Were Credit Card Co.'s Sabotaging Themselves?

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Congress is working on reforms to be applied to the credit card industry. Good. They need it. But, when it became clear that the government was going to bail out floundering corporations, did credit card companies begin to make themselves insolvent in order to get in line for tax payer dollars? With a few exceptions, the credit card companies did not begin to shut down consumer credit until government handouts were known to be coming and the recession underway.

Last Summer however, the credit card industry, almost in perfect synchrony, began in a wholesale fashion to raise interest rates on millions of Americans, and cut back their credit limits to existing debt balance levels. This had several predictable results. First, it cut back on long term revenue projections on the corporation's balance sheets by lowering the long term profit projections on continued and expansion of credit card debt. Second, it induced a large number of credit card holders to close their accounts altogether to avoid the rate increases. Both of the consequences positioned credit card lenders to display financial hardship going forward.

To be sure, it would appear the increase in rates on millions of credit card holders projected higher revenues. But, in a recession, with more than 6.1 million American workers unemployed, credit card defaults were unavoidably going to rise. In fact, the credit card companies actions guaranteed that bankruptcies and defaults would rise. Here is why.

A majority of Americans were accustomed to rely upon unused credit on their card to cover unexpected and non-budgeted expenses which might arise. A perfect example is car repair. It is not possible to accurately budget for car repairs on a monthly or even annual basis. Some years may require only oil changes. Other years may require thousands of dollars for a transmission overhaul. Most American consumers rely upon their vehicles to conduct their daily lives. And most credit card users had grown comfortable with having a line of credit on their cards to cover such emergencies and unanticipated expenses.

Which means, these card holders had budgeted their income in such a way as to not have readily available cash on hand to cover an emergency medical expense or car repair. When the credit card industry reduced their credit line to the customer's current balance, they completely shut many of these Americans off from being able to afford the repairs or medical expense, causing them to choose to default on credit card payments or even mortgage payments to have the cash to keep their car running or heal their sick child. Or worse, they had to file bankruptcy and default on all debt obligations except student loans or other government loans.

In other words, the credit card industry forced their own higher write offs on uncollectable debt. Which negatively impacted their balance sheets and projected earnings going forward. There are several explanations for why the credit card companies shot themselves in the foot in this manner. But the most logical one to this writer is the self-fulfilling prophecy. Here is how it worked.

The card card companies saw a recession getting under way. They rightly anticipated that with rising unemployment, defaults on their outstanding credit card loans would rise. To equalize the losses, they raised interest rates on as many credit card holders as they could get away with. The self-fulfilling prophecy now kicks in. By raising interest rates, they increased the monthly cash payments on credit cards for card holders dramatically, in some cases tripling or quadrupling the monthly payment by raising the interest rate from 8% to 28%. This in turn destroyed the consumer's anticipated budget for the year for food, transportation, education, health care out of pocket expenses, and a host of other needs to keep their lives intact. Workers who were forced from full-time to part-time income and faced higher credit card monthly payments, were pushed into insolvency.

As the link article above demonstrates, higher interest rates induced higher defaults, above and beyond what the recession's unemployment numbers would have created. Given the extensions of unemployment benefits, most of those now in default, would likely not have had to default if the credit card companies had not doubled, tripled, or quadrupled their monthly outlays for credit card payments. The credit card companies made dramatically larger the very defaults they anticipated as a result of the recession.

If some of these credit card companies were not victims of self-fulfilling prophecy, then one has to speculate they were preparing for a dramatic rise in defaults in the hope of getting in line for TARP funds to rescue financial institutions threatened with potential insolvency. Now that the Obama administration has attached strings to receiving tax payer's dollars, the credit card companies are no doubt wanting to avoid government scrutiny or influence over their executive management's actions and the board of directors, possibly resulting in the government requiring their firing as part of the deal to receive public funds to shore up the company's balance sheet. Which puts these credit card companies in quite a pickle, wanting to avoid receipt of public dollars, but having shot themselves in the foot by dramatically increasing present and future defaults on their accounts receivable.

Congress is stepping in. I have railed against the usurious credit card company practices for years now and for sound reason. My central argument is that if a credit card company deems a client so risky as to warrant 32% interest rate, they have no business extending credit to that person in the first place. This is the credit card industry's parallel with the mortgage industry extending housing loans to the unemployed or underemployed. They have created a highly profitable bubble, and that bubble is now bursting. And it could not be bursting at a worse time, given the recession and deficits to rescue to the investment and commercial lending banks.

The credit card industry lobbyists were prime movers in the Bush administration's overhaul of the bankruptcy laws, making it dramatically more difficult for consumers to have their credit card debts written off by bankruptcy courts. Since the bankruptcy reform bill passed, the credit card companies have been handsomely rewarded with increased profits from interest rate bait and switch tactics, and introductory interest rates, and the highly onerous practice of raising interest rates on a customer with a perfect payment record because that customer was a few days late on another company's credit card payment or a medical bill. The Republican deregulation era is now accruing another massive cost to state and federal governments in the form of reduced revenues brought on by a recession and unemployment caused by consumers who can no longer afford to consume due to the practices of the credit card companies.

The credit card companies are now going to face write offs they thought they never would have to face with the advent of the bankruptcy reforms, at the hands of Congressional reforms coming that will permit credit card holders with debt and rates above certain limits to be absolved of that portion of their debt. The Congress must stimulate consumption in our economy again, and one way to do that is to remove the onerous debt yoke on the shoulders of consumers who had maintained a sound credit history until 1) the banks raised their rates and cut off their credit limit, and 2) they became unemployed or under-employed through no fault of their own, and 3) they saw their pension, 401K and other equity investment account balances lose 30 to 40% of their value.

If the Congress the federal government and private sector are unable to reinvigorate this economy and put 4 to 6 million unemployed workers back to work, the deficit and debt problem for government grows ever larger as government revenues continue to contract. America is in the dire position of paying dearly now, or paying dearly later. There is no free way exit from this economic and national debt crisis we find ourselves embroiled in.

Dramatic changes in policy direction are needed to resolve the current crisis, and diminish the threat of the looming one in the form of unsustainable government debt forced by the Medicare/Medicaid projected additions to the national debt beginning as early as 2018, just 9 years away. Many such changes are being discussed from taxing corporate earnings from overseas operations to investing in jobs in whole new industries to meet demands coming for lower cost energy, diminishing pollution effects, providing affordable health care, and investing in education that prepares the next generation for tax paying roles in good paying jobs, instead of non-tax paying roles in the underground economy.

The credit card companies are going to fight some of the changes coming and deny any culpability in contributing to this economic hardship. But, except for capitalism purists, their whining will fall on deaf ears, as 80% of Americans now hold credit cards; and more than half of those have a front row seat to the practices and mismanagement of the credit card companies they interact with on a monthly basis. In large part, the credit card companies did this to themselves with the help of the Republican led government from 2001 through 2006. We know this, because most Americans are honest and responsible and will pay their debts if they have a job and income they can rely upon and are permitted to budget their income and expenses with predictability. The fact that so many are now defaulting speaks to failed management and policy which undermined honest responsible American's ability to pay their debts.

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This page contains a single entry by David R. Remer published on April 23, 2009 12:53 PM.

Leadership and Neighborliness was the previous entry in this blog.

Credit Cards: No relief for the abused. is the next entry in this blog.

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