Credit cards unkindest cut for U.S. consumers

By J Saft
December 3, 2008

James Saft Great Debate — James Saft is a Reuters columnist. The opinions expressed are his own –

Government intervention or not, banks will be cutting up America’s credit cards at an unprecedented rate, with grave implications for the economy and company profits.

The U.S. Federal Reserve last week added more nutrition to its alphabet soup of rescue programs when it unveiled the Term Asset-backed Securities Loan Facility (TALF), under which, among other things, it will lend up to $200 billion to investors in securities backed by credit-card, auto and student loans.

It did so for a very good reason: the securitization market’s freeze now extends beyond mortgages, imperiling run-of-the-mill consumer financing and making it a certainty  that many people who use credit to get them over “cash flow” situations will be, well, denied.

And even though the U.S. car industry may implode if starved of finance and many students will have to defer education, the real potential disaster is in credit card funding, which could push lots of households over the brink and in the process consumption and every business which depends on it, which would be all of them.

Put simply, even with an apparent will to try anything to bring the wheels of finance back into motion it will be very difficult for government to quickly fill the hole left by private finance. Details of the plan are still sketchy, but let’s just take it for granted that it works, even if the plan, at only one year, will give them huge fears about how they get out of their positions at the end of 2009.

Beyond that, the Fed is seeking to kick start securitization by attracting back a species of investors, leveraged ones, who don’t really exist any more.

All other things being equal, the amount the Fed is putting into the TALF should take the ABS market back to about where it was in the first half of 2008, which itself was only a third of the volume we saw in 2007.

But all other things are not equal.

The banks that provide the bulk of credit card funding  generally want to cut back, pushed by their own woes, a conservative read of the economic situation and, potentially, regulatory changes that, while intended to ward off the excesses of the last bubble, will magnify the impact of its bursting.

Meredith Whitney, the Oppenheimer and Co analyst who has so far been ahead in identifying and explaining the weaknesses in the banking system, thinks over $2 trillion of credit lines, or 45 percent of lines available, will be pulled out from under American consumers in the next 18 months, a figure that puts the Fed’s $200 billion for asset backed finance in its proper perspective.

“We are now entering a new era within the financial landscape that will be characterized by expanded forced consumer de-leveraging with a pronounced downshift in consumer spending,” she wrote in a research note.

“We view the credit card as the second key source of consumer liquidity, the first being their jobs. Pulling credit at a time when job losses are increasing by over 50 percent year-on-year in most key states is a dangerous and unprecedented combination, in our view.”

BIG BANKS ALL WANT TO CUT BACK

Whitney notes that the three largest credit card lenders, Bank of America, Citigroup and JP Morgan, who between them account for more than half of U.S. credit card outstandings, have each discussed reducing card exposure or slowing growth. Capital One and American Express, who are another 14.5 percent, have also talked about limiting lending.

That will set the tone for the rest of the industry, which will be grappling with new regulation that, if goes ahead as planned, will impair profitability of credit card lending and push more off-balance sheet securitizations back on to the banking industry’s already strained books.

Cutting back on abusive lending and forcing banks to recognize and account for the risks they take are surely good things, but will have the perverse effect of making the credit crunch worse, at least temporarily.

And looking at the balance sheets of individual Americans, there is good reason to think that the credit crunch should get worse: that they should consume and borrow less and save more. I’d argue that far from being non-functioning, financial markets are closer to pricing in the true risk of lending to consumers now with credit cards charging about 10 percentage points more than 5-year Treasuries than they were six months ago when it was only about a 7.65 percentage point gap.

But the mother of all unintended side effects is that the faster consumers cut back, the worse it will be.

The kind of consumer cut back implied by the consumer credit crunch that now looks likely would blow a hole below the waterline in the U.S. economy, and in U.S. company profits and the stocks that reflect them.

The Federal Reserve and U.S. government’s use of unconventional measures is only just beginning.

–  At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For more columns by James Saft, click here. –

For full coverage of the crisis in credit, click here.

