How to Destroy the Credit Card Industry

Remember 2007? We called this the "subprime mortgage crisis," assuming the risks were contained to one relatively small section of the economy.

But as Nouriel Roubini pointed out last September, "We don't just have a subprime mortgage lending system. We have a subprime financial system."

And so it went: Subprime spread to Alt-A mortgages, which spread to prime mortgages, which spread to auto loans, which spread to student loans, which spread to corporate paper, which spread to …

Credit cards
Yep -- credit cards. Their problem is a controversial one because millions of Americans are not only losing their jobs and seeing their wealth go up in flames, but watching their credit card interest rates go from 8% to 25% or more. That's terrible. It's infuriating. It's frustrating, and you can't blame anyone for being peeved about it.

Not surprisingly, Congress is slogging through new regulation that will, among other things, hinder the "abusive and unfair" practice of banks jacking up interest rates on existing credit card balances.

Regulation, meet confusion
In fact, Senator Bernie Sanders of Vermont went so far as wanting interest rates on credit card balances flatly capped at 15% -- a proposal that was recently voted down by his peers.

Legions of consumers are now upset that these interest rate caps were rejected as part of credit card regulation moving through Congress. "Enough is enough. People are hurting. It is time to stop the rip offs by banks," says Sanders' website.

But there are two sides to this story. Forcefully reining in interest rates on existing balances -- especially to a rate of 15% -- could disastrously backfire if it's intended to help consumers whose problems are ultimately linked to a lack of credit in the economy.  

Confusion, meet insanity
The interest rates that card companies charge consumers aren't simply a profit-making tool. It's a tool to offset the percentage of loans that aren't repaid -- net charge-offs, they're called.

These charge-offs are exploding to historic levels right now and are all but certain to keep rising as unemployment grows. In the latest month alone, here's how major card issuers have fared:

Company

April Charge-Off Rate

March Charge-Off Rate

American Express (NYSE: AXP  )

10.10%

8.80%

Discover (NYSE: DFS  )

8.26%

7.39%

Capital One (NYSE: COF  )

8.56%*

9.33%

Citigroup (NYSE: C  )

10.21%

9.66%

Bank of America (NYSE: BAC  )

10.47%

9.31%

Wells Fargo (NYSE: WFC  )

10.03%

9.68%

JPMorgan Chase (NYSE: JPM  )

8.07%

7.13%

*Decrease is slightly misleading. Capital One recently changed the accounting method it had been using for charge-offs, opting to wait longer before deeming its receivables dead. 

Worse, these numbers are likely a pittance of what's to come. Since unemployment typically lags the end of a recession, the nastiest days for credit card companies are almost certainly ahead of us.

In fact, the Treasury's own recently completed stress test assumed that banks could face average credit card charge-off rates of 22.5% by the end of 2010, which annualizes out to, coincidently, 15%.

2+2 = oh … I give up
Hence, the same government that's demanding banks prepare for card losses as high as 15% a year -- a number that may very well become woefully optimistic -- has thrown around the idea of capping the amount at which banks can offset those losses at the same number. Factor in operating costs, and simple arithmetic tells you that such a law would push the entire credit card industry into bankruptcy in short order. I mean, honestly, when you charge your customers 15% and write off the same amount as losses, you can't keep the doors open very long.

More importantly, banks would react to such regulation by eliminating consumer credit like there's no tomorrow, reflecting that new regulations make their business economically unviable. Remaining credit would evaporate almost immediately. In a recession where the chief complaint is that "banks aren't lending enough," this seems thoroughly insane.

Complex problems, complex blame
Few doubt that banks shouldn't be allowed to run around a trillion-dollar free-for-all. But as soon as you impose regulations that guarantee an industry will lose money, you're doing more harm than good to the consumers you're trying to protect.

President Obama recently said of credit card companies: "These practices, they've only grown worse in the middle of this recession, when people can afford them least."

True. But with losses piling up faster than ever, banks can't afford not to impose these practices. We have a crisis where banks need healthy consumers, and consumers need healthy banks. Both need cooperation from each other. Obliterating one side and hoping for the best won't get us very far.  

For related Foolishness:

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


Read/Post Comments (17) | Recommend This Article (50)

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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 May 19, 2009, at 12:58 PM, crubenst wrote:

    The problem with raising rates to offset "charge-offs" is that essentially the people who actually DO work hard to pay off their debt are financing the debt for people who just decide not to pay. While it statistically balances out for the banks in the long run, it is completely unfair on an individual basis. The problem is that credit card companies continue to push credit on people with bad credit or an inability to repay because they can "extort" others to make up for it. These regulations are necessary and ultimately will end up decreasing credit for people with bad credit or an inability to pay. Something that is a GOOD thing in my eyes. The credit problem we are having today involves a lack of credit for businesses and even people with good credit. That part needs to be addressed. Cutting off credit to those who likely won't repay is not the problem.

