I've heard directly a great deal about the effect of the credit crunch on businesses, mortgages, and car loans. Car loans are apparently unobtainable with a credit score of less than 700; mortgages have been pulled merely for the crime of having a large percentage of your assets in (unmortgaged real estate). Corporate credit lines have been cut or exhausted.
What I haven't heard about is how this has trickled through to the credit card companies. Six months ago, some nice banking experts from the FDIC and other government agencies made a credible case to me that the credit card industry really is different, because default is much easier to see coming. The initial extension of credit is scary, of course, but it tends to be advanced in small amounts, and built up as your relationship with the credit card company goes on. And when they see you missing payments or getting overleveraged, they can lower your credit limit to stop their losses. Indeed, in theory they can call the revolving loan, though in practice, this would cause problems.
Anecdotal reports of credit card offers flooding the mails intrigued me. Were these simply the legacy of already-paid-for direct mailing campaigns? Akin to my experiment last year, where I called my credit card company and asked them to double my limit just for the hell of it (a request that was approved within fifteen minutes), I applied for a credit card. Actually, I accidentally applied for three, which goes to show that you don't have to be too bright to be a blogger. Be careful on those credit card deal aggregation sites, is all I can say.
Result: Instant new credit of about 10% of my annual income from the two that approved me within two minutes. American Express very sensibly makes you wait a few ways for your exclusive Costco membership card/Amex, and when they notice that I seem to have a sudden interest in acquiring large amounts of new credit, I imagine they might just turn me down. The terms on both cards were attractive, with a 0% one year introductory APR, collision liability waiver for car rentals, and other perks that might tempt someone who already has way too many airline miles.
Then I realized that in addition to being too stupid to figure out a fairly simple web page, I had managed to ding my credit score with new credit applications just as I started house hunting. I'm hoping to spin this to them, and you, as a sort of adorable absent-minded-professor dedication to my research. With has the benefit of being sort of true.
Anyway, what to make of the fact that banks are still apparently handing out credit cards like candy? I have several theories
1) The credit card market is contracting unevenly. I have good credit, marred only by a moronic dispute with the New York State tax authorities which drags on despite their admission that they were completely and thoroughly mistaken. I make a middle class income, albeit journalist-middle-class, not corporate-lawyer-middle-class. Aside from a 5% car loan and student loans carried at 2.25%, I am not overburdened by debt. Perhaps the average joes like me are still doing fine, while people who have more trouble with their bills are finding the doors slamming closed. If so, those people should show up in the bankruptcy statistics soon.
2) The credit card market isn't contracting. So far their models are actually working, and their business model remains more reliable than other industries. That should show up in next quarter's earnings numbers.
3) The credit card market needs to take on new customers because people are frantically paying down their high-interest credit cards. I know a fair number of people who have decided that their credit card balance is Public Enemy #1. That's already showing up in the consumer spending numbers.
4) The credit card market needs to take on new customers because they're on the verge of going bust. They're just playing out the Great Countrywide Ponzi Scheme in 2009. That doesn't explain, though, why they're giving me credit cards with 0% introductory APRs.
5) Alex Tabarrok is right and the credit crunch is underwhelming. I'm skeptical, because of all the other problem credit markets. The Fed data on bank credit is interesting, but that's not really where the action in the credit markets is today; you could have increasing bank loans, and nonetheless, decreasing credit supply.
Thoughts?
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Car loans are apparently unobtainable with a credit score of less than 700
Well, the story I heard, through a family member was this:
CarSalesGuy: "We can't make loans anymore. It's killing business."
Brother of CSG: "What, if I have good credit you can't get me a loan?"
CSG: "That's no problem. But if a customer wants a 20k car for no money down and is 7k upside down on their current car, we can't get them a 27k loan! It's terrible!"
I normally shy away from predictions, since for the most part I don't understand what the hell I'm talking about.
However, I'll go out on a limb here and say the credit card market is in deep trouble (actually, I've been saying that ever since the crisis, such as it is, began). Why? Big credit-card lenders are apparently engaged in securitization and overleveraging just like our friends in the mortgage business. Now, maybe they have got their risk premiums dialed in just right, but I'm doubting it. So unless they can de-lever pretty promptly, look for them to collapse as the recession leads to bankruptcies.
There, no nobody can say I didn't say it.
At any moment my credit card balance is approximately 1% of total credit available and less than .5% of my annual income.
I carry no other debt.
I also have not received from the card companies increases in my credit line, whereas two years ago these increases came, unsolicited, like clockwork.
I also have not received many credit card offers in the mail.
My FICO score is through the roof.
