The Credit Card Time Bomb Is Ticking

By Peter D. Schiff

For those holding out hope that the American economy can miraculously avoid a long and deep recession, consumer credit is often viewed as the wonder drug that can cure all manner of economic ills. As such, last week’s report showing that consumer credit grew by $15 billion was widely heralded as proof of America’s economic strength and resilience.

The reality is very different, however: We’re already suffering from the aftereffects of too much debt, meaning that our salvation cannot be found in more of the same.

Death by a Thousand Charge Slips

Credit card debt, which now stands at whopping $957 billion nationally (approximately $3,000 for every U.S. citizen) has, in recent years, taken on a different role in the life of American consumers.

In the past, credit cards were used primarily to purchase big-ticket items, enabling consumers to spread the costs out over many months, making goods a bit more affordable.

Now, however, charge cards are increasingly being used to bridge the gap between cost of living and the diminishing purchasing power of Americans who have been taxed mercilessly by inflation. By buying with available credit instead of unavailable cash, consumers are not simply postponing the pain of higher prices, but compounding it by packing interest expenses into the costs of everyday purchases. In addition, as home equity credit is now unavailable to fund large purchases, many consumers are turning to non-deductible, higher-cost credit card debt as their last remaining lifeline. As such, credit card debt compounds steadily, and for many borrowers, becomes increasingly impossible to pay down.

The statistics tell the tale. According to Equifax Inc. (EFX) a credit card analysis firm, people have been buying more with their credit cards but paying down less. As a result, average balances jumped nearly 9% in 2007 and delinquency rates recently hit a four-year high of 4.5%.

Also, the reliance on credit cards is preventing some of the market’s salutary forces from working. With credit always an option, domestic demand remains strong - despite rising prices. Absent the option of putting more costly gasoline on their credit cards, Americans might have actually been forced to cut back on their fuel consumption, taking some of the upward pressure off gas prices.

It should be painfully obvious that expanded consumer credit is actually evidence of deterioration - not improvement. Unfortunately, when it comes to understanding the economy, there is little common sense on display. By going even deeper into debt just to make ends meet, American consumers are digging themselves, and our entire economy, into an ever-deeper economic hole and laying the foundation for the next major credit debacle. It’s fitting that just as both U.S. Treasury Secretary Henry M. Paulson and JP Morgan Chase & Co. (JPM) Chief Executive Officer Jamie Dimon declared that the worst of the crisis has past, we are on the verge of kicking this credit mess into a much-higher gear.

My guess is that many Americans continue to run up massive credit card debt because they have little intention of ever paying it off. Since many who are underwater on their home loans, and behind on their auto and student loans, too, see bankruptcy as a foregone conclusion, they see no reason not to just go ahead and pile on as much debt as possible while the taps remain open.

Those choking on credit-card debt may also be taking cheer from the gathering government campaign to bail out over-leveraged homeowners. The sheer numbers of consumers who are afflicted with spiraling monthly payments will make credit card relief a potent political issue for crusading congressional and presidential candidates. After all, there are few fundamental differences between those who borrowed too much to buy houses and those who made the same mistake with consumer goods.

If the government bails out the former, then why not the latter, as well? In fact, one reason some homeowners have such large mortgages is that they consolidated their credit card debts into their mortgages each time they refinanced. Why should renters be forced to pay off their credit card debts while homeowners get to have their debts forgiven?

It’s certainly a fair question.

But it may also be moot. Soon, as credit-card delinquencies rise - and losses on pools of securitized credit card debt mount - those supplying the credit will finally get wise to the fact they will never get their money back. As a result, the market for such debt will dry up even more quickly than did the market for subprime mortgages. Credit cards will therefore be much harder to come by and will have much lower limits then they do today. Limited to only the cash in their wallets, Americans finally will be forced to dramatically curtail their spending, and the recession will finally gather serious momentum.

Comments

[fredoil]

Finally someone who is willing to say what really is going on, in a public story. I can't believe how many negative news stories are hitting the market everyday, and yet look at the market pigs run it up yet again. Sometime soon I hope all these pigs get slautered.

[lwaia]

This article does not seem to talke into account that an increasing number of credit card users are using their card as cash and paying off their bill each month, thereby having an ongoing record and avoiding interest charges. Please figure that in your calculations!