62 comments

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It looks like the credit card companies are doing a better job of risk analysis. In a recession wage increases will be limited and job loses will increase. The ability to sell or mortgage property to cover debts will become more difficult. The reduction of credit to those that may have a difficult time paying is both prudent and fair. If the home mortgage industry had been more prudent this recession would be less severe.

Posted by John | Report as abusive

Several comments in response to other comments and the article. The majority of the current financial mess started with the mandate of the Federal government to lending institutions to offer subprime loans. The lenders turned around to unload these high risk loans and the only vehicle that was palatable to the market was selling them as part of a package with blended risk. When the inevitable bubble in the housing market came, the effects were magnified by these packages that included subprime loans.

The point is that the failure of the financial market came from one horrible government program – not from a general over leveraging by the American consumer.

If you want an economy that has full employment – which we have enjoyed now for several decades – then you must have consumers buying to support industry. There really is no other option unless one settles for higher unemployment as the norm.

Posted by Guy Thompto | Report as abusive

“The U.S. Federal Reserve last week added more nutrition to its alphabet soup of rescue programs when it unveiled the Term Asset-backed Securities Loan Facility (TALF), under which, among other things, it will lend up to $200 billion to investors in securities backed by credit-card, auto and student loans.”

The above paragraph summed up for me the root cause of the problem and the solution. The government is bailing out the investors and the banks but doing nothing for the average consumer (taxpayer). $200 Billion in tax cuts to the American public to pay off credit cards or to spend in the economy (if someone is already using credit wisely) would go long way to both remedy the problems of the banks and the economy. If 70% of the economy is driven by consumer spending then anything that puts money back in the hands of the consumer is going to help it recover quicker than bailing out the producers (banks, car companies….etc). Thank God both Obama and McCain supported tax cuts for the middle class in the election. This one measure alone will do more than anything that Paulson and Co. has thought of yet. By the way, someone suggested a few weeks ago giving out (by lottery) 1 Million $25,000 vouchers to Americans willing to drive an american car from the big three. This would take 1 Million vehicles off of the lots and keep the factories producing replenishment vehicles until the credit market gets back to normal. The auto bailout would help both the consumers and the producers. Better in my opinion than trying to manage a $25 Billion investment in the big three out of Washington by reviewing business plans. I wish someone in Washington would paraphrase Bill Clinton from his first election “It’s the consumer stupid…”

Posted by Joe S. | Report as abusive

Capitalism, or free enterprise market economies also must be true to their own philosophies and stated purposes. If you kill the goose that lays the golden egg, you are a pirate, not a capitalist and as such you should be identified and relieved of your authority.

Posted by Peggy | Report as abusive

As a banker in the ’80s, I was leery of the deregulation that allowed interstate banking. That is the cause of the “loss of community values”. Banks were allowed to operate using the most advantageous laws like having a bank in a state with no usuary laws. That allowed them to charge whatever they wanted with no limit. We should reinstate the usury rate at 18% as a national high. We should treat the banks as a monopoly and do away with the interstate banking laws. Making the banks have only community employees and autonomy to operate as the community dictates. It is difficult to cheat your neighbor the parent of the kid your kid plays ball with, or across the bridge table. When you interact with your customers everyday in real life terms, you take better care of their money.

Posted by Peggy | Report as abusive

Guy Thompto: “The majority of the current financial mess started with the mandate of the Federal government to lending institutions to offer subprime loans. ”

NOT TRUE – 80% of Subprime mortgage loans were by PRIVATE lenders like Countrywide and American Home Mtg and Argent. Private lenders are NOT Regulated by the Federal Reserve and DID NOT HAVE TO COMPLY with the CRA (Community Reinvestment Act). Therefore Provate Lenders were NOT FORCED to write Subprime loans – they were encouraged to by firms like Goldman Sachs. These Private Lenders were financed by Goldman Sachs and Lehman Brothers, etc.
http://www.slate.com/id/2201641/

Wall Street gambled Mortgage Backed Securities in Derivatives at 40 X their reserves (see SEC Rule Change in 2004 requested by Goldman’s Hank Paulson). They lost their gamble, don’t have 40 X their reserves to pay – and the Taxpayer is being scammed big time.

