Credit Card Industry Critic Highly Opinionated, Clueless

Adam Levitin, professor of law at Georgetown, is no fan of the credit card industry:

The card industry’s business model . . . needs to change. Just as with subprime mortgages, the credit card business model creates a perverse incentive to lend indiscriminately and ignore delinquencies. Card issuers make money on every credit card transaction, regardless of whether the consumer ultimately pays a finance charge.

Not! Two points:

1. Card lenders do too care about delinquencies. A lot. If Levitin believes interchange (the transaction fees lenders receive from merchants) drives card company revenue and that net interest income is a sideline, he has things backwards. At Capital One last quarter, for instance, interchange fees were $146 million, while net interest income came to $1.8 billion.

2. In fact, card lenders that fail to pay proper attention to credit tend to come to grisly ends—which is why the monoline credit card lender has essentially become extinct. Do you remember First USA? Providian? MBNA? All either collapsed or were forced into mergers following the sort of credit quality deterioration that Adam Levitin seems to believe is beside the point.

P.S.: While I’m at it, Levitin seems to not understand how securitizations work, either. He writes that “when card issuers securitize credit card debt, they transform the credit card debt into a pool of assets used to pay off bonds. If the pool turns out not to be large enough, the bond investors take the loss. But if there’s a surplus, it goes to the card issuer.” That’s exactly wrong. Lenders do have an economic interest in the loans they securitize, and take the first loss in the event of credit deterioration. Which only makes sense. What fixed-income buyer would invest in an ABS structured the way Levitin describes? In fact, card-backed ABS virtually never default.

Levitin is a bankrutpcy law professor, remember. But he seems to not have a clue as to how the credit card industry works. Crazy. . . .

Comments

[Mohamed Soubra:]

Creditcard companies are like brokers they only get a commission on every single transaction and they make an extra forex income from the usage of Crditcard in non USD currency except for the countries that they have a special agreement with the issuers for local settlement,but will the Banks keep on issuing or renewing their client's Creditcard in this creatical economic situation, the answer is no,and the volume of transactions will go down and it is started to be lower than expected this refferring to Visa and Mastercard financial statement.

2008 Dec 12 08:19 AM

[Credit Card...:]

Levitin is not wrong at all. and if he sounds crazy it's only because he is describing a system/business model that is a house of cards. Get real. Ever heard of the rule of thirds? Income for credit card issuers is broken up into thirds: 1/3 comes from interest income, 1/3 comes from fees, 1/3 comes from interchange. Want to hear the real dirty laundry? When credit card issuers need to raise revenue want to know where they go? #1 raise interchange fees--retailers don't have a say anyways, it's a take it or leave it proposition. #2 fees-- issuers can raise late fees and over limit fees by just $5 and have a significant impact on their P&L. #3 Interest rates--Issuers usually are very hesitant to change these because they are very visible and consumers will go and complain to congress. So issuers came up with Tiered APRs from 9% to 29% where 5% of the cardholders get the 9% APR and 50% of the cardholders get the 29% APR. The whole business model is slimy and is about forcing fees and costs down everyone's throats. Just like Levitin said, interchange income has allowed banks to lend recklessly and to develop credit line strategies that drive spend first, and worry about repayment second. Think I'm wrong? Then why do banks count "turns"? Turns indicates the total sales volume spent on a card versus that person's credit line. If a bank can get a cardholder to turn above a factor of 2, the bank will make more on interchange from that customer than they will from interest income. Banks are riding the retailers to death. I'm not even talking about the Walmarts or Targets. I'm more concerned about the dry cleaners and bakeries. Those guys are spending $20,000 or more a year to accept credit cards and in an environment like today, that amount can be the difference between staying in business or going under. Reform MUST come.

2008 Dec 12 12:31 PM

[Credit Card...:]

I almost forgot my favorite part! You use the word "clueless." You quote Capital One interchange income as $146 million. It's in their 10K so it must be true. Let's think about that. Visa published interchange rates of 1.51% for Tier III retailers is a pretty good average to use would mean that Capital One cardmembers only purchased $10 billion last quarter. Actually, according to Nilson Report Capital One's volume last quarter was closer to $30 billion. So interchange gross income for that one quarter was closer to $450 million--but they only reported $150. Where did the missing $300 million go? Maybe rewards? Cap One reported total rewards expense of $180 million in 2007--divide it by 4 and suddenly we've found $45 million of that missing $300 million, but where's the the next $255? Rewards Liability? In all of 2007 rewards liability went up from $1.1B to $1.3B a difference of $200 million. Now divide that by 4 for last quarter and we found another $50 million. Now only $205 million is missing from last quarter. Where did it go? Contra-loss account to shore up losses? No! They wouldn't do that! It must be hidden somewhere. Seriously, you wall street guys need to start doing the math behind the numbers and stop taking the 10Ks as religion. The credit card house of cards is preparing to fall. Don't drive investors off the cliff again.

2008 Dec 12 01:37 PM

[Ingenue:]

"Do you remember First USA? Providian? MBNA?"

Yes, I remember them. I am still a customer trying to free myself from their predatory tactics. I will be canceling a credit card soon after I pay it off. Washington Mutual, which bought Providian, are still employing the same nasty tactics, double-billing, raising interest rates for no apparent reason except greed, and the list goes on.

And Washington Mutual got bought out recently by JP Morgan Chase, another big bank known for their terrible service and continuing predatory tactics.

It has already been debated and proven to death that these predators make more money by these predatory tactics than they do via fair interest rates.

During an investigation into a class action suit against Providian (which they lost), an email from Kar, an officer of Providian, surfaced, in it he wrote "[the] problem is to squeeze out enough revenue and get customers to sit still for the squeeze."

I think the clueless is you, sir.

2008 Dec 13 08:17 AM

[bobbiemcgee:]

CC cos. are a scam on the Public like he says. Charge outrageous fees and 31.99% int when they have bailout money and fed money @ 0%. Hope the whole Country defaults, they deserve to take the losses.

2008 Dec 23 08:27 PM

[Mlynn:]

The high interest rates are charged to people who overspend and don't watch their budgets. We use our credit card strictly for convenience, not as another lending tool. That is what has happened to this spoiled overspending society that has been created by easy credit. Responsible credit card users will not suffer.

Jan 02 03:35 PM