For investors who are tired of worrying about subprime mortgages, here is something new to consider: the $900bn (Rs 36.63 trillion) of US credit card loans. That is the same order of magnitude as troubled subprime mortgages, but the losses on plastic could be larger—these loans have no collateral to back them.
Credit card debt largely fell from financial consciousness for a few years after 2002. “Outstandings,” as the trade calls total unpaid balances, increased at only 3.7% annual rate through 2005—slower than the growth of nominal gross domestic product (GDP). That apparent restraint wasn’t a sign of consumer health, though.
Financially stressed customers merely turned to their houses for cheaper loans. Some of the $2trillion (Rs81.4 trillion) of mortgage refinancing in those years went to pay down monthly balances.
But with home prices no longer rising, they are falling in most of the formerly hot markets, and subprime mortgages are scarce. That safety valve has been closed. Credit card outstandings rose at an 8.4% annualized rate in the second quarter—almost 2 percentage points faster than GDP.
Losses also are creeping up. In the last year, the proportion of loans recognized as bad by big lender Capital One Bank moved from 3.3% to 4.1%, although the losses were compensated by a similar 1 percentage point increase in interest rates, to 13.5%. It could easily get worse.
For the most part, high credit card balances reflect poor underlying personal financial situations.
You pretty much have to be lazy, foolish or desperate to pay that much for a loan.
If the US economy stalls, these weak borrowers are likely to be the first to lose their jobs. Credit card debts are often the first not to be paid.
Lenders claim that they have set rates high enough to compensate for economic setbacks, but that could prove no more accurate than similar claims made for subprime mortgages. A credit card meltdown might have one good side effect—a rethinking of this high-rate, high-loss business—a business that effectively takes advantage of borrowers’ ignorance or greed.
Some people may deserve a little protection from their own financial weaknesses.