[ivy]

Let's not forget that Visa doesn't hold debt- just makes money on each transaction!

[herohero]

In spite of all this, Visa and MA make their money of transactions, as the previous poster mentioned. Therefore, can we really expect either of their stocks to decrease in value significantly? People will just jump from one cc to another, then to a bank card (which is usually linked to Mastercard or Visa) and so forth. I don't see the extreme downside to owning Visa or Mastercard stocks right now.

[RichardMendales]

It's even worse than that. People are using plastic for things it wasn't meant for, and running up higher debt in doing so. A good example is higher education expenses. It's not just that people behind on their student loans are running up credit card debt. Beyond that, student loan availability has not kept up with the above-inflation rise in the costs of education, and students are using credit cards to make up part of the difference.

[gus thetrader]

Not only that but, credit card usage is a global.........He is taking into account just usage in the USA.. but Visa and Mastercard are international............ their transactions should increase.. and so will their profits.

[torino-t]

Just like the 2 previous comments...VISA is a processor NOT a debt holder...the more consumer jumps from 1 bank 2 other the more he/she will use the card...assume they'll be a credit crunch in CC debts in here (USA) it won't affect the global market unlike the CDOs & LOBs of mortgage market.

Outside of Europe, the rest of the world is just starting to get the prestige of carrying Credit Cards & using them. There'll be Billions of transactions in Brazil, Argentina, Chile,...China, India, the Middle East,...

Bottom line, these pull backs in Visa & MA is & is big buying opportunities to both CORE holdings & ofcourse CALL options.

[torino-t]

oops, these pull backs in Visa & MA are & are big buying opportunities

[Skjellifetti]

Instead of guessing, the author should learn to use Google:

www.stlouisfed.org/pub...

40% or so of U.S. households have no credit card debt. The data seems to show that the problems are concentrated among lower and lower-middlle income households.

[Chorniki]

Was in Quizno's at the cash register waiting to pay. In front of me stood a Mom and about 12 year daughter. Mom fishes out a credit card
offering to pay the @29.55 tab. Card rejected. Fished out another card. Rejected. Third try, card is accepted. My turn. Cash. Asked the attendant if the previous spectacle occurred often. ""All the
time, now." Appeared to be from lower-middle income classes.
Hey, the fun is just getting started!

[vasu sheth]

I believe the writer has missed oppertunity when Visa came in market. As many of your writers said this plastic is considered to be a sign of prestige in many developing countries, so please don't underestimate it's use. Not everybody is adding debt to their credit, many of us use this to pay our bills and keep a good accounting system!

[Frogman]

Schiff you must provide evidence and fact. The article has very little sound data and furthermore your dooms days scenario is uninspiring since this is your only position for decades...(even a broken clock is right twice a day) Now I am not disagreeing with you but clearly the Fed will eventually bail the economy out but the dollar will suffer in its wake.

[User 188394]

Credit cards are no different than anything else that is harmful if used irresponsibly and helpful if used responsibly.

[ChristsmartNetwork]

Visa and MasterCard are just processing companies. They do not actually lend money. Schiff should check his facts.

[financeguy]

Hey what about the people who the credit cards on time and avoid APR ... in the present inflationary condition ppl are saving by paying their bills thro plastic

[Cat~eyes]

P.S. Please only come on board if you currently own shares of Visa since it's a place to share information and research related to Visa. Have a good one!!

[bishk1301]

This is ridiculous. Two years ago everyone was bullish and now being bearish and doomsday sayer is mainstream. Anyone who thinks credit cards usage will revert to cash is deluding himself. The government did not bail out homeowners, it bailed out the banks, most of the homeowners would be better off walking away from their overvalued properties. There will be no real bailout for those defaulting on their credit card debt. No one forced the consumer to overspend

[bill west]

Perhaps you have noticed the temporary slowdown and recent minor pullbacks in both Mastercard and Visa. While a check of the popular blogs and wallowing through the assorted financial internet commentary it has become apparent that many people still believe Mastercard and Visa are tied to the often mentioned credit crisis. Discover and American Express have these problems as bill collectors. Mastercard and Visa do not. Remember MA and V are simply toll-takers in the credit economy.

What all credit card companies do have are assorted fee structures, teaser rates, and different “merchant processing percentages”. These can be dependant on many factors and won’t be discussed here in great detail.

