http://executivesuite.blogs.nytimes.com/2008/11/25/the-worst-is-yet-to-come-anonymous-banker-weighs-in-on-the-coming-credit-card-debacle/?em The Worst Is Yet To Come: Anonymous Banker Weighs In On The Coming Credit Card Debacle By Joe Nocera A few weeks ago, I published an e-mail message sent to me from an executive who works in the banking industry — and had become disgusted by what he sees all around him. This weekend, that same banker sent me another e-mail message, which he has also agree to let me publish. It’s another wake-up call. Too bad nobody is listening. Today, we are bailing out the banks because of their greedy and deceptive lending practices in the mortgage industry. But this is just the tip of the iceberg. More is coming, I’m sorry to say. Layoffs are being announced nationwide in the tens of thousands. As people begin to lose their jobs, they will not be able to pay their credit card bills either. And the banks will be back for more handouts. I received a catalog today from Casual Living and in big bold print on the front page, it said “BUY NOW, PAY NOTHING”. Then in significantly smaller print underneath, it said, (until April). That mantra has been sung throughout the credit markets over the last 10 years. The banks waive a carrot in front of the consumer and reel them in and encourage them to go deeper and deeper into debt. They do this by prescreening customers through credit reporting agencies, mailing offers to apply, and to transfer balances at teaser rates or zero percent financing. They base it on credit score and not on capacity to repay. A good credit score does not equate to the ability to repay debt. Over my career, I have seen thousands of consumers that have credit card lines in excess of their annual salaries. Some are sinking under their burden. Some have been fiscally responsible and have minimal amounts outstanding. My 21-year-old daughter, who’s in college, gets pre-approved offers all the time. She has no ability to repay debt, yet the offers flow in just the same. We all know how these lines are accumulated. The banks, in their infinite stupidity, keep upping credit lines because the customer pays the minimum payments on time. My daughter’s credit line started at $1,000 and has been increased over the last two years to $4,400. She has no increased earnings to support this. But the banks do it without asking. And without being asked. The banks reel in the consumer, charge interest rates higher than those charged by the mob, increase lines without the consumer asking and without their consent, and lure them into overextending. And we can count on the banks to act surprised when they aren’t paid back. Shame on them. As a banker, let me describe what we do wrong when we accept and review an application for a credit card. First, we don’t verify income. The first ‘C’ of credit: Capacity to repay, is completely ignored by the banks, just as it was in when they approved subprime mortgages. Then we ask for “household income” — as if other parties in the household could be held responsible for that debt. They cannot. And since we don’t ask for any proof of income, the customer can throw out any number they think will work for them. Then we ask if they rent or own and how much they pay. If their name is not on the mortgage, they can state zero. If they pay $1,000 in rent, they can say $500. (Years ago we asked for a copy of the lease to verify this number.) And finally, we don’t ask how much of a credit line the consumer is looking for. The banker can’t even put that amount into the system. There isn’t any place on the application for that information. We simply put unverified information into a mindless computer and the computer gets the person’s credit score and grants them the biggest line that score and income (ha!) qualifies for. I recently had a client apply for a credit card. She is a homemaker, with no personal income. The house she lives in is in her husband’s name. She would have asked for a $3,000 credit line, just to pay miscellaneous expenses and to establish some credit on her own. So the computer is told that her household income is $150,000; her mortgage/rent payment is zero. The fact is that her husband’s mortgage payment is $7,000 a month (which he got with a no income verification loan). She had a good credit score, but limited credit since she has only lived in this country for the last three years. The system gave her an approval for a $26,000 line of credit! This has got to stop. People are going to be learning hard lessons over the next years. It would help, though, if the banks could change their behavior now, before things get any worse. Tomorrow is already too late. In 2003, Congress passed the Fair and Accurate Credit Transactions Act of 2003. This law was implemented through regulations issued by the Federal Trade Commission in consultation with the federal banking and credit union agencies. It requires all credit card and insurance solicitations to include a disclosure for “prescreened offers.” We are all familiar with them. They are the dozens of credit card offers that are sent, unsolicited, to consumers, usually by mail. The law allows the consumer to opt out of receiving prescreened offers by calling an 800-number. I think Congress did this backwards. Perhaps it could amend the law. The regulation should have required the consumer to opt in, if they so desire, instead of opting out. That would mean that no one would get an unsolicited credit card offer. If a consumer needs a credit card he or she could be given an option to call an 800-number to opt in. Or the consumer could go to their local bank and apply for a credit card in person. Or the consumer could go online and apply for a credit card. The consumer can also view all the best credit cards, nationally, at bankrate.com. Bankrate.com is an invaluable tool for consumers. Some other benefits: (1) It would halt the message being sent that credit is free and perhaps limit irresponsible accumulation of credit lines. (2) It would force the banks to become more competitive in their rates. The consumer is going to need a break and they will need it soon. And credit card rates, which are quite often above 22 percent, is piracy. (3) Eliminating mass mailings would save a lot of trees. I’ve been reviewing many of the banks annual reports over the last month and there is no question that the default rates are on the rise. If Congress doesn’t act today, the bankers will have their hats in their hand before we know it, and doing another a tap dance before the Senate Banking Committee, and asking to be bailed out once again with our tax dollars. Sad, but true.
It’s not really news, although the example is interesting. I just wondered who here pays only the minimum balance on their credit cards? I’ve always paid off the full amount - it equates to an interest free loan for six weeks. I’m not a great fan of personal debt but I suspect that others are more comfortable with it.
The option may be not to use debt financing (on the individual consumer level).
