Odysseas Papadimitriou's  Instablog

If Treasury Secretary Timothy Geithner doesn’t know how to get appropriately compensated for the loans / bailouts that he keeps approving on behalf of the United States Government then he shouldn’t be giving out these loans at all.  His mismanagement of these negotiations is wasting our money.

For instance last year, when Geithner, then operating through the New York Fed, decided to bailout AIG (AIG), the ailing insurance giant was already in negotiations with banks that would have retired their Credit Default Swaps with AIG paying 40 cents on the dollar.  Once Geithner took over the negotiations, he instructed AIG to pay 100 cents on the dollar.  The flubbed negotiations cost American taxpayers at least $19 billion (i.e. 60% of the $32.5 billion that AIG paid to retire the swaps).

What did we get for our money?  Taxpayers saved AIG (AIG) and now own 80% of its stock, but we also saved companies like Goldman Sachs by having AIG act as a conduit for their portion of the bailout money.  As taxpayers, we didn’t receive any stock in Goldman, nor any of the other banks that desperately needed our money to compensate for the bad decisions and bets they had placed.

Now CIT (CIT), too, has gone into bankruptcy after receiving a $2.3 billion loan from taxpayers.  The story is all too familiar. CIT was in danger of becoming insolvent, and the government decided that the potential collapse of the company was too big a risk to the economic systems, and so taxpayer money was disbursed to help prop CIT up.   Here again, our point isn’t that the government shouldn’t have tried to minimize damage to the financial system, but nonetheless, there are ways to administer these bailouts while at the same time making sure that taxpayers are being appropriately compensated for the risks they are taking.  If the government loans a failing company money, it only makes sense that it demand seniority on the loan.  If Geithner had made this demand and stuck to it, taxpayers would be the first to be paid back after CIT’s bankruptcy.  But when Geithner didn’t get that demand satisfied, and he gave the loan anyways he ended up losing 100% of the $2.3 billion of taxpayer money while senior debt holders only lost 30% of their money.

The mishandling of both the AIG (AIG) and CIT (CIT) bailouts point to the same conclusion:  Timothy Geithner does not seem to know how to negotiate effectively and on behalf of his lenders - taxpayers.  Because of his errors, tens of billions of dollars are gone and will never be recouped.  The government seems to be intent on negotiating loans with terms that shouldn’t be acceptable to anyone with expertise in economic matters, and as a result, every time a large company needs help to keep from collapsing, the American taxpayer is providing an unprecedented amount of assistance only to go completely uncompensated for that help.

Disclosure: No positions

Last week, we posted a blog entry that called out Bank of America (BAC) for its plans to begin testing the introduction of annual fees on active credit card accounts. Relative to the October 6th media frenzy that occurred after BofA wrote letters to both Sen. Chris Dodd (D-CT) and Rep. Barney Frank (D-MA), pledging that it would stop re-pricing its existing credit card customer base, these new annual fees are unethical and contradictory to the promise the bank made to both lawmakers and to its customers. Additionally, it is our belief that if Bank of America moves forward with its plans to raise membership fees on existing customers into 2010, it will be breaking the laws mandated under the CARD Act, which is slated to take effect in February of next year.

We knew our blog post might spark some controversy, and that it would likely circulate quite a bit. Nonetheless, we were still surprised when we were contacted by Bank of America’s corporate communications department. The spokesperson who contacted us insisted by phone that Bank of America’s letter to Sen. Dodd and Rep. Frank referred to interest rates and interest rates only, and that it made no mention of annual fees. We found the letter. Here’s what it said:

“In light of the concerns expressed to us by our customers, Bank of America will not implement any change in terms (risk or economic based) re-pricing of consumer credit card accounts between now and the effective date of the CARD Act.”

It’s true. The letter did not mention annual fees, but we also did not find the word interest or rate anywhere in the text. Read the full copy here. A week after it wrote these letters, Bank of America made the announcement that it would begin “testing” the introduction of annual membership fees on select customers. But consider that if an annual fee of $50 is introduced to a credit card account with a $500 balance and a ten percent interest rate, the overall yearly cost associated with that credit card doubles. Now, if that’s not “re-pricing” we’re not sure what is. Like we said before, Bank of America has contradicted itself and misled its customers.