Posted by ap | Report as abusive

Thanks for an excellent post Ms. Peggy. Also, government pressure and requirements that banks make affordable loans available (“everyone deserves a home, car, credit car, education” etc. – whether they can pay it back or not) caused banks to stop keeping loans in house because they knew that they would not be repaid. Instead, they took their fees, sold them to Wall Street, had their friends down the hall at the rating agencies rate them AAA, took their fees, sold them to pension funds, foreigners, mutual funds etc. The builders, realtors, attorneys, appraisers, retailers, politicians – everybody – was making money without regard to the ultimate outcome. We do not have any great leaders now, so there were no adults around to stop it. Oh well. Very predictable if you have knowledge of history and human nature.

Posted by kelly p | Report as abusive

Debt of all forms is now so massive in the US that there are only two ways to deal with it:

1). A full-fledged bankruptcy by the United States of America, in which the nation, all the states, all the municipalities, many of the businesses, and most of the people go bankrupt en masse.

I have no idea what the side effects of that would be, probably the end of human civilization.

2). A massive money-printing binge by the government, enough to devalue the dollar by about 50%. One consequence of that would be that all debt would be downscaled by 50%, which would probably get it to a manageable level.

In scenario 2, we are talking about a 50% devaluation of the dollar, so we are talking about a 100% inflation over a short period of time.

This would be good for debtors (debt reduced in half), and creditors too (they would salvage 50%, instead of losing 100% when debtors all default)

Wages and pension payments would be doubled (they would now be paid in “hollars” rather than “dollars”, one “hollar” being worth half of the old dollar.

Those with cash & bond investments would lose 50%. That’s fair enough, they were the ones that got spared in the 2008 massacre, they can certainly afford a 50% haircut like the rest of us.

Posted by lance sjogren | Report as abusive

Guy Thompto, which federal mandate requires lending institutions to make subprime loans? If you’re referring to the Community Reinvestment Act (CRA), your information is incorrect. It does not require any such thing. The CRA was enacted in the 1970’s, and can hardly be blamed for the current economic situation. The CRA was enacted for the very necessary purpose of preventing lenders from “redlining”–a common and unfair practice in which depository institutions opened branches and accepted deposits in certain ethnic and lower socioeconomic communities while refusing to lend to those same depositors–effectively using these depositor’s money to make loans to predominately middle-class and affluent Caucasian borrowers. The CRA does not require institutions to make loans to non-creditworthy borrowers. Even still, the current mortgage crisis cannot be blamed on subprime borrowers, but on greedy bankers who capitalized on a convoluted and ill-constructed secondary market scheme that they believed lowered their risk of making haphazard loans far in excess of what borrowers could afford—both prime and subprime borrowers—and without regard for the real sustainability of such practices. If the CRA were to blame, the current mortgage crisis would have surfaced much sooner.

Posted by Corey | Report as abusive

Perhaps it’s about time the consumer learns a bit about economics. Excess debt always has its risk and debt is not necessarily required to drive an economy.
For instance the German economy has been one the strongest in all of the world while its consumer debt has been one of the least.
I personally have had ZERO debt throughout my 68 years, although have to show by a long shot more than most Americans, therefore I cannot be convinced that it requires debt for consumer purchases to flourish; While we should not compare personal debt with corporate debt.

For the US consumer to ween himself off the debtor status will be painful for process for years to come, but it’s not a death sentence, we will become stronger when the healing process has ended. It’s also about time the government (on both local, state & federal level) to learn that there is no such word as “infinity” in debt.

Posted by ddavid | Report as abusive

Guy Thompto: “The majority of the current financial mess started with the mandate of the Federal government to lending institutions to offer subprime loans. ”

YES THAT IS TRUE !! It also holds true for “private institutions” as it becomes an indirect forced consequence to follow the market to stay competitive. We, the shareholders not only require but “expect” that of our investments. [The greed of instant earnings instead of long-term results]. Therefore, the shareholder becomes very much part of the picture.

Posted by ddavid | Report as abusive

By banks cutting credit cards,is great, they are taking away there own rights to rip off the american people, with 20% interest and all kinds of hidden charges, I am glad they are suffering, it serves them right!