  • Report this Comment On May 19, 2009, at 1:23 PM, mikecart1 wrote:

    Agree with above guy. I love all these people that pay fees monthly for credit cards. It allows me to steal all the money through cash back cards that usually return to me 1-5% yearly for paying my credit card on time. Credit cards are the true equalizers! :D

  • Report this Comment On May 19, 2009, at 1:33 PM, Scoobrs wrote:

    I agree with crubenst. The problem here isn't a lack of credit in the economy. Our economy has made credit available far too easily for far too long on overvalued collateral. The problem is when banks make loans that they know the consumer can never fully pay back based upon irresponsible speculation that the consumer will try to make partial payments instead of filing bankruptcy and limiting their mounting balances. Witness the widespread acceptance and exploitation of credit card balance flipping across the industry. When banks do this, they also give their shareholders a grossly inaccurate picture of the real-world value of their loan portfolio, which will never be paid in full. If we fail to regulate these practices, then we are simply enabling another boom-bust cycle that will wipe out more responsible American businesses.

  • Report this Comment On May 19, 2009, at 3:24 PM, Wh1sp wrote:

    Perhaps, then, if congress insists on appearing to be "doing something" the best course of action would be to cap interest rates a a set percentage above the firm's recent charge off percentage. While this would still suffer from some time delay, and would lump everyone's risk together, isn't that the norm so far anyway in this crisis? While I agree with some of what Scoobrs is saying, history has taught us that any capitalist system is prone to boom bust cycles. While I agree easy credit will make these cycles more vaulted, they are in some respects inevitable. Tulips, anyone?

  • Report this Comment On May 19, 2009, at 3:53 PM, TicoHombre wrote:

    I'm sorry. Credit cards were never meant to be used to live off of. Never meant to pay doctor's bills. No one should ever have to have more than 3. People have misused credit, and we the community get to share in paying for the mistakes and abuses of others. Same as my tax dollars are paying for TARP and other bailouts of the irresponsible.

    On the other hand, I'm not saying there aren't abuses among the credit card companies. They use too broad of a stroke in desperately and hastily trying to correct a problem they were partly responsible for creating. It took two to Tango.

    People will abuse until they get slapped or spanked for it. Fiscal responsibility!!!!!! When will the consumer start accepting responsibility for his own ignorance, misuse and stupidity? This is the same reply I give to the Liar's loans and Alt-A loans and other sucker loans that people got into and want others to get them out of. NO, NO, NO.

    I have near perfect credit, carry 4 mortgages and have no other debt. Don't need TARP, or caps on interest, or bailouts. You can do it people, but the first step is in accepting responsibility for your own decisions and actions.

  • Report this Comment On May 19, 2009, at 4:45 PM, RADARTHREE wrote:

    Today's paper tells us that those who have no balance and repay their cards in full each month are about to see new charges, annual fees etc. Gone will be cash back and miles programs as those of us who are responsible are targeted.

    It's too late to go back to writing checks, so what are we going to do?

  • Report this Comment On May 19, 2009, at 5:19 PM, SteveVaughan100 wrote:

    I also read in today's NY Times that as someone who pays their balances in full each month, I may be punished through annual fees and the reduction of cash-back rewards (this started for me around 6 months ago).

    What we should do is band together and start punishing the credit card companies - don't they need our cash flow to keep their businesses running? Why are they still sending out numerous offers (last year it was several BILLION) or sending me blank checks to use?

    If I'm going to be dinged for this, I'll just start using my checkbook and cash - let's see how long the credit card companies can work without us 'deadbeats' (their term for people who pay their bills in full and on time).

  • Report this Comment On May 19, 2009, at 5:40 PM, PeterJPh wrote:

    All of the above! If everyone would pay on time and stay within their credit limit, banks would not collect the billions dollars in fees. These are a major source of revenue and not just a penalty for poor paying customers. If banks would not have extended credit to those who have a history of not handling it responsibly, they would have been in better shape overall. I didn't know what "Credit" was until I came to this country 30 years ago. We cannot continue to live like "buy now and pay later." This is true for all of us and government too.

  • Report this Comment On May 19, 2009, at 5:40 PM, ErnieEK wrote:

    My wife and I raised a family, paid off mortgages, paid our bills on time, hardly ever kept a credit card balance, never had bad credit. Now paying off credit card balance each month, have a cashback rewards AARP Chase Visa Card, paying me rewards just for having and using the card. I use it for everything I can and NO fees.