Bank of America’s spokesperson also maintained that BofA’s plans to increase annual fees on existing credit card accounts into 2010 would not be a violation of the CARD Act. However, it is precisely because of the lack of explicit language in the bill that Bank of America could find itself in trouble. Whether or not the increase of annual fees on existing credit card accounts is illegal under the CARD Act will be left up to regulatory interpretation. However it is our strong belief that that after the CARD Act takes effect neither regulators nor lawmakers will have any appetite for credit card issuers who use tactics like this to dodge the stipulations of the CARD Act that promote consumer protection by preventing banks from re-pricing existing credit card balances.

In our last post, we used Chase (JPM) as a precedent to illustrate how things might play out for BofA (BAC). Additionally, based on the 1996 ruling in the Supreme Court case, Smiley v. Citibank (C), it is the opinion of the General Counsel of the FDIC that the term interest includes “numerical periodic rates … annual fees, cash advance fees, and membership fees.” This proves our contention that interest rates and annual fees are linked by regulatory definition. This has been our argument since we began covering this issue, and is a nuance Bank of America doesn’t seem to understand.

Naturally, at the end of our call, Bank of America asked that we stop circulating our blog post from last week. But we’re going to hold off on that until they provide the public with some clearer answers. The more digging we do, the more it seems like Bank of America should be taken to task. And it’s possible that we’ve just cracked the surface.

Disclosure: No Positions

It seems that Bank of America (BAC) has already reneged on the October 6th promise it made to stop raising the interest rates on the credit cards of its existing customer base.  Just a week after making this pledge, BofA announced that it would begin introducing annual membership fees, ranging from $29 to $99, to select customers next year.  Combined, these two announcements result in a net win of zero for consumers, and in an unethical bait and switch play on the part of Bank of America.  Why?  Because, according to regulation, interest rates and annual membership fees fall under the same umbrella.  They are both considered finance charges.

While BofA (BAC) postured as if was taking a step towards consumer protection in making the announcement that it would stop raising rates, the introduction of new annual fees to existing credit card accounts will still result in increased finance charges for account holders, even if those finance charges are referred to and assessed by another name.  For insight, consider that the addition of an annual fee of $50, on a credit card account with $500 balance and a ten percent interest rate, would double the overall yearly finance charges associated with that card.

Bank of America is using the introduction of these new fees as a tactic to shore up its credit card portfolio in the face of falling profit margins.  However, going about it in this way is at best unethical.  When you strip away the industry and product specific terminology, BofA’s pledge that it would stop raising interest rates set a reasonable expectation among its customer base that the cost of their credit card accounts with the lender would not rise again.  Additionally, with many consumers closing out their credit cards or transferring their balances due to rate hikes, a promise to stop raising those rates could very well be viewed as a marketing promise – reactive marketing, but marketing non the less.  Subsequently introducing, new annual fees violated this promise based on the expectation it presumably set with the bank’s existing customers.

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Recently, Bank of America (BAC) announced that it would stop raising interest rates on the credit cards of its existing customer base.  This news comes ahead of the February 22nd deadline mandated in the Credit CARD Act, and is certainly a step in the right direction.  However, there is an issue that hasn’t been raised that would put this announcement into better perspective.  How much of Bank of America’s existing credit card portfolio does this news really affect?

Even after the bank has already re-priced millions of credit card customers into higher interest rates, the national media seems to be treating BofA’s (BAC) announcement as a sign that the North Carolina-based bank is falling in line with the spirit of consumer rights—that it has ended the practice of raising rates in the midst of this credit crunch.  Unfortunately, it is not at all clear what this announcement actually implies given that the media has toed the company line, and has not asked the necessary questions to put this announcement into perspective.

