In its strongest attack on pending bankruptcy reform to-date, the Consumer Federation of America charged yesterday that card issuers have aggressively stepped up credit card marketing and credit extension while endorsing and promoting tighter bankruptcy laws. The CFA based its charges on the growth in credit card solicitations and credit lines. According to the CFA report entitled: “Recent Trends in Bank Credit Card Marketing and Indebtedness”, credit card solicitations have doubled and unused credit lines have tripled over the past five years. The CFA also pointed to the surge in sub-prime credit card loans as an example of “irresponsible lending”. MasterCard responded to the charges by saying all economic trends continue to support the ability of American consumers to manage their credit card spending and debt appropriately. MasterCard’s chief economist cited figures showing 40% of Americans pay-off card balances each month and 97% of cardholders make card payments on-time. VISA reportedly cited the drop-off in direct mail response rates as off-setting the growth in the number of credit card solicitations. The industry funded Bankruptcy Issues Council also piled on yesterday saying it is “ironic” the CFA opposes needs-based bankruptcy reform while 68% of Americans support the changes.
CFA ATTACKS CARD ISSUERS AS IRRESPONSIBLE
Last year in February and December, the Consumer Federation of America (CFA) issued reports on credit card debt and its financial impact on consumers. The reports revealed that 55 to 60 million households (55-60% of all households) carry credit card balances and that these balances average more than $7,000, costing these households more than $1,000 per year in interest and fees.
The reports also concluded that this mounting credit card debt was the most important reason for the rise in personal bankruptcies (1.3 million in 1997). In recent years, the industry significantly increased its card marketing to low and moderate income households. Not surprisingly, then, typical Chapter 7 bankrupts had relatively low incomes and high credit card debts — in 1996, after-tax income of $19,800 and credit card debts of $17,544 according to research by the industry-funded Credit Research Center.
Experiencing rising losses from these insolvencys, the credit card industry organized a campaign to persuade Congress to restrict access to Chapter 7 bankruptcy. The campaign succeeded in persuading the House of Representatives to pass legislation quite similar to the proposal developed by the industry. This month, the Senate will consider only slightly less restrictive legislation.
This report examines the recent behavior of those credit card banks that have extended the large majority of all revolving credit. Most importantly, it demonstrates that recently these banks have expanded their marketing and extension of credit at the same time they have increased their political spending on a bankruptcy “reform” campaign intended to reduce their mounting debt losses. This report also suggests a far more effective and fairer strategy to reduce consumer financial insolvency and personal bankruptcies.
Banks Expand Card Marketing and Related Credit Extension
Banks now extend the large majority of all credit card debt. As the table below shows, the ratio of bank credit card debt to all revolving credit was 79.1% in the first quarter of 1998 and is even higher for credit card debt since an estimated 5% of revolving credit is not card debt, according to the Fed. This percentage has grown significantly in recent years.
TABLE 1: RELATION OF BANK CARD DEBT TO ALL REVOLVING CREDIT Bank Card Debt All Revolving Credit BCC/ARC 1998 (Jan-Mar) $425 billion $537 billion 79.1% 1997 $386 $531 72.7% 1996 $344 $499 68.9 1995 $281 $443 63.4 1994 $221 $365 60.5
Sources: Bank card debt from Veribanc, Inc.; revolving credit from Federal Reserve Board.
Despite rising chargeoffs (bad debt losses), banks have recently expanded their card marketing and credit extension. This marketing and credit extension has risen much more rapidly than bank card debt, as the table below shows.
TABLE 2: BANK CARD MAILINGS, CREDIT LINES, AND DEBT (billions) MailingsUnused CreditDebtAll Credit Extended (UCL+D) Lines 1998* 3.2b (proj.) $1, 778 b $425 b $2,203 b 1997 3.0 1,499 386 1,885 1996 2.4 1,183 344 1,527 1995 2.7 954 281 1,235 1994 2.4 725 221 946 1993 1.5 582 195 777 1992 0.9 499 179 678 1992-98 Increase 255% 256%137%
*Data on mailings for January through March and projected annually; data on credit lines and debt for end of March.
Sources: Data on mailings from BAI Global Inc., data on credit lines and debt from Veribanc, Inc.
The above table suggests two striking trends. First, total credit extended on bank cards (unused credit lines plus actual debt) rose to more than $2 trillion by the end of March 1998.
Second, in the past six years, bank mail solicitations and unused credit lines grew nearly twice as rapidly as bank card debt. Banks have been far less restrained in their marketing and credit extension than consumers have in their accumulation of credit card debt. That has been especially true recently. In the 15-month period from the beginning of 1997 to the end of March 1998, all revolving credit increased 7.6% and bank card debt rose 23.5%, but unused bank credit card lines increased 50.3%.
