The growing level of consumer debt in the U.S. is creating a drag on the economy.
All
over the world, people are keeping fingers crossed that the $700
billion financial system bailout works the way it is supposed to and
eases the worsening global credit crunch and restores confidence in the
markets. But while the government has been focusing its attention on
worldwide fallout from the mortgage debacle and the Wall Street greed,
another storm is gathering on the horizon.
With all
that’s happened since, it’s easy to forget that back in August 2008 the
U.S. Treasury Department stepped in to take the reins of Fannie Mae and
Freddie Mac, the two government-sponsored home loan banks. With the
country facing more than $12 trillion in residential mortgage loans, no
one wanted to stand by while Fannie Mae or Freddie Mac goes broke
marked cards.
But
who is watching as the rest of the country goes broke? The U.S. is
quickly moving toward the next financial credit crisis—this one involves
credit cards, and it could be a problem facing millions of Americans,
not just over-reaching homeowners who are facing foreclosure.
Charging the basic necessities
Consumer
spending has kept the U.S. economy growing for the last two decades. In
addition to shopping for homes they didn’t actually quality for,
consumers used their credit cards and revolving credit accounts to rack
up more than $2 trillion in household debt. Where they once indulged in
high-ticket items like electronics, plasma TVs, autos, and appliances,
today they’re forced to scale back and spend more and more on the basic
necessities.
When cash-strapped families have a hard time
making ends meet because of rising prices, they rely on their only
alternative—credit. Consumers are pushing the upper limits on their
credit cards in order to pay bills, feed their families, and gas up
the car. Some even use their cards to pay their mortgages, and that spells disaster.
The
lending industry, now barred from aggressively issuing sub-prime
mortgages, has turned its attention to marketing credit cards with high
fees, over-blown interest rates, and complex terms hidden in the fine
print or written in obscure language. Unwary consumers are setting
themselves up for future defaults, and doing it in record numbers.
Dug In Deep
Debt and delinquencies on the rise
Credit
card borrowing grew at an annual rate of 4.8 percent in July 2008, up
from a growth rate of 3.5 percent in June. But while the volume of
credit card purchases continues to rise, on-time monthly payments are
falling.
The percentage of people who were delinquent on
their credit card payments rose slightly in the second quarter from the
same time last year, while average debt per borrower jumped 8.6 percent,
according to credit reporting agency TransUnion LLC.
For the
quarter ended June 30, 1.04 percent of credit card holders were
delinquent at least 90 days on one or more of their cards. That compares
with 0.91 percent for the second quarter of 2007, although it did
represent a decline from 1.19 percent in the first quarter of 2008.
The
decline from the first quarter to the second quarter likely reflected
tax refunds and economic stimulus checks. Since delinquency rates tend
to be seasonal, they usually go down in the second quarter.
Late
fees and sky-high interest rates—some as high as 24 percent or
more—keep accumulating and threaten to keep the economy sluggish. Every
dollar that goes toward paying fees and interest on credit card balances
is a dollar that can’t be spent at the grocers, the hardware store or
Starbucks.
How did shopping on credit get so out of control?
Technology
has made it impossible to escape the temptation to whip out those
credit cards. Television commercials like Visa’s “Life Takes Visa; don't
let cash slow you down,” suggests that cash is out of date. With
e-commerce, retailers are now open 24/7. Home shopping networks and
catalog
800-numbers let your fingers do the shopping.
Credit
card companies market to our most basic instincts and appeal to the
herd mentality that suggests, “If everyone else is doing it, it must be
OK.” And if mere suggestions offered through television commercials
don’t do the trick, there’s always the direct approach—an estimated six
billion credit card offers hit the mail annually.
Debt and the job market
Consumers have been on a fast
moving shopping spree that’s about to grind to a halt. Wages are not
keeping up with inflation and too many jobs are going by the wayside.
Higher
prices and rising jobless rates are inextricably linked to loan
defaults and credit card delinquencies. The U.S. Labor Department
reported that unemployment rose from 5.7 percent in July to 6.1 percent
in August—a five-year high. Employers slashed 84,000 jobs in August, the
eighth straight month of declines, with a total of 605,000 lost jobs
for the year.
It’s a vicious cycle. Employers get worried
about the economy and their own profit margins and start cutting the
workforce. More people have less disposable income and are unable to pay
their bills, which leads to more mortgage defaults, more credit card
delinquencies, less consumer confidence, and on and on
trick cards.
But
the worst is yet to come. There is a lag between the time someone loses a
job and when mortgage loans default or credit card delinquencies
appear, so we might just be seeing the tip of the iceberg. Moody’s
predicts household credit conditions will continue to weaken through the
remainder of the decade, with another 5 million homeowners at
significant risk of default.
The Looming Catastrophe
Banks and lenders getting squeezed
Banks, already weighed down with defaulted loans, could face even more troubled mortgages on their books, as well as unpaid
credit card debt.
Credit card companies like Visa and MasterCard bear relatively little
risk for defaults and other payment problems. It’s the banks issuing the
cards that assume responsibility for the debt.
Failures are
expected to reach such a high level that the Federal Deposit Insurance
Corporation (FDIC), the Washington-based agency that insures deposits at
U.S. banks, may not be able to insure all deposits—even with protection
extended from $100,000 to $250,000 per account under the bipartisan
rescue plan now in place. They already raised the number of “problem”
banks to 117 in June, up from 90 at the end of March. Ten banks closed
down in 2008, the fastest pace in bank closures in fourteen years.
Even
before the Treasury Department's takeover of Fannie and Freddie, the
two mortgage giants that own or guarantee around $5 trillion, or roughly
half of the U.S. home loans, had been on a less than solid financial
footing. The more mortgage default rates escalated, the more their
capital base eroded.
The government’s $700 billion rescue
plan may help curb further deterioration in the markets, or ease the
credit crunch affecting banks and major corporations, but not much is
being done to ease other credit troubles. The big question: Will growing
consumer debt lead to another round of massive losses and write-downs
at banks and other financial institutions in the coming months?
Under the radar: Packaged credit card debt
Very
little attention has been paid to the fact that, similar to
mortgage-backed securities, credit card debt is packaged and sold to
investors. The inevitable defaults could lead to big losses, not just
for the credit card lenders, but also for pension funds and other
institutional investors who are buying the debt.
The
securitized debt backed by credit card receivables is a $915 billion
industry. Increased defaults could unravel the whole game, just as
delinquencies in the
housing market brought down the $900 billion in mortgaged-backed securities.
Does
this add up to an inevitable recession? You will get as many answers as
the number of politicians and economists you ask. (As the joke goes, if
you laid all the economists in the world end-to-end…they still could
not reach a conclusion.)
Consumer debt going global
While
we as nation seem only vaguely aware of this looming credit
catastrophe, MasterCard has already set its sights on duplicating its
U.S. business model internationally. Poised to take advantage of new and
growing access to credit in countries like Brazil, Hungary, Poland,
Russia, India and China, the credit card giant is anticipating a
projected revenue growth rate of 39 percent.
Easy access to
credit may be a compelling, albeit temporary, method to jump-start an
emerging economy. It paints a rosy picture and offers promises of better
living. But unless the populace of these countries is warned to use
credit cards with discretion, shoppers globally will surely be lured
into the same mistakes U.S. consumers make — and quickly become
saddled with the same kind of debt.
