Saturday, July 26, 2008

The Straw That Breaks The Camel's Bank?

Last October, Fortune published an article, The $915B bomb in consumers' wallets, which highlighted the problem of credit card debt in America. The article described the "doomsday scenario" as follows:

Just like CDOs and other asset-backed securities, credit card debt is sliced, diced, and sold off again as packages of securities. Rising delinquencies would hurt not only the banks involved but the securities backed by the credit card receivables. Those securities would decline in value as consumers defaulted, leading to bank losses as well as portfolio losses in the hedge funds, institutions, and pensions that own the securities. If the damage is widespread enough, it could wreak havoc on the economy much as the subprime crisis has done.

Importantly, the article mentions that credit card debt is different from subprime debt in a fundamental way:

Unlike mortgages, credit card debt is unsecured, so a default means a total loss. And while missed payments are at a historical low, they show signs of an uptick: The quarterly delinquency rate for Capital One, Washington Mutual, Citigroup, J.P. Morgan Chase, and Bank of America rose an average of 13% in the third quarter, compared with a 2% drop in the previous quarter.

Keep in mind that was last October. This past week, Harvard Law professor Elizabeth Warren testified before the U.S. Congress' Joint Economic Committee. I quote the following from the CNN article, Middle class: 'On the edge':

Adjusted for inflation, median household income dropped by $1,175 between 2000 and 2007...

At the same time, the average family is spending $4,655 more on basic expenses, such as gas, housing, food and health insurance. Gas alone costs $2,195 more for a family making the same commute in May 2008 as it did eight years earlier.

Families with children saw their child care costs soar. Those with children under age 5 spent an additional $1,508 a month, while after-school costs for older children rose $622.

To cover these soaring expenses, many people have had to turn to credit cards. Nearly 10% of total disposable income in the United States goes to paying off such debt, Warren said.

"There have never been since the Depression so many families standing right on the edge," Warren said. "Families have tightened their belts. They have cut down in every discretionary spending area they possibly can."

"These costs are tearing a hole in the family they simply can't make up," she added. "You can't cut out enough lattes to pay for health insurance in America."

In article posted on ABC News, Credit Cards: The Next Financial Crisis?, Alice Gomstyn reports that to avoid a financial crisis, credit card companies are increasingly raising interest rates, lowering credit limits and canceling inactive accounts. I quote the following:

In the first three months of the year, commercial banks in the U.S. took losses on 4.7 percent of their credit card loans, up from 3.9 percent the year before, according to the Federal Reserve.

In the last two weeks, major credit card players like American Express, Capital One, Citigroup and Bank of America have all reported larger losses from unpaid card bills. American Express saw second-quarter profits from its U.S. credit card business fall a stunning 96 percent from $580 million in the spring of 2007 to $21 million this year. (Overall, the company reported $655 million in second-quarter profits.)

"The credit card companies have really found themselves in a huge, huge hole," said Robert Manning, the director of the Center for Consumer Financial Services at the Rochester Institute of Technology.

Manning argues that banks themselves, not credit card users, should shoulder much of the blame for rising delinquencies and defaults. As the financial slump took hold, he said, banks started relying on their profitable credit card arms to compensate for losses in other divisions such as mortgage lending.

This practice, he said, came at a price -- revenues were being bolstered, in the short term, by drives to offer higher credit limits and more credit cards to higher-risk borrowers.

Credit card lending became "a bit too aggressive," said John Ulzheimer, the president of consumer education for, a credit card information site. "People were getting credit vehicles maybe they should not have been getting. Those bad issuances of cards are, in many cases, coming home to roost right now."

Interestingly, the article goes on to state:

Analysts agree that credit card troubles alone likely won't be enough to topple any one bank in the same spectacular fashion that subprime mortgage losses led to the collapse of Bear Stearns.

But Ron Ianieri, the chief market strategist for the investor education company Options University, said that for banks already suffering from other financial woes, more trouble on the credit card front "could be enough to be the straw that breaks the camel's bank."

"I don't think a credit card crisis would be strong enough to collapse a bank under normal conditions, but these aren't normal conditions," he said. "These banks are teetering right now as it is. One more push -- it doesn't have to be a big push -- and it could knock them off the top."

Analysts like Ulzheimer, however, don't see the need to ring any alarm bells and neither, apparently, do the banks.

"We obviously do not know the extent of the current downturn, but the position of our company today is financially sound and competitively strong," American Express CEO Ken Chenault said in a Monday conference call on the company's earnings.

If you ask me, the slide in American Express' share price is sending an ominous warning to all investors that the credit crisis is far from over. Americans were using their inflated house prices like an ATM machine to extract from their home equity lines of credit, but when house prices started to decline, they switched over to credit cards to make ends meat.

I have been warning my readers that the worst is ahead of us, not behind us. We will experience a prolonged period of debt deflation that will rip through the global financial system. Incidentally, credit card debt is not just an American problem; the United Kingdom and other European nations face similar credit card debt problems. As their economies slow, consumers there are also trying to survive by taking on more debt, including credit card debt.

