Question: When you can't squeeze more equity out of your house, what do you do?
Answer: Max out your credit cards.
That is why the next horror for beaten-down financial firms is the $950 billion-worth of outstanding credit-card debt.
Credit-card debt is unsecured, meaning consumers don't have to make down payments when opening up their accounts. If they stop making monthly payments and the account goes bad, there are no underlying assets for credit-card companies to recoup. With mortgages, in contrast, some banks are protected both by down payments and by the ability to recover at least some of the money by selling the property.
The consumer debt bomb is already beginning to spray shrapnel throughout the financial markets, further weakening the U.S. economy. "The next meltdown will be in credit cards," says Gregory Larkin, senior analyst at research firm Innovest Strategic Value Advisors. What's more, the U.S. Treasury Department's $700 billion mortgage bailout won't be a lifeline for credit-card issuers.
Credit-card loses are already taking a bite out of lenders' balance sheets. Bank of America, the nation's second-largest issuer behind JPMorgan, revealed on October 6, 2008 that roughly $3 billion of its $184 billion credit-card portfolio has soured, a 50% increase from a year ago.
Some banks and credit-card companies may be exacerbating their problems.
To boost profits and get ahead of coming regulation, they're hiking interest rates. But that's making it harder for consumers to keep up. That'll only make tomorrow's pain worse. Innovest estimates that credit-card issuers will take a $41 billion hit from rotten debt this year and a $96 billion blow in 2009.
As with mortgages, banks bundle groups of so-called credit-card receivables, essentially consumers' outstanding balances, and sell them to big investors such as hedge funds and pension funds. Big issuers offload roughly 70% of their credit-card debt. But it's getting harder for banks to find buyers for that debt.
Source: BusinessWeek, October 20, 2008