Hair of the Dog, Part 3

In general, legislative responses to the recent financial crisis just amaze me, and I am a fairly jaded observer of Congress with very low expectations.

First, Congress responds to a crisis caused by too much debt and overleverage by ...borrowing a trillion or so dollars and deficit spending.

Second, Congress responds to a crisis caused by too much subsidiazation of  home ownership by ... subsidizing home ownership

Now, Congress has apparently responded to a crisis where risky debt was mispriced by... passing a law to reduce debt costs for the riskiest borrowers and shift that cost to the least risk.

Nice job.

  • LoneSnark

    I don't get the last one. The article does not explain why the bill makes it more costly to give credit cards to individuals with low risk. All it does is not let you jack up someones interest rate, which is only a problem if you gave them a low rate to begin with. But people that pay off their debt every month (like me) have absurdly high interest rates, because we never pay interest. Does anyone else have an idea?

  • Is that last article the right one? I didn't see anything to do with government action. I couldn't find the words "congress," "law," or "bill" in it (and neither could my search function). That being said, stupid congressional action would be as surprising as a sunrise.

  • Eddie

    If you'd been listening to our esteemed majority leaders on Capitol Hill, you would realize that the economic crisis was caused by two factors, none of which you list here.

    First, Bush did it. It's all war debt from when he shot money out of cannons at the impoverished, peaceful citizens of Iraq.

    Secondly, it's the fault of corporate executive bonuses. Those greedy CEOs took all the money we'd be earning if they paid us all better and used it all up on expensive vacations, private planes, and luxury cars.

    Any extra economic damage was obviously due to all of us donating too much money to our local racist political organizations.

    See? None of this silly blame on home subsidies, or shoring up credit companies put at risk by congressional mandate.

  • Tim

    Scandi:

    "These fees are the credit card industry's response to credit card legislation that will, among other things, restrict credit card issuers' ability to raise interest rates on existing balances. Credit card issuers are looking for ways to raise income before the new rules take effect in February."

    In other words, legislation is restricting pricing cues on high risk debt; and the credit card issuers are adding fees and costs to low risk debt to make up the difference.

  • LoneSnark

    But Tim, they can't do that. There is no law requiring a credit-card company issue cards to risky people. As such, non-risky people will simply seek no-fee credit with companies that have no poor customers. Now, it might make sense if Credit companies have no way of knowing who is a risky customer, which I find unlikely.

  • LoneSnark - when they give you the card, they can assess your current risk and assign you an interest rate based on risk. But the legislation prevented them from adjusting your interest rate upward based on increased risk. Thus, the attempt to raise money in other ways.

    You pool all these accounts, and since you aren't charging people in the pool for increased risk (until default, when, hahahaha, charging for increased risk doesn't get you anywhere), you add fees to other parts of the pool to compensate. The Coyote is entirely correct.

  • LoneSnark

    But that should only be a temporary situation. As old cards expire and new customers apply for cards without the grandfathered in protections, then the card issuers should manage to stop having the risky as customers or make them pay in another way, right? Maybe instead of jacking up interest rates they slap on unregulated fees.

  • Jess

    LS,
    You're kidding, right?
    If any credit entity were to "limit" access to credit now (that's the key word) would you be surprised if there were any, say, backlash?

  • Tim

    LS: But the turnover rate isn't that high; and the new applicants have low risk -- so the market creates no-fee and low interest rates for those 'good' customers. If I have a good credit score; why would I apply for a poor credit card with high costs?

    The one thing that they used to do was offer the low rates and no-fee cards; but those terms would change if risk went up. Oops.... can't do that now.

    The only tool they have left to manage risk is to lower available credit. This has the nasty side effect of lowering credit scores by changing the ammount of available credit in use; which makes other unsecured lenders lower their limits, and so on.

    And Jess is right. There is already agitating about the limited access to financial insturments as a "Social Justice" issue. That's what kicked off the Fannie Mae and Freddy Mac festival of stupidity -- "It's not fair that poor people can't get $180k mortgages!"

  • LoneSnark - you still seem to be missing the point that risk in a credit card pool changes after the cards are given out.

    OK? Suppose you gave a card to an A-1 applicant. Good income, good assets, debt well within control, plenty of excess credit available. Two years later Mr. A-1 loses his job and then gets a divorce 8 months later as a result of the stress.

    Abruptly he's lost half his assets and more than 1/2 his income. His utilization rates are going through the roof. You can't raise his rate to compensate for the risk any more under the new law. You can cut his credit limit or take away the card, but believe me, taking away the card is often unproductive if the borrower is really strapped. You can cut his credit limit to encourage him to pay it off. That's all. But suppose he's now got 5K on the card - your odds of losing most of that 5K are pretty high. But you can't raise his rates to compensate for that risk or to get out early, which increases the chance that he will ratchet up the balance on that card ASAP - it is probably his cheapest way to get money. What's he gonna do, walk into a bank and ask for a loan when he doesn't have a job?

    So to handle such risks (which are uncontrollable at time of origination), you institute other fees and so forth to help you offset those risks, and you institute them on the entire pool.

    One of the features of CC debt is that chargeoffs are way higher than default percentages. When they default, they default and you lose everything, and because it is credit of accommodation, naturally your borrowers getting into trouble will tend to run up their balances before defaulting. So even if 5% of your good pool over a few years transitions into high-risk (an excellent performance), you are going to lose more than 5% of the pool principal. You can't market cards at high rates to good borrowers. You have to cover your losses from interest and fees, and if you can't raise the rates to individuals as borrowers transition to higher risk categories (which encourages them to raise cash elsewhere) then your only recourse is to raise prices to all the borrowers in the pool.

    I can also promise you that banks will be cutting credit limits like lightening the moment they detect a move to higher risk, including charging groceries, or clothing at cheap stores, etc, or a sudden change in payment habits (abruptly converting to running a balance when borrower usually pays all or most charges within a few months). Credit cards are going to become a really bad option for emergency cash, because the banks will spend a jackload of money for data to tell them when to cut credit limits, so when you need that card, the odds that you won't be able to use it will be very high.

  • Zach

    "I can also promise you that banks will be cutting credit limits like lightening the moment they detect a move to higher risk, including charging groceries..."

    Awesome. Once again, those of us who are responsible get screwed so that those who are irresponsible can get off the hook. It's the MO of liberals and Democrats. I buy almost everything (including groceries) on 1 card and pay it off in full every month. But if I have to worry about my credit limit getting cut in response, and having to pay overlimit fees, and all that junk, I guess I'll have to go back to cash (I despise checks).

    Thanks, Democrats.

  • Mesa Econoguy

    Creation of even riskier financial derivatives (all financial instruments are “risky”) is being driven right now by our vise-grip and duct-tape amateur legislators, like Barney Frank.

    And the renewed regulatory oversight is even more likely to fail under current configuration. Overseen by Barney Frank.

    Did I mention that Barney Frank is, was, and has been running Fannie & Freddie?

  • Val

    Thank you thank you! I love seeing those three things summed up like that... I have been saying exactly those things to clients for several years now. The one thing that nobody seems to understand, much less mention, is how screwing around with the risk premia at the most basic levels created the problems we wonder about now. That IS the core issue. And I am not talking about credit cards - they are a very small part of that problem.

    BTW, think about how much wealth flowed from that imbalance, and where did it flow to?

  • Val

    "vise-grip and duct-tape amateur legislators, like Barney Frank"

    I love that - I will start using that one.