This latter trend raises the question, why have banks expanded solicitations and credit lines while forced to write off increasing bad debt losses — according to Veribanc, from 3.0% of outstanding debt in 1994, to 3.4% in 1995, to 4.4% in 1996, to 5.4% in 1997, to an annual rate of 5.6% in the first three months of 1998? Despite the rising losses, for most banks credit cards are still profitable. During the past decade, credit cards have been the most profitable bank product. While profit margins have declined in recent years, for those banks marketing cards aggressively, they are still large enough to sustain huge debt losses and marketing expenses. As CFAs 1997 reports indicate, last year, consumers paid more than $60 billion in interest and about $10 million in fees on credit cards. Banks collected the large majority of this revenue.
Who Pays Credit Card Losses
Credit card companies have run ads claiming that all bankruptcy — related losses are paid by consumers — an average of $400 per household per year. That would only be the case if creditors raised prices to cover bad debt losses.
There is little evidence that creditors have raised prices to cover increasing losses. A significant percentage of these losses represent credit card chargeoffs. But, as the table below shows, there is no relationship between bank card interest rates and chargeoff rates.
TABLE 3: BANK CARD INTEREST RATES AND CHARGEOFF RATES Interest Rates Chargeoff Rates 1998* 15.7% 5.6% 1997 15.8% 5.4% 1996 15.6% 4.4% 1995 16.0% 3.4% 1994 15.7% 3.0%
Sources: Interest rates from Federal Reserve Board; chargeoff rates from Veribanc, Inc.
The fact is that, for many years, bank decisions about credit card prices have been independent of credit card losses. For two decades, the average credit card interest rate has hovered around 18% (1.5% on the unpaid balance monthly). (The rates reported by the Fed are somewhat lower than that of other data sources such as Bank Rate Monitor.) These rates are the highest which banks believe they can change.
It is true that, recently, banks have raised prices for some of their riskiest customers. They have hiked typical late payment and over-the-credit limit fees to $25 and have raised the interest rate charge to many of these late payer and over-the-limit customers to well over 20%. But these fees are paid mainly by a minority of customers. CFAs 1997 reports estimated that about one-third of households with a card pay off all balances in full, and most other cardholders make payments on time and do not exceed credit limits. Who, then, pays for the credit card losses? In the past several years, a portion has been paid by the minority of cardholders who were assessed most fees. But most of these losses have been “paid” by bank investors to the extent bank stocks have been depressed by declining credit card profitability. Most of the roughly $20 billion in bank card losses last year were borne by investors who earned a lower return on their investments. At most, only several billion dollars of this amount can be attributed to rising credit card fees.
Which Banks Extend the Most Credit and Do So Most Prudently
Just as the portion of credit card debt held by banks has increased recently, so too has the portion held by a few big banks. As the table below shows, at the end of last year, a few banks held more than half of all bank card debt. In fact, if announced mergers had been consummated, five institutions: Citicorp; MBNA; Banc One/First Chicago; Chase Manhattan; and BankAmerica/NationsBank/Barnett would have held 53% of all this debt. (These institutions also accounted for most recent mail solicitations; in fact, in 1997 Banc One accounted for more than one-quarter of all mailings.)
TABLE 4: BIG BANK CREDIT CARD DEBT AND NET CHARGEOFFS Debt* Net Chargeoffs As (12-31-97) % of Yearend Debt (1997)** Citicorp $57.5 billion 4.2% MBNA 48.3 2.2 Banc One 40.7 6.0 Chase Manhattan 35.2 3.6 First Chicago 18.7 6.2 BankAmerica 11.8 5.8 NationsBank 10.0 5.6 First Union 8.2 8.2 Wells Fargo 6.9 7.5 Wachovia 6.9 3.6 US Bancorp 5.7 4.0 PNC Bank 4.0 4.7 Peoples Mutual 3.4 2.4 Fleet Financial 3.1 6.2 Norwest 2.5 3.9 First National (Neb.)2.4 7.5 Bank of Boston 2.3 5.1 Mellon Bank 2.3 13.5 KeyCorp 1.9 6.3 Corestates 1.6 13.1 Barnett Banks 1.5 3.8 National City 1.5 4.1 First of America 1.4 5.0 Crestar 1.2 6.8 SunTrust 1.1 3.9 Mercantile Bancorp 1.1 7.6
*Debt includes that held by institution and that which was securitized.
**Chargeoff rate computed only on debt held by institution.
Source: Veribanc, Inc.
