U.S. Heading for a Credit Card Bubble? – It’s Deja Vu All Over Again!

Starting in late 2006 as hints of how deep the Subprime crisis could become – and during 2007 as our fears were realized – the mortgage-selling business in the U.S. basically evaporated. However, enterprising financial institutions soon found a way to keep the money rolling in – they started giving away credit cards. And foremost in their sights were those that relied heavily on smaller personal or business loans and lines of credit.

Small businesses have always been hard-pressed to borrow money to fulfill expansion goals, and entrepreneurs are accustomed to risking their homes or other assets as collateral to take out a loan or line of credit. These forms of credit tend to have lower interest rates than credit cards and the rates are usually fixed or tied to a benchmark such as the prime rate. Credit cards on the other hand, have notoriously high – some would say usurious – rates that the issuer can seemingly change at will.

Given the global credit crunch and the lack of liquidity in the capital markets, borrowing money for small business and individuals has been even more difficult of late, but it seems there is plenty of liquidity in the credit card industry. More and more, individuals and small business now find themselves forced into accepting credit cards as the only means available to them for borrowing money.

Déjà Vu the First

Credit card issuers are famous for offering introductory “teaser” rates (now where have we heard this before? ) that after a few months revert to a rate that would make Tony Soprano envious. We’ve all seen the ads and they clearly work as total U.S. credit card debt as of April 2008 was estimated at more than $800 billion – one year earlier, it was $650 billion.

There are those that argue that credit card default rates are much higher than other forms of lending and that justifies the higher rates. It is true that credit card defaults are higher than lines of credit and default rates continue to rise, but maybe this has more to do with institutions basically approving anyone that can complete a form rather than applying a real test of financial capability.

Déjà Vu the Second

Credit card issuers – just as the mortgage lenders did with the subprime loans – continue to roll credit card debt into asset-backed securities which are then re-sold as Collateralized Debt Obligations. This effectively hides the true risk profile of the underlying securities and I’m pretty sure we have been down this road before and it was not pretty.

Did we not learn anything from the past few years?

About the Author

Scott Boyd has been working in and writing about the financial industry since the early 1990s. As a technical writer and project manager with several of Canada’s leading financial institutions, Scott has produced educational materials for investment system end-users including portfolio managers and traders. Scott now administers and contributes to OANDA FXPedia and regularly provides commentaries for the OANDA FXTrade website.

This article is for general information purposes only. It is not investment advice or a solicitation to buy or sell securities. Opinions are the author’s — not necessarily OANDA’s, its officers or directors. OANDA’s Terms of Use apply.