The key question that the media should be asking is: how many of the customers in Bank of America’s (BAC) portfolio still have a low rate that is not part of an introductory offer?  If the bank still has millions of customers below a 10% non-promotional interest rate, then this announcement has merit:  BofA’s assurance not to raise those rates matters.  If, however, there are only, say, 100,000 customers that have a low non-introductory rate, then this announcement only affects a small number of people–too small to deserve the kind of attention BofA’s announcement received. We need to know the percentage of the credit card portfolio that this news affects in order to come to conclusions about the nature of the announcement and what it means in terms of Bank of America’s position on consumer advocacy.

I don’t want to be cynical about possible good news, but my experience says that Bank of America (BAC) has already re-priced everyone that it planned to.  The announcement implies that Bank of America is making an active attempt to be pro-consumer in its operations, while in reality it’s likely that they’ve simply finished re-pricing their portfolio of credit cards.  If so, then this announcement is nothing more than an attempt to create media coverage out of standard operating procedure.  Perhaps worst of all, the media seems to be buying into the announcement, and is now providing Bank of America with much needed positive PR spin by recasting the bank as a mighty corporation that remains in touch with the needs of its customer base.

The Wall Street Journal’s article on this story, for instance, is headlined: “BofA Holds Line on Credit-Card Costs.”  The New York Times headline reads “Bank of America Makes Pledge on Credit Card Act,” while the Washington Post’s reads “Bank of America Won’t Hike Card Rates.”  Before interpreting positively or negatively with respect to the company, shouldn’t the media ask what Bank of America’s (BAC) announcement really means for its customers?  If it turns out, as I suspect, that this story is simply Bank of America trying to get some publicity after finishing the task of raising credit card rates, then the national press is doing the job of Bank of America’s public relations department, and what we’ve been reading is hype and not news.

Disclosure: No positions

Certain economic factors, like unemployment and credit card default rates are intertwined.  So it’s absolutely natural that in an economic climate where experts are predicting a ten plus percent unemployment rate before the end of the year, credit card companies will have to change the way they do business in order to remain safe and profitable.  As we all know, most issuers have been doing this by raising interest rates on both new and existing customers.

Wells Fargo (WFC) has recently joined its peers in announcing that it too will raise the rates on the credit cards it offers.  According to Kevin Rhein, group head of card services at Wells Fargo, “this is something we’ve been contemplating for quite a period of time… We had just reached the point that we don’t think we can offer credit cards at the current pricing and keep credit flowing.”  Rhein’s announcement is interesting because it seems to suggest that Wells Fargo waited as long as it could before instituting these new rates.  He states that the impetus for this change was the bank’s recognition that the flow of credit was actually in danger, which is another way of saying that the profitability of Wells Fargo’s credit card department was at risk.  This, and the fact that the rate hikes are not scheduled to go into effect until November 30, one day before Congress’ new suggested enactment date for the CARD Act, suggests that Wells Fargo really has waited until the last minute before raising rates.

Wells Fargo’s (WFC) decision to remain hopeful in a rather bleak economic climate can be looked at in two different ways.  For the bank’s investors, the choice to wait until the last minute for rate hikes is unreasonable.  No other bank waited or is waiting now.  With the unemployment rate on the rise and federal law threatening to prohibit the rate hikes as early as December 1st, Wells Fargo’s banking peers increased their rates to insure the viability of their credit card businesses.  Wells Fargo chose not follow suit in the hopes that the economy would turn around — an assumption that was unsupported by the nation’s economic forecasters.  From an investor’s standpoint, Rhein’s assumptions were poor on this front — so much so, that we are worried about the general decision making abilities of Wells Fargo’s credit card services department and the bank in general.  What other bad assumptions are they operating under as they conduct business?

On the other hand, for Well Fargo’s (WFC) customers, the choice to raise rates at the last minute is commendable.  In a period where the economy is making it more and more difficult to pay bills, Wells Fargo’s credit card customers are being allowed to pay off their balances at a lower rate for as long as Wells Fargo can afford it.  Wells Fargo’s decision shows that the lender potentially has more concern for its customers than it does for maintaining profitability.

In the end, it’s hard to determine how to view Wells Fargo’s (WFC) credit card business practices.  All in all, only time will tell whether their policy turns out to be beneficial or disastrous and reflective of a card services department that’s been asleep at the wheel until forced into action by federal deadlines.

Disclosure: No positions