The chargeoff rate is the best indicator of the prudence and responsibility of institutions extending credit. It is not a perfect index; for example, it can be inflated by selloffs of debt (securitization) and deflated by rapid increases in outstanding debt. Nevertheless, it is accurate enough to be used as an important statistic by investors.
Banks with chargeoff rates below 3%, even if they market aggressively, do so fairly prudently and responsibility. On the other hand, banks with chargeoff rates above 6% are highly likely to extend too much credit to high-risk consumers. Even if their bank card operations are profitable, they are lucrative at the expense of many consumers who are loaded up with debt that they will not be able to repay. It is hypocritical of these creditors to complain that they need bankruptcy relief.
Creditors Strategies to Restrict Consumer Access to Bankruptcy
Last year, credit card companies and banks organized a campaign to restrict consumer access to Chapter 7 bankruptcy. (In Chapter 7, all or nearly all unsecured debts are discharged; in Chapter 13, most debts are repaid over time.) This campaign has been extensively reported on by the press. (For example, see Jacob M. Schlesingers lead article in the June 17, 1998 issue of The Wall Street Journal.) Campaign strategies include:
Research disseminated, among other means, in advertisements;
Campaign contributions totaling millions of dollars;
Lobbying the National Bankruptcy Review Commission;
Lobbying of Congress that cost Visa and MasterCard alone more than $2 million in 1997;
Grassroots lobbying by creditors in congressional districts and states; and
Attempts to intimidate the bankruptcy bar.
CFA asked the Center for Responsive Politics to compute the campaign contributions of big banks in the 1997-98 cycle. They found that the 25 largest credit card banks made $3.6 million in PAC, soft money, and individual contributions. Interestingly, the big five banks (noted in the previous section) contributed more than $2.5 million of this amount.
Why were these contributions made? Certainly the banks wished to influence legislators on financial services issues other than bankruptcy reform, especially modernization. But is should be noted that, since legislation passed by the House is predicted by the industry to reduce bankruptcy losses by about $4 billion annually, if this bill becomes law, big banks could well recover an additional $2 billion or more a year from their political “investment” of several million dollars.
How Consumer Insolvencys, Including Bankruptcies, Can Be Reduced
It is unclear whether contemplated bankruptcy reforms will reduce personal bankruptcies, let alone consumer financial insolvencys. On the one had, restricting access to Chapter 7 bankruptcy, together with other proposed measures, would prevent consumers from discharging as much debt and would probably discourage them from declaring bankruptcy as frequently. On the other hand, by allowing creditors to collect more debt, bankruptcy reforms would encourage credit card banks to market and extend credit more aggressively. Thus, it is quite possible that these reforms would aggravate the problem of consumer financial insolvency.
At the very least, bankruptcy legislation should include creditor responsibility measures that reward responsible credit granting and punish irresponsible credit extension. Here, irresponsibility is defined as granting credit to consumers who are highly likely to default on their debt obligations. One specific measure Congress should seriously consider is to make it difficult for lenders who extend credit to consumers with high consumer debt to income ratios to collect this debt in any bankruptcy proceeding, even one involving Chapter 13. Since most experts believe that consumer debt to income ratios (excluding mortgage debt) should not exceed about 20%, 40% is a ratio that should be considered as a threshold.
While in most instances it is not politically practical to require aggressive and irresponsible credit grantors to cease and desist, these lenders could be identified, criticized publicly by opinion leaders, and jawboned privately by regulators. Most of those big credit card banks with chargeoff rates over 6%, for example, should be on this list.
Regardless of the success of any of these efforts, many consumers must use credit cards more intelligently. Frankly, for most consumers it is foolish to carry any balance on credit cards. The large majority of the more than $70 billion cardholders are paying each year in interest and fees is wasted; it could be allocated much more sensibly and satisfactorily on other goods and services or on savings.
Even more foolish than carrying large credit card balances for a long time is using home equity to refinance credit card debt without curbing credit card use. Fed research suggests that over 40% of home equity borrowing is used to refinance consumer debt. Even more recent research, by Brittain Associates Inc., indicates that about two-thirds of households that use home equity loans to refinance credit card debt run up new credit card debts. In the future, particularly in any recession, many of these households risk losing their homes.
MASTERCARD RESPONDS TO CFA
MasterCard reaffirmed its confidence in consumers’ ability to responsibly manage their finances Wednesday following the report from the Consumer Federation of America.
