About those lowered credit card limits: The card companies have no money to lend you

[HamdenRice]

When the financial crisis started, and was blamed on mortgage backed securities, most Americans learned for the first time that mortgage loans that were made by banks were sold to investment banks, packaged together, sliced into mortgage backed securities, and sold to institutional investors.

These mortgage backed securities were the basic building blocks of the investment portfolios of banks and other large funds. Even though only a few of these mortgage backed securities were in default (at first), the banks and investment funds refused to accept any mortgage backed securities because it was impossible to tell which of these securities would be the next to fall. Trillions of dollars worth of bank assets were effectively frozen, and credit and interbank transactions came to a standstill.

While Americans learned more about mortgage backed securities than they wanted to know, what they did not learn was that it wasn't only mortgages that were sold, packaged and turned into securities. Car loans, student loans and credit card debt are also packaged into asset backed securities.

Across the blogosphere, lots of people are complaining about credit card companies freezing or lowering credit limits. Almost every post I've read tries to understand this as an individual problem -- "why is the bank doing this to me when I have a good credit rating?" seems to be a common complaint.

But it's not an individual problem. What you really need to understand is that the credit card companies have run out of money. They have no money to lend you. That's why they have to lower your credit limit to what you already owe, or if you haven't used your credit card, cancel it altogether.

Before the credit crisis, most credit card accounts were sold, just as mortgages were sold, to investment banks for packaging as "credit card receivable asset backed securities." It wasn't the credit card company that was lending you money. They were just a conduit and "servicer" of your debt. The Chinese central bank and state administration of foreign currency, middle east oil funds, commercial banks of all kinds, pension funds and other institutional investors were actually lending your that money through these credit card receivable asset backed securities.

Well, in the same way that no investor will accept mortgage backed securities, no investor will accept credit card receivable asset backed securities.

The market is dead. Virtually none of these securities can be sold.

That means the credit card companies have run out of money. They have no money to lend you so they have to lower your credit limit to what you already owe.

This obviously does not bode well for the retail sector as the Christmas shopping season begins.

The same goes for car loan asset backed receivables. That's why, although a bailout of the car industry is on balance a good idea, it will mean nothing as long as there is zero market for car loan asset backed securities -- because the car loan companies have no money to lend you if you need a car loan to buy a car. We can save the car companies and turn them into producers of the best green electric hybrids on the planet, but if consumers can't get car loans, it's unlikely that they will be able to sell those great new cars.

Your credit card company does not want to tell you it has no money, so it will come up with all kinds of excuses to make it sound like it's your fault that they are lowering your limit or canceling your card. But it isn't.

So let me repeat: No matter how good your credit rating is, the credit card companies have no money to lend you.

[ORDagnabbit]

1. heres a great vid to understand how money is created

www.moneyasdebt.net

[SmileyRose]

2. Same reason oil has tanked - those who could yanked money out all at once.

[HamdenRice]

3. Slightly different

Oil was up as a result of speculation. The problem with credit card securities is a problem of liquidity. There was no "speculation" in these securities, because they were uniformly priced based on yield.

[ProfessorGAC]

4. I Was Going To Say Something Similar, HR

There is little connection between liquidity and commodity speculation. The only likely regular connection is if liquidity is too in too many areas, the speculators won't get as many people floating their credit on margins. Other than that, you and i concur that oil prices were driven to levels unjustified by demand due to speculation run amok.
GAC

[HamdenRice]

10. "oil prices were driven to levels ... ue to speculation run amok."

And it's amazing how much damage the Bush administration allowed energy speculation to do to the economy -- from Enron's cost to California early in the Bush years, to the squeezing of family budgets by big oil and speculators that imo helped precipitate the foreclosure crisis.

[fasttense]

5. No One needs a loan or a credit card to buy a car.

All you need is a good paying job and realistic prices for the products.

Why are new car prices so F***ing high that it takes a year's salary to pay for it? Why are used car prices just as bad?

Why is my annual salary so F***ing low that it barely covers the cost of a new car? Why do I have to borrow to cover the cost of a falling apart used car?

And to make matters worse, in the majority of America we have absolutely NO public transportation.

So, what the F*** is wrong with this picture?

[HamdenRice]

6. You are probably right that credit inflates prices of cars

Car prices are high because people can afford to buy them on credit. Presumably they'd be lower if everyone had to pay cash, but I'm not sure how much lower. The cost of making a car (as opposed to its price) is still pretty high and is the floor below which the price can't go if the car company is going to make money.

Also, credit makes sense for big ticket items because it enables people to smooth out the cost over the life of the item. In other words, if a car lasts 15 years, there's nothing unreasonable about a consumer taking more than one year to pay for it -- even theoretically to the point of only paying 1/15th of the price per year. In fact, since car loans are typically about 3 years and the car lasts 15 years, you could argue that it's unfair for people to pay for such an item as quickly as the typical car loan requires.

Basically whether we are talking about business, government or consumers, it makes sense to spread out the cost of something that last a long time over some period of time.

It makes a lot less sense to buy things like clothing, vacations or food with a credit card or loan because those things don't last a long time.

[zbdent]

9. I think the fact that the "zero percent financing" is a very big contribution

to what screwed the car companies. I mean, as long as the buyers were paying above and beyond the car's original price, that would be pure profit for the companies, if they financed the "loan" ...

[cap]

7. Let's also add in the risk

Who can guarantee that each and every month for 3-5 years that they will have the income to pay a car loan? Who can guarantee that they will have a job aka revenue stream to support this?

What company can guarantee that they will pay the worker?

So who's left holding the bag but the banking/credit system. They try to price in risk but they can't hold the risk so they sell off the loan/credit card.

