Looming Credit Card Bust?
The credit card industry’s business model is basically a disaster waiting to happen. If people pay their bills in a timely manner, the credit card companies don’t make much money. And if people default on their bills, they lose money. So the correct strategy is to try to get people to carry heavy month-to-month balances that charge usurious interest rates without ever quite tipping over the brink into default. So far, it’s worked out pretty well for them, but Eric Dash and Andrew Martin observe that the happy days may soon be over:
ut if unemployment breaches 10 percent, as many economists predict, the rate of uncollectible balances at some banks could far exceed that level. At American Express and Capital One Financial, around 20 percent of the credit card balances are expected to go bad over this year and next, according to stress test results. At Bank of America, Citigroup and JPMorgan Chase, about 23 percent of card loans are expected to sour.
Even the government’s grim projections may vastly understate the size of the banks’ credit card troubles. According to estimates by Oliver Wyman, a management consulting firm, card losses at the nation’s biggest banks could reach $141.5 billion by 2010 if the regulators’ loss rate was applied to their entire credit card business. It could top $186 billion for the entire credit card industry.
Fortunately for the credit card firms, federal regulators have made it pretty clear that forebearance and bailouts will allow them to slink away from bad loans without too much trouble. But whatever the opposite of “green shoots” is, this could be that.
Meanwhile, it strikes me as a bit of a problem for neoclassical economics that if market interactions worked the way they say they do, the entire credit card industry would barely exist. People would understand the true cost of failing to pay off their full monthly balances and would almost never do so. And credit card companies would compete with one another to offer consumers a better deal on lending terms rather than competing to get more-and-more clever about tricking people into taking out loans that ill-serve their interests.
38 Responses to “Looming Credit Card Bust?”
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May 11th, 2009 at 10:48 am
Last week Bank of America increased its APR on my credit card for no reason from 8% to 14%. Honestly! Actions like this, if replicated generally, will only contribute to more defaults. Also, I have to admit, my attitude about the bailout changed somewhat after I saw their notice.
May 11th, 2009 at 10:52 am
Only three outcomes are likely:
Humans aren’t rational…
Humans ARE rational, but in way opaque to economists.
All the above.
May 11th, 2009 at 10:53 am
it strikes me as a bit of a problem for neoclassical economics that if market interactions worked the way they say they do, the entire credit card industry would barely exist
That’s not quite right. The problem with neoclassical economics illustrated by the credit card industry is the thinness of credit markets and resulting constraints. In a perfect Walrasian or Arrow-Debreu world, consumers could spread consumption costlessly across time and states, but of course information asymmetries make the credit industry profitable.
You don’t need to rely on short-sightedness or trickery to get you to the point you want.
May 11th, 2009 at 11:00 am
Good timing since the Senate is debating (and will shortly pass) the credit card holders’ bill of rights today. I wonder how much of their profits were from using 30%+ interest rates, jacking rates up with no warning, and giving cards to 18-year-olds too irresponsible to use them properly?
May 11th, 2009 at 11:01 am
People would understand the true cost of failing to pay off their full monthly balances and would almost never do so.
..blah blah underestimate the intelligence of the American public blah blah…
And credit card companies would compete with one another to offer consumers a better deal on lending terms
They do! Amex lured me away from Discover by offering a much better cash back rebate. See also frequent flier cards.
May 11th, 2009 at 11:06 am
Matt, you write “If people pay their bills in a timely manner, the credit card companies don’t make much money. And if people default on their bills, they lose money”. Both of these statements are completely and utterly wrong. They can and do make money in both scenarios; it is only when either payment trends or loss rates fall outside of the models that earnings are reduced. This is really an algorithmic business that prospers even in downturns if properly managed. Right now they’re getting hammered because NCOs are well above expectations and they’ve made a conscious decision to shrink assets. But make no mistake, the current financial crisis is being priced into the product offerings now.
