The defaults that started with the sub-prime loans crisis in the US leading to a global $7.7-trillion loss in stock market value since October, are now showing signs of moving into the US credit card industry that will hit the balace sheets of the card issuing banks.
Reports indicate that a substantial portion of of the 158 million US card holders using 1.5 billion cards have started defaulting and banks had to write of approx $21 billion in bad credit loans in the first six months of this year and expect a further loss of $55 billion in the next 12 months.
The mortgage crisis has been the focus of the US public, media and the government alike that no one noticed or too tired to view the oncoming of the next shockwave – credit cards, as the lethal combination of mortgage losses and now the surge in credit card defaults has the potential to bring the entire US economy to its knees.
While campaigning in Edinburg, Texas, US presidential candidate, Barack Obama had warned students at the University of Texas-Pan American, way back in February this year, ''Just be careful about those credit cards, all right? Don't eat out as much.'' After the foreclosure crisis, he had warned ''credit cards are next in line.''
As with nearly all US banks giving mortgage loans to people who could ill afford them, the same story is expected to unfold in the credit card industry where banks have been aggressively peddling credit cards over the years to consumers who are least eligible to hold one, including students, as returns from cards is higher than other banksing services.
One commentator remarked that access to easy credit with unrealistic balance limits and the underlying message that it's OK to spend what you don't have, is as unsound as any sub prime mortgage scam.
For years, consumers in the US have become ever more dependent on credit cards with American Express, the largest credit card issuer in the US coined the famous by line ''Never leave home without it.'' Now an average American does not leave home without at least 10 credit cards and a whole host of other supermarket credit cards in his wallet.
Five big financial companies, Discover Financial Services, Bank of America, Citigroup, JPMorgan Chase and Capital One Financial issue around 80 per cent of all US credit cards.
Credit card issuers like Visa, MasterCard, American Express, Discover and the 10 banks that dominate the industry spend an estimated $2 billion a year in marketing.
Of late retailers, a wide range of companies, sports teams, unions and even universities have joined the bandwagon and have launched specialized cards like the car companies that suddenly woke up to find that they made more money on car loans than selling cars.
How deep is the problem?
According to Federal Reserve figures, in the US alone more than $850 billion in unpaid credit card balances is at stake and fast approaching $1 trillion, roughly the same amount as in the subprime market.
CNN reported that worldwide, consumers have racked up more than $2.2 trillion in purchases and cash advances on major credit cards in the last year.
The unpaid debt portion of this with US consumers is $68 billion, thus increasing credit card debt by 7.8 per cent, the largest increase in seven years.
Even as they spent, consumers had been going into default at a stunning rate with delinquent credit card accounts this year hitting a six-year high of 4.9 per cent and the charge-offs -when banks give up on collecting debt, have reached a all time high of 5.5 per cent in the second quarter, as per the latest data available with the US Federal Reserve.
Since last year, major banks were setting aside billions as reserves for credit card loan loss and anticipating an increase of 20 per cent in non payments over the next two to four quarters.
Capital One, one of the biggest credit card banks, was forced to write off $1.9 billion in bad debt in the last quarter of 2007 and serious delinquencies among some of the biggest lenders rose by 50 per cent or more in the value of accounts that were at least 90 days delinquent.
Just like the mortgage debt which created a financial havoc worldwide, credit card debt is pooled and then resold to investment houses, other banks and institutional investors.
US credit card debt grew by 435 per cent from 2002 to year-end 2007, from $211 billion to approx $915 billion.
About 45 per cent of this $915 billion in credit card debt has been packaged into these pools, which not only creates a risk to a few banks but many other institutions as well who will be forced out of business due to credit card debt write offs.
The national savings rate was 10 to 11 per cent in the l980s and since 2005, Americans have saved less than 1 per cent of their disposable incomes with a negative saving rate as of March this year, making an average America broke, and credit cards played a major role in getting them there.
Currently, the losses on credit card debt which stands at 5.5 per cent could rise to 7.9 per cent and the industry will stand to lose $55 billion this year, as the financial crisis has seen companies laying off thousand of workers all over the US. People will add up to the credit card debt as the unemployment rate has increased by about 2 million people in the last 12 months.
The US Department of Labour reported that the US shed 1,59,000 jobs in September and the list of companies which have announced a cut in jobs read like a Who's Who of corporate America: Merck, Yahoo, General Electric, Xerox, Pratt & Whitney, Goldman Sachs, Whirlpool, Bank of America, Pepsi, Hewlett Packard, Alcoa, Coca-Cola, the three big Detroit auto manufacturers, leading newspapers, banks and financial institutions and nearly all the airlines.
To solve the ever increasing credit card defaults, banks and consumer groups are lobbying US regulators to forgive 40 per cent of the debt of most financially stressed consumers who are close to bankruptcy and they could pay off their remaining card debt, interest free in five years.
Banks could begin with this test scheme on 50,000 consumers, in hopes of expanding it to tens of thousands of others.