The real credit card problem: It’s not bad loans so much as bad lenders

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For a long time—ever since the subprime mortgage market fell apart in 2007—people have been warning that credit cards were going to be “the next subprime.”

Well, there have been a whole lot of other next subprimes since then: non-subprime mortgage loans, investment banks, Scandinavian island nations (well, one Scandinavian island nation), etc. And yet the credit card business stubbornly failed to implode.

The reason was pretty simple: Credit-card lenders—unlike their mortgage brethren in recent years—never thought they were immune from losses. Significant borrower defaults have always been part of the business model. In a bad recession those losses are going to get much worse, worse than the lenders ever planned for, but there’s not the same falling-off-a-cliff trajectory that we’ve seen lately in other financial sectors. At least not until now.

I got a hint of the new credit card troubles last week talking to Michael Croxson, the president of debt counseling giant CareOne Credit. He said CreditCareOne was suddenly getting a lot more calls from people with solidly middle class incomes (in the $50,000s) and okay credit scores (above 600). I asked if credit card lenders were being caught unawares by this. Actually, he said, they’re causing it:

People with four or five credit cards who thought their outstanding credit lines could see them through a tight spot are getting notice that their credit lines are being cut. With that cushion gone, they run into trouble. “Not that it’s a cushion you should ever rely on to pay for living expenses,” Croxson said, “but if it disappears suddenly, that’s another ball that’s dropped.”

Then, in Wednesday’s WSJ, banking analyst Meredith Whitney described what’s going on in more depth (I recommend reading her entire op-ed piece, but this part seemed especially salient):

[C]redit-card lenders are currently playing a game of “hot potato,” in which no one wants to be the last one holding an open credit-card line to an individual or business. While a mortgage loan is largely a “monogamous” relationship between borrower and lender, an individual has multiple relationships with credit-card providers. Thus, as lines are cut, risk exposure increases to the remaining lender with the biggest line outstanding.

Here, such a negative spiral strategy necessitates immediate action. Currently five lenders dominate two thirds of the market. These lenders need to work together to protect one another and preserve credit lines to able paying borrowers by setting consortium guidelines on credit. We, as Americans, are all in the same soup here, and desperate times are requiring of radical and cooperative measures.

This last point is a crucial one, with application far beyond credit cards. In normal times, what drives our economy forward is individuals (and corporations) looking out for their own interests. In a financial panic, individuals and corporations looking to get their money out before others do simply speed the collapse. It’s one of the clearest cases in all economics for collective action. So if I hear one more person saying that all we need to do is let the free market work its magic