8/20/2005

Daily Kos: Your Credit's The October Surprise 2005

Your Credit's The October Surprise 2005
by cskendrick
Sat Aug 20th, 2005 at 16:33:41 CDT

... Big Banks anticipating Bankruptcies, Defaults

..Bank of America.. on charge-offs as resulting from the new bankruptcy law:

Credit card charge-offs increased from the second quarter of 2004 ... 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..

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.... 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)...

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:

1. The average credit card balance is $10,000.
2. A good credit rating will get you rates in the 8-9% range these days. Let's go with 8.5%.
3. So tacking on 1% in principal is a bit steeper a shock than what the Tribune is making out.
4. How much? Try the average customer who is working a minimum payment going from $85 a month to $171 -- a 101.2% increase.
5. 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.

Daily Kos: Your Credit's The October Surprise 2005

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