    People who abuse their credit deserve what they get. If they can't plan and save for what they want, they deserve what they get. It's all greed and stupidity if people get in over their heads. America is suffering for the 'gimmie' generations and have brought it on themselves. Now they are stupid enough to listen to and believe idiots like Obama/Biden, Pelosi/Reid, and all the other social democrats who are more than willing to become their masters.

    What a bunch of stupid people to vote for liberals, including RINOs like Specter, Collins, Snowe, McCain, etc.

    You made your bed; now lie in it. The problem is, you are dragging the rest of us down with you.

  • Report this Comment On May 19, 2009, at 7:14 PM, leggomyusername wrote:

    Radar3, it's not too late to go back to using checks and cash. We've been using only those for 5+ years now. Many people we know have successfully converted more recently. It still DOES 'hurt' when we can't just have what we want, but all in all my family financial situation is stable right now despite all the same environmental factors everyone else is facing. Including a job loss. This is better. Give it a try!

    The article forgets that the card companies also collect fees from merchants when you use the card. That should be what covers their overhead. Interest rates should cover their cost of carry plus losses. The credit card divisions, like the other parts of the banks, need to cool their jets and remember they are supposed to have steady-eddie, dividend paying stocks. If you want cool & exciting go buy a dot.com

    For now, if the company costs are higher than their revenue, the general idea is to cut costs. Not to jerk customers around. Check out the small banks and credit unions, I bet they are getting new customers by the droves.

    But all that said, rates probably have to go up some. Because both charge-offs and cost of carry (the rates the credit card companies pay) are going up. Just not by as much as the cards are trying to grab from cardholders right now.

    For ErnieEK, unfortunately life is not fair. Do what you can to take care of yourself, family and neighbors. And then get over the fact that others' problems are affecting people like you and me. They always do. And they give you the chance to do some good. Instead of whining. (Even though I am conservative too, I'd rather do something about our politicians and society instead of whine and call names.)

  • Report this Comment On May 19, 2009, at 7:40 PM, philis50 wrote:

    1. The credit card banks would have gone into bankruptcy because of their other toxic assests. We the American people foot the bill for trillions of dollars thanks to our elected officials. We saved the banks!!

    2. Now the credit card banks want to thank us by charging us 20% interest or more on balances.

    3. Our elected officials are at it again. They have sided with the credit card banks and will allow them to screw the American people again!

    Stop listening to the BS about chargeoffs and the misdirection from all the lobbyists. The banks did the same thing with credit cards as they did with mortgages. Send all of our bought and paid for politicians to China and put all the crooks running banks in jail.

  • Report this Comment On May 21, 2009, at 3:35 PM, mjtria wrote:

    I would like to know just how much of the charge off rate is actually against principal that was lent out, as opposed to the total of principal, interest, fees, interest on fees, etc.

    How much in the way of fees, fines and interest does the average charged off account rack up? CC companies add 20% as legal fees to the amount that is to be recovered in a failing account. Is that amount viewed as part of the chargeoff?

    Most likely an I suspect that the CC companies are still not losing money on their loans, just not making as much as they would like. And that they have just found a way of saying that they are "losing" massive amounts, while still making decent profits.

  • Report this Comment On May 21, 2009, at 4:57 PM, davegetrational wrote:

    The government should forget about the Credit Card companies and have the banks adopt "Social Credit". approach for government and their banks. This is an approached suggested in the dirty 30s and in retrospect should have been adopted. $50 dollar loans to poor people to start business have only had default rate of 5%.

  • Report this Comment On May 24, 2009, at 11:49 AM, rdlincoln wrote:

    I'm not sure who is fooling who. I have a FICO score of 805. I have several cards and a combined credit limit of about $60,000. I actually owe about $3500, much of it at 2.99%. Whenever I received solicitations for "cash back" or "rewards" cards, they always came at a higher interest rate that exceeded the "reward" percentage. I didn't bite!

    The real problem today is that the American society has been watered down and diluted to accommodate the lowest common denominator. How is it a benefit to society to sink the American (and world) economy while making credit readily available to those who are likely to default because they make poor financial decisions? Home loans have to be repaid. Credit card balances have to be repaid. Folks, the people in charge of our financial and political world are largely, a bunch of idiots!

  • Report this Comment On May 25, 2009, at 8:37 PM, crsawyer wrote:

    As one of the few who does not use personal credit cards, I haven't been affected by increases in rates or additional fees. I've used debit cards, cash and checks and gotten along just fine. However, I have to point out the credit card reform bill still lacks teeth. No other industry, other than payday loans, is allowed the leeway credit card companies have to change the game on the consumer mid-stream. This is why I refuse to use them.

    Remember, the credit card companies and major banks were the ones just a couple of years ago who lobbied to get bankruptcy reform passed, making it harder for the average consumer to declare bankruptcy. These are the same companies who have received TARP funds.

