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Generational Dynamics Web Log for 26-Dec-07
As credit card defaults surge, banks become more restrictive with credit

Web Log - December, 2007

As credit card defaults surge, banks become more restrictive with credit

New rules may affect the way that your FICO score is computed.

In the last few months, the "credit crunch" has caused banks to hoard cash, reluctant to lend it even to other banks. And now, expect to see banks become reluctant to lend it even to consumers, especially those in the "high risk" category with low FICO scores.

Part of the banks' motivation for this change is that more consumers are defaulting on their credit cards.

This has been a while in coming. One of the things that have surprised analysts this year is that consumers have been paying their credit cards bills prior to making their mortgage payments. You would think that people would rather risk losing their credit cards than losing their homes, but it's turned out that the opposite is true: A person can always go live with relatives, but he needs his credit card to buy groceries.

Finally, however, with mortgage defaults and foreclosures surging, credit card delinquencies and defaults are beginning to catch up.

According to a recent analysis by AP of data representing 325 million credit card accounts:

The value of credit card accounts at least 30 days late is 26% higher than a year ago.
Defaults -- where lenders give up hope and write off the debt -- rose 18% in the last year.
Serious delinquencies -- accounts at least 90 days delinquent -- were up 50%.

Many analysts see this as the next wave of problems for financial institutions, in conjunction with the continuing wave of mortgage defaults.

It turns out that credit card debt is "securitized" in much the same way that subprime mortgages are securitized. Credit card debt from millions of accounts is combined into pools, which are sold to banks, investment houses and institutional investors. Over $400 billion of credit card is packaged into these pools. As credit card delinquencies and defaults surge, the value of that $400 billion in credit card pools becomes questionable, and more "writeoffs" will be necessary, just as writeoffs of mortgage-backed assets have had to be written off.

It also turns out that many banks were issuing credit cards to people who are poor risks, just as many subprime mortgages were given to people who were poor risks.

So, just as mortgage lenders waited to long to tighted mortgage lending standards, credit card lenders have waited too long to tighten credit card standards.

In fact, it's already getting harder to borrow money from the bank -- for credit cards, for home equity loans, for mortgage loans, for card loans, or any other kind of credit.

As part of this effort, the formulas for computing the FICO credit score are changing.

The formulas have always taken into account such factors as consumers' level of credit indebtedness and payment histories, length of credit histories, number of recent credit openings and inquiries, and the type of credit used, to determine scores.

The exact formulas are proprietary and secret, but an article in the Wall Street Journal lists some of the changes that will be made in the next few months:

It will be more forgiving of occasional slips by consumers, but will take a harder line on repeat offenders.

The new formula will particularly target three groups: subprime borrowers; those with "thin," or young, credit files; or consumers who are actively seeking new credit.

The new formula will give more points to consumers who maintain a variety of credit types, such as credit cards, a mortgage and auto loan, because it shows they can manage payments on different kinds of loans. It penalizes borrowers who use a high percentage of their available credit.

A person with only one account in arrears will not be penalized; but someone with multiple delinquent accounts will have a lower score.

High risk people who "piggyback" on someone else's good credit by sharing a credit card will no longer gain from doing that. This will eliminate certain kinds of credit card fraud, but will also hurt legitimate users -- people who give a credit card to a child or a spouse as an authorized user to help boost their credit score.

All in all, it will be getting harder to obtain credit, and banks will be more punitive of people who are delinquent.

If there's any way that you can do what these people did with their blender, you'll be much better off:

(26-Dec-07) Permanent Link
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Generational Dynamics Web Log for 26-Dec-07 As credit card defaults surge, banks become more restrictive with credit

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Generational Dynamics Web Log for 26-Dec-07
As credit card defaults surge, banks become more restrictive with credit