May 11th, 2009 at 11:10 am
Doesn’t this go to the “two types of losses” question? If someone defaults on a card, the merchant was already paid, it’s just the bank losing the money. In effect, is bailing out $100B of card losses paying off a stimulus that went into the economy at the time the purchases were made? (In which case, we’re really screwed because the economic benefits of that spending are already worked into the current situation.)
May 11th, 2009 at 11:13 am
I wonder how much of their profits were from using 30%+ interest rates, jacking rates up with no warning, and giving cards to 18-year-olds too irresponsible to use them properly?
Jacking up rates with no warning is clearly bad behavior, but your other two points are things that do not really bother me. In fact your point about giving cards to 18 year olds I find actively insulting and just dumb. 18 year olds are adults. We give them all the rights, responibilities, and priviledges of adulthood, and that include credit cards. Denying them that or getting mad at the credit card companies for treating them the same as everyone else makes no sense. (And yes I realize that 18 year olds cannot legally drink, but I think the drinking age should be lowered to 18 for this same reason.)
30%+ rates are very high, but if people sign the contracts and then carry a high balance, I mean, they knew what they were getting into. I never carry any kind of balance on my cards as I dislike the very concept of being in debt at all, so clearly I just don’t get the mindset, but I have very little sympathy for people who knowingly go into self destructive debt and then complain about it. As a side point, this is why I think we should raise taxes and cut services to balance the budget, and then raise taxes and cut services some more so that we can pay off the national debt. Like 6-8% of our budget is paying interest on the debt. That’s just stupid.
May 11th, 2009 at 11:16 am
Don’t forget that the credit card companies gross 2-3% on every transaction. Granted, American Express has a ton of affiliated businesses, but does anyone seriously think that that they are losing money on their non-revolving credit cards?
May 11th, 2009 at 11:18 am
I saw this article yesterday and wondered who the Credit Card Industry was paying to get it published.
First and foremost, it’s all industry spokesmen — no consumer advocates, no neutral parties. All we hear is that the industry is losing billions.
It’s completely appropriate to wonder about the timing of this article, given the moves to end the abuses by the credit card industry in the Congress and even in Obama’s address just this past Saturday.
Finally, what a load of rubbish. We’re dealing with an industry that will use any excuse, any hole in the law, to perpetrate fraud against consumers.
Consumers are the victims of these practices both as unwilling taxpayers and as customers of these banskers.
Consumers who are victims of these practices have not declared bankruptcy. They generally pay their bills on time!
May 11th, 2009 at 11:20 am
giving cards to 18-year-olds too irresponsible to use them properly?
I had a credit card as an 18 year old. You can’t rent movies without a credit card. You’re an adult at 18. If you’re too irresponsible to own one, then you default on your payments and give up the right to have a credit card for 7 years, when you’re in your mid-to-late 20s and hopefully know better.
And vorkosigan1, American Express charges something like 4% a transaction, double the going rate. That’s why you see a lot of vendors refusing to accept them.
May 11th, 2009 at 11:21 am
Mark: Tautologically, credit card companies make money by having revenue. Having borrowers default means you don’t get their money. Having borrowers borrow over the short term and not pay late fees means you don’t get very much of their money. Credit card companies can hedge their bets significantly, but in the long run you actually have to be getting money out of your borrowers.
May 11th, 2009 at 11:25 am
Gotta give credit where credit is due!
MattY makes a very insightful comment.
The rational consumer of neoclassical,neoliberal,neoKeynesian economics would ruin the crdit card business.
May 11th, 2009 at 11:28 am
I’m sorry but the above statement is the opinion of someone who’s never been out of work for any significant amount of time and/or who has no idea what he’s talking about.
The entire scandal about this is that people originally signed up for low rates and that the banksters say they can increase those rates to whatever they want, regardless of the payment history of the person in question.
No one signed up for 30%+ rates.
May 11th, 2009 at 11:35 am
If properly managed? And other than that, how was the play Mrs. Lincoln? Hasn’t the past year shown us the iffy nature of the assumptions that went into the creation of these models? We should also pay attention to the difference between the banks who issue the cards, and Visa and Mastercard who just handle the transactions. And then there’s AMEX that lives in both worlds.
