Credit Card Pushers Pump Up Profits—and Risk
This article is from the November/December 1998 issue of Dollars and Sense: The Magazine of Economic Justice available at http://www.dollarsandsense.org/archives/1998/1198scher.html
This article is from the November/December 1998 issue of Dollars & Sense magazine.
Tell your friends and relatives you're writing an article on credit cards and see what happens. Everybody has a horror story. Here are only two I've heard recently.
A friend who pays off her credit card balance every month received a letter over the summer from her credit card company, Providian Financial, saying it was closing her account "primarily because you have not been using it." Of course, she has been using her card. She, like a third of all card holders, merely avoids generating any interest charges by paying her balance in full every month. Providian, a California-based specialist in "high risk" customers, doesn't like that. It, like all credit card companies, makes most of its revenue on interest charges and penalties. Having my thrifty friend as a customer just wasn't worth Providian's while.
Another friend's story is a bit more painful. He's a graduate student who used his student loan to clear all of his credit card debts earlier this year. Within eight months, he'd racked up another $18,000 on his credit cards. You might call him a nut, or just an underpaid adjunct professor trying to get by, but what about the credit card companies? They fall all over themselves to keep him as a customer, upping his credit limits, plying him with cards... The credit card industry hopes he'll overspend - and because they delay the pain, credit cards make that easy to do. Somehow money becomes even more unreal when it's plastic.
Since the early 1990s, banks have gone wild, upping credit limits on their customers' credit cards by more than a third, blanketing the country with 3 billion offers in 1997 alone, reaching further and further beyond their core customers in the middle class. Among the beneficiaries of banks' desperate search for credit card profits are men at a Waltham, Massachusetts homeless shelter who, though unable to afford rent, regularly find credit card offers in their mailbox with come-ons like "Receive the Credit You Deserve."
In an era of fraying safety nets and increasing inequality, banks shamelessly peddle plastic as the way for those left behind to live the good life, even if that means using credit to buy groceries. More poor families have credit cards and it should come as no surprise that their credit card debt is growing as the welfare net is eroding. While only 20% of poor families had a credit card in 1983, 40% did in 1995. Their balances are higher than ever, exceeding $1,300 on average in 1995, up from $700 in '83 (calculated in '95 dollars). Deeper in debt compared to their overall income than wealthier cardholders, they are left with no cushion if crisis strikes.
Because there are no sober-faced bankers dissecting our credit histories before approving our loans, it is hard to remember that's exactly what we are doing when we toss that shiny plastic to the shoe saleswoman - taking out an instant loan from a bank. At least, that's what we're doing if we don't pay off the balance right away. But some low- income newcomers to the world of credit cards, like the students in an adult literacy program I know in Brooklyn, treat their card as if it were an old fashioned installment plan. Until a class discussion set them right, they proudly sent in a check each month for the minimum payment, not realizing it was possible - let alone beneficial - to pay off the whole balance in one lump sum.
These new customers, plus the middle class who are going further into credit card debt, are giving the pinstriped pushers just what they want. Credit card debt rose 23.5% in just over a year, from January 1997 to March 1998, and more of it is owed by lower income cardholders. Sixty three percent of all U.S. households now owe money on their credit cards, and last year they spent $70 billion in interest charges and fees. Credit card debt now accounts for 43% of all consumer loans and is growing far faster than all other types of household borrowing, including home mortgages or auto loans. The average household now owes an amount equal to 95% of their yearly income. That's up from 60% in 1960 and 75% in 1980. And the more borrowers owe on all types of loans, the greater their risk of bankruptcy if they suffer even a minor financial setback or lose their job.
With the Providians and Citibanks alike going after more lower income customers, the credit card companies also may be exposing themselves to greater risk. "The new card holders are different and potentially riskier," wrote two economists with the New York Federal Reserve Bank in a recent study. People denied a card in 1989 qualified for one in 1995. They typically carry more debt from auto loans and the like on top of their credit card balances. Furthermore, they are more likely to be unskilled laborers working in on-again, off-again jobs with erratic income. They are more in debt relative to their income than wealthier cardholders and more likely to miss a payment. But as we will see, ballooning consumer debt threatens not just desperate lower income cardholders or a bank's bottom line but the whole economy.
The Banking Industry
How can banks afford their drive into the lower income market, making riskier and riskier loans? With credit cards' declining profit margins, perhaps the banks are asking how they can afford not to. Credit card operations are still lucrative, especially compared to other parts of the banking business right now, but cost a lot to keep going. During the 1970s, when credit cards still were relatively new, banks sunk a lot of money into upgrading already high tech processing operations, and only made their money back in the 1980s, according to a history of the industry by Joseph Nocera. Even before that, the credit card business walked a slow and volatile road toward profitability.
