Why Wall Street is Making Your Credit Cards More Expensive

Similar to the selling off of mortgage pools to Wall Street institutions, pension funds, and insurance companies, the credit card issuers have been packaging and selling pools of credit card debt for over twenty years.
The practice has accelerated over the past six years as seven of the largest issuers of credit cards packaged an increasing amount of card debt into securities and sold them to the same types of investors that buy pooled mortgages. Within the last two months, for example, JP Morgan Chase has sold over $5 billion in packaged credit card debt.  

The ability to package and sell off credit card debt has provided issuers with a powerful incentive to raise interest rates, card fees, and penalties as offloading the debt reduces the risk of default for the bank. The interest rate on credit card debt pools is usually linked to a lending rate such as the London interbank offered rate (LIBOR) with an added premium which comprises the return on the investment. In the case of JP Morgan Chase’s recent offering the rate was set at the one month LIBOR rate plus 85 basis points (.85%) for a return of a little over one percent for a one year offering.
By basing the pool’s interest rate on LIBOR, the investment is considered to be a variable rate but the LIBOR rate isn’t considered to be very volatile so the credit card issuers have a pretty good idea of what the deal will cost them over time. The best part of the deal for issuers is that the buyers have assumed much of the risk for the packaged accounts at a low interest rate while the issuers can keep most of the profit from hiking rates, fees, and other charges. In effect, once a package is securitized and sold, banks can earn more without a commensurate rise in risk at their card holders’ expense. Securitization gives banks "more of the upside with less of the downside," agrees Elizabeth Warren, a Harvard law professor. “If a bank that sells off card debt doubles a borrower's interest rate, it will typically keep most of the profits from this increase — yet, may not bear all the exposure if the account later defaults.”
Securitization has been a "major impetus" for issuers to increase penalty fees and rates in recent years, says Adam Levitin, a Georgetown University law professor and card expert. Issuers "have little to lose if they squeeze too hard (if consumers default), but a lot to gain if they can extract additional payments" from card users, he says. Agreeing with the idea that increased fees on customers are the result of securitization, Travis Plunkett, legislative director for the Consumer Federation of America said, "Securitization, has increased the willingness of credit card companies to offer riskier loans. And to compensate, they have moved to a business model that involves hitting consumers with very high — often unjustifiably high — rates and fees."
The other issue tied to increased rates and fees is that lower income households pay a disproportionate amount of fees and penalties, making them more profitable for card issuers than their higher income holders. Studies have shown that households with incomes below $25,000 are twice as likely to pay credit card rates of more than 20% than those earning $50,000 and five times more likely to pay such rates than those earning $100,000. Another study revealed that lower income households, while 10% of the total accounts paid 40% of banks’ fees.
Banks across the board vehemently deny that securitization and increased customer costs are linked, saying that new data tracking tools help them identify higher risk borrowers which helps them pinpoint which customers should pay more in fees and penalties. There were no comments in relation to fee and rate hikes that are now being put in place which will affect, what are considered to be, the lowest risk card holders. Another comment from the industry was given by James Chessen, chief economist at the American Bankers Association who said, "Securitization is a method of funding credit card loans. Penalty fees and rates are entirely separate and completely avoidable." This comment isn’t exactly accurate either as while penalties may be avoidable, many of the new fees are being imposed on customers outside of any kind of penalties.
One thing everyone agrees on is that losses on credit card accounts are on the increase with delinquencies at their highest point in six years. Charge-offs, resulting from banks give up on collecting unpaid card balances, are on the increase as well. Industry analysts are estimating that write-offs will set a record for 2009, with forecasted numbers hovering around $100 million. Should write-offs reach that level, it would equal about 10% of all credit card debt. While much smaller than the amount of outstanding mortgages, continued deterioration of credit card accounts could put many financial institutions at risk of failure.   
With increasing calls for regulation of securitization practices, credit card issuers are citing economic conditions and losses resulting from the meltdown of mortgages in their portfolios as reasons that regulators should take a hands-off approach toward their ability to raise funding. In the meantime they’re securitizing as much debt as possible. Among large card issuers, Bank of America, Citigroup, Discover and JP Morgan Chase have securitized approximately half of their credit card portfolios. American Express has offloaded about a third and Capital One has securitized almost three quarters of its portfolio.
Banks are also reacting to the passage of the Credit CARD Act which is intended to curb abusive rate and fee hikes. Left with a window where the provisions of the Act will be phased in between August of 2009 and February of 2010, credit card issuers are hiking rates and fees before restrictions go into effect. Banks also campaigned vigorously against the passage of that bill saying that restrictions would reduce Wall Street’s appetite for credit card backed securities which, in turn, would restrict the availability of credit and make it more expensive. 
The implications for credit card issuers, holders and the overall economy are steep as unemployment and higher fees combine to push card holders into delinquency and default. Even after hiking expenses across the board, credit card issuers are continuing to take losses as they restrict credit availability to risky borrowers. Card holders, in turn, are seeing their credit availability slashed at a time when they need it the most, resulting in spending cutbacks.
Card holders are reacting to fee hikes by searching for better deals with different issuers but many don’t have the option of changing due to low credit scores or maxed out credit availability. Those on the edge and likely to default are headed toward debt settlement, or other forms of debt relief. While debt settlement provides immediate relief and long term benefits for the card holder, an avalanche of settlements would be another huge challenge for the credit card issuers. 
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