mega bank said it best.
As well as I remember it “Our job isn’t to help our customers save more. Our job is to help them spend more”
Mission accomplished.
There is no way to save the bad debt. The bailouts such as they are only delay, probably slightly, the pain and make it worse. If by chance they do somehow do prevent a more severe financial dislocation and recession they promise to be a drag on the economy for a generation that will prevent a recasting of the economy. Turning it away from its destructive obsession with consumption to focusing on production and savings.
The manic bailout plans are not designed to save the economy per say but to save its current finance centric structure which has given so much wealth and power to our lords of finance. Paulson et al imagine they are the indispensable ones. The ones from whom all economic good comes. Even as they have destroyed the balance sheet of the majority of Americans with their rolling collapsed bubbles. And of course their success in bringing about Wriston’s dream. A society trapped in debt peonage. One with no savings and a very limited ability to produce things. A society of consumers who can no longer consume at an ever increasing rate.
October 22nd, 2008 at 7:35 am
Re: One with no savings and a very limited ability to produce things
From a banking POV it’s not clear why the above would be a good thing. Banks do need savings, otherwise they have no money to lend. And an economy that doesn’t produce stuff is an economy that can’t consume much either.
October 22nd, 2008 at 7:39 am
Telling picture – it would be more so if you indicated the source.
October 22nd, 2008 at 8:03 am
Just so that nobody’s confused by 21 above; VISA Inc is not just “not representative of credit card companies generally” – it’s not actually a credit card company in the normal sense of the term. That’s specifically because VISA Inc doesn’t provide credit (which is why it doesn’t have interest income). VISA is the company which provides the payment infrastructure for credit card systems; the “service fees” are the fees paid by the credit card companies for using VISA’s network.
October 22nd, 2008 at 8:03 am
Banks need deposits, not necessarily savings deposits. In fact savings deposits are inferior to checking deposits because the latter are free.
You’ll have to go back to Econ 102 to learn how increased lending begets increased deposits which begets more lending. The magic of fractional reserve banking. A pejorative term among Libertarians and less respectable kooks. The pure Libertarian/Austrian School critique of fractional reserve banking has some strong logical and dare I say ethical points but like all pure ideologies their ideal world can never be achieved.
This year alone banks have lost more money than they have ever made since the beginning of time. It’s not as bad as it sounds because the same has happened or nearly so in the early 1930’s, the early 80’s, the early 90’s, the early 00’s. From 1840 through 1908 bank panics and wipeouts went on every decade like clockwork too. Banks always lose it all. Bankers however seem to come out alright so there isn’t really any incentive to prevent wipeouts because they make their best coin in the moments just before the fall.
October 22nd, 2008 at 9:00 am
This is absolutely the next shoe to drop – just look at the earnings from American Express yesterday. They recognize that their considerably wealthier clientele are going to have real problems paying back this debt. And it’s important to keep in mind the credit card companies success in lobbying for fewer Chapter 7 bankruptcies – this will really start to haunt a number of consumers.
October 22nd, 2008 at 10:22 am
If you want a pretty deep dig into how the credit card money is spread around, download or buy Paying with Plastic from the MIT Press.
October 22nd, 2008 at 11:29 am
What an odd chart. Why in the world would it start at 1999? Increasing credit card debt has been the case for the last 3 decades. It’s not like there was stable credit card debt during the 90s and then all of a sudden it took off in 2003 in the face of stagnant wages. Credit card debt increased by more than 50% in the 90s even while there were moderate real wage increases.
October 22nd, 2008 at 12:40 pm
oh mixner, don’t play such stupid little games. really, it’s like you’re not even trying.
Howard, you’re an ignorant fool.
the chart means exactly what it looks like it means: in the face of stagnant real wages, people have been using credit (as well as tapping HELOC and in other ways extracting equity from their homes) to sustain (or even improve) their standard of living.
No, it doesn’t mean that. It doesn’t tell us anything about total credit use at all. And what is “real wages?” Total wages? Average wage? Median wage? You don’t know, do you? And why is comparing wages to credit card debt meaningful anyway? Why not income or assets? What’s it supposed to be telling us?
there’s nothing mysterious here: for example, i’m not sure what the bottom line represents specifically, but i know what it represents intellectually
Huh? What does the bottom line represent “intellectually,” Howard? What’s that even supposed to mean?
because there’s no absence of available information to demonstrate the stagnation of real income.
Apparently, there’s so much of this information that you cannot produce a single example of it.
From the Bureau of Economic Analysis:
Real GDP
1999: $9,470 billion
2007: $11,523 billion
Percent Share of GDP in Wage and Salary Accruals
1999: 48.1%
2007: 45.8%
Real Wages and Salaries:
1999: 48.1% of 9,470 = $4,555 billion
2007: 45.8% of 11,523 = $5,277 billion
That’s a 16% increase in real wages between 1999 and 2007.
as for the distribution of credit card debt, for crissake, you answered your own frickin’ question (i’m going to assume you looked up the information accurately): half of the households have more than $2200 in credit card debt.
Wrong yet again. You need to read more carefully. As I wrote, the survey found that over half of households had no outstanding credit card balance at all. The $2,200 median applies only to the minority of households that have a balance. So only a quarter of all households owed more than $2,200 on their credit card.
October 22nd, 2008 at 3:43 pm
See, Mixner? I knew you could contribute something if you just tried. Though I’m still kind of confused about your posting style. You’re always telling us what we don’t know, but you never tell us what we do know. I find this kind of odd, since you obviously have looked at the data.
So what does it tell us?
October 22nd, 2008 at 5:38 pm
That sure is an interesting chart and sad because it shows how the middle class seems to be disappearing. The banks may be playing a delicate balance but my sympathy goes to the debtors as they don’t seem to have any way out from this situation with their income staying the way it is.
Evelyn Guzman
Debt Challenger
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