Credit Cards: The Plastic Trap
"It was too easy."
After houses, consumer credit? While bankers plug up the breaches created by the mortgage earthquake as best they can, another bubble threatens them: Americans have been living their dreams on credit. And, having overheated up their cards, millions of households will have problems making their payments ...
Maria, a housekeeper in a San Francisco clinic, came to the Polk Street Money Mart to borrow $150 (110 Euros) on her October month-end salary. Yet the usurious rate practiced by this boutique is posted in big letters on the wall: $35.50 for $200! But Maria has no choice: "I don't have anything to buy diapers with for the baby; the fridge is empty ..." This young woman who is raising her son alone has already gone through the ceiling of two credit cards: "I've got close to a 6,400 Euro balance, while I earn barely 1,400 Euros a month." In the beginning, Maria used her Bank of America card for exceptional expenses only, such as the pediatrician's bill. Then she got into the habit of paying the grocery with it ... "It was too easy." Today, she is suffocating. Because in the United States, credit cards are commonly used to borrow. And everything pushes you to repay no more than a minimum amount every month.
Thus do millions of Americans find themselves caught in the "plastic trap." And experts are predicting a new deflagration. "In fact, there's a double financial bubble. The real estate credit bubble has exploded ... The next will be about consumer credit," warns Robert Manning, finance professor at the Rochester Institute of Technology, and author of the best-seller, "Credit Card Nation." The two problems are linked: "Because of the tax advantage, Americans repaid 250 billion Euros of credit card balances with money drawn from real estate between 2001 and 2006," he explains. "During that period, in defiance of the laws of economic gravity, people's real income declined ... but the price of real estate doubled, which completely distorted their perception of their debt capacity." The global balance on American credit cards is up to 700 billion Euros. Now that their houses can no longer be used as "cash machines," and economic activity is slowing down and unemployment rising, what proportion of this debt will turn out to be toxic? In the second quarter of 2008, the national default rate jumped to 7.3 percent. But it seems that that's only the beginning: according to the firm Innovest Strategic Value Advisors, credit card issuers will have to write off 29 billion Euros of losses this year and 69 billion more in 2009.
The big commercial banks are very exposed: the trio, JPMorgan Chase, Bank of America and Citigroup together have 330 billion in outstandings. On October 6, Bank of America announced a 2.1 billion Euro loss on its credit card division. Meanwhile, Citibank treasurer Gary Crittenden explained that if the economy continued to slow down, "credit card losses could exceed their historic records." But specialized issuers, such as Capital One and Discover, are even more dependent on this activity (62 percent and 97.8 percent, respectively). And here once again, we're talking about a cluster bomb. The big issuers have securitized significant portions of their credit card balances and sold them to third parties: speculative funds and pension funds. Investors are holding 260 billion Euros of assets backed by this kind of debt.
The last ten years, for plastic as well as housing, greed eclipsed all common sense. As consumer credit is one of the most profitable banking activities, bankers gave out cards like there was no tomorrow, including cards to high-risk clients. These "rotten" loans could represent as much as a third of the total portfolio, according to the Innovest firm. That ratio could rise to 45 percent among the most reckless issuers, such as Washington Mutual, recently taken over by JPMorgan. It was very difficult for American consumers to resist the Siren call of invasive marketing. Gifts, zero percent interest for a year ...: nothing was too much to lure the shopper. Bombarded with solicitations, inundated with emails and harassed by marketing appeals, the "grasshoppers" signed on en masse for new cards. Without - of course - paying attention to the clauses written in microscopic letters stipulating that the bank could increase its interest rates unilaterally. "Good" clients, those with reasonable incomes and credit, found themselves being offered higher ceilings on their outstandings. And why not? Getting into debt, after all, is part of the American culture where health and higher education are ruinously expensive. It's a proof of optimism. Practically a patriotic duty! Remember that George Bush exhorted his fellow citizens to go out and consume right after the September 11, 2001, attacks ... "Advertising and marketing have developed a culture of instant satisfaction of desires," observes April Lewis-Parks, from the financial counseling firm Consolidated Credit in Florida. "Not only do American parents refuse their children nothing, but they also fail to teach them to live within their means."
Anxious to exhibit their social success, envious of the neighbors' standard of living, Americans have confused "desire" and "need." And they've treated themselves to their dreams ... on credit. At present, gross domestic product (GDP) is over 73 percent dependent on household consumption and the real savings rate has dropped below one percent. Unheard of since the Great Depression. Excessive consumption has settled in, encouraged by an administration that set a bad example. Governments and regulators found no fault with that. "Since the end of the 1970's, financial lobbies have taken over Washington. They pushed deregulation and blocked everything that could have constrained their expansion," recalls Professor Robert Manning.
Like unscrupulous "pushers," financial establishments consistently and unethically sold their "junk" to the most vulnerable populations: immigrants, seniors, students. For example? Public Interest Research Group has been fighting for years to stop banks' "predatory" tactics in public universities. "Excessive and costly credit card debt has aggravated students' problems while they were already penalized by increases in tuition cost," this association recently testified before Congress. Banks, which maintain open tables on campuses, attract students with free T-shirts, Frisbees, pizzas and sodas. They make agreements with alumni associations and have even signed contracts with several schools, including the University of Illinois. In exchange for royalties, these universities supply them with confidential information about their students.
Today, the return to earth is brutal. Not only are financial establishments soft-pedaling their marketing, but they are also turning the screws on their clients. They are unilaterally lowering borrowing limits and canceling inactive cards. Above all, creditors are severely sanctioning all unmet payment deadlines with heavy late fees or increases in interest rates, which can rise savagely from nine to 24 percent, even 39 percent! That risks aggravating default chances still further.
At New York's civil court, which handles cases below $25,000 (17,800 Euros), complaints concerning unpaid credit-card balances have tripled since 2000, to constitute nearly half of all cases. Mandated by the banks, debt collection agencies negotiate reductions in outstandings there. There's the same trend in Florida: "We have 30 percent more calls than last year and people are more distressed," notes April Lewis-Parks, whose firm advises people who are over-indebted. "On average, clients have five credit cards. Compared to last year, the average level of outstanding debt has tripled to 17,100 Euros. For 12 to 15 percent of them, personal bankruptcy is the best option."
This augurs poorly for consumption and growth in 2009. "We won't have any choice: we'll have to go through a systematic program for the renegotiation of the American consumer's debts," predicts Professor Robert Manning, who has developed a method for evaluating repayment capacities. And once this shock has been absorbed? "We can't act as though nothing happened. We'll have to reduce our standard of living and reform our growth model." Will the American "grasshoppers" be capable of rebuilding a more frugal civilization? Of saving? Of investing in infrastructure, research, and education rather than flaming out in immediate consumption? It's not easy to rethink the American dream.