It's like a game of pass the ticking time bomb. At some point that bomb goes off. The system is trying to pass that bomb back to the average citizen by increasing interest rates and decreasing credit limits. And by getting the average citizen to pay for corporate bailouts.

[HamdenRice]

12. Car loans are more like mortgages

They are considered to be "secured loans" because the buyer pledges the car as collateral for the loan. Hence if you stop making payments, you get a visit from the repo man. In this way they are like mortgages, where the house is pledged as collateral for the loan.

But the auctioned car rarely brings in as much money as the remaining balance on the loan, because cars depreciate in sale value so quickly.

Credit card loans are "unsecured" by contrast.

[madinmaryland]

11. "in the majority of America we have absolutely NO public transportation."

So true. And why? There has been no push for public transportation in more than 50 years here. It's all been about the highway.

[Donnachaidh]

23. Ford and other early automakers had a hand in destroying public transportation

I'll have to look up the reference, but the automakers had a large hand in quietly destroying public transport in some areas. Such as the Red Line system in LA, trolleys in other towns. I think today's public should be given a eye-opening lesson on just how MUCH damage the carmakers have done to mass transportation in this country. As recent as the 70's and 80's, when the electric car was destroyed very very quietly.

[madinmaryland]

24. That is very true. They started in the 50's, with trains and other mass

transit options.

[KharmaTrain]

8. And This Is New? Maybe To Most...

The credit game has always been a shell game...they only dished money out temporarily and made their profits on extending that credit and the money associated to it...in hopes that enough people would get stuck in revolving charges to not only pay back their loan many times over but create the funds to expand the game. For decades this game worked just fine as most people didn't fall into revolving hell and the profits were good, but never exploited. Then came MBNA and others that saw the real money in the revolvers as well as fees on those who dared to keep a zero balance...they could make more off what people owed them than what they owed...and the money went straight out the door to the investors...little was held in reserve. The long time fear was a big credit crisis where the companies would be faced to collect on all the revolves and couldn't...and that appears to be where we are. Hold on tight...especially to "what's in your wallet".

The credit market is in deep freeze and nothing Klink Paulsen and Helicopter Ben are doing is easing that mess...if anything, it's gotten worse as the issue of defaults and bankruptcies are ignored and money is dished out to cover the latest mess rather than clean up the cause.

It's wiser now to remember that if you don't have the money, don't charge it. Get used to a cash & carry society.

[L0oniX]

13. Hmmm ...that doesn't explain why I just got a $10,000 credit card.

[smoogatz]

14. So, basically you're saying that investors have lost faith

in the ability of consumers to repay their credit cards. Which means their outlook on the state of the economy going forward is extremely grim: full-on depression, 25-30% unemployment, the whole deal.

[HamdenRice]

16. It's a bit more complicated. Would you drink a bottled water if 1 of 100 was poison?

That's the way former Treasury Secretary Paul O'Neil explained it, and it's one of the best analogies I've heard about the crisis in mortgage backed and credit card receivable backed securities.

It's not that they are all in default, or even that most are in default or are expected to go into default. It's that if 1/100 or 1/10 (we don't know what portion) are in default or heading toward default, it's impossible to know which ones.

O'Neil asked a reporter, if you wanted to drink a bottled water, and knew that 1 in 100 bottles was poison, but could not know which, would you drink any of them?

That's why the structure of the asset backed securities market has exacerbated the crisis many fold.

So most credit card securities are probably at this point fine, but no one will buy any of them. That means credit card companies can't extend credit. That means consumers can't buy. That means more companies will go bankrupt. That means more unemployment. That means more credit card defaults. That means more credit card receivable securities going bad. That means institutions refusing to buy credit card securities ...

It's a vicious cycle.

[smoogatz]

22. Wow. Crazy.

Good thing our economy's built on the firm footings of the financial services industry! I guess one solution would be to go back to the old system of fewer credit cards in the hands of fewer consumers, including only those with good credit. If you do away with the bundling (which is ironically designed to dilute risk), you do away with that 1/100 chance of default (or whatever it is). But of course if the entire consumer economy is built on the endless growth of credit card debt, you're screwed. Damn. Good thing I work for the government!

[SOS]

15. Quite a business model

They borrow from the Fed at 1% and lend it out and 25%, yet they have no money.

It's time to nationalize this parasitic failure.
Create a national bank and collect a sensible rate of return.
Of course then the CEO of Citi wouldn't make $25 million a year.

[HamdenRice]

17. The credit card companies are not borrowing from the Fed

They are borrowing from institutions that buy credit card securities -- mostly banks, pension funds, foreign central banks, etc.

[SOS]

20. TARP to encourage investment in consumer debt-backed securities

The latest TARP plan offers up to $200 billion in special loans to investors who will then buy consumer debt backed securities — securities based on credit card debt, student loans and auto loans. The idea is to encourage investment in these vehicles so that lenders will loosen their recently-tightened requirements and then allow more lending to take place.

http://www.yieldingwealth.com/fed-treasury-ready-to-boost-credit-card-debt-fueled-consumer-spending/

You are correct, I was wrong. The money is funneled from the tax payer to the cc companies, but not directly from the Fed.

[slackmaster]

18. They're reducing the liabilities on their books in order to preserve adequate capitalization

That's how I see it.

[HamdenRice]

21. These liabilities are not on their books

For one thing, in the topsy turvy world of bank accounting, a credit card account is an asset, not a liability to the bank.

But more importantly, the point of securitization is that whether asset or debt, it is removed from the banks books and becomes a self-standing special purpose business entity.

[pnwmom]

19. The problem for the good credit card users is that, through no fault of theirs,

their credit rating will go down along with their limits.

You get more points for using a smaller proportion of your credit limit. So as limits go down, people's credit ratings will also go down, even though they're not doing anything wrong.