Well, I’m just getting back in the saddle of walletwatch, and of course the big issue in banking — and in all news, of course — is the $700 billion bailout plan of Wall Street. Of course, the bill just barely failed earlier today. (I’m officially with those who declare John Boehner and his Republican colleagues in the House the “Caucus of Crybabies,” claiming that a little speech by Nancy Pelosi made them not want to vote for the bailout. But I digress.) During the negotiations of the bill over the past 11 days, it has been hotly debated as to whether bad credit card debt, bad car loans, and other types of debt ought to be among the bad assets that lenders can discharge.
Myself being someone who agreed with those saying that escalating defaults on credit card debt could be the next subprime disaster, I initially assumed that bad credit card debt ought to be eligible to be bailed out. However, a Moody’s report that I received from a friend with a subscription changed my mind. Securitized credit card debt — despite the fact that defaults are at their highest amount since the new bankruptcy law went into effect at the end of 2005 — are still a safe bet. It is home mortgages, in fact, that are still front and center in this crisis. The latest figures from the American Bankers Association show that one in 11 mortgages is delinquent or in foreclosure. I’d say that’s a pretty serious problem.
That word describes credit card debt and the trillions of dollars that Americans cash out of their homes in the form of home equity withdrawals and refinances.
That is, banks often encourage consumers to use their home equity to pay off mounting credit card balancers. In doing so, borrowers convert unsecured revolving loans (their credit cards) into debt secured by their homes, effectively using their homes like an ATM.
Since 2000, banks have rapdily increased the credit limits on credit cards sent to “subprime” cardholders. These same customers were often encouraged to consolidate this debt into their mortgages when they refinanced.
And with home values coming down or leveling off in many metro areas, the end of the buy-everything-you-can-and-charge-it era might be over. Or, at least we’d hope that bank regulators would actually keep an eye on it from now on.
But for so many people tapping into the home piggybank in recent years, we would be seeing far higher levels of credit card debt (and defaults). Now that the home piggybank is empty, credit card defaults are running up fast. But credit card debt is actually much lower than it would otherwise be, but for the home mortgage bubble. And while a default on a credit card doesn’t cost you your home, the interest runs up much faster than on a mortgage.
To the extent that we’re already concerned about the level of credit card debt in the US, shudder to think what it would look like without the mortgage bubble. Maybe consumers would have purchased fewer flat screen TVs and less gas for the car and milk for the kids if they had to pay for it with high cost credit card credit rather than with low cost mortgage credit. But I suspect we would still have seen a lot of the same spending, so instead of facing a foreclosure crisis, we would instead be facing a much more pronounced version of the credit card debt problem. The future would be here now.
Our country’s federal banking regulators are deliberative, slow-moving agencies. Except on very rare occasions, they’re not known for using their authority to implement broad, sweeping action. And they’re even less known for broad sweeping change that could be beneficial for consumers. That’s why the Federal Reserve made huge waves last week when it proposed new rules governing credit card agreements, which has the effect of making credit cards more fair for every day Americans.
Here’s the legal mumbo jumbo: under the Federal Trade Commission Act, the Federal Trade Commission normally has the power to prohibit companies from implementing “unfair and deceptive acts and practices.” But in the case of financial institutions, this power is instead delegated to a given financial institution’s federal regulator. Since these powers were delegated to them, federal regulators have only used them only on a couple of occasions. That’s what makes this move so monumental.
The Fed’s new rule would prohibit or restrict some of the worst credit card abuses, including:
– Raising interest rates on debt that has already been charged
– Assessing late fees when consumers are not given a billing statement within a reasonable amount of time to make a payment
– Applying a payment to the balance with the lowest rate if different interest rates apply to different balances on the same card
– Charging fees to open an account and receive credit
This is great news for consumers, as these rules go a long way to making credit card terms and conditions more understandable. Yet I would still argue that more work needs to be done, which a number of bills currently in Congress would do. Other groups have been talking about the benefits of this move for consumers — as well as what the Fed left out. Consumer groups have been writing about the positive effects on consumers, as well as additonal steps, as has Professor Adam Levitin on his blog (careful — this link is a little busted so you have to scroll down to see his post on the new rules).
But what I find most blog-worthy is the timing of this new rule. The hot financial news out there is about how the Federal Reserve was asleep at the switch when it came to regulating subprime mortgages, and how that lack of regulation led to huge problems not just for the borrower whose home was lost, but also for people who invested in subprime mortgage-backed securities. Is it possible that the Fed foresees a parallel crisis saw trouble brewing in the credit card market and didn’t want a repeat of the subprime mortgage crisis?
To over-simplify the subprime mortgage story, lenders shoehorned every day borrowers into very complex mortgages. These borrowers couldn’t understand and couldn’t afford these mortgages, and ended up not being able to make payments. Hundreds of thousands of borrowers have now defaulted, and more defaults are still to come. These defaults subsequently have ruined the quality of the subprime mortgage-backed securities that these loans were packaged into.
Just like subprime mortgages, credit cards are difficult to understand, and new numbers tell us that Americans are getting in debt up to their eyeballs. And just like subprime mortgages, credit card debt is packaged into securities and bought and sold on Wall Street. Whether or not averting a financial crisis was its intention or not, kudos to the Federal Reserve for tightening credit card rules not just for the benefit of our consumers but for our economy as well.
That was the question on Hugh Hamilton’s most recent edition of Talk Back on New York-based WBAI. With guest Tim Westrich of the Center for American Progress, Hamilton discussed whether defaults on credit card-backed securities could have the same implications as the defaults on mortgage backed-securities, which sent capital markets in a freefall.
Maybe the reason so many Americans don’t understand the credit crunch is that the media doesn’t speak our language. They still can’t seem to speak in a way Americans understand, despite having countless reporters and media devoted to it, including two entire cable networks — which in reality are hot ladies talking money with bald dudes.
