More good news, for debt collectors

By Felix Salmon
September 14, 2010
the charge-off rate is hitting new highs and rising alarmingly. (It was 9.8% in the same quarter of 2009, and 10.1% in the first quarter of 2010.)

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When the financial crisis caused a sudden stop in the availability of home equity lines of credit, credit-card default rates naturally spiked. No longer could consumers spend as much as they like, and then, when their credit-card debt got out of control, pay it all off with a cash-out refinance.

But two years after Lehman Brothers collapsed, credit card default rates are still high — in fact, at 10.8% in the second quarter of 2010, the charge-off rate is hitting new highs and rising alarmingly. (It was 9.8% in the same quarter of 2009, and 10.1% in the first quarter of 2010.)

Consumers are continuing to rack up new credit-card debt: far from paying down their balances at all, they’re charging new stuff every month. Yes, the total amount of credit-card debt outstanding is falling — but that’s only because the banks have given up on collecting an enormous amount of it — they wrote off $81.6 billion in 2009, and another $43.5 billion in the first half of 2010.

I, for one, didn’t expect credit-card charge-off rates to rise in 2010: aren’t we meant to be in a recovery? Weren’t they extremely high to begin with? Haven’t card companies been reducing credit limits and generally trying to rid themselves of uncreditworthy customers for a couple of years now?

I do think that this data series is probably going to prove a good proxy for the point at which the US population as a whole gets less pessimistic and begins to think that we’re no longer in a recession. I don’t think that the goods being charged onto these credit cards are silly luxuries: it’s just that for a very large part of the country, it’s extremely difficult to live within your means. The banks keep on having to write off credit-card loans as it becomes clear they will never be repaid — but just because a loan is written off, doesn’t mean it disappears. The debt remains, and will weigh down the cardholders’ finances for many years to come. It just now belongs to debt-collection agencies rather than banks.


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“. . . it’s just that for a very large part of the country, it’s extremely difficult to live within your means.”

??? I don’t get this; could you please explain?

Posted by Curmudgeon | Report as abusive

The default rate may have peaked in Q2; Amex tends to be a leading indicator and they have reported improvement in charge-off rates.

Also, there is typically a lag between the GDP bottom, and the peak in defaults. Borrowers usually have some capacity in the form of savings, additional borrowing, etc which means that they take a while to default when circumstances worsen. Depending on the type of loan, this lag can be anywhere from 6 – 18 months.

Bottomline, it’s not surprising that charge-offs rose in Q2. It would be much more worrying if they were still rising in Q4 and Q1 next year.

Posted by shamir_k | Report as abusive

@ Curmudgeon – flat screen TV’s, trips abroad, large houses etc are expensive. The only way to afford them is to consume 115% of your income. See Felix’s recent posts on Greece for more detail about how this works. consume, borrow, default, then somehow miraculously borrow more despite your defaulting on previous loans.

Posted by johnhhaskell | Report as abusive

The mortgage companies are protecting their collateral. Refinancing to pay credit card bills and using home equity loans to pay consumer debt places the home as collateral.

If the family decides to file bankruptcy they will also lose their home because the unsecured debt was secured by the home equity loan or the refinance loan.

Posted by DebtSolution | Report as abusive

@johnhhaskell – That’s certainly true, but that’s all discretionary stuff. From the context, it seemed Felix was saying that in large parts of the country it was extremely difficult to put food on the table and a roof overhead. I’m trying to figure out if Felix is saying that costs of necessities are outpacing incomes in large parts of the country, which is troubling, or that people are still buying unnecessary stuff they can’t afford (which is also troubling, but in a very different way).

Posted by Curmudgeon | Report as abusive

I don’t think Felix meant new TVs or other one-off purchases when he said people were having trouble living within their means. I believe that in the good times, many homes began to accumulate new bills (multiple phones, internet, higher car payments, higher car insurance, higher house payments, higher credit card balances) which now feel neccessary. What began as a luxury now feels essential.

Posted by drewbie | Report as abusive

The Cards business is one of the most concentrated in the world. BofA, Citi, JPM, and CapOne issue the lions share of all cards.

A 10.8% default rate, while high in historical terms, is an “easy” enviroment to operate in because the average rate on outstanding balances is likely in the 18% range.

With a cost of funds at effectively zero their gross margin including default is 7.2%. That is easily highter than the gross margins on their commercial or residential loan books. Take out all the expences of debt collection prior to default and all the other substantial expences of running a cards business and you are still left with pretty darn good net margin numbers.

The reason that people with some what shakey credit scores say 600-700 can still get cards is because even with the worlds most powerful predictive information systems(which the major issurers absolutely have) it is hard to identify which 108 customers out of 1000 will fail to repay their debts.

People with truely spotty credit (sub 600 FICOs) are as a rule not being issued cards in the current enviroment, except pre-paid credit cards. If they do get a traditional credit card the terms are simplyly foolish… $50 dollar annual fee, maximum allowable interest rate in the state that you live (or 29.9% as my state has no limit.) For that you get a credit limit of perhaps $500 – $1000. With terms that outrageous default rates can be 25% on your “sub prime credit card portfolio and your’s still making money.

My mutual savings bank dosen’t even offer credit cards… just debit cards. Year to date our Net interest margin is 3.4% the highest in our history which dates to the civil war.

Posted by y2kurtus | Report as abusive

Drewbie comes very close, I think. The baseline-acceptable standard of living has been rising more quickly than incomes, is my point.