I think the Lake Wobegon effect comes into play.
May 11th, 2009 at 11:40 am
Credit card companies (and banks in general) make a lot of their profits from fees. Just yesterday I opened up my BoA credit card statement and discovered that BoA was claiming I was late with my last payment. so they charged me $39.00, plus interest on the previous months balance, which I thought I’d paid in full.
I simply did not feel like hassling with them so I just wrote the damn check, but I am certain that I paid my bill within a week of receiving it because this is what I always do. So I looked at the current bill to see how long they give me to make the payment.
The bill was produced on May 2, and the due date was May 24. That give you very little leeway in case anything happens (slow mail going either way, a bill getting lost under a stack of junk mail for a week, etc.). And of course, this is all by design. If Obama does one thing with this credit card bill, I hope he regulates the amount of time these companies have to give you before they can charge a late fee. It should be at least 30 days from when the bill was received by the consumer and that 30 days should be to the date when the payment must be postmarked. No more gaming of the postal system to squeeze late fees.
May 11th, 2009 at 11:41 am
No one signed up for 30%+ rates.
Not true. While banks can arbitrarily raise rates, they have to notify you and cannot bump the interest on existing balances without your permission. When you get the notice in the mail, it says that the bump only takes effect if you use the card after a certain date. You can cancel the card, cut it up, etc and carry on paying the old rate on whatever existing balance you might already have.
May 11th, 2009 at 11:43 am
I just don’t get the mindset
Ok, how about this: you make an income that allows you, after expenses, to put up to $500 on your credit card bill each month and pay it off in full. You’re flexible on this, and if you’re determined, you can lower this amount to $250 in spending on the credit card each month, given your normal expenses.
Then your car breaks down and you have to do $1000 of repairs to get to work. So now you have $1500 on your credit card, but you can only pay off $500. Even if you scrimp and save the next month, your still have $1250 + interest on your credit card, and once again, you can only pay $500, so the next month, you’re down to $750 + interest. And so and and so forth. Meanwhile, the interest is building up. That’s the mindset: the mindset of not being wealthy while facing unexpected expenses while trying to keep up with your rent. Then the interest rates spike, making it harder to pay off that CC debt you incurred because of unforeseen expenses. Yes, there are a lot of scenarios you can conceive where a “responsible” person doesn’t get blindsided by these expenses, but it’s perfectly reasonable to conceive of a person living an otherwise responsible life getting hit by a debt carried on a credit card that takes a while to go away.
Like 6-8% of our budget is paying interest on the debt. That’s just stupid.
How much of your household budget goes to paying interest on your mortgage? How much of your household budget goes to paying interest on a car loan?
May 11th, 2009 at 11:43 am
Not necessarily. For your claim to be true the value to the consumer of smoothing their consumption over time would have to be lower than the cost of paying the interest rate.
I think real source of disagreement between those who want more credit card regulation and those who don’t is over what the real value of this consumption smoothing is to consumers. Most people seem to accept that there are behavioral factors at play as well as information costs and asymmetries that lead consumers off of the path of homo economicus. “Consumer advocates”, seem to underestimate or ignore the consumer benefits of consumption smoothing and therefore might be overestimating the case for regulation.
May 11th, 2009 at 11:47 am
Q. Who will save Capitalism from the Capitalists?
A. Barack Obama.
May 11th, 2009 at 11:59 am
slow mail going either way, a bill getting lost under a stack of junk mail for a week, etc.
Dude, electronic payments. You get an email when your bill is available and stating when it’s due, it gets credited within 24 hours. (Of course, if your bank account doesn’t have sufficient funds when they try to pull the money electronically, that’s another $39.)
May 11th, 2009 at 12:07 pm
MattB:
So if you manage to plow through the fine points of their junk mail, figure out whatever strange conditions they’ve cooked up this week, all you’ve done is prolong the misery (and low apr) till the next week when they’ll hit you with yet another set of instant rules.
