The Credit Card Debt Crisis: The Next Economic Domino

Hot on the heels of the banking crisis, the employment crisis, and the mortgage/foreclosure crisis, the country is on the verge of experiencing a credit card crisis.

According to the Federal Reserve, the total outstanding credit card debt carried by Americans reached a record $951 billion in 2008 -- a number that will only climb higher as more and more people reach for the plastic to make ends meet. What's more, roughly a third of that is debt held by risky borrowers with low credit ratings.

Credit card defaults are on the rise and are expected to hit 10 percent this year. This will obviously drive many banks closer to failing their stress tests -- but it will have an even greater impact on the lives of people who find themselves sinking deeper and deeper into debt.

It's a particularly vicious economic circle: every day, Americans, faced with layoffs and tough economic times, are forced to use their credit cards to pay for essentials like food, housing, and medical care -- the costs of which continue to escalate. But as their debt rises, they find it harder to keep up with their payments. When they don't, banks, trying to offset losses in other areas, then turn around and hike interest rates and impose all manner of fees and penalties... all of which makes it even less likely consumers will be able to pay off their mounting debts.

And that's not the end of the economic downward spiral. As more and more Americans default on their credit card debt, banks will find themselves faced with a sickening instant replay of the toxic securities meltdown from the mortgage crisis. In another example of Wall Street "creativity," credit card debt is routinely bundled together into "credit-card receivables" and sold to investors -- often pension funds and hedge funds. Securities backed by credit card debt is a $365 billion market. This market motivated credit card companies to offer cards to risky borrowers and to allow greater and greater amounts of debt.

As these borrowers continue to default, banks and the investors who bought their packaged debt will take a serious hit. And how are the credit card companies trying to offset the rise in bad debts? By raising rates on the rest of their customers -- making it likely that more of them will end up defaulting, causing even more losses for the banks. And round and round and round we go.

And such is the paradoxical nature of the meltdown that Americans keep being encouraged to go back to spending in order to get the economy rolling again. But the problem is, more and more Americans are broke. So the only way they can spend is to charge it, running up balances on credit cards that are structured in a way that makes it harder and harder to pay them off.

Getting dizzy yet?

For years, credit card companies have been fattening their bottom lines with an ever-widening array of fees. Late fees, cash-advance fees, over-the-limit fees. In 2007, lenders collected over $18 billion in penalties and fees. JPMorgan Chase, the nation's top credit card lender, recently began charging many of its customers $10 a month for carrying a large balance for too long a time -- that's on top of the interest they are already collecting on those balances.

And interest rates are escalating. Earlier this month, Citibank warned customers that if they miss a single payment, they could see their interest go up to 29.99 percent (so nice of them to shave off the .01 to keep it from being 30 percent, isn't it?). The company also recently raised rates by 3 percent on millions of non-payment-missing customers. Citibank is not alone: Capital One raised its standard rate on good customers by up to 6 points, and American Express raised rates by 2-3 percent on the majority of its customers.

Sen. Chris Dodd, chairman of the Senate Banking Committee, accuses the banks of "gouging," saying, "the list of questionable actions credit card companies are engaged in is lengthy and disturbing."

Perhaps he should send the bankers a Bible bookmarked to Deuteronomy 23:19: "thou shalt not lend upon usury to thy brother." Indeed, Sen. Bernie Sanders told me last week that he is working on "anti-usury" legislation.

For their part, the bankers have tried to cloak their behavior with corporatespeak. A Citibank spokesman called the rate hikes the result of "severe funding dislocation," and said, "Citi is repricing a group of customers in our Citi-branded consumer credit card business in the U.S. to appropriately manage these risks." An AmEx spokeswoman chalked up its rate hike to "the cost of doing business."

Making such pronouncements particularly galling is the fact that many of the banks summarily raising interest rates and piling on the penalties have received billions in bailout money. Our money. We gave Citi $45 billion, Bank of America $45 billion, JPMorgan $25 billion, AmEx $3.4 billion, Capital One $3.6 billion, and Discover $1.2 billion. In fact, American Express and Discover converted to bank holding companies to make themselves eligible for bailout funds.*

Yet that money seems to have been delivered with no strings attached. Banks cash their bailout checks, then turn around and gouge their most vulnerable customers. Priceless.

One of the ironies of the credit card crisis is that the financial industry laid the foundation for much of the trouble we are seeing with its full-throated -- and deep-pocketed -- support of the cynically named Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, a truly loathsome piece of legislation that opened the door to many of the banking abuses we are witnessing. It made it much tougher for Americans to file for bankruptcy -- even the millions of hardworking Americans whose bankruptcy is the result of a serious illness (fully half of all bankruptcies are the result of crushing medical expenses). It also did nothing to rein in the kinds of lending abuses that frequently turn manageable debt into unmanageable personal financial catastrophes.

