Next credit implosion - credit cards
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Last year, just as the subprime crisis happened, credit card debt took off. The home-equity ATM had been shut down, so people turned to the last source of easy money they had left, the most expensive debt on the menu, credit card borrowing.
Since credit card debt has been growing much faster than the economy - more than 8% in last year's third and fourth quarters and over 7% in May (the most recent month reported)- people are apparently using it as a substitute for income. Thus, for the past year or so we have still maintained the standard-of-living illusion.
But a big crunch is coming - and here's why. Credit card debt, like mortgage debt, gets bundled, securitized, and sold off by banks. Citigroup (, ), one of America's largest credit card lenders, just reported that it lost $176 million in the second quarter through securitizing such debt. That happens when the buyers of those securities observe rising delinquency rates and rising interest rates, and decide the debt is worth less than Citi thought. More generally, the amount of credit card debt that is securitized nationwide has plunged by more than half in the past five months because it's getting riskier. That means credit card issuers will be charging customers higher interest rates, and since the banks can't offload as much of the debt as before, they'll have less money to lend to cardholders.
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Scary stuff man.
Re: Next credit implosion - credit cards
So... your saying that my CC's rates will go up? Also can they reduce the amount-limit on my cards if I have $0 balance when payyment is due.
Re: Next credit implosion - credit cards
^^^ yes, and yes.
The issue over credit cards is that they are 'unsecured' debt ... so if the cardholder goes bankrupt the sponsoring bank is facing a total loss. This is opposed to a home loan or a car loan where the sponsoring bank will get at least some portion back in the form of foreclosure/repo and auction.
There has been discussion in other threads that the credit card banking industry now seems to be splitting along two paths. Some banks will only issue cards to 'prime' borrowers (i.e. people with a verifiable income ... people whose assets exceed their debt ... people with 720+ credit ratings) - so they can offer much lower interest rates / fees and still turn a profit because the risk of bankruptcy and/or non-payment is tiny. If these banks currently have 'subprime' cardholders (i.e. people whose income cannot be proven / depended on, people who have tons of other debt, people whose credit rating is below 600) they will raise interest rates and fees sky high in order to pursuade these 'subprime' cardholders to change banks / cards. This is to help protect the bank from future losses.
There is another group of sponsoring banks who IS willing to take loss risk by issuing credit card accounts to 'subprime' borrowers. But these cards will have very high interest rates, low credit limits, high fees etc. in order for the underwriting bank to try and earn enough money from the 'subprime' credit card holders who DO pay their bills to cover losses caused by other 'subprime' credit card holders who don't.
The concept is similar to the one now used for auto insurance or homeowner's insurance. Young male drivers are expected to pay much higher insurance premiums than middle aged female drivers, because the risk of having an accident is much higher for the young males. People with houses located in the Mississippi hurricane path or near a seismic fault line are expected to pay much higher insurance premiums than people with houses located in 'calm' areas with no history of 'natural disasters'. People with low incomes / people with unreliable incomes (like self-employed dancers) / people with a lot of pre-existing debt / people with low credit ratings etc. are FAR more likely to file bankruptcy. And unlike the past where the losses were spread over ALL credit card holders, the recent trend is to group these cardholders together as being high risk ... make this group pay interest rates and fees that are commeasurate with the sponsoring bank's risk of loss, and leave the 'prime' credit card holders' interest rates and fees at lower levels.
The underlying reason for banks doing this was described above ... the ability of the bank to package and resell 'credit card based' bonds to investors and thus avoid tying up the bank's money. However, those investors are now running scared after taking big losses from 'subprime' mortgages, such that nobody wants to buy bonds whose value / income potential is based on 'subprime' credit card repayments actually taking place on time (or at all). As such, lenders who want to deal in 'subprime' credit card debt must supply their own capital in order to back those credit limits ... which means that the rate of return has to be EXTREMELY pursuasive for investors who have many other options in regard to making high risk investments with high reward potential.
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Re: Next credit implosion - credit cards
Quote:
Originally Posted by
Melonie
^^^ yes, and yes.
The issue over credit cards is that they are 'unsecured' debt ... so if the cardholder goes bankrupt the sponsoring bank is facing a total loss. This is opposed to a home loan or a car loan where the sponsoring bank will get at least some portion back in the form of foreclosure/repo and auction.
I'm not sure, but I think that even if a person goes bankrupt, they are still liable for their debts with the new bankruptcy laws.
Re: Next credit implosion - credit cards
Thanks. I don't know too much about bankruptcy law. What's the difference between Chapter 7 and Chapter 13?
Re: Next credit implosion - credit cards
^^^ Chapter 7 involves a total elimination of previously existing debts by the bandruptcy court (with certain exceptions like student loans, back taxes etc.). But since the change in bankruptcy laws people are only eligible for chapter 7 if their incomes fall below the 'median income' in their zip code area. If the person's income level falls above the 'median', they are no longer allowed to file Chapter 7 and instead are compelled to file Chapter 13. A Chapter 13 filing typically involves a court ordered repayment plan where every dollar earned over the next 5 years (above the amount needed for basic costs of living) must be paid out to creditors on a proportional basis.
So yes you are correct that where a credit card bank would lose 100% of an outstanding credit card balance as the result of a Chapter 7 bankruptcy, they might only lose 80%-60%-40% in a chapter 13 filing depending on the income potential and other pre-existing debts of the person filing bankruptcy. Of course, the credit card bank would also incur additional costs as a result of a chapter 13 filing ... legal / bookkeeping etc.
Again the point is that banks are now taking a 'defensive' posture to minimize their future exposure to both Chapter 7 and Chapter 13 bankruptcy losses. Those 'defensive' measures involve dropping credit limits (which limits the potential amount that the 'subprime' credit card holder can borrow and then go bankrupt on), and jacking interest rates sky high (which allows the bank to earn more money before the account goes delinquent and/or a bankruptcy is filed to offset later losses).
Also, like a safe driver male under the age of 25, and like a Mississippi resident who used a very good homebuilding contractor and 'oversized' materials in their house, self-employed dancers with good credit ratings are now going to be lumped together with other 'subprime' borrowers and forced to pay higher credit card interest rates despite the fact that their personal credit history may be excellent.
Re: Next credit implosion - credit cards
Quote:
Originally Posted by
Melonie
Again the point is that banks are now taking a 'defensive' posture to minimize their future exposure to both Chapter 7 and Chapter 13 bankruptcy losses. Those 'defensive' measures involve dropping credit limits (which limits the potential amount that the 'subprime' credit card holder can borrow and then go bankrupt on), and jacking interest rates sky high (which allows the bank to earn more money before the account goes delinquent and/or a bankruptcy is filed to offset later losses).
A 40$ late fee on an account of $1,000 limit is the same income on an account of a $2,500 limit. The difference is, there is only half the money to worry about.
Heck, might even be able to slip some over-limit fees in there too with a smaller balance.