    Loss is always a cost of doing business. Executives at BOA, Citibank, etc. are supposed to be the experts on assessing risk. But actively courting high risk customers as banks have done during the last decade is the height of greed and short term thinking.

  • Report this Comment On June 01, 2009, at 2:40 PM, bmialone wrote:

    Through deceptive practices, credit card companies have forced late payments, over-limit balances, and the inability to make minimum payments so they could jack up interest rates and charge high fees.

    With each and every instance, they hit the consumer with high fees and unethically high interest rates. I knew a young woman who was fired from Wells Fargo for doing what was once common, removing the charges from the accounts of customers she thought deserved it. Her orders were to never remove charges no matter how good the customer.

    The research shows that these practices brought on this crisis because most people knew they could meet their minimum payments when the entered into the initial "contracts," were making their payments, and want to make their payments. It is a small minority who merely "choose not to pay." Intentional deceptions and trickery was the largest single factor in forcing their own customers over the edge.

    Also, credit card companies intentionally targeted inexperienced youth because they knew parents would pay the debts in order to protect our children's credit ratings. After entering college, my own daughter was taken advantage of twice, owing two to three times ($2000.00 and $9000.00) what she initially charged because of huge fees, doubled and tripled minimum payments suddenly required, and giant leaps in her interest rates applied to past balances as well as future charges. I paid them, just as the companies expected, because it is grossly unfair to force our youth through trickery into financial servitude or bankruptcy when they are just beginning their adult lives.

    Although I never pay interest because I pay in full every month, Bank of America through a smoke and mirrors scheme with computer debits and credits tried to literally steal money from me and it took an inquiry from my Senator to stop them. Also, despite their so-called crisis and my instructing them in writing three times to stop mailing me blank checks, I still receive them, lately about once a month.

    They deserve to go under. If all of those rapacious fees were put back in the pockets of the people they were extorted from and they were forced to accept only fair interest payments like they used to 10 years ago, our economy would look very different right now.

    Therefore, I have no sympathy and prefer bailout money to local and regional banks, not these large multinational companies called banks. Also, other than credit cards for the miles and percentages back, I won't go near banks. I use only credit unions and I take loans only from my favorite credit union that never sells it loans. When mistakes are made on my account, I want someone who has to look me in the eye and correct it, not someone in a warehouse God knows where following a script or they will be fired. If we all did so, the credit card industry would be forced to clean up its act to stay alive.

  • Report this Comment On June 01, 2009, at 3:13 PM, bmialone wrote:

    mjtria is correct. These companies have been and still are making profits. The public and our elected officials have forgotten what profit is: the cream on the top after ALL costs of doing business have been met. They say lower than expected returns and other similar phrases and we hear loss and in the red. What is really means is they are not making the profits they had hoped for and planned on, not that they are going under. Just like they do to the individual consumer, they are playing games with complicated numbers in order to gouge the public.

    Banks could have renegotiated terms of mortgage loans, but they refused because they were greedy, then they wail when people they gave the loans to start defaulting because they can't make the payments.

    They drove people into permanent debt with their abusive, deceptive credit card practices and then they cry foul when people can't make their payments.

    The mortgage crisis, credit card crisis, and health care cost crisis (and therefore access to medical care) are all connected. The financial and insurance sectors have evolved into predatory parasite industries. Really they are both part of the financial sector now, as are large retail companies who've been making more on credit payments than on selling goods, thus they've been forcing their sales staff to open so many new credit card accounts each month or face losing their jobs.)

    As giant international corporations they own other companies or are owned by larger companies and they could do what companies used to do, shift funds around. In fact, in the 1980s corporations used to buy companies to bleed in order to prop up or grow other companies. Now they behave as though shifting resources at all is an impossibility.

    In my opinion, if they have access to one penny of their own that keeps them from going under and they only break even, they do not need any bail out money and they shouldn't get it because that is how business is supposed to work. When they make profit, their investors get it, when they only break even, they don't.

    The finance industry has found a new way to make big bucks, this time off of the tax-payer dime. Once again an industry's lobbyists are treating our legislators like the uninformed dupes they keep proving to be.

    The best thing for the American public is for our legislators to get their information from publicly funded independent research groups with no ties to any industry, but instead loyalty only to the good of the public. That's what government agencies should be funded to do, for us. (God forbid, though, we actually pay taxes to fund such agencies to work on our behalf!)

    Instead, government officials get their information from those who stand to profit (and that is true of just about everything they make decisions for us about).

    ErnieEK: These are international companies, not American companies, and overseas investors refused to accept lower profits when all of this hit the fan last year. Refusing lowered profits meant refusing to renegotiate loans and change policies so people could make their payments. Instead, they jacked everything up further grabbing for every penny of profit they could get, and we Americans took it in the teeth.

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