The financial industry spent $100 million lobbying to get the bill passed -- and millions more in campaign contributions. The result was a sweetheart law for the financial industry -- with 18 Senate Democrats voting for it.

And the banking lobbyists are at it again.

There are currently several bills in Congress designed to roll back some of the worst provisions of the 2005 legislation. In the Senate, Robert Menendez has put forth the "Credit Card Reform Act," and Chris Dodd has introduced The Credit Card Accountability, Responsibility and Disclosure Act ("the Credit CARD Act"). In the House, there is Rep. Carolyn Maloney's Credit Cardholders' Bill of Rights.

The banking industry is pushing back hard. But wait, you might ask, aren't the banks broke? So where'd they get the money to lobby against credit card reform?

From us. There may not be much transparency about the hundreds of billions of taxpayer dollars doled out through the TARP program, but we know where at least some of the money has gone: into making sure that none of the Bankers Gone Wild behavior that led to the current disaster is curtailed.

In December, the Fed approved new rules that will, among other things, limit arbitrary rate increases on credit cards, cap some fees, and require the credit card companies to more clearly disclose the often confusing -- if not downright misleading -- terms customers are agreeing to. But these rules won't go into effect until July 2010.

Why would the Fed make rules that won't go into effect for a year and a half? We can't afford to wait until then.

Congress needs to tell the bankers that their Beltway credit has been denied and pass laws reforming the credit card mess -- before the credit card blaze turns into another economic conflagration.

* An earlier version included Capital One among the companies that had converted to bank holding companies to make themselves eligible for bailout funds. In fact, Capital One became a bank holding company in 2004.

Are you being forced to use your credit cards to make ends meet? Has a credit card company jacked up your interest rate after missing a single payment - or raised your rate even though you haven't missed one? Have you been charged unexpected add-on fees? If so, we want to hear your story. Share it with us by emailing [e-mail].

We are also looking for citizen journalists to help cover the economic crisis. Click here to join our team reporting on how the meltdown is impacting your neighbors and your community.

Comments

[HoraceOvidson]

greed ends up punishing itself. let's all slap ourselves in the face.

[ponderingmuch]

Please keep this issue front and center.

After yet again vowing to never use my credit cards again, I lost my eyeglasses.

Did not have the $600 available in bank account, but need glasses to do my work, let alone live.

I am now up to (without doing anything to cause the jump) to 28% on the one card that went through.

LIMIT THE RATES!!! PLEASE!!

[nachtengel]

Thank you Arianna for finally bringing this all to light. I have been asking and talking about this issue for almost a year, and very few are willing to cover it. IMHO I think this will do far more economic damage to the US economy then the housing crisis, and even if the gov coughs up 2 trillion dollars for this crisis alone, which just seems unlikely, this will kill all trust and belief in the stability of our system by foreign banks that own this debt.

What we also need to remember here, is that unlike the real estate crunch, where at least there is a property to foreclose, and resell to recoup something, with credit debt, there is no way to get back debt from a family of 5 buying $500 in groceries a month, $200 in utilities a month, and $200 in gasoline a month if both or even one of the parents were to loose their jobs.

That alone is 10k in debt a year, at likely 30% if they miss one payment. Essentially that will add another 3k a year. And god forbid if kids gets sick, or even worse. And forget about natural disasters, insurance of any kind, and even making your land tax payment.

It's insane, and very likely that most families will never recover, let alone keep their house or keep their car.

[SingledadNH]

It's amazing how what is simple common sense to the lay person largely escaped the prescience of the economic pundits and policymakers. We have an economic system that is well over 60% dependent on domestic consumption - - consumption that is ever-increasingly dependent on credit-based spending. Such a noxious concoction is a recipe for indeterminate stagnation. As long as cash-strapped consumers can no longer utilize easy credit, the economy cannot regain anything resembling a healthy status, let alone have a solid foundation.

[UnkaDano]

I long ago viewed credit card debt as another form of slavery where the politicians are paid to look the other way.

[zrants]

Most major bank and credit companies have failed to follow the trail of carrots being laid out by the Fed. Discount rates for banks are at an all-time low, yet few have passed these rates on to the consumer.

Congress should rewrite the bankruptcy law to authorize bankruptcy courts to modify rates and terms on mortgages and credit cards for people facing foreclosures or bankruptcy. Vacant properties are glutting the market, driving down the tax base, and bankrupting local governments. All properties are losing value, not just the ones in foreclosure. Keeping people in their homes will solve that problem faster than bailing out the banks or buying bad assets. Both the borrowers and the lenders have lost value in these homes, not just the banks. This is where the courts can even the playing field.

While Congress is amending the bankruptcy law, they can also authorize the courts to renegotiate credit rates and terms on credit cards. Kill two birds, so to speak. If someone is going bankrupt it pretty much affects their life, not just their mortgage. Congress is authorized to expand the court system for just this sort of temporary emergency, and, once lending institutions can predict how the courts will rule, many will decide to negotiate rather than go to court.

