Credit cards

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.

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10 Responses to Credit cards

  1. Matthew says:

    Hope you’ve noticed the delicious irony that your wail against credit-card debt prompted Google to send your way a vast stack of credit-card ads.

  2. theboxtank says:

    Credit Cards

    The New York Times and Frontline have teamed up to for an investigation seeking to learn more about the credit card industry in the United States. The team looks at techniques used by the industry “to earn record profits and

  3. Michelle says:

    Well done Felix, you have banged the nail on the head.

  4. Linda says:

    What is sad is that a lot of individual credit card debt begins at age 18 when kids are bombarded with credit card applications in the mail and on college campuses. Most kids at that age do not have a job that can support a credit card and also have very little idea of what is in store for them as a result.

  5. Greg says:

    And it gets worse.

    HereÌs an article about what Morgan Stanley chief economist Stephen Roach has been saying about the coming Ïeconomic Armageddon.Ó

    Basic line of thought is this:

    Massive trade deficit = falling dollar = interest rates rising much higher much faster than Greenspan would like (higher interest rates being necessary to keep foreign money in T-bills and keep inflation low.)

    ÏTo finance its current account deficit with the rest of the world America has to import $2.6 billion in cash. Every working day. That is an amazing 80 percent of the entire world’s net savings.Ó

    So rates rise hard and fast and with them the interest Americans pay on their mountains of credit card and home mortgage debt.

    ÏTwenty years ago the total debt of U.S. households was equal to half the size of the economy. Today the figure is 85 percent.Ó Ouch.

    Rates shoot up. Personal bankruptcies abound. Foreclosures as far as the eye can see. Plagues of locusts. Cats sleeping with dogs. In general, no fun at all.

    And donÌt take it from Roach, hereÌs Greenspan himself on the issue:

    ÏThe Fed chief also seemed to be practically guaranteeing higher interest rates, saying that investors who weren’t hedged against a rise were Îdesirous of losing money.ÌÓ,1,4822433.story

    Oh, and weÌre overdue for a massive flu pandemic which could affect 30% of the worldÌs population and kill 7 million people in a *best case* scenario:

  6. Amanda says:

    What a great piece, Felix. This post is very near and dear to my heart. I am fascinated by our culture’s strange pas de deux with consumer debt. You are correct when you say that Americans absorbed the shock of the recession by parcelling it up and increasing our average individual debt load. What cannot be ignored, however, is the culture’s complicity in encouraging this behavior. Remember after September 11th when President Bush told Americans to be patriotic by spending what they normally would on the holiday season? (Actually, we increased spending over the previous year.) Easy credit has allowed us to cognitively divorce spending from income. It’s become emotionally driven because the consequences are experienced at too great a distance from the original stimulus.

    To illustrate the psychology behind this phenomenon, consider how hard it is to diet. If you ate a piece of cake and immediately gained two pounds, you would be less inclined to eat cake. But a week or two of marginally increased calorie intake, and it’s hard for our brains to link the cause and the effect. Though we know the two to be related to each other, because we are impulsive, craving, emotionally-foggy beings who love cake and new shoes, we will find ways to believe what we want to believe. Be it the multi-billion dollar consumer credit or diet industry, we buy in. And because afterward we feel guilt and shame (who were we to think there was such a thing as a free lunch!), we imagine it to be an individual problem. But the truth is that entire economies are floated on the ease by which our cognitive dissonance is circumvented. People are only beginning to wake up to the fact that consumer credit is not the gift it is presented as. There will certainly be a growing backlash against creditors, and hopefully with time it will lead to a new exploration of how our culture constructs ideas about value and worth.

    If you haven’t checked out Arline Prigoff’s book Economics for Social Workers: Social Outcomes of Economic Globalization, you might want to give it a glance. Minds, Money, and Markets by Shlomo Maital is another favorite (an oldie but goodie). I obviously have a particular point of view on the subject, but day after day of counseling people around spending and debt will do that to you!

  7. jame says:

    Good article, Felix, although one could make a good argument that ‘consumer spending’ and credit card spending is the feel-good result of the property market. People think they’re rich when their housing values go up, particularly when they’ve been able to refinance mortgages and other loans at ultra-low rates – sometimes even negative rates when adjusted for inflation. That scenario is going to end. I don’t know enough to predict whether that means real estate prices are going to pop. Prices in London and Sydney are more ridiculous than, say, New York, so there’s probably still room to go. But eventually housing prices will decline. Let’s just hope such declines are gradual and spread out across the country, rather than suddenly and all at once.

