Credit Cards: The Next Financial Crisis?

To make up for losses, card companies raise interest rates, lower limits.

ByABC News
September 12, 2008, 6:32 AM

July 25, 2008 — -- Paul Takhar has $50,000 in credit card debt. The California man said that since his real estate business went south, he's relied on his credit cards to survive. But lately, making payments has grown tougher because the interest rate on one of his cards has increased.

He said he tried to negotiate for a lower rate, but had no luck.

"I'm going to try to make the payments as long as I can," he said. "I'm struggling."

Takhar's experience is not unique.

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With banks limiting home equity lines, gas and food bills on the rise, and homeowners struggling to make their mortgage payments, some Americans are turning to credit cards to make ends meet. Many, however, are finding their cards more expensive to use as credit card companies increasingly raise interest rates, lower credit limits and cancel inactive accounts.

It's all happening, some industry watchers say, for a good reason: The companies are trying to avert a crisis.

In the first three months of the year, commercial banks in the U.S. took losses on 4.7 percent of their credit card loans, up from 3.9 percent the year before, according to the Federal Reserve.

In the last two weeks, major credit card players like American Express, Capital One, Citigroup and Bank of America have all reported larger losses from unpaid card bills. American Express saw second-quarter profits from its U.S. credit card business fall a stunning 96 percent from $580 million in the spring of 2007 to $21 million this year. (Overall, the company reported $655 million in second-quarter profits.)

"The credit card companies have really found themselves in a huge, huge hole," said Robert Manning, the director of the Center for Consumer Financial Services at the Rochester Institute of Technology.

Manning argues that banks themselves, not credit card users, should shoulder much of the blame for rising delinquencies and defaults. As the financial slump took hold, he said, banks started relying on their profitable credit card arms to compensate for losses in other divisions such as mortgage lending.

This practice, he said, came at a price -- revenues were being bolstered, in the short term, by drives to offer higher credit limits and more credit cards to higher-risk borrowers.