Sur-prise, Surprise, Surprise!
It won't be just college kids and retirees on fixed incomes who are sandbagged, either. Many small business owners use personal credit cards as cash flow management tools. Likewise persons who work for commission, or have seasonal cash streams (skilled and unskilled laborers, for example).
Banks are already budgeting for massive defaults, on the order of tens of thousands of cardholders. It might not be nearly enough.
It promises to be a nightmare for millions of surprised working- and professional-class families.
It also promises to be a nightmare for issuers of credit cards, because what is about to happen to the consumers could scare them out of using cards at all in the short run.
"Your Credit Card Payment Just Doubled"
From the outset, there seems to be question if banks really are doubling their rates at all. From what I have been able to tell, some people would prefer that cardholders be surprised -- after the new bankruptcy laws become effective on October 17 of this year.
The reasons are not purely remunerative; some just like the idea of debtors being disciplined, which in fact is the purpose of the credit reforms.
The problem is that the reforms come simultaneously with a strengthening of the bankruptcy laws, insofar as creditors are concerned. And those who lend funds to those who want them are calling the shots this time around.
Steve Bucci, President of the Consumer Credit Counseling Service of New England, says...
Also, it has been widely reported that minimum payments are doubling from 2 percent to 4 percent. This is just not true. They are increasing, but not by a set percentage.
What's 'just not true' is that it's a simple change from 2 to 4 percent. But your minimum payment most certainly is increasing by the end of the year.
Melody Warnick indicates that:
So far, MBNA, Citibank and Bank of America have announced they are doubling minimum monthly payments on credit card balances from 2% to 4%.
Big Banks anticipating Bankruptcies, Defaults
While rates are not mentioned, Bank of America does comment on charge-offs as resulting from the new bankruptcy law:
Credit card charge-offs increased from the second quarter of 2004 reflecting growth and seasoning in the portfolio, the impact of last year's changes in minimum payment requirements and bankruptcy reform. Consumer credit quality remained strong in all other categories.
Provision for credit losses was $875 million, up from $580 million in the first quarter of 2005 and $789 million a year earlier.
This is the bank, the creditor, and they are losing money on the deal.
We get more details in the section for "Global Consumer and Small Business Banking:
Global Consumer and Small Business Banking earnings decreased 8 percent to $1.60 billion from $1.74 billion a year earlier. Revenue rose 5 percent to $7.06 billion.
The decline in earnings occurred because of an increase in provision expense due to increased credit card charge-offs. Also, included in this quarter's provision was $210 million to establish a reserve for anticipated net charge-offs from additional minimum payment requirements for consumer credit cardholders, which will be implemented in the fourth quarter.
Revenues are up 5% but earnings are down 8% -- almost all attributable to the $210MM reserve mentioned above.
This is going to hit people who like having good credit the worst.
On account they will do whatever it takes to keep up the payments, and keep their credit ratings golden. Some are feeling the bite already.
Susan Chandler and Ann Therese Palmer of the Chicago Tribune don't seem to think it's a big deal, which is interesting given the anecdote they lead with.
The minimum is really all Randy Mundinger can manage right now.
With two teenagers at home and a new business that pays him half what he once earned at Motorola Inc., Mundinger is writing checks for the smallest amount he can on each of the family's three credit card bills.
So Mundinger, 46, is less than happy to hear that his minimum payments on about $9,000 of debt are almost certain to rise in coming months.
"That's going to make our budget a lot tighter. We're not taking vacations right now. We don't eat out as much as we used to. My wife is working two jobs," he said with a sigh. "I guess I'm going to have to cut back on going out completely--no more movies, no more restaurants, no more video rentals."
1% Principal, plus Interest, plus Fees. Every Month, Please.
The article also describes a formula, in which creditors charge 1% principal + interest as the basis for the new minimum payment, which works out to about a 54% increase on $5,000 at 12% interest.
Some of the assumptions are questionable.
A May 2004 CardTrak Article describes that the average carded household carries a balance of $8,000.
An April 2004 article offers some additional nuggets:
...households in the $75,000 to $100,000 income bracket carrying the heaviest load of nearly of $8,000 per person [with credit card]...
Scott Reeves for Forbes magazine suggests that it's closer to $9,200 per household.
Another source sites it as being $9,312 as of the end of 2004.
And Business Week adds this ominous note:
Energy is taking a bigger share of consumers' budgets, but Americans are offsetting that by saving less and borrowing more.
Household debt hit a record 123% of aftertax income at the end of the first quarter. Most of the rise is in mortgage debt, but
nonmortgage borrowing was up $14.5 billion in June (8.2% at an annual rate).
The ability to refinance at lower mortgage rates has contributed to the spending spree. Households took out $139 billion in cash-out refinancings last year and increased their home-equity loans by $178 billion. The added $317 billion was 3.7% of last year's household disposable income. Without that extra "income," spending might have been much weaker.
