Following the collapse of the subprime mortgage market, the ensuing collapse of the much larger mortgage-backed securities (MBS), collateralized debt obligations (CDO) and credit default swaps (CDS) markets, and the general impact all this has had on credit markets in general, a lot of people are starting to wonder, are credit cards the next big problem?
It's no secret that many Americans live beyond their means. Rather than aiming to pay off their mortgages and rest secure that they were finally out of debt, many people have chosen instead to take out home equity loans, basically turning the value of their homes into cash to spend on things like new cars, flat screen TVs and so on. It's what has fuelled the growth of the consumer-based US economy in recent years.
It makes sense therefore that as banks become less keen to issue loans, the cost of living rises, and mortgage repayments get costlier, that more and more people are defaulting on credit card repayments. According to a Washington Post article:
"The deterioration in consumer credit, the latest downturn to whack Americans after the housing slump and mortgage meltdown, threatens one of the linchpins of the U.S. economy. Over the past 10 years, credit card debt has gone up 75 percent as Americans' real wages and savings rate have stayed flat. That means Americans have been spending beyond their means -- and fueling economic growth with borrowed money.
Now, the housing crash, financial downturn and contracting economy have made it more difficult for Americans to settle their bills, setting off a downward spiral. As people fail to pay off their credit card bills and other loans, banks must put away money to cover expected losses. So banks lend less. Americans who tended to rely on loans to fuel their spending must cut back, readjusting their spending habits to conform with what they earn."
I agree that credit card defaults are probably the next big problem and some people will have to adjust their lifestyles – which isn’t necessarily a bad thing. Americans spend more than they earn, which is not sustainable. You can’t keep a country growing on nothing so there needs to be an adjustment.
But I don’t believe we will see as big a crash as we did with subprime mortgages. I don’t know for sure but I don’t think there is the same kind of securitization of credit card loans like we saw with the mortgage industry. Firms are too aware – and afraid – of the risks associated with collateralized debt now – or at least they should be. CDSes, CDOs and MBSes ended up being worth a lot more than the actual loans underlying them and so when everything went into default, a lot more was owed than just the underlying debt. Basically the securitization of the debt ended up escalating the problem many times over.
I do think we will see a credit card problem. But I don’t think it will have as many ramifications as the subprime mortgage crisis because I don’t think there is the same amount of securitization – at least I haven’t heard of a market of credit card debt-based derivatives. Please correct me if I am wrong. I’ve no idea if firms are out there buying and selling credit card-backed derivatives. If they are the industry obviously has learned nothing and deserves all it gets. But do we the "innocent" consumers deserve too suffer too? There are protesters standing on the corner of Wall Street who would argue "no".