Visa began as BankAmericard in 1958 (changing its name in 1976), the first charge card ever that aimed to be accepted not just by a single department store, like a Sears card, or by restaurants, like Diners Club. The postwar consumer boom was built on an explosion of buying on credit; but at first customers were paying for their new refrigerators and sofas through store installment plans, paying retailers directly, month by month. Bank America wanted those customers for itself, so it invested in Bank Americard's expensive start-up. Bank salesmen blanketed California, recruiting businesses one by one to accept the card, and recruiting cardholders with mass mailings. Then Bank America developed a network of banks to do the same nationwide, building a customer base and a retail base at the same time. (This same process is now being pushed globally. Until the recent crisis, the world's largest credit card issuer, Citibank, was busily exporting the consumer dream of buying on plastic to Asia's new monied classes.)
In the United States today, Mastercard and Visa operate as networks of banks - and increasingly since the early 1990s of nonbanks like Providian - that issue cards under their imprint. They operate almost like coops, sharing in the expense of keeping the system going. And the costs are high. While most of the cost of a home mortgage is the money a bank lends, much of the cost of a credit card loan is the paperwork. Credit card companies have all the expenses of sending a zillion piece mailings for new customers, processing the credit card receipts, reimbursing the local merchants' bank, and maintaining the powerful computers that approve or disapprove your credit card within seconds of being swiped by a salesperson. That high overhead exerts pressure on banks to really put that expensive infrastructure to use once it's in place, and try to suck more and more interest-paying customers into the system.
Banks and freestanding credit card companies like Providian cover the risk by keeping their interest rates high even while interest rates are dropping elsewhere in the economy. The flood of nonbank players into the business in the 1990s was supposed to heighten competition and put a damper on those interest rates. That didn't happen. Instead 3,000-plus credit card pushers all trying to steal each other's customers just cut into all of their profits, saturating the "market," forcing small players out of the game, and making it harder to charge annual fees. Fees in 1991 provided as much as 24% of their revenue. Now, only 10% of their revenue comes from annual fees and the small charge to the retail store or other business accepting your card for a purchase. Interest charges of 16% - or even 24% for the unlucky customers who've missed a few payments - bring in all the bucks these days, along with shortened grace periods, and new and improved penalties of $25 a pop for everything from exceeding your credit limit to paying late. Some cards have eliminated the grace period entirely, charging interest from the day you make a purchase. Rates are so steep that even on the average card, as Doug Henwood points out in a recent Left Business Observer, it would take 34 years to pay off a $2,500 balance if you paid only the bank's suggested minimum.
While credit card loans were always risky - banks "wrote off" five times more credit card than commercial loans as uncollectible - they are writing off even more today. Last year, banks wrote off $20 billion in credit card loans - 5.5% of the total debt outstanding. The norm was 3% until the mid-90s. The banks' exposure is serious enough that the federal government's Comptroller of the Currency warned credit card banks to improve their credit standards.
Banks claim new and improved computer programs now allow them to isolate out risky prospects from sound ones. But they really seem to be containing their risk by changing the rules of the game. For instance, they are not "writing off" the customers who defaulted on their credit card debt. Instead, they've invented a new credit card for them. "Secured" credit cards are one of the fastest growing products in the business, designed for people like yet another friend of mine who defaulted on his student loans and is now eager to return to the fold of creditworthy Americans. For an annual fee, a hefty initial processing charge and a $90 deposit paid to Providian, one of the largest issuers of secured cards, my friend won the right to charge his card up to a whopping $400 credit limit.
Banks are also trying to contain their risk, not by scrutinizing who deserves higher credit lines, but by campaigning for bankruptcy reform that will restrict consumers' access to more favorable bankruptcy laws (see box). Once enacted, (and the two houses of Congress are negotiating a final plan this fall), the banks could become even worse pushers, argues Stephen Brobeck, executive director of the Consumer Federation of America: "By allowing creditors to collect more debt, bankruptcy reforms would encourage credit card banks to market and extend credit more aggressively."
Debt For Sale
With credit card debt riskier and at a new high, how can banks carry so many loans on their balance sheets? After all, by law they must keep on hand capital amounting to about 6% of their outstanding loans, and there's $500 billion in credit card debt out there. The quick answer is they don't. Since 1987, when First Boston invented the practice, the big players have removed some of their credit card debt from their balance sheets by selling it off to investors, much as they sell off home mortgages. Together the major credit card banks - Citibank, First Chicago, NationsBank (which just merged with Bank America) - and other credit card issuers sell off the right to collect on about $40 billion worth of their credit card debt to investors. This maneuver gives them more money on hand to loan out, pumping up their desire to find new, perhaps riskier, customers, while removing the loans from their balance sheets and ultimately increasing the bubble of debts left unpaid.
