Oct. 7, 2008 at 8:00 AM ET
Credit card debt and mortgage debt are two sides of the same coin on the American personal finance landscape. And now, it appears they are poised to become a two-headed monster. Consumers with credit card debt can expect to feel the walls closing in on them in the coming months, as card-issuing banks search for creative ways to cut back on risk and raise cash.
On Tuesday, msnbc.com reported on a new policy at American Express that allows the firm to penalize consumers based on where they shop and which bank holds their mortgage. Given the tenuous state of the credit card-issuing business, expect other issuers to follow suit, if they haven't already. Experts say consumers also should expect their credit limits to be lowered for what might seem like arbitrary reasons and their balance transfer fees to climb.
"Consumers are probably not accustomed to that but we live in a new world," said Carol Kaplan of the American Bankers Association, explaining the new caution among lenders. "(Banks) have suffered a lot of losses and they are doing whatever they can to reduce risk. They have people that work all day and all night who try to come up with new formulas to assess risk."
Some elements of those formulas might surprise you. Few consumers would consider the credit limit implications of the stores they shop at -- and in fact, they can't, as American Express wouldn't tell MSNBC.com which stores it deems as "risky." Still there's nothing illegal about the practice, and with losses mounting, it's not surprising that card issues are resorting to new tactics.
In the first quarter of 2008, banks charged off 4.7 percent of credit card loans, a 33 percent increase from the first quarter of 2006, according to the Center for American Progress. That timing is no coincidence; that's when easy credit for home equity loans dried up. In 2009, according to consulting firm Innovest StrategicValue Advisors, banks will charge off nearly $96 billion in credit card debt, double the projected 2008 losses.
That's why credit card issuers are running for cover.
"Delinquencies and defaults are soaring," said Robert Manning, author of the book "Credit Card Nation."
He said believes some major credit card issuers might not survive the current crisis. "They suspended the financial laws of gravity and put individual households on steroids," he said. "... Now (banks) don't really know what to do."
One thing they are doing, said Bill Hardekopf, who operates LowCards.com, is finding excuses to lower consumers credit limits.
"What issuers do is tighten up standards of how they analyze risk," he said. The simplest way to reduce risk, he said, is to reduce credit limits. Card issuers never reveal their strategies publicly, so it's never immediately obvious what's happening behind the scenes, Hardekopf said. But he believes efforts have begun to systematically reduce some users' credit limits, akin to a quiet change earlier this year which saw many cardholders' interest rates mysteriously rise.
Asked if Bank of America is using new criteria to lower credit limits, spokeswoman Betty Reiss said, "We adjust credit card limits based on the individual cardholder's risk profile and performance with us." She declined to answer additional questions. Capital One and JP Morgan Chase did not respond to requests for interviews.
But based on anecdotal reports, Hardekopf said, "What they seem to be doing is sending out notices saying they are lowering credit limits."
Because of card agreements, credit card issuers cannot simply close accounts and demand full payment. But they can do the next best thing: Raise the cardholder's interest rate. They can also lower credit limits repeatedly to prevent a consumer from making any new purchases. That's effectively the same thing as closing the account.
Lower limits can hurt consumers in myriad ways. Consumers with a balance that's over the limit -- even if that occurs as a direct result of a shrunken credit limit -- face over-limit fees and can see their interest rate raised to the "default" rate of 32 percent or more. Lower limits also hurt credit scores. Credit utilization is a key component of credit scores, accounting for about one-third of the magic formula that generates that score. Consumers who carry a credit card balance that's more than 30 percent of their credit limit are punished by the credit score formula, Hardekopf said. Credit score expert John Ulzheimer suggests an even more agressive goal -- he says cardholders should try to keep their credit usage down at around 10 percent of their credit limit.
Tim Westrich, who researches credit card debt at The Center for American Progress, said cardholders won't really know for some time what to expect.
"We just don't because we've never been in this situation before," he said, adding that he is particularly concerned about small-business owners who use credit cards to fund weekly operations.
Manning predicted the credit card crisis in his 2001 book, "Credit Card Nation." In it, he described the see-sawing of personal debt between credit cards and home loans, with skyrocketing home prices enabling consumers facing big credit card bills to simply take out a low-cost home equity loan or cash-out mortgage refinance. But with the market for home loans all but gone, credit card debtholders have nowhere to turn.
As a result, overall credit card debt has climbed 4.1 percent since 2006, according the Center for American Progress.
During the glory years, banks pulled in immense amounts of fee-based revenue from credit card accounts. According to research firm R. K. Hammer, credit card issuers raised about $17 billion in 2006. Congress' General Accountability Office said in a report that one-third of all cardholders paid at least one late fee last year.
Card issuers also used the same tricks as mortgage issuers to expand their empires, rolling their loans together and selling them off as asset-backed securities on Wall Street. Moving debt off their balance sheets allowed major issuers like Capital One to operate aggressive customer-acquisition campaigns. Meanwhile, investments in "credit card receivables" were a cash cow for investors.
But now, Congress is scrutinizing banks' fee-happy habits. Just last week, the House of Representatives passed the Credit Card Holders Bill of Rights, which limits the fees banks can charge. The timing couldn't be worse for card issuers.
"Now is not the time to be attracting the attention of Congress or regulators," making it unlikely that the issuers will dare to raise fees to get out of trouble, Manning said.
And they can't turn to Wall Street for help, either. The market for credit card securities is drying up, caught in the same swirl that is dragging down mortgage-backed securities, Manning said.
"This is a double financial bubble that's bursting," Manning said. "There is no way these receivables can perform."
That leaves card issuers with only one option: reducing their exposure to risky consumers any way they can.
RED TAPE WRESTLING TIPS
Consumers should expect credit card issuers to behave like wounded animals in the upcoming months. Given the desperate state of some issuers, consumers should be even more vigilant than usual. Notices of credit limit adjustments or interest rate hikes can be easy to miss.
"They can look like a piece of junk mail," Hardekopf said. "But if (banks) lower your credit limit and you don't notice, you can blow by it," he said. He urged consumers "not to do anything to raise your credit risk or (lower) your credit score," as card issuers will be looking for any excuse to raise rates.