The end game of all this will likely be a prolonged period of debt deflation. An article in the Asia Times, Debt capitalism self-destructs, correctly points out the following:

The once-dynamic US economy has turned itself into a system in which it is difficult to find any institution, company or individual not over their head in speculative debt. Undercapitalized capitalism, also known as debt capitalism, has been the engine of growth for the US debt bubble in the last two decades. This debt capitalism cancer is caused by a failure of central banking.

In the face of a broad systemic collapse of debt capitalism, where capital has become dangerously inadequate and new capital hazardously and prohibitively scarce, having been crowded out by massive debt collateralized by overblown assets of declining value and with a credit crisis that clearly requires systemic restructuring and comprehensive intensive care, those in the US responsible for the financial well-being of the nation seem to have been reacting tactically from crisis to crisis with a script of adamant denial of obvious facts, symptoms and trends, with no signs of any coherent grand strategy or plan to save the cancerous system from structural self-destruction.

This band-aid short-term approach to artificially pop up share prices in the collapsing equity market and to maintain insolvent financial institutions with technical life-support will lead only to long-term disaster for the whole economy.

But before we get to that point, policymakers should watch William Greider's interview with Bill Moyers (click here to watch interview).

I quote the following from the transcript:

What were you thinking as you saw that report from Cleveland?

WILLIAM GREIDER: Made me angry all over again, even though I know the story. And then I thought, "This is usury." This is a living example of what the Bible prohibited, which is the sin of usury. Most Americans have never heard of it probably.


WILLIAM GREIDER: Usury, to be clear about it, is rich people taking advantage of poor people by lending them money on terms that are sure to make them fail. All three of the great religions, Judaism, Christianity, Islam, had a moral prohibition against usury because they recognized that society can't function like that. People of great wealth and their institutions like banks naturally have the power to overwhelm people of lesser means. And you can't allow that in a decent society. It won't survive.

BILL MOYERS: Where were the gatekeepers? Where were the watchdogs? Why did it take the Fed so long to put an end to-


BILL MOYERS: -predatory practices?

WILLIAM GREIDER: To make the story overly crude, Congress repealed the law against usury. It was done in 1980 by a Democratic Congress, Democratic President. And, of course, the Republicans all piled on and voted for it. And that was the first stroke, only the first of many, in which they stripped away the regulatory laws from the financial system and from banking.

And that allowed the free market modernized gimmicks of one kind or another, all these things we're now reading about, to flourish. And that's where we are. I mean, the gatekeepers said to the banking industry and to the financial industry, "We don't think federal control or regulation is good for you, so we're, therefore, liberating you to do your own thing."


BILL MOYERS: Maybe that's why all the foreign investors rushed in yesterday to buy Fannie Mae and Freddie Mac-

WILLIAM GREIDER: It might have some connection, yes.

BILL MOYERS: -if they know the taxpayers are going to put the money in, they've got a pretty good-

WILLIAM GREIDER: They've got what you might call a no-lose proposition. And the other part of that, and this would be simple. You could pass this in three days. Restore the federal law against usury. That won't have too many details to it at first. But it'll be a general statement that the federal government is prohibiting the kind of outrageous predatory practices, which have become general in this country, of not just banks but other financial firms.

BILL MOYERS: Credit card companies and-

WILLIAM GREIDER: Credit card - yeah, it's a long list. We know those abuses.

BILL MOYERS: Put some limits, some boundaries?

WILLIAM GREIDER: Well, eventually you have to draw very precise boundaries, I think, and restore some structure that says, okay, you can get a return of X on credit cards, but you can't get a return of triple X, right? And that kind of regulation. And that's not easy to draw. It takes a while.

But the first law that would just reassure the public, we're against usury. Muslims are against it. Christians are against it. Jews are against it. And we're going to develop a government laws that prohibited and penalized these institutions when they get caught doing it.

BILL MOYERS: Excessive interest, owned loans.


BILL MOYERS: That's what you mean by usury?

WILLIAM GREIDER: That's the narrowest meaning. But the larger meaning is wealthy people, whether they're banks or individuals, ought not to be able to use their power, their wealth to exploit people who don't have wealth, great wealth. That's not too complicated. And I'm not being utopian here. I'm just saying that you can reestablish legal-slash-moral limits on the behavior of finance and their wealthy patrons. And if they don't want to observe those rules then they need not apply for emergency loans at the Federal Reserve or the Treasury Department.

BILL MOYERS: In other words-

WILLIAM GREIDER: You see what I'm getting at? And-

BILL MOYERS: Yeah, in other words, so-

WILLIAM GREIDER: -and this is a-

BILL MOYERS: -if there's a bailout, certain conditions on that bailout.


I think Mr. Greider is absolutely right on this but I fear that the banking industry will continue to lobby for less regulation to continue their financial rape of U.S. and global consumers. But bankers beware: excessive credit card debt will ensure a prolonged period of economic weakness as consumers get into more debt to pay off their rising bills. If things get really bad, we will witness massive credit card defaults and yet another financial crisis.

Finally, the trailer above comes from the award winning documentary, Maxed Out: Hard Times, Easy Credit and the Era of Predatory Lenders. If you have not seen it, it is well worth renting it to understand the plight of millions of Americans that suffer from the burden of massive credit card debt.

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