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The Coming Credit Card Debt Meltdown

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The Coming Credit Card Debt Meltdown Powered By Docstoc
					All over the world, people are keeping fingers crossed that the $700 billion financial
system bailout works the way it is supposed to and eases the worsening global credit
crunch and restores confidence in the markets. But while the government has been
focusing its attention on worldwide fallout from the mortgage debacle and the Wall
Street greed, another storm is gathering on the horizon.

With all that's happened since, it's easy to forget that back in August 2008 the U.S.
Treasury Department stepped in to take the reins of Fannie Mae and Freddie Mac, the
two government-sponsored home loan banks. With the country facing more than $12
trillion in residential mortgage loans, no one wanted to stand by while Fannie Mae or
Freddie Mac goes broke.

But who is watching as the rest of the country goes broke? The U.S. is quickly
moving toward the next financial credit crisis—this one involves credit cards,
and it could be a problem facing millions of Americans, not just over-reaching
homeowners who are facing foreclosure.

Charging the basic necessities

Consumer spending has kept the U.S. economy growing for the last two decades. In
addition to shopping for homes they didn't actually quality for, consumers used their
credit cards and revolving credit accounts to rack up more than $2 trillion in
household debt. Where they once indulged in high-ticket items like electronics,
plasma TVs, autos, and appliances, today they're forced to scale back and spend more
and more on the basic necessities.

When cash-strapped families have a hard time making ends meet because of rising
prices, they rely on their only alternative—credit. Consumers are pushing the
upper limits on their credit cards in order to pay bills, feed their families, and gas up
the car. Some even use their cards to pay their mortgages, and that spells disaster.

The lending industry, now barred from aggressively issuing sub-prime mortgages, has
turned its attention to marketing credit cards with high fees, over-blown interest rates,
and complex terms hidden in the fine print or written in obscure language. Unwary
consumers are setting themselves up for future defaults, and doing it in record
numbers.

Debt and delinquencies on the rise

Credit card borrowing grew at an annual rate of 4.8 percent in July 2008, up from a
growth rate of 3.5 percent in June. But while the volume of credit card purchases
continues to rise, on-time monthly payments are falling.

The percentage of people who were delinquent on their credit card payments rose
slightly in the second quarter from the same time last year, while average debt per
borrower jumped 8.6 percent, according to credit reporting agency TransUnion LLC.

For the quarter ended June 30, 1.04 percent of credit card holders were delinquent at
least 90 days on one or more of their cards. That compares with 0.91 percent for the
second quarter of 2007, although it did represent a decline from 1.19 percent in the
first quarter of 2008.

The decline from the first quarter to the second quarter likely reflected tax refunds and
economic stimulus checks. Since delinquency rates tend to be seasonal, they usually
go down in the second quarter.

Late fees and sky-high interest rates—some as high as 24 percent or
more—keep accumulating and threaten to keep the economy sluggish. Every
dollar that goes toward paying fees and interest on credit card balances is a dollar that
can't be spent at the grocers, the hardware store or Starbucks.

How did shopping on credit get so out of control?

Technology has made it impossible to escape the temptation to whip out those credit
cards. Television commercials like Visa's "Life Takes Visa; don't let cash slow you
down," suggests that cash is out of date. With e-commerce, retailers are now open
24/7. Home shopping networks and catalog 800-numbers let your fingers do the
shopping.

Credit card companies market to our most basic instincts and appeal to the herd
mentality that suggests, "If everyone else is doing it, it must be OK." And if mere
suggestions offered through television commercials don't do the trick, there's always
the direct approach—an estimated six billion credit card offers hit the mail
annually.

Debt and the job market

Consumers have been on a fast moving shopping spree that's about to grind to a halt.
Wages are not keeping up with inflation and too many jobs are going by the wayside.

Higher prices and rising jobless rates are inextricably linked to loan defaults and
credit card delinquencies. The U.S. Labor Department reported that unemployment
rose from 5.7 percent in July to 6.1 percent in August—a five-year high.
Employers slashed 84,000 jobs in August, the eighth straight month of declines, with
a total of 605,000 lost jobs for the year.

It's a vicious cycle. Employers get worried about the economy and their own profit
margins and start cutting the workforce. More people have less disposable income and
are unable to pay their bills, which leads to more mortgage defaults, more credit card
delinquencies, less consumer confidence, and on and on.

But the worst is yet to come. There is a lag between the time someone loses a job and
when mortgage loans default or credit card delinquencies appear, so we might just be
seeing the tip of the iceberg. Moody's predicts household credit conditions will
continue to weaken through the remainder of the decade, with another 5 million
homeowners at significant risk of default.

Banks and lenders getting squeezed

Banks, already weighed down with defaulted loans, could face even more troubled
mortgages on their books, as well as unpaid credit card debt. Credit card companies
like Visa and MasterCard bear relatively little risk for defaults and other payment
problems. It's the banks issuing the cards that assume responsibility for the debt.

Failures are expected to reach such a high level that the Federal Deposit Insurance
Corporation (FDIC), the Washington-based agency that insures deposits at U.S. banks,
may not be able to insure all deposits—even with protection extended from
$100,000 to $250,000 per account under the bipartisan rescue plan now in place. They
already raised the number of "problem" banks to 117 in June, up from 90 at the end of
March. Ten banks closed down in 2008, the fastest pace in bank closures in fourteen
years.

Even before the Treasury Department's takeover of Fannie and Freddie, the two
mortgage giants that own or guarantee around $5 trillion, or roughly half of the U.S.
home loans, had been on a less than solid financial footing. The more mortgage
default rates escalated, the more their capital base eroded.

The government's $700 billion rescue plan may help curb further deterioration in the
markets, or ease the credit crunch affecting banks and major corporations, but not
much is being done to ease other credit troubles. The big question: Will growing
consumer debt lead to another round of massive losses and write-downs at banks and
other financial institutions in the coming months?

Under the radar: Packaged credit card debt

Very little attention has been paid to the fact that, similar to mortgage-backed
securities, credit card debt is packaged and sold to investors. The inevitable defaults
could lead to big losses, not just for the credit card lenders, but also for pension funds
and other institutional investors who are buying the debt.

The securitized debt backed by credit card receivables is a $915 billion industry.
Increased defaults could unravel the whole game, just as delinquencies in the housing
market brought down the $900 billion in mortgaged-backed securities.

Does this add up to an inevitable recession? You will get as many answers as the
number of politicians and economists you ask. (As the joke goes, if you laid all the
economists in the world end-to-end...they still could not reach a conclusion.)

Consumer debt going global

While we as nation seem only vaguely aware of this looming credit catastrophe,
MasterCard has already set its sights on duplicating its U.S. business model
internationally. Poised to take advantage of new and growing access to credit in
countries like Brazil, Hungary, Poland, Russia, India and China, the credit card giant
is anticipating a projected revenue growth rate of 39 percent.

Easy access to credit may be a compelling, albeit temporary, method to jump-start an
emerging economy. It paints a rosy picture and offers promises of better living. But
unless the populace of these countries is warned to use credit cards with discretion,
shoppers globally will surely be lured into the same mistakes U.S. consumers make
— and quickly become saddled with the same kind of debt.

				
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posted:1/25/2011
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