Even our country’s top economic officials can’t explain it without speaking in gobblydegook. Check out this interview with former U.S. Treasury Secretary John Snow in this clip and Jon Stewart’s translations.
How defaults on credit cards could contribute to the credit crisis.
Just like mortgages, lenders package our credit card debt into trusts, then sell this debt to investors on Wall Street. As credit card payments are sent to the bank, the bank ships them off to the trusts, where the investors receive their payments from them. This frees up the banks funds so they can make more credit card debt available.
But with more people defaulting on their credit card debt, observers are predicting that the quality of credit card securities will begin to deteriorate. This is what happened in the subprime mortgage market: people who didn’t understand their mortgages began to default on them, which ruined the quality of the securities that these mortgages were packaged into However, observers debate how badly credit card securities will deteriorate.
In a column in the New York Times last week, Joe Nocera says its only “frothy.” But his column shows a lack of evidence as to why increased defaults won’t rattle credit card securities. The “explosive” prediction comes from BusinessWeek, who declares that “The party was paid for with credit cards,” and “the hangover will be a whopper.” It cites weakened securitizations and anecdotes of Americans with debt problems. (Strangely, their article isn’t available online.) The more sensible approach of “bubbly” comes from the Center for American Progress report “House of Cards.” This report uses Federal Reserve data to illustrate increasing reliance on credit cards, combined with increasing defaults. It only speculates on credit card debt contributing to the credit crisis.
Walletwatch is taking a break from its usual content of credit cards and bank accounts to take a look at the larger problem: the credit crisis. This explosion on our nation’s financial markets has the Federal Reserve taking its most vigorous action since the Great Depression. But what exactly is happening, and what does it mean for ordinary Americans?
Even whizzes on Wall Street don’t understand all of it. According to today’s New York Times, even Robert Rubin — the former Treasury Secretary and a Citigroup exec — needs to ask “experts” to explain things to him. This article from today’s New York Times is of great assistance. http://www.nytimes.com/2008/03/19/business/19leonhardt.html?hp
This weekend, the Federal Reserve helped to finance a deal to sell the troubled investment bank Bear Stearns to JPMorganChase. As widely repored, Bear was selling for $60 a share last week — and was near $160 last spring — but on Sunday was sold for only $2 a share, which is less than its building on Madison Avenue in NYC is worth.
What does this mean for Joe Blow consumer? While the Fed is willing to bail out large Wall Street firms who make bad decisions — egregiously bad decisions, in fact — it hasn’t done much for regular homeowners, especially for those who now owe more than their homes are worth. While their move to rescue Bear Stearns is certainly warranted to restore confidence to financial markets, you’d think they’d make similar moves to rescue our country’s middle-income Americans.
The federal government ought to do more to help homeowners who made bad decisions, not just Wall Street investors who made bad decisions. Who else does the Fed’s bailout doctrine apply to — any Wall Street firm that fails? Many Washington groups have kicked around the idea of the federal government buying up pools of bad mortgages at a discount and re-finance the borrower into a loan at the present value of the house. While the lender “takes a haircut” under this scenario, everyone has to lose before the situation gets better.
Former Fed Vice Chair Alan Blinder, now a professor at Princeton, wrote this in today’s Washington Post:
First, everyone should take a deep breath. To those living far from the canyons of Manhattan, the sky is not falling. If you don’t want to sell your home, forget about falling house prices. Even on paper, it’s unlikely that you’ve “lost” anything near what you “gained” in the run-up. Yes, the economy is limping, but it’s not collapsing. And the effects of the Fed’s interest rate cuts and the stimulus package that Congress enacted last month are still to come.
Mass.) and Sen. Chris Dodd (D-Conn.) are working on a fine bill that, by easing some of the stresses in the mortgage market, could do some real good. I urge Frank, Dodd and the Democratic leadership to expedite the process, and congressional Republicans should stop standing in the way.
In 1933, Franklin Roosevelt famously told Americans that “the only thing we have to fear is fear itself.” Unbridled fear is gripping today’s financial markets. We need some soothing words right now — followed by actions, as FDR’s words were. Who will step forward?
The rate of auto-loan defaults recently reached a 10-year high of 3.4 percent. And one local auction company saw repossessions nearly triple last month compared with a year ago.
This statement by McCain’s presidential campaign seems to highlight his lack of knowledge of economic issues. By calling for lenders to voluntarily “help” their “good customers,” he seems to ignore that many times lenders were aggressively pushing financial services with difficult-to-understand terms that were not intended to be “helpful” to consumers.
ARLINGTON, Virginia, March 11 /Standard Newswire/ — U.S. Senator John McCain today issued the following statement on the economic challenges facing America’s homeowners:
“Undermined by sagging home values and a national credit crunch, our economy has slowed, presenting challenges to the prosperity of American families. While it is the government’s role to help the honest, hardworking homeowner in this time of distress, it is not the government’s role to bail out investors who should understand that markets are about both return and risk, or lending institutions who didn’t do their job. It’s important that managers and investors are held accountable for their own decisions. And we need to monitor the impact of the many, important steps that have already been taken. We don’t want to do something in the short-term that damages our economy in the long-term.
“Lenders should also be thinking about how to help their good customers who are having difficulty through no fault of their own. For example, as companies bear the costs of product recalls when their products cause harm to customers, perhaps financial institutions should be thinking about their accountability to their customers. In the interests of transparency, financial institutions need to fully disclose their losses, only then can regulators and rating agencies really do their jobs.”
Wallet Watch promotes policy solutions to make basic financial services — checking accounts and credit cards — safer and more understandable products, so that Americans can make better decisions about where they access credit and reduce their overall indebtedness. More >>
