The reason there was barely a recession at all following the US stock-market
meltdown of 2000-2001 is usually explained by talk of "consumer spending".
It would probably, however, it would be more accurate to thank credit cards
instead. Most consumer spending is on credit cards in the US; what’s more, all
credit-card spending is considered consumer spending, even when the cards are
used for business purposes.
The credit boom in the US – according to an eye-opening New
York Times article today, credit-card charges increased from $338 billion
in 1990 to $1.525 trillion in 2003 – has certainly helped to fuel the
expansion of not only the US but also the global economy. It has also, however,
destroyed most of the trust that Americans have in their lenders.
When your lender is your local bank, you know the manager, the bank knows you
personally, and everybody is very clear on what your credit line and interest
rate is. When you borrow on a credit card, you might not even be sure what company
is issuing the card, you almost certainly have never talked to anybody at the
company, and both your credit line and interest rate can be altered at the sole
discretion of the card issuer. The New York Times has egregious examples, like
Ed Schwebel, whose interest rate went from 9.2% to 18% overnight, despite the
fact that he always paid his credit-card bill on time. Steve Strachan, meanwhile,
had his interest rate hiked from 5.25% to 20.21%, again without him ever making
a late payment. The new rate was so high that if he paid the minimum amount
each month, his total debt would go up even if he didn’t spend any money on
his credit card at all – and since the credit card company was steadily
reducing his credit limit to just above his balance, paying the minimum would
mean exceeding the limit and incurring penalty fees.
Probably smartly, most of the major credit-card companies refused to comment
for the New York Times story. They did find one chap, however, willing to put
his foot in his mouth:
Andrew Kahr, a financial services consultant who devised some widely used
consumer-lending strategies, including the zero-percent teaser rates, said
consumers should be able to recognize that the business is a "game of
Lending, I think it’s fair to say, should never be a "game of
chance", especially when credit-card companies, in a search for growth,
are pushing the envelope of creditworthiness when it comes to their cardholders,
both by issuing cards to riskier credits and by increasing credit limits more
or less across the board.
The broader problem, however, is that credit cards are now performing a role
they were never designed for in the first place. For those of us who pay off
our balance in full every month, they’re very useful things. For many individuals
and small business owners, however, they’re much more than that: they’re their
primary source of financing. You know the cliché about the independent
film which the director financed by maxing out his credit cards? It’s now a
reality across thousands of industries.
The weird fact is that even as credit has been expanding rapidly across the
US economy, individuals and small business owners are finding it as hard as
ever – if not actually more difficult – to get a loan from the bank.
Banks are not actively telling their customers that if they want more
credit they should sign up for a Visa card, of course, but they don’t need to.
For millions of Americans, credit cards are the only credit they can get.
We’re not talking small sums of money here, either. Many small business owners
carry six-figure revolving sums on their various cards; Steve Strachan, meanwhile,
was being charged $1,500 a month in finance charges alone, on a balance of $77,000.
In today’s low interest rate environment, such interest rates can reasonably
be considered usurious: the bank’s cost of funds for that $77,000 is maybe $130
a month, which means they’re charging a markup of somewhere over 1,000%.
Many small business owners are hard-working, talented individuals who, like
most people, don’t like thinking about money very much. The genius of the American
economy is that the main criterion for becoming a successful landscape gardener,
say, is being a good landscape gardener, rather than being someone with a head
for figures. But the explosion in credit-card debt in the US is essentially
a tax on financial ignorance. Fee revenue on credit cards alone has now exceeded
$20 billion a year – that’s revenue from charging cardholders $15 for
paying their bill by phone, or $35 for getting their payment in just a few hours
late. If 144 million Americans have credit cards, that means the average
cardholder is paying over $140 a year in fees, and, assuming that the 40% of
cardholders who pay their cards off in full every month don’t get anywhere near
that figure, the fee burden for the typical "revolver" – someone
who never really pays down his balance – will be substantially higher.
More invidious still are the interest charges. Here’s an example of some calculations
which I have to do and which no bank will help you with: the situation, in which
I do sometimes find myself, where I have say a $2000 credit card bill coming
due, $1000 in the bank, and a big paycheque coming in one week. The credit card
interest rate is quite a lot lower than the bank’s overdraft facility: in the
region of 9% as opposed to 18%. But if I pay only $1000 of my credit card bill,
the remaining balance of $1000 will start accruing interest not from the day
the bill was due, but from the day the initial charges were incurred. So it’s
actually cheaper for me to pay the credit card in full and borrow $1000 from
the bank for a week than it is to pay $1000 of the credit card balance off now,
and the rest when I get paid.
I’m a financial journalist, however: I think that way. Most people, in contrast,
faced with exactly the same situation, simply pay the minimum due on the credit
card – maybe $50 – and keep a reasonable cushion of cash in their
chequing accounts. There’s some kind of internal stigma associated with a bank
overdraft, you see, which is not associated with a credit card balance, and
people would generally much rather have the latter than the former. It’s the
age-old paradox of consumer finance: someone who has $2000 in their savings
account and a $5000 credit-card balance thinks they’re saving money. And thousands
of small business owners, I’m afraid, make a less egregious but more costly
mistake: rather than go to the effort of finding a loan, they simply run up
the balance on their credit cards.
A few years ago, I realised that I wasn’t going to be able to pay off my credit
card balance that month – or the next month, either. It wasn’t a huge
amount of money, but if I’d done nothing and simply let it acccumulate as I
continued to spend more on my credit card, I would rapidly have found my debts
spiralling. Instead, I found a friendly credit union who lent me enough money
to pay off the credit card balance, and paid them back on an installment loan
over the course of a year. The most difficult thing about the whole process
was getting a mere one-year loan: everybody was trying to point me to more expensive
two-year, three-year or even five-year options. But I knew exactly what I wanted,
and eventually I found it.
US card issuers now make $30 billion a year in pretax profit on their credit
card operations. That number is so large that banks have no incentive to aggressively
sell their loan products instead: their credit cards are much more profitable.
The fewer customers they have taking out formal loans, the more customers they
will have taking out informal loans in the form of credit card debt, and the
more money they will make.
Credit cards are magnificent engines of economic growth: many economists believe
that one of the main reasons that China cannot sustain its present levels of
GDP growth much longer is precisely because consumer credit has never taken
off in the country. In the US, however, they have become an untameable monster
which actually reduces the kind of well-constructed small business finance which
could power the economy much more sustainably. Bad money drives out good, they
say, and the same is true for credit. US borrowers have become addicted to expensive
and easy debt; the banks, of course, are the willing pushers. And there’s no
rehab program in sight.