So I don't know what conclusion you can reach other than there is a credit crisis out there.
I concede my use of credit is not the norm and inferring problems from a sample of a not-normal person is dicey.
Can someone explain point 4 for me?
I really don't see how taking on new customers would help credit card companies who cannot borrow.
I really don't see how taking on new customers would help credit card companies who cannot borrow.
They can turn worthless cash in to valuable debt-backed securities!
Serious, I don't really know. Maybe the promise of merchant fees.
@ech
I don't think you understand what you're saying.
Let me say up front that I agree that you shouldn't make a $27K loan on a $20K car.
However, let me deal with the situation as it stands:
Let's say you own a dealership - And for ten years you've been able to make that $27K loan easily.
Your business would be booming and your projections would say that you had money to make improvements in infrastructure, maybe hire some more people..etc. In addition, the manufacturer would expect you to start taking larger deliveries of cars and parts.
So you're chugging along and growing and in that ten years, you go from selling 100 cars a month to 300. You triple your workforce and double the size of your inventory.
Suddenly, you can't make that $27K loan any more and your business is cut by over half. You have cars piling up on the lot and salesmen sitting around playing cards. You see the manufacturer getting a $25B bailout and you're cutting your workforce just to keep your head above water.
That's why CSG says it's terrible.
"Car loans are apparently unobtainable with a credit score of less than 700; mortgages have been pulled merely for the crime of having a large percentage of your assets in (unmortgaged real estate)."
I don't think people with credit scores above about 620 or so are having much trouble obtaining sensible car loans. I think it's true that car dealers can't do the flaky deals anymore that have made up a significant part of the business until recently.
The second part about mortgages pulled because people have too much in unmortgaged real estate -- what? I obtained a mortgage very recently, and certainly the lender, Bank of America, did not count against me the fact that I own other paid-off real estate.
Here's a crazy thought, which also has the virtue of being incredibly simple:
Credit is contracting for those who are not deserving of it, but not contracting for those who are deserving.
It isn't a "credit crunch" that worthless banks with worthless assets can't get someone to hand them a few billions; it's a very good thing.
On the other hand, Megan, and millions like her, are a much better bet for repayment. So Megan, and millions like her, end up getting tons of credit.
However, this isn't the whole story. I think, with the ridiculously low interest rates we've had for 8 years, credit card lending has gotten out of hand, like housing lending. As the bubbles in the housing and finance sectors collapse, it seems the new artificial credit created by the Fed will be mopped up in other sectors. Watching credit cards mushroom inclines me to believe credit cards are the next housing market, and will soon come undone.
Alex Tabarrok is right and the credit crunch is underwhelming. I'm skeptical, because of all the other problem credit markets. The Fed data on bank credit is interesting, but that's not really where the action in the credit markets is today; you could have increasing bank loans, and nonetheless, decreasing credit supply.
Um, where is the credit market these days, then? I thought the Minnesota Fed data was quite interesting - it was much more convincing than the so-called "debunkings" of it by the likes of Mark Thoma and others (which debunkings were completely UNconvincing).
So, Megan, can you provide a breakdown of where the non-intra-financial-industry credit market is these days? Frankly, I don't care whether banks (or whoever) are lending to each other; I only care whether banks (or whoever) are lending to the rest of society. The volume of financial industry commerical paper is irrelevant if the rest of society is still getting loans. The volume of inter-bank lending is irrelevant if banks are still lending to non-financial businesses and people. I don't care what the LIBOR or commercial paper rates are, just the volume of lending.
So, Megan, what is your evidence for #5?
Commercial paper and various other sorts of financial instruments have taken up a lot of the role that used to be filled by bank lending. And the commercial paper market dropped to nonexistent last month.
I'm still getting credit card offers in the mail.
I am also getting notices from my current cards that if I miss a payment, the interest rate goes to prime + 21%.
When the bankruptcy laws were tightened my first thought was that the credit card companies were nervous.
Maybe the credit card companies have a handle on things. They do get paid for every transaction, whether you carry a balance or not. They can also fairly arbitrarily raise your rates.
I think credit card companies really have some gigantic buffers against failure.
Imagine 5 guys, each with 10,000 in credit card debt @ 30% interest. Each pays enough to cover the interest each year without attacking the principle.
That's 15,000 in interest each year. If one guy goes tits up, they still make a profit! If next year another one goes bankrupt, they still make a small profit!
Year One: 50000 principal x .30=15,000. Write off 10k, made 5k.
Year Two: 40000 x. 30= 12,000, write off 10k, 2k profit.
