14 Jan 2009: The Coming Meltdown. Part Four: Consumer Credit
In this last part of my four-part series on what I believe will be a very bad 2009 economy, I want to talk about problems in consumer credit.
As is the case with mortgages and car loans, virtually all consumer credit is securitized. This means that your MasterCard and Visa, your store department cards, furniture loans, computer loans–all the lenders loan you the money, and then bundle up the right to receive payment, sell it to a trust, and get more cash to loan out yet again. (Since credit card companies are borrowing money at less than 1% and loaning it to you at 8%…or 18%…or 28%…that’s a lot of cash, and huge profits.)
But what happens when people can’t pay their credit cards because of a meltdown in the economy? The same thing that happens when people can’t pay their mortgages: a crisis.
(As a sideline comment: Ever notice how the word “crisis” doesn’t start getting thrown around until banks start losing money? People began losing their homes to foreclosure in ever growing numbers as part of the mortgage meltdown in late 2007, and it accelerated through 2008. When did the crisis happen? Not until the major Wall Street players started feeling the impact. This explains why *none* of the TARP money thus far allocated has gone to help regular folks save their homes. Now off my soapbox.)
How will we deal with this crisis? Many of the credit card companies have already formed National Banks, which allow them to receive TARP money. For example, in a significant story that has been virtually ignored by the press, Capital One Financial Corp. has already received over $3.5 billion dollars from TARP, and American Express got $3.39 billion. And the biggie, Citigroup, has received about $45 billion (most of which, of course, is unrelated to its credit card operations).
What happens when this money runs out? Will the credit card companies stop authorizing credit cards to anyone who has a pulse (and some who don’t)? Will interest rates rise? Will fees increase?
A combination of all of the above. WAMU has recently canceled a large number of credit cards whose owners have not used them for some time. Previously, such cards were kept on the books in the hope that they would be used in the future; WAMU apparently decided that it didn’t want the risk that these cards would actually be used. And many issuers are canceling people who pay off their credit card balances every month. The reason? They aren’t making a big enough profit on folks who actually pay their bills.
Credit card Interest rates have risen significantly–in some cases, by two orders of magnitude (100 times)–in recent months. What? You didn’t notice? That’s because, although the rate you pay is the same, the rate at which the credit card companies borrow has been cut by over 95%. The Federal Funds Rate dropped from 5.25% in September of 2007 to 0.25% or less now. Just think: a 400% profit would be earned if the credit card companies borrowed money at 0.25% and charged only 1% interest.
Now I know that not everyone pays interest on their credit cards (which is partially made up for by the ever-increasing annual fees, late and overlimit charges and the like), but a borrower paying 18% interest is paying the credit card company nearly 100 times more than it cost the company to borrow the money. Rather than cutting rates, the credit card companies are simply pocketing the extra money.
If the government TARP money isn’t enough, and rising fees and interest rates aren’t enough, what will happen? The credit card companies will file for the same bankruptcy many people are forced into by the unconscionably high rates and high fees they are being charged.
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