Credit Card Debt

It seems every week or so, just as we get going on a certain topic for Ways of the World, a new event occurs that upstages our current discussion. This time, of course, it's the General Motors bankruptcy. We had seen this coming, as we wrote here some time ago, and we do want to talk about it with you. But for today, we'll stick to our current program: some commentary on consumer borrowing and a little on the new law.

Americans had a total of $945 billion in credit card debt at the end of March, according to Federal Reserve data. Other government information tells that there were about 130 million households in the country at that time. These figures divide out to an average credit card debt per household of just over $7,200. A different Fed survey of consumer finances that covers 2007 indicates that half of the households who have a credit card had at least $3,000 in balances then. The constant publicity and recent legislation regarding credit cards suggests that this debt must still be growing, evidently without bound.

But this is not so. In the last six months, the total amount of credit card debt has started to go down. That is, people really are paying off more than they're adding in new charges. The graph below shows clearly that an unprecedented contraction in credit card debt is occurring.

In fact people are apparently constraining quite considerably their use of credit cards for new purchases. The Fed data also show that the rate of finance charges added to balances increased markedly in the first quarter this year to 13% from 12% in the prior quarter. So people's debt paydowns are large enough and their new charges small enough that their total balances are falling despite the higher interest costs.

Indeed, total consumer spending has been falling, an unusual development in and of itself. People have historically tended to keep expanding their outlays, even during recessions. They just increase spending more slowly then. But this second graph shows the striking difference now – and one big reason for it: the lower outlays for gasoline in recent months. Gasoline is one item we think people tend to charge heavily to credit cards, so this could be a factor in the reduced debt. But as we are all painfully aware, gasoline prices have tilted back up once again in the last couple of months, subsequent to the periods covered by our data here. So we will have to see what happens to the spending and borrowing figures yet to be published.

About those higher interest costs. There are probably several reasons they have gone up. This specific measure is the actual finance charges as a percent of the outstanding balances. One factor we can cite is higher delinquencies, eliciting more late fees on top of the interest. The delinquency rate for the first quarter (Q1) is 6.50%, up from 5.66% in Q4 and the highest ever in the 18-year history of this information; this means that people are more than 30 days behind making even a minimum payment on 6.5% of their outstandings. A second issue is probably higher interest rates; banks may be thought to profiteer in setting their rates, and indeed the new federal legislation addresses such a perceived strategy. On the banks' behalf, though, we would point out that risk is much higher now, so higher rates are not surprising and can even be seen prudent. And third, from a political viewpoint, the banks may well have wanted to raise their rates in anticipation of just such restrictions on them as were enacted last month. More rate hikes and other actions may come in the months ahead, before the various features of the law become effective.

The new law, the Credit CARD Act of 2009*, signed by President Obama on May 22, will help make the setting of credit card lending terms a less abrupt and more orderly process, requiring 45 days' notice for a change in terms, for instance. At the same time, we think a couple of the features are actually too hard on the banks. The banks probably set themselves up for the stricture against raising rates on outstanding balances. This is a popular item among consumers and likely reflects the often substantial hikes the banks forced on them; one example we saw was an increase from 12% to 24%. In contrast, floating interest rates on mortgages don't get doubled; many have a ceiling of 2% on each increase. Banks might well have followed such a more measured strategy with credit cards too. But we believe the banks deserve to be able to do something about the rates. In a mortgage or a car loan, there's a maturity date. The bank knows when to expect its money back – and it is the bank's money that we have spent up front – but in a credit card situation, the bank doesn't really know how long the customer will take to repay. So there's an added element of risk here that's not present with other kinds of loans.

And we're therefore even more concerned about the new rule prohibiting the banks from raising rates when the customer defaults on some other debt. This "no cross default" provision hardly seems reasonable to us, even if the customer is current on the credit card bill. Clearly, the customer carries more risk if they're missing other payments. But, yes, raising this rate would make the customer's life harder.

So none of this is as simple as it looks. These parts of the law would look to make high credit limits less profitable for banks, so they might well cut limits more. And we'd surmise that they will exercise greater scrutiny before granting credit to someone with spotty records elsewhere. Maybe they should have done that to begin with, but a good number of people are likely to be unhappy at getting rejected for a card in the first place or for an application for a higher limit. Maybe in the end, that would actually be to people's benefit.

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*Credit Card Accountability, Responsibility, and Disclosure Act" – Credit CARD. Here's the White House Fact Sheet on the law: http://www.whitehouse.gov/the_press_office/Fact-Sheet-Reforms-to-Protect-American-Credit-Card-Holders/

And we also call your attention to an informative consumer website: http://www.creditcards.com/, which has rate quotes and other helps. It's the kind of catalog of credit card information that http://www.bankrate.com/ is for savings.

By coincidence, Debbie Loeb posted another helpful credit card site on Hodgepodge the same day as our original post here. See http://www.cardratings.com/. Thanks, Debbie!