Why banks are boosting credit card interest rates
— -- Tommy Newsom was shocked when his bank nearly doubled his credit card interest rate this year, to 27%, for no apparent reason. A customer rep told him the law allowed the bank to do so, and that was all the justification it needed.
"I never missed a payment," says Newsom, 63, of Mesquite, Texas, who owes about $5,000 on the card. "The bank is just looking for a reason to maximize profits."
In recent years, banks have sharply raised interest rates and penalty fees on credit cards. As the economy tanks and banks' mortgage-related losses balloon, some banks are stepping up such increases to boost revenue. Bearing the brunt are consumers for whom a jump in rates and fees can make it tougher to pay their bills at a time when household budgets already are being stretched.
A key driver behind this trend: securitization. From 2003 to 2007, seven of the largest issuers of credit cards packaged an increasing amount of card debt into securities and sold them off to investors, just as banks did with mortgages, a USA TODAY review of banking records found.
Selling off credit card debt has given banks a powerful incentive to raise card fees and penalties, according to interviews with dozens of industry analysts, academics and investment specialists.
Here's why: When banks package and sell card debt, they pass along to investors some of the risk the debt will go bad. Yet, banks often get to pocket much of the profit from rate and fee increases on those accounts. Imposing higher fees on more accounts — without a comparable rise in risk — lets banks raise revenue and keep profits up, at customers' expense.
Securitization has been a "major impetus" for banks to expand penalty fees and rates in recent years, says Adam Levitin, a Georgetown University law professor and card expert. Banks "have little to lose if they squeeze too hard (if consumers default), but a lot to gain if they can extract additional payments" from card users, he says.
Banks deny any link between securitization and rising penalties. They say fees are rising because of superior data-tracking tools that allow banks to draw precise profiles of card users. Banks can price debt fairly, officials argue, with riskier borrowers paying more, as they should.
"Securitization is a method of funding credit card loans," says James Chessen, chief economist at the American Bankers Association. "Penalty fees and rates are entirely separate and completely avoidable."
As the debate unfolds about whether — and how much — securitization drove up penalties, analysts are bracing for an acceleration in credit card losses. Already, delinquencies are at their highest point in six years. Defaults, triggered when banks give up on collecting bad loans, are rising rapidly, too.
By the end of 2009, banks are likely to write off a record amount — up to $96 billion, or about 10% — of all credit card debt, says Innovest Strategic Value Advisors, a research firm that was among the first to predict the mortgage meltdown. The credit card market is a fraction of the size of the mortgage world, but its collapse could threaten some issuers' solvency and make it harder for others to absorb financial shocks, says Gregory Larkin, a senior analyst at Innovest.
"Mortgages were simply the first storm to make landfall," Larkin says. "Credit cards are next."
Experts worry that the $700 billion authorized by Congress to help stabilize financial markets will do little to solve the underlying problems.
"Securitization is an important economic tool," says Rep. Carolyn Maloney, D-N.Y. "But when we saw the subprime (mortgage) meltdown occur, we started really looking at credit cards as the next crisis. We have to crack down on the abuses."
Several bills in Congress, including Maloney's Credit Cardholders' Bill of Rights, seek to clamp down on hair-trigger fee and rate increases. The Federal Reserve has proposed limiting rate increases on existing debt and curtailing excessive fees for borrowers with marred credit.
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