Consumer credit card debt

Giving credit where credit is due: Wall Street fuels consumer debt binge

Terry Ideker put herself through nursing school with student loans and four credit cards. But her job at an Omaha, Neb., hospital didn't pay enough for her to support her kids and keep up with the mounting debt. With $8,000 in credit card bills on top of other expenses, she filed for bankruptcy last spring.

The process freed Ideker from her credit card bills--but not, alas, from new credit card offers. Despite her bankruptcy, she has been getting roughly two solicitations a month to renew her credit lines. Some cards come preapproved.

The solicitations are no clerical error. America is in fact so awash in money for consumers to borrow that almost anyone with a pulse is a potential cardholder today. Outstanding credit card debt has doubled in the past five years to $500 billion, while the amount of debt households must now service has grown to its highest share of income in 20 years. Personal bankruptcies, at 1.1 million, are at their highest level ever.

Already, consumer groups are starting to blame banks for rapacious marketing tactics. And economists worry that the current debt overhang will deepen the next recession. Some even see a disturbing parallel to the junk bond debt binge of the 1980s, which exacerbated the economic downturn and its accompanying credit crunch earlier this decade.

Street smarts. What's behind all this borrowing? It isn't just a consumer shopping frenzy or loan-happy banks. The real driving force has been clever Wall Street financiers. Over the past decade they have figured out a way to take bundles of credit card loans and sell them as bonds to investors; that in turn has made lending so profitable that card issuers can afford to take chances on the less-than-creditworthy set.

Last year, investment bankers raised nearly $50 billion for credit card operations this way. Deal making gets more attention, but it's this repackaging work that has been the growth business on Wall Street during the 1990s.

It's a simple but powerful concept. "In the old days," says Ed Bankole, a senior analyst at Moody's Investors Service, "a bank would lend $100 to a credit card holder and wait until the cardholder paid it back--sometimes six to nine months later--before lending that $100 again." Now, he says, the bank immediately takes that loan and a bunch of other loans and sells them to investors as bonds.

The advantage to the bank is that in days, instead of months, it can have its money to lend out again. The investors want these bonds because their yields are higher than bonds of similar risk and maturity. This trick, known as securitization, has generated big fees for the Wall Street firms that put the deals together. Last year, the top five firms in the field generated nearly $150 million.

What's made this practice such a bonanza for card issuers is the difference between the rates it gets and pays out. The cardholder's interest to the issuer is on average about 15 percent, while the issuer's interest payments to the investors who buy its bonds equal less than 7 percent.

With such big rewards, it's no wonder the industry is rushing to roll out more cards. Banks, department stores, gas stations, and phone and car companies have pushed credit for some time. But today Americans also can get a credit card from their union, grocery store, and online service, to name a few. The Association of Trial Lawyers has a card. So do fans of Frank Sinatra.

MBNA America and First USA, once pipsqueaks in a business dominated by giants like Citibank and Chase Manhattan, have in less than five years joined them among the top five credit card issuers in the country. And they couldn't have done it without Wall Street's help. First USA, a Dallas-based credit card company, had $2.8 billion in loans in 1992 and nearly $22.4 billion at the end of 1996. Nearly 80 percent of those funds were raised through securitization.

The consternation over mounting debt--at 5.45 percent of balances, delinquency rates are at their highest since at least 1973--may be having some impact. The double-digit growth rate in credit card loan volume has slowed, and mail solicitations are down as well, to 2.4 billion in 1996 from 2.7 billion in 1995. Indeed, last week credit card company Advanta reported worse-than-expected earnings because of higher delinquencies. Its stock price plunged, dragging down other bank and credit card company stocks.

But even with the drop in solicitations Americans still receive roughly 20 credit card offers a year. With profit margins so high, companies can afford to be cavalier about the risk of customers' not paying them back. That undoubtedly will keep the economy strong a bit longer. But if the Federal Reserve boosts interest rates at its meeting this week and stock prices plunge, watch for even more Americans going the way of Terry Ideker.