  8. Stephen Strachan says:

    I am the ‘Steve Strachan’ mentioned in the above

    NY Times article. There are a few other aspects

    of the article that were omitted due to “space

    and editorial constraints”; ergo, the reason for

    my presence here today.

    My Equifax, Experian and Trans-Union CBR reports

    all seem to agree on one thing…that I’ve never

    been late on any account (be that the 10 or so

    that I DO have, or the 40 or so that I DON’T!!!)

    Consequently, I have watched my FICO score fall

    from approximately 737 (with almost $500,000 in

    unsecured debt — yes, you read that right!), to

    the high-600s — after cutting the amount of my

    outstanding debt by almost 70%!!!

    My largest creditor is BankOne (previously known

    as First USA Bank). They have this lovely little

    practice of lowering credit lines almost down to

    the very dollar of balance…this has the net

    effect of raising the percentage of debt to the

    available credit, which in turn has a net effect

    of lowering the FICO score. This “triumvirate”

    then allows BankOne their self-fulfilling ability

    to raise my interest rates due to the perceived

    higher level of risk!!! The reality of it all is

    that I’ve paid down 70% of the debt so have been

    rewarded with FIVE back-to-back rate increases

    (at last count).

    At one point, BankOne had raised my APR on an

    already-existing balance of $70,000 from 7.99% to

    24.99%…again, there are NO late payments, NO

    returned checks, and NO over-the-limit charges.

    These increases were ostensibly due to my “debt

    ratio” (the fact that I had actually PAID OFF the

    $70,000…PLUS ANOTHER $700+…was immaterial.

    The numerous “3.99% for life” offers BankOne had

    sent me were cancelled and the account closed!!!

    I paid off OVER $70,000 in approximately 90 days

    so as to be able to take advantage of their 3.99%

    offer, as per the numerous offerings received and

    fully documented my payments and contacts along

    every step of the way. During the last 30 days

    or so alone, I sent almost $60,000 so as to be

    able to lower my finance charges by about $1000/


    As a small business owner, I DO know a bit about

    the law. If I were to engage in such a practice

    it would be a clear case of “bait and switch”.

    When I vociferously questioned BankOne about the

    decision to actually CLOSE my account, LET ALONE

    to not honor as much as even $1 under the 3.99%

    offer, I was told that even though the balance

    was paid off IN FULL (and then some) the good

    people at Fair, Isaacs and Co. (FICO) had not

    reflected those payments so the account was being

    closed, and not even a $1 “convenience check”

    would be honored by BankOne.

    That particular account had a $90,000 credit line

    prior to its being lowered to $70,000…as I’m

    sure you’re all aware, available credit lines as

    high as this are NOT just “given”, they can only

    be earned…and earn it I did!!!

    The NY Times article touched upon a few details

    relevant to another credit line I had with US

    Bank. This was a $54,000, PRIME + 1% FOR LIFE

    credit line…again, earned, not simply granted.

    I had this account for over 10 years…again, NO



    One day in 2003, I received a letter from US Bank

    stating that my ALREADY-EXISTING balance of about

    $48,000 was being raised from the CONTRACTUAL

    “Prime Plus 1% (then 5.00%) to 20.21% unless I

    declined this “Change of Terms” in writing, which

    I did, naturally. Consequently, US Bank closed

    THAT account (apparently, I would have been seen

    as an “acceptable risk” at 20.21% on a $48,000

    balance as opposed to 5% on the same amount.)

    Frankly, I have never considered myself to be an

    “activist” in this regard. If I were deserving

    of such treatment and actually qualified as a

    “delinquent account”, I would accept my fate and

    “belly up to the bar’, albeit ruefully. This was

    NOT the case in these circumstances, however, so

    the opportunity to expose these practices to the

    NY Times and PBS/Frontline was welcomed.


    Steve Strachan

  9. lost of people now are applying for credit cards for personal or business purposes. beforehand, you have to choose a credit card company with low interest rates and good reward system. You should compare the benefits you can get from various financial institutions.

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