Archive for November 7th, 2008

The Coming Credit Card Crisis

When the stock market crashed in 1929, it took more than a year before it sunk in that the crisis was not a short recession or a major correction.  Analysts were hopeful, the public expected a return to the ‘roaring 20s’ style economy, and some thought it was necessary to break the speculative bubble that had engulfed the country.

As job loses escalate, foreclosures continue to increase, now due as much to job loses as bad loans.   Companies and businesses are being forced into painful cutbacks due to the shrinking economy.   And, of course, that feeds on itself.  Any effort the economy makes to come back gets hit by the fact the housing market remains weak and jobs continue to be lost.  The worst may be yet to come.

Right now the US public debt is well over $10 trillion.   That is mind boggling.  But credit card debt alone, owed by consumers is over $900 billion (up from only about $240 billion in 2002).  Think about that — during the property bubble we not only achieved the lowest equity in property ownership in history, but while doing that have gone into immense credit card debt.   The fact it jumped so far so fast shows that we’re in uncharted territory.  This also suggest that this shoe is yet to drop, the credit card crisis may be the straw that breaks the camel’s back.   Oh, and about half this has been packaged as securities and sold as investment products.  Sound familiar?

The average household owes almost $10,000 in mostly unsecured credit card debt.  And as the economy slows, many people put off dealing with the pain by charging ever more to their credit cards hoping for a new job or something to save them from bankruptcy.   Almost a third of all those filing for bankruptcy have over a year’s worth of income in credit card debt.  Meanwhile, credit card companies continue predator style lending, urging people to increase debt, often with hidden clauses that assure that any late or missed payment — often on any debt owed anywhere they can track — will cause a massive increase in interest payments.

It’s no mystery why they do this — they’re in it for money.   And, as with mortgages and stocks, short term profits are good, even as the long term situation because unsustainable.  Rather than a speculation bubble we’re seeing the growth of an unsustainable debt bubble.  Debt is treated as an assett by the firms to which the debt is owed.  All this credit card debt thus inflates the value of banks and financial institutions which own it.  If the recession is even half as severe as expected there could be a massive increase in credit card defaults, sending a ripple through the financial markets as powerful as that as the subprime mortgage crisis.

In other words, our chickens are not yet done coming home to roost.

Capitalism needs credit to function.  Credit is the stuff that allows the economy to grow.  It is the life blood of a market economy.  If credit dries up or a crisis creates a collapse of credit markets, that’s the equivalent to a body being drained of blood.  It ceases to function.  Unlike human bodies, an economy can be restarted.  But the old economy will have died, and the new one will have to operate under new conditions, with much of the old wealth gone.  In that sense capitalism has a Hindu flair — the economy dies and then is reincarnated as something new, perhaps paying a kind of karmic debt for the imbalances of the last life.

Folks, this stuff is depressing.  Right now things look bleak, but if the credit card crisis becomes a reality — and there is no reason to think it won’t — then things will go south quickly.  Consumer spending will dry up, and the economic recession could spiral into itself so fast that it becomes a depression.  The $750 billion paid to try to prop up credit markets will be sucked away as well, and we’ll simply have even higher debt, making it almost impossible to spend our way out of the depression.  American capitalism could suffer a fate not unlike Soviet communism, an ironic twist of history.

Can this be avoided?   I’m not sure.  But one thing is certain: pretending this isn’t on the horizon and hoping for the best isn’t a good strategy.  That’s what people did in light of the warnings about the housing bubble, and look where that led!   Moreover, one reason credit card debt has grown so fast in the past years is government deregulation, and laws beneficial to credit card companies.   And for this we can’t blame the Bush Administration alone — Delaware has a huge credit card business, and Joe Biden has been protecting them over the years.  This is another bipartisan crisis in the making.

As individuals, we need to pay down credit card debt while we can.  I love credit cards, I hate cash.  Cash sits in my wallet because I pay for everything by credit.  Not those wimpy debit cards, credit cards offer much better protection in case of being stolen.  And we usually pay it back that month.  When we carry debt (and now we have minor debt for good cause), we’ve been able to keep our average interest rate below 4.0% by using special offers.  Now, though, while I will still use credit cards, I want to get that debt down to virtually zero.  Pay it off every month.

For government, we need proactive action.  Identify securities that are tied to risky credit card debt.  Stop predatory lending (it may be too late) and figure out just how fragile the system is.  But don’t bail out credit card companies.   I’m at a loss right now on how to deal with this.  I plan to learn more about this coming crisis.  The mountain of public and private debt that has bought us thirty or so years of illusionary wealth is falling apart, and the conquences have yet to be fully appreciated.

More than ever I think we’ll need Barack Obama’s ability to inspire as much as actual governmental action.  These problems stem from the fabric of our culture in recent decades.   We can’t fix things so we can live like we have been; how we’ve been living is the problem.  We will be forced to change fundamental aspects of our way of life in coming years.   And this process of death and renewal is only beginning.