Not Ready for Subprime Time

Despite a rise in bankruptcies, credit card companies mailed 5 billion solicitations over the 12-month period ending on March 31, 2002, according to the Consumer Federation of America (CFA). That's almost 50 solicitations per household.

These are the same companies that pushed for new legislation to stem the increase in bankruptcies, which reached an all-time high of 1.5 million in one year, according to In a press release, CFA Legislative Director Travis Plunkett said, "Credit card issuers are shamelessly escalating their marketing and available credit to stratospheric levels while demanding that Congress give them relief by making it harder for consumers to declare bankruptcy. Can any of them explain why they need this relief when their profits are increasing... ?"

One of the criticisms of the legislation is that it does nothing about the credit card industry's aggressive lending policies. According to today's Wall Street Journal, however, federal regulators may be taking up the cause.

Last month, the Federal Financial Institutions Examinations Council issued new guidelines that will require credit card issuers to rein in the issuance of "subprime" debt, i.e., credit offered to people with spotty credit records or low income. The proposed rules would also change accounting procedures and require companies to keep higher reserves to offset bad loans.

According to the Journal, MBNA(NYSE: KRB) and Capital One(NYSE: COF) have already begun increasing their reserves by $200 million to $300 million. That's money that comes straight out of the bottom line -- meaning lower earnings per share. It also means reduced earnings power in the future, because the money will earn government bond rates rather than higher rates as loans to customers.

As for the broader economy, the Journal article suggests that a decrease in the amount of credit extended to high-risk borrowers would hurt consumer spending and, therefore, the economy in the short term. If that's the price of reducing the amount of debt taken on by people who are already maxed out -- 37% of credit card debt is subprime, according to credit agency Equifax -- then that's a price we must pay.

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