It’s Time to Prevent the Credit Card Meltdown
Irrational exuberance is back. That’s my best explanation for the ten percent plus gains in the stock market today following the historic cascading collapse (as it was called on CNBC’s Fast Money) of the stock market last week. There are other explanations, of course. You can say that a bottom was established. You can blame it on the end to margin calls and hedge fund selling. You can call it an optimistic response to the world’s evolving bank bailout plan. Or you could say that stocks were way too cheap at their levels on Friday. Having considered all of those explanations, I still prefer irrational exuberance.
The eyes of the world over the past three weeks have been focused on the credit crisis and its benchmarks - Libor (the London Interbank Offered Rate measuring the willingness of banks to lend to one another), credit default swaps (insurance written against bond defaults that represents the perceived risk of bankruptcy of a company and the ease of a company of accessing the capital markets), and the yield on U.S. Treasuries (measuring the flight of money to safety). Now that the governments of the world seem determined to take all necessary measures (and spend almost any amount of money) to restore confidence in the banks, and the meteoric rise in the U.S. stock market on October 13th suggests that investors have some confidence in these measures, it’s the potential for decreases in consumer demand that have me concerned about the economy and the stock market.
During the past year, the price of oil has collapsed from around $150 to around $80 on concerns about demand destruction. At a certain point in the rise of oil, consumers simply stopped buying gasoline as the price was too high for their budget, and the destruction in demand spilled throughout the economy. Given that consumers are increasingly relying on credit cards for everyday expenses such as food and gas, that the repricing of risk in the credit market seems sure to extend to consumers through decreases in the availability of credit and increases in the cost of maintaining their debt load, and that increasing unemployment is expected as the recession deepens, it seems logical that Americans will have to continue to cut back on their spending.
During the internet crash and recovery, paper profits in the housing market allowed consumers to borrow against the equity in their home and pay down credit card debt. With one prominent investor estimating that 80-85% of Americans are broke absent the value of their home, and the decline in housing prices leading to a hesistancy among banks to lend against decreasing equity (if there is any equity left at all), the only options left for many Americans will be to decrease their spending, stop paying their credit card bills, or declare bankruptcy. These factors have led many to expect, as Business Week argues, that credit cards will be the next meltdown in the financial system.
Amidst the unprecedented capital crunch and Congress’ passage of the bank bailout to free up the credit markets, many lawmakers and stock market investors/analysts argued that the bailout of Wall Street was really a bailout of Main Street. But when it came to assist consumers facing the destruction in their ability to purchase goods, it was only the House (and not the Senate and certainly not the President) that approved the Credit Cardholders’ Bill of Rights.
While earlier in the year it appeared that reform of the credit card industry had some momentum between the actions of the Federal Reserve and consideration of proposals in Congress, the problems in the banking system have added to the arsenal of arguments for opponents to credit card regulation - giving viability to the argument that we shouldn’t be threatening the viability of the banking system and increasing their costs at the same time that banks are unwilling to lend even to one another and in need of a massive bailout and massive capital injections. Read more about this persuasive argument in the Wall Street Journal.
However, if this nation and the world are to stop lurching from one crisis to another - the real estate slowdown, the subprime mortgage mess, the commercial paper market, credit default swaps, independent investment banks, Fannie Mae and Freddie Mac, the bankruptcy of insurance company AIG, bank deposit safety, and insolvent banks - the tactics of the credit card industry which led (or trapped) many consumers into the cycle of debt must be faced eventually. It seems to me better to rewrite the rules of the financial system to assist consumers while one is recapitalizing the banks than to have the credit card meltdown spoil the efforts to spur recovery by the federal government as consumer demand deteriorates after a wall street, but not main street, bailout.
This does not mean that the arguments against the Maloney bill are not persuasive. It doesn’t mean that the WSJ piece wasn’t correct at the time (since adoption of the bill during a 20 percent market decline could have been dicey). And it also doesn’t mean that I believe the Credit Cardholders’ Bill of Rights should be adopted as passed by the House (since it seems obvious that it should be rewritten in light of the credit crisis and the effects that the credit crunch are likely to have on both banks and consumers).
But now that the stock market has returned to irrational exuberance, it’s time for the government to get ahead of this crisis and target some of the policies that got consumers, and subsequently their banks, into trouble.