Who's the Victim?
Like most capitalist enterprises, banks' desperate pursuit of credit card profits is not a victimless crime. There are plenty of victims littered along the road, and many are low income. "Jesse" is in Debtor's Anonymous now after racking up $93,000 in credit card debt after losing her job at a warehouse and failing to apply for unemployment benefits. Her sister almost lost her home after paying for the birth of her son on a credit card - her husband was working temp jobs at the time, and they had no health insurance.
Like Jesse and her sister, the new lower income customers tend to use credit cards when their income drops, not just for convenience like many middle class customers, according to a study published by the Institute for Research on Poverty at the University of Wisconsin. For instance, while the better off tend to cut their credit card use during a recession, the poor and near poor use them even more.
With stagnating middle class incomes, however, the middle class also might be caught in more credit card debt than they expected. Unlike lower and upper income Americans, they are the only group whose incomes have not yet returned to their pre-recession, 1989 level, and some may have charged up their credit cards expecting more of a rebound to help them pay off their bills. Brobeck of the Consumer Federation even blames credit cards (as opposed to stagnating incomes, steep housing prices, lost health insurance or erratic job markets) for the skyrocketing bankruptcy rates: "Mounting credit card debt was the most important reason for the rise in personal bankruptcies (1.3 million in 1997)," he says.
The other victim of credit card companies' desperate strategies is the economy as a whole. In good Keynesian fashion, consumers have been driving economic growth. But in a period of income stagnation, and with greater access to credit, consumers have been doing their spending more and more with debt. This creates a "consumer debt-driven business cycle" that creates new dynamics - and longterm problems - for the economy.
"The great fear is, if we go into recession, we'll be saddled with record levels of debt," says Tom Pally, an economist with the AFL-CIO. In 1997, consumer debt peaked to record levels, created not just by credit cards but by home equity and other loans.
In this new sort of business cycle, Pally argues, people borrow and spend, kicking off economic growth. But over time, as their debt burden grows, they have to spend more and more just on interest charges, thus dampening their ability to generate growth through more purchases. Then the economy slows down again. During any recession, more people lose their jobs and wages shrink, cutting into their spending power. But high levels of debt leave consumers even less able to borrow and the economy will constrict even more than usual.
Deflation - falling prices and wages - is another threat on the economic horizon made worse with high levels of debt. One fear is that the downward pressure on prices already apparent in Asia could turn the United States' low inflation rate into negative inflation, or deflation. Falling prices and wages make it even harder for people to pay back the loans they borrowed when prices and wages were higher. This makes their debt payments even more expensive. The economy skids to a stop, and as in the Great Depression, people become afraid to borrow and invest because of the ballooning cost of the money down the road.
Let the Debtor Beware
Even those like Brobeck of the Consumer Federation who are critical of the banking industry's greedy pursuit of lower income credit card holders hesitate to call for a halt to the practice. The New York Federal Reserve Bank economists say that as long as banks "cover any extra risks they are taking, and as long as borrowers understand the price they are paying," both sides can benefit. The problem is that credit card companies do everything they can to ensure customers don't know the price they are paying. At the very least, bank regulators must force credit card companies to reveal right on our monthly bills how much it will cost us in interest charges by the next month and by the end of the year if we don't pay the bill in full right away (the Senate approved a mild version of this in its recent bankruptcy bill).
Congress must also stop credit card companies from offering ridiculously high lines of credit that delude us into thinking we can carry heavy amounts of debt. Credit limits tap into our deep sense of power as consumers and distort our sense of our wealth. Jesse from Debtor's Anonymous reveals, "I used to see credit cards as an asset. If they give you a credit line, it increases your sense of importance." Credit card companies should enforce reasonable credit limits instead of using them as yet another opportunity to profit from those who exceed them.
If they actually do this, the credit card companies need not cover their risk by charging high interest rates and hidden penalties. Such usury is another form of "fringe banking," almost as bad as those rent-to-own stores targeting low income folks for double the usual price of a television set in "easy" monthly installments. Congress might also cap the interest rates the companies can charge, a move Rep. Joseph Kennedy pondered a few years back. A cap need not force the companies to dump their new, high risk, customers, as they direly warned when faced with the prospect. They need only do their jobs as bankers and enforce reasonable credit limits.
If nothing else, this quandary of how best to stop credit card companies from feeding off the economic insecurity of lower income Americans reveals how urgently we need to develop less exploitative ways of raising people's incomes and easing their credit crunch. America's economic health must be built on more than easy credit so those slipping through the safety net don't end up desperately trying to charge their way back to financial stability.