Rely on a Credit Card? Read This

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If you want to boil down the past two years into a few sentences, it goes like this: Banks took on too much risk. When those risks backfired, banks conserved capital. When they conserved capital, lending decreased. As lending decreased, businesses had to cut back, laying off workers and canceling investment.

Less credit, more pain. That's the life of a country reliant on debt. So we should pay attention to what banks plan on doing with the single most important source of consumer credit -- credit cards -- in the months ahead. And I really do mean the single most important source. Last winter, bank analyst Meredith Whitney noted that credit cards are the top fallback source of consumer liquidity, second only to paychecks.

To see where credit cards might be heading, here's a summary from the Federal Reserve's recent Senior Loan Officer Opinion Survey on Bank Lending Practices report:

For prime borrowers, about 50 percent of [banks], on net, expected to increase interest rate spreads, reduce credit limits, and reduce the extent to which loans will be granted to customers who do not meet credit-scoring thresholds. On net, about 45 percent of banks also expected to raise minimum required credit scores and about 40 percent expected to raise annual fees for prime borrowers. Expectations for tightening various terms were relatively more common for loans to nonprime borrowers. For nonprime borrowers, about 75 percent of banks expected to increase interest rate spreads, and about 60 percent expected to reduce the extent to which loans will be granted to customers who do not meet credit-scoring thresholds and to reduce credit limits. In addition, about 55 percent and 45 percent of banks also expected to raise minimum required credit scores and to raise annual fees, respectively, for nonprime borrowers.

Less credit. Higher interest rates. More fees. Tighter standards. You can't blame banks for doing this -- credit card default rates are through the roof -- but it means those relying on credit cards, especially those with checkered credit histories, are going to have a very tough time maintaining reasonable credit lines.

Many of these changes are in response to credit card reform passed earlier this year. Most of the new regulations don't go into law until February, although Congress is racing to speed up the start date. Most banks still aren't compliant with impending regulatory changes, meaning most of the credit tightening probably hasn't been dealt yet.

You can also see how much further credit card lines may be slashed by comparing current outstanding lines to Whitney's estimate that 60% of all lines will be eliminated between the end of 2008 and the end of 2010:


Outstanding Credit Card Lines,
Q4 2008

Outstanding Credit Card Lines,
Q3 2009


Bank of America (NYSE: BAC  )

$827 billion

$572 billion


Citigroup (NYSE: C  )

$1 trillion

$815 billion


Discover Financial (NYSE: DFS  )

$207 billion

$174 billion


JPMorgan Chase (NYSE: JPM  )

$624 billion

$584 billion


If Whitney's right and 60% of all available credit will be eliminated, major banks still have a lot of credit lines to hack away at.  

Long term, that's a good thing. Too much credit was extended under too loose terms during the boom years. But if you ask me, there still seems to be a disconnect between the reliance on credit and economic shifts making credit less available.

For example, the savings rate has crept back up to about 3% to 4% lately -- still less than half its long-term average. If credit cards are consumers' second-most important source of liquidity, loan terms on those credit cards are being dramatically tightened, and unemployment is more than 10%, you'd expect the savings rate to go up radically. Yet despite the improvement from the negative savings we had in years past, a 3% savings rate is still remarkably low -- especially for an economy trying to heal itself from a debt binge. From the early 1950s until about the mid-1990s, you won't find a single period when the savings rate was remotely close to 3%. Eight percent, 9%, 10% was always the norm.

Bottom line: There are concrete signs that credit costs and availability are about to get a whole lot worse, yet it still feels like we live in a world where a safety net is defined as the number of American Express (NYSE: AXP  ) , Visa (NYSE: V  ) , or MasterCards (NYSE: MA  ) you hold in your wallet. I can't see how that'll end well, and it reiterates and underlines the difficulties still facing the American consumer.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. American Express and Discover Financial Services are Motley Fool Inside Value recommendations. The Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (10)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 11, 2009, at 4:55 PM, TMFKris wrote:

    Maybe people would save more if credit's getting more costly and unemployment looms. Or maybe tighter credit and a lost job would lead to decreased savings as the money has to be spent on day-to-day expenses.

    Kris, Motley Fool copyeditor

  • Report this Comment On November 11, 2009, at 6:48 PM, RobertC314 wrote:

    Well, it's hard to blame a card company for not continuing to lend to people who have shown they won't pay it off. Good for them for finally coming around. This is going to cause a bit of short term pain for everyone if it brings credit practices back to something resembling reasonable it will be worth it.

  • Report this Comment On November 13, 2009, at 2:50 PM, Finanne wrote:

    A return to sensible lending practices is fine. Some people cannot handle credit cards well, whether it's due to low income or poor judgment.

    However, when you consider what the banks can borrow at and the rates they are now charging customers - even those with excellent credit - there's something more going on. It may come back to bite those banks with the most egregious practices.

    For me, credit cards are a convenience. Saves me having to carry lots of cash or visit the ATM/bank every week. Every time I charge something, the bank makes money. I'm sure they make more on that than it costs them to carry my account.

    I tend to ignore the interest rates because I don't carry balances, but one of my cards is about to raise the interest rate to 23.99%. I won't close the account, but I will stop using it. If they, or any other bank, start charging me an annual fee, I'll be kissing them goodbye.

    A return to reasonable lending practices would be a good thing long term, but it would be naive to think that was the banks' motivation. As soon as they solve their OWN problems, they'll be off to the races again - with higher fees and interest.

    As for relying on credit cards... for those who have any wiggle room, it's time to rethink that.

  • Report this Comment On November 13, 2009, at 3:15 PM, Finanne wrote:

    I agree with TMFMiloBreathed. Sometimes it's a matter of CAN'T pay it off.

    This isn't about banks suddenly deciding to stop lending to people who won't pay it off. It's about banks' bottom line. They're not eliminating people who "won't [or can't] pay it off." They're just making more money off them.

    Consider what it costs the banks to borrow versus the interest rates they're charging. Those with excellent credit, who do pay it off, are being hit, too.

    If you have cards, and it hasn't hit you yet, it will.

    The fact is, carrying credit cards IS a safety net for those of us without health insurance. A high limit card could make the difference between getting life-saving treatment in time and not. Transferring money isn't so easy when you're in an ambulance.

    Nevertheless, at some point, relying on credit cards for their convenience stops being sensible. The banks are pricing themselves across that line.

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