This is a completely lawless industry and their actions shift from week to week accordingly.
Again, no one signed up for 30%+ rates.
May 11th, 2009 at 12:15 pm
you think there was anger at the bank baillouts? Wait until you try bailing out a credit card company…
May 11th, 2009 at 12:15 pm
Bank of America just cut my credit limit in half. Since I never came within 10% of that limit, I couldn’t care less. Several years ago, there was a bill in Congress to require that the credit card companies use the postmark on a payment envelope as the official due date. The bill naturally went nowhere.
May 11th, 2009 at 12:17 pm
In fact your point about giving cards to 18 year olds I find actively insulting and just dumb. 18 year olds are adults. We give them all the rights, responibilities, and priviledges of adulthood, and that include credit cards. Denying them that or getting mad at the credit card companies for treating them the same as everyone else makes no sense.
I think you misread me. What I said was that credit card companies profit heavily off young adults. Obviously 18-year-olds should have all the rights other adults do (including drinking). But it’s true that 18-year-olds are generally not known for their good decision-making skills, and many living on their own for the first time get into trouble with credit cards. So let’s call a spade a spade: these companies actively try to profit by taking advantage of inexperienced people with poor decision-making skills. Check out a college campus these days and see how many of them are giving away free t-shirts etc to any student who applies for a card (permission they have with exclusive deals with the college, of course). All this is within everyone’s rights, but it’s certainly sleazy.
May 11th, 2009 at 12:23 pm
Bank of America just cut my credit limit in half. Since I never came within 10% of that limit, I couldn’t care less.
Ah, but you should, because they just screwed with your credit rating by decreasing your used-to-available credit.
May 11th, 2009 at 12:40 pm
the credit card companies are taking advantage of the very human inability to properly discount to present value.
So, they compete on up front savings (no fees! cash back! miles!), while they get you on the long term things.
This has nothing to do with intelligence. It has to do with basic human psychology. A bit of pleasure now (getting that item by plastic) is worth far more then the pain (paying for it) later. By removing the pain of paying from the pleasure of getting, the card companies get us to overspend. And, of course, we also are very, very bad at properly estimating the chance of a disaster happening, and making us miss payments or whatever. Again, not intelligence. Basic psychology and behavioural economics.
May 11th, 2009 at 12:41 pm
The “rational consumer” by definition is “free to choose” whether or not to incur credit card liabilities.
A “rational consumer” might choose to have a mortgage or a car loan but he/she does the math before every purchase and would never charge that new HDTV or suit unless he/she knew the bill could be paid without incurring extra fees.
Of course, there now some ex “rational consumers” who have begun charging groceries on their card.
But they obviously didn’t behave rationally so fuck em, they’re just getting what they deserve.
May 11th, 2009 at 12:47 pm
I’m another person who just had my credit card company reduce my credit after I brought the balance to zero and kept it there for the last couple of years. So my credit rating is probably affected.
And MattB, you are so wrong to suggest cutting up your credit card. you’re screwed coming and going. If you cut up that card and send it back to them, especially a card you’ve had for a long time, that also negatively affects your credit rating because A. it’s a company you’ve had credit with for a long time and B. your amount of available credit is reduced even more drastically than the credit card company’s actions. I had a friend who did that and saw her credit rating plummet.
May 11th, 2009 at 12:52 pm
Here is the thing. It is possible to have credit cards work effectively for consumers. We use our card constantly and pay off the entire balance automatically every month.
I am an accountant, and I have the requisite anal retentiveness to make it work for our family. And the track record of paying it off every month for over 11 years.
The problem people face is when we use credit cards as a savings account. The savings account is how to handle the car repair. Sure, charge it, then use the money from savings to pay it off in full, and then use the next couple of months to replenish the savings.
But too many of our consumers never get to that point because we have consumed too much too quickly, and get buried to the point where all we can aspire to is to be out of debt. If we can get to our young adults, and get them to do some basic things very early, then you can really impact their lives. But we have left the field clean for only the credit card companies far too often, and they don’t have the same interest.