Consumers can't continue to live this far beyond their means. As interest rates rise, the cost of servicing the debt will increase (although only slowly, since most consumer debt is fixed-rate). The easy borrowing that's boosting spending today will come back to cut spending tomorrow. If interest rates rise slowly, as we at Standard & Poor's expect, the problem will be modest. But if they soar, consumer spending could drop sharply.
Which means that by the end of 2005, credit card debt will be approximately $10,100, if trends continue for both increase in debt and the interest rates paid on same.
My Test Case...
In sum, here's what I think the test case is:
- The average credit card balance is $10,000.
- A good credit rating will get you rates in the 8-9% range these days. Let's go with 8.5%.
- So tacking on 1% in principal is a bit steeper a shock than what the Tribune is making out.
- How much? Try the average customer who is working a minimum payment going from $85 a month to $171 -- a 101.2% increase.
- That's called doubling.
...and HIS Rant
Our next contributor (unattributed, compliments of About.com) About.com has a soapbox narrative on what is happening:
The new bankruptcy law will be in affect October 2005 and the credit industry is keeping the rise of minimum credit card payments as quiet as possible.
This is BIG, BIG NEWS! Yet except by accident, have you heard any major announcement about raising minimum payments? Did you see it blaring on the primary news channels? Your credit card payment just doubled. Isn't that newsworthy?. Don't you think this should be shouted from the house top? But instead it is spoken of in whispers... until the new bankruptcy plan is neatly in place. Coincidence? I don't think so.
And why has it been so "unannounced"? First of all it is very unpopular with the industry's "best customers"... those are the ones so deep into credit card debt that they cannot see the top. Secondly, bottom line profit loss is at stake if these "best customers" can more easily declare bankruptcy and have this debt written off before the new law takes affect.
Why the Hush-Hush?
Easy. There's money in it...and as we'll cover shortly, potential for serious economic loss. As of right now, the interest rate goes up to 30.43% if you're late even once. And on October 17, when the new bankruptcy laws come into play, guess what? You'll pay that high rate for being late, and you'll like it.
How many people will this affect? The group most at risk are those people who currently pay just the minimum balance, or close to it.
That's just it; there is considerable uncertainty of late, as to just how big a percentage of U.S. cardholders pay the minimum balance.
Cardweb.com shares the following"
A new survey suggests the impact of higher minimum credit card payments may only affect 10% of U.S. cardholders. However, other previous surveys indicate that as many as 39% of Americans may be making minimum payments.
....
One-year ago the "Cambridge Consumer Credit Index" found that 39% of consumers with revolving credit card balances were making minimum payments and that 39% of Americans were paying off their credit card balances in full each month. The research also found that among revolvers, 39% paid less than half the balance owed but more than the minimum, while 19% paid more than half their balances.
How Bad Can It Get?
I think the question should start with something we can wrap our imaginations around: How bad does it start?
Let's use the above values as a range -- somewhere between 11% and 39% of cardholders will be at risk -- people who either always or sometimes pay the minimum.
We could figure out a precise estimate, but let's just go with between 1% and 4% of all cardholders will default as a result of these changes, and another 1% to 4% will struggle on, incurring 30% default rates as a result of late and insufficient payments.
No big deal, right?
Um...no. And here's why.
As of July 2005 credit card volume was at $651 billion for 2Q 2005.
And per the Fed, Total US consumer debt a whopping $2,145.6 billion as of June 2005.
So, what's 1%-4% of $2.1 trillion? Oh, just $20-80 billion in credit card defaults.
Which would be covered by credit card companies significantly increasing the spread to prime that they charge the surviving debtors, which would both increase the vulnerability of same to falling under the default cloud, and decrease remaining cardholders' willingness to incur additional consumer debt.
Just in time for Christmas 2005, a large fraction of American credit card users are going to be given a very bad case of sticker shock. A small portion of these will be financially ruined, another small portion soon threatened as card rates are jacked to cover losses due to default, or their own rates transcend 30% due to late or insufficient payment on their balances.
Why Grinching Christmas is Macroeconomically Unsound
The American economy lives and dies by 4Q, especially in a sluggish economic cycle. Starting in 2000, you could short the S&P index by trading SPY contracts, from January to September, go long from October to December, and turn a 107.7% profit by the end of 2004. Had you remained long the entire time, you would have lost 17.7%.
And you would have made money every single year.
Before that, not so much. Times were better, then.
So, what is the consequence going to be, of over 100 million consumer debtors going into the holiday season with a suddenly-enhanced fear of putting their vacations, their festivities, their presents on the card?
Prediction: Significantly reduced consumer spending; the price of pushing one's cash flow after the bankruptcy laws change is just too severe to contemplate.