Posted by FelixSalmon | Report as abusive

Curmudgeon, suppose you’re a responsible person, living within your means and only buying reasonable things. If a huge number of your neighbors in the immediate vicinity are consuming more than their means because they are able to take advantage of HELOCs, periodic cash-out refinancings, taking loans out against their 410(k)s and assorted other techniques to borrow much, much more than their household income, then the “reasonable things” that you have to purchase will go up in price.

In macroeconomic terms, the increased ability to pay of your borrowing-and-consuming neighbors will reflect increased aggregate demand, and hence the AD curve will shift rightward and the price level will subsequently rise. The marketplace doesn’t care that real household incomes aren’t increasing, just that the ability to pay has increased.

So it doesn’t matter if you decide to “live within your means” and not engage in debt-financed consumption as morally-satisfying as that sounds to the Peter Schiff acolytes. Unless your household income is increasing (and in most parts of the country, the median household income is lower now than it was ten years ago), your neighbors behavior is going to eventually drive up the amount it takes you to “live within your means”, even if you are completely responsible. This effect was made most visible during the recent credit bubble in the price of housing in several U.S. cities.

Posted by Strych09 | Report as abusive

@Strych09, thanks, I think I understand that. And thanks, Drewbie and Felix, that was what I was asking. I know that we have necessities today that weren’t even on the radar 20 years ago (I hate to think of what my landline/smartphone/cable/Internet bill is, for example).

I’m thinking more of the sociological than economic aspect of Felix’s statement. Have we, in fact, created a society that is culturally incapable of living within its means? Even at a national savings rate at 6%, that’s pretty trivial. Further, does our economic system require consumer overspending to keep everyone employed, keep the GDP growing, etc?

Posted by Curmudgeon | Report as abusive

“I believe that in the good times, many homes began to accumulate new bills (multiple phones, internet, higher car payments, higher car insurance, higher house payments, higher credit card balances) which now feel neccessary. What began as a luxury now feels essential.”

I think this is part of the issue, and more helpful than talking about big screen TVs. However the elephant in the room that people do not want to talk about is children. Children cost a freaking fortune, and US society (like pretty much every society) is unwilling to accept that the world is pretty damn crowded and getting more so.

In a place like Mali, overpopulation takes the form of people dying from starvation. In a place like the US things are not that crude, and few if any kids are dying of starvation; but this doesn’t change the incontrovertible fact of overpopulation. Rather, in the rich world, overpopulation shows up in things like the ever-increasing cost of raising a child.

While this is going on, our same society which tells people to be responsible in how they spend, to go to college, etc etc, also tells people that they are ENTITLED to a child, heck they’re entitled to as many as they want, and that they are doing a great and noble thing by having children. 19th century Britain had its flaws but at least it, like similar societies, did not foist this delusion on its inhabitants.

Personally I have no problems with any of this. I’m happy with almost anything that reduces the numbers, so I don’t care if Americans stop having kids because they finally realize they can’t afford them. However I don’t think a society functions well when it operates under collective delusion — and this is the central delusion of modern poor+middle America — that they have the right to as many kids as they want, and that after having the kids the money required to raise them will simply magically appear as needed.

Posted by name99 | Report as abusive

y2kurtus, can you explain your math a little?

Let’s say a bank has a $1m credit card portfolio where half the balances are paid off in full each month, and the other half stay at a high level. The default rate across the whole portfolio is 10.8%, which means a loss of $108,000. The interest rate on the half of the cards which pay interest is 18%, which means interest payments of $90,000. You get my point — I don’t see a big gross margin here. I see a loss.

Posted by FelixSalmon | Report as abusive

“Drewbie comes very close, I think. The baseline-acceptable standard of living has been rising more quickly than incomes, is my point.”

Felix, I think you need to examine the assumptions here a little more closely…

There are many discretionary decisions (what car to drive, what house to buy) that are difficult to back out of the budget. Once you commit yourself to these expenses, you are more-or-less locked into them for a while. There are many other choices (cable subscription, cell-phone service, gym memberships) where there is a lot of momentum behind a decision once it is made. People CAN back out of these (at least once they fulfill the contract), however they will often feel “poorer” if forced to do so. Sticky expenses.

When times were good, many people allowed “lifestyle creep” to eat up their entire income. Sometimes they allowed it to eat MORE than their income, borrowing off their home equity or credit cards in the hope that continuing salary or real-estate increases would come along to balance the books.

Suddenly times turn bad, bonuses dry up, and many people lose 10%+ of their income, even if they aren’t out of work all together. What was once a sustainable (or almost sustainable) lifestyle is now unsustainable.

It is kind of silly to suggest that there is a “baseline-acceptable” standard of living that is coming into play, because that varies so widely from person to person. There are plenty of families that live happily on $50k income. Glen Esnard is apparently unable to live on $250k income, at least not if he is forced to pay taxes. People define what is “baseline-acceptable” by what they have become accustomed to, not by some non-existent societal standard. And when their personal situation is reversed, they feel that pain.

Posted by TFF | Report as abusive

y2kurtus can probably explain it better, but aren’t the carried balances generally greater than those on the cards that get paid off each month? A $1M credit card portfolio might have $800k rolled over and $200k that gets paid off immediately, even if half the cards fall into each category. Run the numbers on that and they come out very differently.

Moreover, defaults are not (usually) immediate. A borrower might charge $5000 for a vacation, make payments on that for five years at 18% interest (while continuing to re-borrow whatever principal gets paid off), and then eventually default on the $5000 balance. The five years of payments could easily approach the eventual amount of the default.

Posted by TFF | Report as abusive

Debit Collectors a pain,and that’s the time you need for a professional to deal with these companies. Go the torney-san-diego/mortgage-debt/

Posted by Anonymous | Report as abusive