May 11th, 2009 at 1:19 pm
I work full time at a medium-sized company that offers above average, but not phenomenal health coverage. Over the winter I came down with three kidney stones, all of which were too big to pass naturally so I had to have surgery. The total cost for all the procedures was $16,000 of which my health provider covered 90%. If I could have written a check for the $1600 I was on the hook for I would have done it in a second, but since I couldn’t- it had to go on the credit card. As much as people like to run around moralizing about irresponsible debt accumulation- totally unexpected health costs are the heart and sole of the problem.
May 11th, 2009 at 1:32 pm
“I never carry any kind of balance on my cards as I dislike the very concept of being in debt at all, so clearly I just don’t get the mindset, but I have very little sympathy for people who knowingly go into self destructive debt and then complain about it.”
I never carried a balance for more than one month from the time I got my first credit card until I was 27. Then I spent 4 months unemployed after finishing grad school and had car trouble in the meantime. It took me 6 years at arbitrarily-hiked interest rates of up to 30% to get back to a zero balance. Bastards made a fortune off of me.
Sure, plenty of people who get trapped in credit card debt were behaving foolishly and irresponsibly, but don’t underestimate the viciousness of the trap.
May 11th, 2009 at 2:11 pm
mkd: As much as people like to run around moralizing about irresponsible debt accumulation…
Exactly. Whenever I hear this moralizing crap — and we get it in tons — all it’s telling me is that the person saying it has never been unemployed or sick for extended periods of time.
May 11th, 2009 at 2:29 pm
#31: That seems like an easy idea to test, since there are quite a few countries where individuals aren’t suddenly subjected to unpredictable spikes of medical expenses. Do those countries actually have fewer personal debt problems?
To a greater extent than their lower income inequality can already account for, that is. We shouldn’t forget that despite our high per capita GDP, *most* Americans don’t have that much income to try to live off in the first place, compared to other technologically advanced countries. The credit card industry is a highly successful form of class warfare – not only does it take from the poor and give to the rich, but it also convinces the poor that it was their own idea.
May 11th, 2009 at 5:46 pm
Whenever I hear this moralizing crap — and we get it in tons — all it’s telling me is that the person saying it has never been unemployed or sick for extended periods of time.
And whenever the “moralizing crap” starts, the good little bleeding-hearts rush in shouting “UNEMPLOYMENT! MEDICAL EXPENSES! THE PEOPLE ARE INNOCENT VICTIMS!!”
Does it happen that way? Sometimes. Meanwhile, the Best Buy circular arrived yesterday like it does every Sunday, with its selection of $3000 televisions. Obviously everyone is paying cash for those things, because only “INNOCENT VICTIMS!” run up credit-card balances, amirite?
Pretending that “personal responsibility” is some kind of wingnut weirdness isn’t doing anyone any favors.
May 11th, 2009 at 7:00 pm
Re: You can’t rent movies without a credit card.
Huh? I pay cash, or use my debit card.
Re: Ah, but you should, because they just screwed with your credit rating by decreasing your used-to-available credit.
Depends. If his balances are still under 10% of the new limit, his credit rating is unaffacted.
Re: So my credit rating is probably affected.
See above. If you have a 0$ balance, your credit rating is unaffected.
Re: If I could have written a check for the $1600 I was on the hook for I would have done it in a second, but since I couldn’t- it had to go on the credit card.
Why not just make arrangements to pay off the debt in installments directly to the hospital?
Even if they charge interest (and often they won’t) chances are it will be a lower rate than a credit card. True, if you default you’ll eventually be dealing with bill collectors and a hit to your credit rating, but overall you’re likely to get a better deal.
May 11th, 2009 at 8:38 pm
“Pretending that “personal responsibility” is some kind of wingnut weirdness isn’t doing anyone any favors.”
Oh, I forgot, lack of empathy along with the moral superiority is the hardest thing to explain.
May 15th, 2009 at 11:44 am
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