“Unfortunately, we’ve been hearing that the sky is falling under the weight of consumer debt for years,” said Lawrence Chimerine, Ph.D., consulting economist for MasterCard International and Managing Director and Chief Economist of the Economic Strategy Institute in Washington, D.C. “But when you examine the fundamentals of the American economy, and the financial condition of the American family in particular — which is not only favorable but is actually improving — you will find a completely different story.”
“All economic trends continue to support the ability of American consumers to manage their credit card spending and debt appropriately,” Chimerine said.
“Consumers are managing their finances responsibly,” he added. Forty percent pay their credit card balance in full every month, and 97 percent pay on time every month. Additionally, the growth in both credit card debt and consumer debt overall is slowing, according to data from the Federal Reserve.
“In light of these facts and the positive condition of the overall economy, there simply is not the crisis that CFA has been pronouncing for years,” said Chimerine. “In fact, the large amount of unused credit is clear evidence that consumers are behaving in a rational and even conservative manner when it comes to the use of their credit card. Credit limits, after all, do not equal consumer borrowing.”
Regarding credit card solicitations, Chimerine pointed to the consumer benefit. “The many solicitations are good news for consumers who can compare card programs and choose the combination of annual fee, interest rate, and other card attributes that best meet their needs.”
“Consumers are doing a good job of taking advantage of the benefits that credit cards offer while managing the associated debt appropriately. There are no signs of significant trouble in the current economy,” Chimerine said.
MasterCard International has the most comprehensive portfolio of payment brands in the world. With 23,000 member financial institutions, serving consumers in 220 countries and territories, MasterCard is the industry leader in quality and innovation. More than 600 million MasterCard, Maestro, Cirrus and Mondex cards are accepted at more than 15 million locations worldwide. In 1997, gross dollar volume exceeded $600 billion. MasterCard can be reached through its World Wide Web site at http://www.mastercard.com.
BIC RESPONDS TO CFA
With regard to bankruptcy reform, the issue before Congress is whether the bankruptcy system should continue to allow people who can afford to pay their debts to walk away from them. Last month an overwhelming bipartisan majority in the House of representatives voted to reform the system t require those who can repay a significant portion of their debts to do so. The Bankruptcy Issues Council is confident that the Senate will soon take a similar view.
Critics miss this central point, that bankruptcy reform is about ensuring that the bankruptcy system provides debtors with the protection that they need-no more, but no less.
It is most ironic that the Consumer Federation of America and other critics are at odds with needs-based bankruptcy reform, a concept supported by 68% of american consumers, according to an independent survey.
According to a TechnoPolitics/Public Opinion Strategies poll of 1200 adults, a substantial majority of Americans believe that those filing bankruptcy should be required to pay back at least a portion of their debts and a near majority believe that Federal laws make it too easy to go broke in America.
The national sampling asked, “When people file for personal bankruptcy, do you believe that they should be forgiven all past debts with no obligation — or, that people should be required to use any assets they have to pay off a portion of their debts.”
Only 10 percent said people should be forgiven all past debts, while 68 percent felt they should be requuired to pay off at least a portion of their debts. Twenty three percent didn’t know.
The survey also asked respondents to agree or disagree with this statement: “Federal law makes it too easy for people to file bankruptcy and avoid responsibility for paying their bills.” Fourty-nine percent agreed, while 25 percent disagreed and 26 percent didn’t know.
The House last week passed legislaton that would make it tougher for those filing personal bankruptcy to walk away from their debts. The Senate is expected to act on a similar measure later this summer.
DEBT COUNSELORS RESPOND TO CFA
Debt Counselors of America, a nonprofit organization which helps consumers get out of debt on the World Wide Web (http://www.dca.org) feels that although banks are increasing the number of solicitations for credit, increasing credit lines, or making credit available to consumers that might not have been considered in the past, the bottom line is that consumers exercise personal responsibility when it comes to indebtedness.
Michael Kidwell of Debt Counselors of America stated, “Consumers need to have a clear understanding if they should accept additional credit offers or extend themselves further. Consumers are under the common misconception that somebody else is watching over the amount of credit extended to them. Just because a lender offers to extend you credit does not mean you should accept it.”
Debt Counselors of America hosts an online chat room at http://www.dca.org that consumers visit for advice and often carry on conversations about credit offers.
Wayne Ruckman, a DCA staff Certified Financial Planner said, “Some banks do examine your reported income and debt but you are more likely to receive additional credit offers not due to available income but because of your good past payment history. Ultimately, the consumer needs to exercise responsibility in accepting new lines of credit. It’s okay to say no.”
When consumers find themselves in over their heads they often turn to Debt Counselors of America on the Web at http://www.dca.org or http://www.GetOutOfDebt.org for assistance.