The Pressures on US Consumers from their Credit Card Debt

Most economic pundits seem to agree that the US consumer has reigned in spending in the face of the economic uncertainty we’re all experiencing. In addition to consumers slowing their spending, their actual ability to spend is being impacted in other ways – for example, by having to pay more in interest payments to their credit card issuers.

As they attempt to continue to deliver sustained financial performance in the face of accelerating credit losses, several of the major US credit card issuers have been taking steps involving adjusting the repayment terms associated with outstanding (revolving) credit card balances. The general tactic is to significantly raise interest rates on the revolving balances for those cardholders who haven’t defaulted on their credit card debt. (See this article on Payments News re: a November 15, 2008 news story titled “Citi to Raise Credit Card Interest Rates” – and, in particular, the comments from Citi’s cardholders).

This is somewhat analogous to having a mortgage lender raise your mortgage interest rate following the foreclosure of the house next door. The issuers attempt to maintain their financial performance by generating more revenue from the customers who continue to be able to pay.

In addition, many issuers appear to be reducing the credit lines available but currently unused on many of their credit cards.

The combined effect is such that the major card issuing banks (they’re now all actually banks – including American Express and Discover) have dipped their hands deeper into their cardholders’ wallets, increasing the amount they must pay each month and reducing the amount of credit they have available on their credit cards. So, consumers simply have less money (or credit) available to spend – helping to drain more out of consumer spending, further weakening the economy.

The steps being taken by the issuers to try to preserve their own financial performance could actually help accelerate increased credit losses as those consumers who were “close to the edge” financially are pushed off the cliff by the newly imposed rate changes, etc. We could be entering a vicious financial spiral.

So, what to do?

Going to the extreme, if the card issuing banks were fully nationalized – and, therefore, had no public stockholders they had to try to please with their financial results – they could alter their behavior and maintain the prior low interest rates on the revolving balances in their portfolio – in effect putting the difference into the cardholder’s pocket every month. They might even, in the process, help some cardholders avoid defaulting as they struggle to balance their budgets. But this approach only seems possible in a world where financial performance of the credit card business itself doesn’t have to be sustained at historical levels.

In a world of nationalized banks, those banks might also decide to tap into new revenue sources – such as charging a monthly or annual fee to the other major portion of their cardholders (the “transactors” – those who pay their bill off in full every month), This approach is similar to raising taxes on the wealthy – but obviously it only works if it’s done across the industry – and that’s not something likely to happen in a world of publicly traded banks competing for the business of those transactors.

But we don’t (yet?) live in a world of nationalized banks in the US. On the other hand, we are seeing increasing focus by government on the actions of US banks – including limiting their ability to pay management bonuses, etc. if they are recipients of major amounts of public capital.

For example, could the US government dictate to those card issuing banks who accepted public capital that they are not allowed to increase the interest rates charged on existing revolving balances without special approval – i.e., that the banks must honor the interest rates on revolving debt that they had in place when the consumer borrowed the money in the first place? At a time of record low interest rates, it’s hard to justify raising rates because of funding costs. Special approval by the financial regulators could provide an “out” in the unlikely event credit funding costs did rise significantly.

What about the reduction in credit lines? There’s a lot of talk in Congress about need to see the banks increase the amounts of credit available – to both consumers and businesses – while in the credit card world, the banks are pretty aggressively reducing the credit available to help those with revolving balances to help avoid additional potential credit losses in the future.

While helping consumers de-leverage seems like the best objective, if the politicians and regulators really want to insure consumers have access to credit, they may want to consider additional steps. For example, perhaps a revolving credit account could be viewed as having two parts – the existing revolving balance for which the issuing bank is fully at risk and the remaining credit line for which some sort of government guarantee could be provided in lieu of the issuer reducing the credit line? Perhaps issuing banks could charge consumers a small “credit availability” fee for the unused portion of their credit lines – a fee that could apply to both revolvers and transactors?

There are always an infinite number of options from which to choose. I began this note by ruminating about how the US credit card issuing banks were helping to accelerate a decline in the US consumers’ ability to spend. It seems like some sort of middle ground could be found that would avoid that spiral while still helping consumers remain as financially viable as possible. Of course, all of this hangs in the balance of employment – saving a minor amount in credit card interest repayment doesn’t much matter if one has just lost their job.

[Update: Monday, February 9: From USA Today: Chase adds fee for low-rate credit cards]