Year Three: 30,000 x.30=9,000, write of 10k, 1k loss.
Year Four: 20,000 x. 30=6000, write of 10k, 4k loss
Year Five: 10000 x. 30= 3000, write of 10k, 7k loss.
20%/40%/60%/80%/100% fail rate, and they only lose 5,000 on 50,000.
Credit card companies will be fine.
Their M.O. has been to throw money around to see where it will stick, and charge high enough interest to ensure that they will profit or at least break even in the face of a high default rate. The above example is an extreme example of why that plan works.
First you forget to register to vote, now you overlook the fact that applying for multiple credit cards would have a negative effect on your score...?
Megan, you need to eat a good steak before you lose it altogether.
According to the Mineapolis Fed data, at least as of October 8, "while commercial paper issued by financial institutions has declines, commercial paper issued by nonfinancial institutions is essentially unchanged during the financial crisis". Looking at the updated data at the Fed website (as of November 7), that's essentially unchanged.
Now, of course, financial institution commercial paper is the bulk of the commercial paper market. But I repeat - why do I care whether one financial institution lends to another (which is essentially what the financial institution commercial paper market is), so long as the rest of society still has credit available?
Those NON-financial institutions that access the commercial paper market are still doing so, to the same extent as before. Some may pay a bit higher rates, but it's not like the credit isn't available.
What is a 'credit score'? Maybe knowing yours is the problem. Living via credit score is the same as NOT saving money.
Loans are easy to get: one need only the ability to pay it back.
Unfortunately that little condition has been overlooked.
Toxic,
That's fine in theory, but the credit card companies are levereged up based on the value of those outstanding balances. They've been both securitizing and pledging those balances as collateral. Hence, they can't make the writeoffs you suggest quite so easily.
Posted by Dave | November 10, 2008 12:24 PM:
It seems to me that the bank has nothing to gain by increasing your limit, but they have to put aside reserves anyway. Maybe they did this when they had reserves to burn, but this to me isn't a real freezing.
-dk
Lord knows I can't get a car loan. But then, I couldn't a year ago.
I suspect Dick King has the right explanation for Dave's story. I am similiar to Dave in having excellent credit, but I also use that credit (about 10% of my home equity in a HELOC and occasionally a few thousand on a credit card for a couple of months), so lenders do make money off me. I continue to get 3-6 offers a month (although last year it was 6-12) and recently got an unrequested limit increase.
Well of course it isn't as simple as my example. Didn't mean to say it was.
But I think the point holds: credit card companies should be fairly resilient because the business model has a healthy amount of velvet to protect itself from spikes in default rates.
One of the advantages of being an unsecured creditor is that you are fully aware your ass is always hanging in the wind. The mortgage companies thought they had titanium clad ass armor, only to realize too late it was moldy old security papers.
One of the advantages of being an unsecured creditor is that you are fully aware your ass is always hanging in the wind
The question is whether they have priced the risk correctly. You have more faith in them than I do.
@Nick to me: I don't think you understand what you're saying.
Sure I do. Megan was saying nobody can get a car loan. I was saying that the car loan equivalent of interest-only, stated income ARMs were impossible to get as opposed to the 20% down, 30 year fixed-rate loan.
I have sympathy for the grunt workers at dealerships being crushed by the double hammer of whipsawing gas prices and the credit crunch. I am less sympathetic for the dealers and manufacturers that built a business model that was unsustainable. (i.e. 5 year new car loans, when your push is to have people flip their car after 3 years.) If you end up upside down on every car you buy, as some point you have to stop buying.
Also, does GM have significant exposure to the credit card market through GMAC?
A note on the Credit Crisis: the claim that large corporations are unable to borrow money is absolutely false. (Note: I administer corporate credit deals for a living). Large businesses do not wait until they need money to seek credit. They set up long-standing credit facilities with pools of multiple lenders. They can borrow through these credit facilities any time they want, subject only to the terms and limitations of the original contract. The problem for such companies has not been lack of credit but its cost. LIBOR rates went through the roof last month and since many loans are set up to have a monthly rate reset few companies escaped getting hammered on either existing or new loans. Recently the rates have gone back down again, an this aspect of the crisis seems to be over now. However this is not to say that small business which only borrows when it needs to, is having an easy time getting loans. That's the true crisis: small businesses may not be able to get credit at all, since banks are still hoarding money.
And what happens when those standing facilities mature....
I'll bet the reason you have no problem getting credit is that the cc companies have so much personal information on you that they actually know you are Megan McArdle, Atlantic blogger, and that a mix of public image and personal rectitude makes the likelihood of your defaulting close to 0.
