Implosion of the Credit Card Banks

Anybody with a credit card from a major bank needs to read and understand this article. You may or may not have seen Ann Minch, the Internet YouTube debt revolt phenomenon on Fox News or on Suze Orman's popular CNBC financial TV show, but what has happened to the credit card industry over the last few months is astonishing. The company that tracks credit card chargeoffs ("charging off" is the act of making an accounting entry indicating that a debt is not expected to be repaid), Fitch reports that starting from an already high overall figure of 7.4% in January, by August the rate was 11.52% and the number of credit card holders being charged off each month would contract the base of credit card holders nearly 12% in a year's time. That means that each month the customer base for credit card companies shrank by almost 1% and that assuming those chargeoffs reflected the average amount of credit card debt carried by the other cardholders, the bad debts owed to the banks went up by that amount also (keep in mind the cardholders being charged off may well have run their cards up and have higher than average balances).

Taking the figures month-by-month, and assuming that no new cardholders are being added (probably a negligible figure in this economic climate), for every thousand cardholders at the beginning of January there would be just 880 at the end of December. Fitch expects the chargeoff rate to continue increasing through the first quarter of next year, so the cardholder base will perhaps erode even faster than that. With cash flow from defaulted cardholders drying up, the banks are squeezing everybody else with increased interest (called "ratejacking" and fees) and when their squeeze pushes some over the edge into default they have to squeeze those who remain all the harder. Advanta Bank, once the 11th largest issuer of credit cards in the country had to shut down all of its cards to new charges at the beginning of June and its chargeoff rate reached 55.95% in a single month (June). Advanta now has probably less than 10% of the performing cardholders they once had because they raised everyone's rate over 30%.

That's happening to the other major banks, just a bit more slowly. For instance, the last three months of chargeoff rates at Bank of America were 12.5%, 13.8% and 14.54%--much worse than the averages found by Fitch. Within a single quarter, they lost 3.5% of their cardholders. In fact, Bank of America lost $9.6 billion on their banking business in the third quarter of 2009, making up $8.6 billion of it on trading profits that may or may not be real, probably don't reflect actual cash flow, and in any case are the result of taking on large amounts of risk. In other words, if it weren't for accounting trickery, BofA's situation would have been much, much worse than they reported.

To rub salt in the banks' wounds, the debt buyers who relieve the banks of their defaulted credit card receivables have been pulling back sharply. During good times banks could expect freshly defaulted acounts to fetch twenty-five cents on the dollar. As the recession worsened that figure went substantially below ten cents on the dollar. Now with the opportunity to pursue defaults at an all-time-high their difficulty collecting on those defaults means the junk debt buyers are themselves laying off workers and unable to make purchase of fresh defaulted debt at any price.

Defaulted debts require adding "Tier 3" capital to offset them, which is painful for banks-it's a category that regulators scrutinize closely in assessing a bank's health and that banks work hard to minimize in order to avoid triggering additional regulatory oversight of their daily operations. It is likely that some of the "too big to fail" banks will require another bailout. Other banks will have to be taken over by the FDIC, which itself does not have nearly the funds it needs to perform orderly liquidations of all the failed banks and pay back the insured funds of their depositors.

Officials first suggested the FDIC assess the banks to make up the shortfall, but the banks don't have the money. Then it was thought that having the banks prepay three years of premiums would solve the problem, but again the banks could not have funded that plan either. It appears the FDIC itself will require a bailout.

For consumers, this is the end of the credit line. For the least-impacted consumers life will return more closely to an all-cash lifestyle, while the consumers who were heavy users of credit cards and carried balances will either struggle to pay them off or face a future of uncertain consequences after they default. Once the economy improves enough for junk debt buyers to obtain access to funds with which to make purchases of defaulted debt, the consumers who defaulted will have to grapple with being in collections, and in many cases they will face lawsuits and wage garnishment, liens, levies and additional federal taxes because of the debt. Many consumers are unaware that legal and practical mechanisms are available to them to prevent those consequences even in the absence of repayment or bankruptcy