Within a year or so, the US economy has fallen sharply from abundance to scarcity.
Americans, who normally reserve credit cards mainly for the purchase of things like gifts and appliances, now routinely take out plastic to pay for groceries and gasoline.
Trends strongly suggest, however, that this plastic-fueled spending spree can’t continue for long. The casualties are piling up. Card holders are increasingly defaulting on their debts and going into delinquency.
Alarmed card issuers are getting so stern with borrowers that many consumers are reining in overall spending. Lower credit limits, climbing interest rates, and increasingly frequent refusals to approve applications for cards have left consumers with fewer options.
Consumers’ Predicament
Credit card issuers have been faulted for raising interest rates on cardholders who aren’t currently behind on payments but have failed to retain decent credit scores.
Bank of America last month notified some of its cardholders that their rates would be doubled — to as high as 28% — without offering any justification for the move. Some consumers complain they have been hit hard despite no apparent fall in their credit scores. The bank, which has 40 million credit card accounts, has called the rate increase a “periodic review.”
Many don’t rule out the bank’s aggressive rate hikes being copied by other card issuers in the near future.
How We Got into This Mess
The cause of the credit card crisis can be traced to the mortgage mess. As housing prices zoomed up in the past decade, a false feeling of financial security misled borrowers into maxing out their credit cards. The subsequent drop in home prices ruined many. The burden of the debt is mounting, and countless borrowers are not in a position to pay in time.
Lenders are not less responsible for the mess. When the money was still rolling in, they became reckless in a race to give money to anyone with decent FICO scores — sometimes even to people with far less than stellar scores.
Some Gain from the Crisis
The dismal times have meant one more vicious cycle in the market. As more households are sliding into financial peril, many consumers are being trapped by higher cost lenders.
With banks going for secured credit cards, the companies specialising in giving cards to people with poor credit scores have netted huge numbers of accounts. Collection agencies, too, have barged into the credit card game. Many of them offer debtors cards at a fixed rate of around 19%.
Furthermore, despite state regulations intended to curb a recent proliferation of payday and other high-rate lenders, such businesses are thriving.
Is FICO Responsible?
Banks have long trusted FICO credit scores to judge the worthiness of borrowers. Some industry insiders argue, however, that the companies that provide credit scores, such as Fair Isaac, Equifax, Experian, and TransUnion, are partly to blame for the mess because their credit scores failed to predict risk accurately.
In the past, some people have doctored FICO scores to help borrowers qualify for credit cards. But more than that, a series of unforeseen problems have combined to wreck the credit-scoring system.
The new FICO 08 scoring system, however, will perhaps help lenders get better measures of the creditworthiness of prospective borrowers in the future.
What Lies Ahead
It isn’t easy to forecast when and how borrowers’ economic pain will end as the US hasn’t faced a credit crunch of this magnitude in the past two decades or so. Apparently, many will simply have to learn how to better live within their means.