The outcome of the Capitol Hill hearings will be as follows-

We are currently heading toward an election. The continued bloviations on credit card practices can be equated with the oil company monopoly hearings that commence every time gas goes over $3 per gallon. (The lack of exploration and refinery construction won’t be debated here) Nothing has changed in oil for the most part has it? Not too much will change in the credit card industry either.

The do- nothing politicians will get some quotations in the record and little will change in the credit card industry with the exception of the following areas-

Credit card companies will reduce or eliminate many teaser introductory rates.
Bank issued credit card qualifications will become stricter as some defaults may increase.
Credit interest rate percentage increases will require customer notification and payment or payoff options to allow the customer a chance to prevent the implementation of these penalty rates.
Terms and credit card policies will be re-written in more layman friendly language.
Secured credit card options may be used more frequently when credit worthiness is questioned.

And now of most importance to Mastercard and Visa shareholders:

The numerous bank and merchant associations will square off on Capitol Hill complaining or justifying the “processing fees” of 1 to 4 percent that are paid directly to Mastercard and Visa. Those fee structures will remain in place with some attempts at downward renegotiation for some of the largest merchants. The little merchants won’t have much bargaining power. Sorry but that’s the law of large numbers. These processing fees will simply be passed on to the consumer if necessary. Don’t forget there is always the cash price versus the credit price if you are feeling really squeezed.

However with the increasing cashless nature of society in the United States and the international consumer markets skyrocketing the credit card business is becoming fully entrenched in the world of financial transactions large and small. As the emerging markets begin to trust the credit services of their respective banking systems; the issuance and accounting practices will become trusted and fully implemented. Paying by credit also provides fraud protection and faulty product redress in many cases.
Cash will soon become simply the path of last resort for emergencies, illegal businesses, persons “living off the grid”, and tips for persons employed in the service industries.

Bottom line: Mastercard and Visa are perfectly positioned for the continued growth of the credit card industry and will provide rich rewards for persons who invest early in both these stellar companies.

Disclosure- Long MA, V, XOM

[investmentAction]

Ya, i live in Asia.
Visa is damn strong here man.
And Olympics in coming! Transaction will rocket!

Check out my analysis... investmentaction.blogs...

[Go figure]

For many years I have quoted the phrase, figures lie and liars figure. Funny thing about numbers, usually you can make them say whatever you want.

I am not of the belief that credit is not a serious issue in this country. I do believe that doom and gloom attracts more attention.

Consider that through the last two significant up cycles, 1995-2000 and 2003-2007, outstanding consumer credit (federalreserve.gov) has spiked from a few percent a year increase to 10% or 15% in years following negative market returns (yahoo ^GSPC historical). Could there be a correlation between choosing to put your money to work versus paying off or paying down debt?

There are many people in this country that can not handle money, but there is also a large percentage that can, and with significant dollars. I for one usually do not pass up "12 month same as cash" or 2.99% until paid in full offers. 2004 saw an increase in consumer debt jump 10.92% from the previous year of 5.64% and the S&P returned 32.78% from March 2003 to March 2004. Sounds like smart money to me.

[User 196270]

True, Visa and Mastercard make money on transactions and are not exposed to debt but tightening credit standards + lower limits + curbed spending as a result of tighter credit standards = Fewer transactions. No one is recession proof. I know we all want to think that these companies are bullet proof, as do I (I am a Visa shareholder and a former Mastercard shareholder). V and MA are great long term investments but I have been at this for a long time and have seen Equities assigned high multiples based on potential and actual growth but when expectations are high and economics cause them to miss a quarter or two those stocks will fall faster and harder than they rose. And if you think they are recession proof all I can say is that everyone thought housing was as well. You can only spend more than you make for so long and sooner or later the music stops.

[fxtrader07]

Funny, how many morons here are harping at Schiff that "he ought o get his facts straight on visa" - while he never said any bad word about the company anyway? Because it doesn't matter! Forget about Visa, this is about the ticking time bomb that will drag the us further into recessionary territory and make for the next round of pain at banks and lenders. subsequently pain for retailers and finally for a lot of companies (among them lots of widely loved high-tech-companies, mind you!) depending on a quick recovery of the us economy as global markets for all their growth cannot really make up for prolonged us-recession