In other words, your experiment was doomed because you're not just some nobody Jane Galt or whatever.
"The credit card market isn't contracting. So far their models are actually working, and their business model remains more reliable than other industries."
There's a simple explanation for this: the way to make money in lending is to charge interest rates higher than your default rate. Credit cards do this. Yes, default rates have doubled recently -- to ~6%, if memory serves -- but if you're charging ~18% interest, you can still make money with a 6% default rate. Credit card companies and alternative lenders can still operate profitably in this environment, because they charge rates high enough to compensate them for the higher default risk.
Re: And what happens when those standing facilities mature....
Most coporations have a mix of facilities that mature at different times. Nor is it the case that new facilities aren't being established-- we just had a new one come on-line last week (and I only know about it because my employer is one of the lenders; probably there are others that we aren't involved in). Except for some obvious suspects-- you know, the ones with CEOs on a firstname bassis with the Chapter 11 judge-- most large corporations are good credit bets. As I posted, for large corporations the crisis has been one of cost, not availability.
It's small business that bearing the brunt of the credit crisis. But that's no small problem, as a great deal of American job growth and innovation comes from small business. Microsoft will do perfectly fine, thank-you-- but what about the next Microsoft trying to go from start-up to growing concern?
Data:
My nineteen year old son, attending college, gets about one pre-approved application per week. Usually from an airline. So does my eighteen year old son. But then again, so does my eleven year old daughter. She's been paying a minor tax assessment for years. Does that mean she has a credit rating? Are these credit card companies as dumb as rocks, or what is their problem?
I had an interesting conversation with someone who works for American Student Assistance the other day.
Apparently they're running scared.
If the student loan vampires start to tumble we'll see chaos unrivaled.
Hey
The credit card companies are backed by the banks and the banks are getting relief from the goverment. Instead of raising everyone's limit, what they are doing is lower them and raising interest rates without telling consumers.
We are in a credit cruch and will be for awhile. Your credit is the #1 thing that will make or break you. Even if you make a good salary, if you have poor credit, you are considered poor.
You need to be smart about your credit and pay off your debt or try fighting the credit system by repairing your credit. It can be done and their are professionals out there that can help you.
Dr. Jennifer Baxt
Re: I think the criterion for involvement of our military has become less a national threat of survival than the threat not getting all the neat things we’d like to have.
This is only true if you are frequently in need of new credit. I will need a new car loan someday (hopefully not for 2-3 years) but it will be a while before I even think of buying a house. And I pay off my credit card balance (if there is one) every month so I basically don't care what the interest rate on the card is. Obviously no one should go out of their way to trash their credit rating, but people who obsess over every last point of their FICO are worrying about triffles. Keep your balance low or (best) non-existent and pay your other bills on time. You won't have any credit troubles.
When I advise clients with cc debt, I explain that paying off that debt is roughly equivalent to putting the same dollars in a risk free investment that pays 18% or more after taxes. That is better than any investment that I can offer. Pay off those balances; and then we'll talk.
Argg. While I was buying my house, I discovered that a student loan I had in deferment came out of deferment. I didn't pay it for a couple months because while it was in deferment, Michigan sold the loan to another company. No big deal except I've been receiving junk from that particular company for years. Turned out I had been throwing away my statements. It dropped my credit a tiny bit, but I was told it didn't affect the terms of my loan. If I hadn't been buying a house, I probably would have continue throwing those statements out for many months.
My last couple credit card offers in the mail came from Washington Mutual, relatively recently. My wife and I were joking that if we'd opened them, we'd have found them asking us for a credit line....
@Dave
As noted, credit card companies would benefit little by raising your credit or offering you new cards. You're probably a 'deadbeat', too, and pay off your balance every month, right?
As a deadbeat myself, I haven't gotten any raises in credit line in about 3-4 years, even though I use my cards extensively (convenience, formerly miles, now the small rebate one can earn make it worth it). So I do get solicitations for new cards -- about one every two weeks from American Airlines, mostly.
But someone else above pinpointed the reason that the credit card market could cause problems for the financial system: even if the business models of the cards and their debt is fine, credit card debt has been packaged into CDOs for some years, credit default swaps have been written on those CDOs, probably (in the last two years) in amounts hugely larger than the actual debt, along with various more exotic derivatives in amounts far larger than the actual capital.
It's not the debt, its the LEVERAGE, as usual. And derivatives, if I understand correctly, ended up becoming a huge supplemental leverage on the financial system as a whole over the last decade. So I do expect problems on that front (but not on the actual operations of credit card companies), and similarly on student loans.