I’m assuming most CFAs, especially those looking to do research in their careers, are not like the average person in that they will extend themselves beyond their means. My credit limit is 5% of my income and I rarely max out, when I do, its for a large purchase where I want to capture my 1% cashback and I pay it back the same day. I’ve missed 2 payments, but that was because of forgetting to pay, not an inability to pay. I would like to think future equity analysts and portfolio managers are better than most when it comes to this…
> I’ve missed 2 payments As an aside: these seemingly innocuous events can have significant impacts on your FICO score, and can stick for many years. Maybe give yourself a recurring monthly reminder to pay any credit-related invoices.
Interesting article. I’m shocked at how many of my friends who are affluent carry credit card balances, but these are mostly non-finance people. I have no consumer debt – only my mortgage. I use my Amex to get miles and pay it off every month.
Credit cards are a far smaller issue than mortgages. The bonds themselves aren’t usually put into CDOs or any such structures. AAA CC bonds are usually pretty well structured, in order for them to actually lose money they’d have to have a massive and sudden payment rate shock as well as a default shock. Payment rates would have to plummet from the high-teens to 20s, where they are now, to the single digits while default rates would have to go up into the high teens and 20s, multiples of where they are now. It is very difficult to “bust” a CC master trust. Not to mention that most aren’t “prime” or “subprime” specifically, they are mixed trusts where they have mostly socialist (not completely) structures. Not saying it’s impossible, or even improbable, but saying that it’d be a pretty swift and breathtaking movement in the credit environment.
spierce Wrote: ------------------------------------------------------- > Credit cards are a far smaller issue than > mortgages. The bonds themselves aren’t usually > put into CDOs or any such structures. AAA CC > bonds are usually pretty well structured, in order > for them to actually lose money they’d have to > have a massive and sudden payment rate shock as > well as a default shock. Payment rates would have > to plummet from the high-teens to 20s, where they > are now, to the single digits while default rates > would have to go up into the high teens and 20s, > multiples of where they are now. > > It is very difficult to “bust” a CC master trust. > Not to mention that most aren’t “prime” or > “subprime” specifically, they are mixed trusts > where they have mostly socialist (not completely) > structures. > > Not saying it’s impossible, or even improbable, > but saying that it’d be a pretty swift and > breathtaking movement in the credit environment. Very interesting - how is a credit card “payment rate” defined? From data I have seen credit card defaults seem very correlated to unemployment and the economy. Is there a certain state of the economy (8% unemployment, 10%?) where you think these trusts would break down?
Interesting piece…to show up the same day I read this article. http://www.iht.com/articles/2008/12/02/business/col03.php
theyare Wrote: ------------------------------------------------------- > spierce Wrote: > -------------------------------------------------- > ----- > > Credit cards are a far smaller issue than > > mortgages. The bonds themselves aren’t usually > > put into CDOs or any such structures. AAA CC > > bonds are usually pretty well structured, in > order > > for them to actually lose money they’d have to > > have a massive and sudden payment rate shock as > > well as a default shock. Payment rates would > have > > to plummet from the high-teens to 20s, where > they > > are now, to the single digits while default > rates > > would have to go up into the high teens and > 20s, > > multiples of where they are now. > > > > It is very difficult to “bust” a CC master > trust. > > Not to mention that most aren’t “prime” or > > “subprime” specifically, they are mixed trusts > > where they have mostly socialist (not > completely) > > structures. > > > > Not saying it’s impossible, or even improbable, > > but saying that it’d be a pretty swift and > > breathtaking movement in the credit > environment. > > > Very interesting - how is a credit card “payment > rate” defined? > > From data I have seen credit card defaults seem > very correlated to unemployment and the economy. > Is there a certain state of the economy (8% > unemployment, 10%?) where you think these trusts > would break down? You can visit most master trust’s RegAB website, Capital One has their own for COMET (Capital One Master Execution Trust). IIRC it’s the amount of principal paid over the total principal balance. You can see this amount for COMET here. http://media.corporate-ir.net/media_files/IROL/70/70667/abs/COMT/COMT_2002-CC_0704_October_2008.pdf In fact, you can check out all of C1’s securitization trusts (CC, prime/subprime auto…etc) there. RegAB dictated that they set up websites, or other communication mediums, for this type of information. Frankly, I’ve got no idea what type of unemployment rate would correlate to a specific loss rate to actually break a CC master trust. I’d be pretty bad. Think of it this way, if 10% of your receivables are being received, that means that you pay off your AAA bonds in less than 10 months. Your loss rate, even in the teens, would be mitigated by your excess spread. As you can see from that investor report, COMET has a yield of 21.02%, since many bonds are fixed rate and even the LIBOR bonds are low right now, their excess spread may be in the low teens, counteracting most of the defaults. As it is right now, a AAA bond would be repaid in about 5 months with turbo am. As far as the idea that the $2TR cut in lines would kill people, keep in mind that the Fed reports CC principal outstanding of about 900bn. She is saying that there are lines out there for $4TR. That means that Americans are less than 25% tapped on their lines and may only be about 50% tapped after this happens. The people who are already in trouble have tapped out their lines, so a reduction is worthless. They’re just cutting off an infected appendage, which isn’t a bad thing. If anything this’ll just cut the lines on a lot of people who don’t use them anyway.
"A good credit score does not equate to the ability to repay debt. " I disagree. Since missed payments and high outstanding balances negatively influence your score, the credit score is a good reflection of one’s ability to pay their loans, credit cards etc. Of course it doesn’t indicate that someone can pay the full balance immediately but it does reflect diligence one exercises in paying off debt.