[OPE] Business Week, "The next meltdown: Credit cards?"

From: <glevy@pratt.edu>
Date: Fri Oct 17 2008 - 14:14:45 EDT

The next meltdown: Credit cards? - MSN Money
Extra10/17/2008 12:01

The next meltdown: Credit cards?Card issuers are
struggling to defuse a consumer-debt bomb that could blow an estimated $41
billion hole in their businesses this year -- and even more in 2009.

By BusinessWeek
The troubles sound familiar:

Borrowers falling behind on their payments. Defaults rising. Huge swaths
of loans souring. Investors getting burned.

But forget the
now-familiar tales of mortgages gone bad. The next horror for beaten-down
financial company is the $950 billion worth of outstanding credit card
debt -- much of it toxic.

That's bad news for players such as
JPMorgan Chase and Bank of America that have largely sidestepped -- and
even benefited from -- the mortgage mess but have major credit card
operations. They're hardly alone. 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, a senior analyst at research firm
Innovest Strategic Value Advisors.

Adds William Black, the
senior vice president of Moody's Investors Service's structured finance
team: "We still haven't hit the post-recessionary peaks (in credit
card losses), so things will get worse before they get better."

What's more, the Treasury Department's $700 billion mortgage
bailout won't be a lifeline for credit card issuers.

The big
companies say they're prepared for the storm. Early last year, JPMorgan
started reaching out to troubled borrowers, setting up payment programs
and making other adjustments to accounts.

"We have seen
higher credit card losses," acknowledges JPMorgan spokeswoman Tanya
Madison. "We are concerned about (it) but believe we are taking the
right steps to help our customers and manage our risk."

How would raising interest rates help?
Some banks and credit card
companies may be exacerbating their problems. To boost profits and get
ahead of coming regulation, they're increasing interest rates. But that's
making it harder for consumers to keep up and will make tomorrow's pain

Innovest estimates that credit card issuers will take a
$41 billion hit from rotten debt this year and a $96 billion blow in 2009.

Those losses, in turn, will wend their way through the $365
billion market for securities backed by credit card debt. 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. Interest rates have been rising on
credit card securities, a sign that investor appetite is waning. To help
entice buyers, credit card companies are having to put up more money as
collateral, a guarantee in case something goes wrong with the securities.
Mortgage lenders, in sharp contrast, typically aren't asked to do this --
at least not yet. With consumers so shaky, now isn't a good time to put
more skin in the game.

"Costs will go up for
issuers," warns Dennis Moroney of Tower Group, a consulting firm.

Sure, the credit card market is just a fraction of the $11.9
trillion mortgage market. But sometimes the losses can be more painful.
That's because most credit card debt is unsecured, meaning consumers don't
have to make down payments when opening 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.

Bad credit factors into subprime equation
Making matters
worse, the subprime threat is also greater in credit card land. Risky
borrowers with low credit scores account for roughly 30% of outstanding
credit card debt, compared with 11% of mortgage debt. More than 45% of
Washington Mutual's credit card portfolio is subprime, according to

That could become a headache for JPMorgan, which
agreed on Sept. 25 to buy the troubled thrift's credit card business and
other assets for $1.9 billion. Says a JPMorgan spokeswoman: "We are
aware of the credit quality of (WaMu's) portfolios and will manage risk

Credit card losses are already taking a
bite out of lenders' balance sheets. Bank of America, the nation's
second-largest issuer behind JPMorgan, revealed on Oct. 6 that roughly $3
billion of its $184 billion credit card portfolio had soured, a 50%
increase from a year ago. At the same time, the bank, which is also
dealing with the broader financial tumult, said it would have to cut its
dividend by 50% and raise $10 billion in fresh capital. The stock stumbled
more than 25% the next day when investors largely scoffed at the new
shares B of A was offering.

"The good news for us is that
we have the strength to get through this, but the bad news is that the
earnings recovery does take a while," says Bank of America spokesman
Bob Stickler. "We are prudently adjusting our underwriting standards
to adapt to changing economic conditions."

American Express, which caters to wealthier borrowers, upped its
provisions for credit card losses from $810 million to $1.5 billion in the
latest quarter, a sign that even upscale consumers are having trouble.

"We have enhanced our credit models and continue to prudently
manage our risk by scaling back some card acquisition efforts and reducing
credit lines where appropriate," an American Express spokeswoman

Continued: Like 'Boiler Room'

'Boiler Room'
The industry's practices during the lending boom are
coming back to haunt many credit card lenders. Cate Colombo, a former call
center staffer at MBNA, a big issuer bought by Bank of America in 2005,
says her job was to develop a rapport with credit card customers and
advise them to use more of their available credit. Colleagues would often
gather around her chair when she was on the phone with a consumer and
chant: "Sell, sell."

"It was like 'Boiler
Room,'" says Colombo, referring to a 2000 movie about unscrupulous
stockbrokers. "I knew that they would probably be in debt for the
rest of their lives."

Unless, of course, they default.
Responds Bank of America spokeswoman Betty Riess: "The allegations do
not reflect our practices. The bank has nothing to gain by extending
credit to people who do not have the ability to pay us back."

Regulators and politicians are trying to curb some of the
industry's abusive practices by limiting interest rate increases,
abolishing certain fees and cracking down on questionable billing
practices. Under rules proposed by the Federal Reserve, a borrower would
have a 21-day grace period before being hit with a late fee, instead of
the few days offered by some companies now.

A similar plan
working its way through Congress would allow banks to increase rates only
on consumers' future purchases -- not existing balances. And under both
proposals, credit card companies would have to allocate account holders'
payments equally to balances with different interest rates. Currently,
companies first apply payments to the debt with the lowest rate, which
means it takes longer and makes it costlier for consumers to pay off their

Government may ban some practices
The Senate isn't
expected to vote on the matter until early next year. The Fed's proposed
rules, currently being reviewed by the industry, could take effect around
that same time. But lenders seem to be preparing for the worst-case
scenario: an outright ban on some practices.

To get ahead of
rules that would hamper their ability to re-price accounts, for example,
many companies are jacking up interest rates. A survey of major issuers by
advocacy group Consumer Action found that 37% of companies had raised
rates across the board, even for borrowers with relatively pristine credit
records. "In anticipation of a federal crackdown, card companies are
scouring their portfolios and tightening credit," says Tower Group's

Even consumers like Michael Polemeni, who miss only a
single payment, can find themselves in the crosshairs of credit card
companies. The independent computer specialist relied heavily on his
credit cards for child-support payments and business expenses. Polemeni
generally made more than the minimum payment each month, carrying a
balance of about $2,000. But in July he missed a payment, and Providian,
owned by Washington Mutual, jacked up his rate from 9% to 30%. "I was
shocked because I am a very good customer," say Polemeni, who paid
off the full balance immediately. WaMu didn't return calls for comment.

Not everyone will be able to pay down their debts like
Polemeni. And that could make for a vicious cycle: As credit-card
companies raise rates, more consumers fall behind on their payments, which
then hurts the issuers. Says Innovest's Larkin, "We are going to see
the banks massively hit."

This article was reported and
written by Jessica Silver-Greenberg for BusinessWeek.

Published Oct. 17, 2008

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