If the standards are controlled by the Feds, they can tweak it as needed, lenders and borrowers will know what their limits are, and, Congress can pull back when the crisis is over.

[JohnHermina]

You are right. I found this article to be very informative and well written. Thank you.

John Hermina

[tbrunson]

WOW!! I can't believe the number of replies on this EXCELLENT article. There is a lot of rhetoric about the impact that the recession I know that components of the economy that have the most "systemic" impact must be addressed. However, it seems that the pain of the masses is only being looked at in terms of how it impacts the "system." Folks there are people hurting out here.
http://www.newquestcity.com/templates/contentpages/gettingback.cfm

[sweet1125]

Credit cards are far too dangerous for anyone. It gives you a false sense of wealth and makes you spend way beyond your means. Credit card companies reel in more and more people each year into getting this plastic cards of debt. In these recessionary times, it is better to be prudent in spending. It is much better to use a debit card or cash. Credit cards if anything should only be used in case of an emergencies. People need to realize that in the end credit cards just lead you into debt. People are setting them selves up for bankruptcy. Especially if spending is an addiction for people. The economy is going through a crisis and at this time charging payments on credit cards should not be option for anyone. And i agree with "aftang" our tax dollars bail out banks and in the end they screw you over. This is going to be an endless chain.

[PrescottPatriot]

NATIONALIZE THE BANKS

THE SOONER THE BETTER

PASS THE WORD

[Dragonslazer]

If you knew what Nationalizing the U.S. banks would do, not just to the United Stats but the rest of the world economy?

Watch this clip, http://watch.bnn.ca/#clip144230 BNN speaks to John Taylor, chairman, CEO & CIO, FX Concepts.

And you will know why Nationalization is NOT an option.

[jiggystyles]

AGREE It's going to happen at some point. The Sooner the better... so we can fix the mess.

[lifeinfullcolor]

Say good-bye to buying big ticket items, who's going to spend 25% a month extra, on updating something they already have? So what's going to happen to our consumer driven economy, the hole just keeps getting deeper.

[themainpoint]

Very interesting take on the whole meltdown by Reagan's assistant secretary of the Treasury.
http://www.counterpunch.org/roberts02242009.html

[lostinNJ1]

A very interesting Frontline piece, "Secret History of the Credit Card" was aired in 2004 and foresaw this crisis then. It discusses how several Supreme Court Decisions have led to these predatory-type lending schemes. It also highlights the OCC (Office of Comptroller of Currency) part of the Treasury Department. It has power to curb these practices, but surprise, surprise they have done very little. They have ursurped the states' role in addressing credit card complaints- of course the states are not happy at all with this. Chris Dodd is interviewed: all of his attempts to get legislation passed to even improve notification to consumers has been blocked. They also interview various consumers who have been unfairly hit, along with a general consumer panel. Really fascinating.
Here is the link: http://www.pbs.org/wgbh/pages/frontline/shows/credit/view/

[iameliot]

One more important point:

Bank of America CEO Ken Lewis tried to downplay this issue when he testified, saying that less than 20% of B of A accounts had been raised to these high rate levels in 2008. That may be true, but it ignores the millions of existing B o A accounts that had already been raised in prior years.

Tens of millions of performing accounts are now suffering rates of 24-29%.

Congress needs to pass a FEDERAl usury law capping rates on all accounts, including existing ones, at a reasonable rate .....e.g., 4% over the fed funds rate.

[Russ White]

Increasing your interest rate does 3 things for the banks. First (and most obvious), it garners them more profit. Second, it increases their cash flow because not only did your interest rate go up, so did your minimum monthly payment. And finally, it extends the time they have you as a customer. Not by a few months, but potentially decades.

Let's take a $10,000 credit card balance.

At 6% interest and a $70 minimum monthly payment, you'll pay that puppy off in just over 20 years. Up that to $140 per month and you're down to just over 7 years.

Pump that 6% interest up to the 29.99% that people are starting to see.. your minimum monthly payment pops to $250 per month, and it will still take over 20 years to pay off the balance. Want to pay a little extra? Make a $300 payment and you'll be paid off in 6 years.

[Dragonslazer]

THE BANK'S RUSE

AN ACCOUNT OF HOW THE BANK'S IN CANADA HAVE CHANGED THE RULES ON HOW THEY LEND MONEY AND PROVIDE CREDIT FROM JUST 6 MONTHS AGO.

If you want to know how the credit freeze crisis is effecting and creating a domino effect up here in Canada. A country that does't have a subprime mess, a banking system that is the strongest in the world, no bailouts and no bank failures have resulted in what has been going on around the world.

But how they are doing business is going to exasperate the situation up here more to the down side.

Just click on to this link http://dragonslazer.blogspot.com/