In the face of weakening economic conditions, many people have found the interest rates on their credit cards heading significantly higher.  As a result of “risk based” pricing by the nations largest banks, many of these individuals saw higher interest rates even though they were not delinquent on their payments.  According to CreditCard.com, the average outstanding credit card debt for households was $10,679 at the end of 2008.  This puts the average yearly interest cost on credit card balances at over $2,000 if we assume the average credit card rate is 14.2% (according to IndexCreditCards.com).

Right now, banks are cutting credit lines and raising fees — and have been reluctant to pass along the savings resulting from Federal Reserve interest-rate cuts meant to boost the sagging economy. President Obama has met with credit card executives and has called for an end to abusive credit card lending practices. Last year, the Federal Reserve passed changes to credit card practices that will take effect in 2010.  The House has just passed a bill deemed to be the Credit Card “Bill of Rights” targeting credit card fees and rates.  The Senate is expected to pass its own version shortly.  Restrictive legislation is being passed at the same time that banks have absorbed about $55 billion in credit card defaults last year, up from $43 billion in 2007.  These defaults could are likely to reach $65 billion this year.

The crux of the problem facing the banks is that credit card lending is unsecured, meaning that if an individual decides to default on his/her credit card debt that the bank has no asset to seize as compensation.  This is leading to massive charge-offs (debt that has been deemed uncollectible) at the banks.  Losses on consumer credit are probably the number one drag on bank earnings right now and these charge-offs jumped to an annualized rate of 8.8 percent in February, the highest in 20 years of data.  The credit card losses at the banks are directly correlated with the unemployment rate in the country, and according to Moody’s, credit card charge-offs are likely to peak at 10.5 percent in mid-2010.

One of the issues that very few people are talking about because it hasn’t shown up in the data yet is that the average outstanding credit card debt for households is growing, and due to the recession, is doing so at an even more rapid pace.  It’s pretty clear that in household where someone has lost a job, cash would only be used sparingly and only to pay for items that couldn’t go on a credit card such as mortgage payments, car payments, and education expenses.  The reason behind this is that since the time frame in which the person will regain employment is very uncertain, its in the best interest of the individual to deplete their savings as slowly as possible so they can continue to live in their home and drive their car until they find new employment.  The credit card would be used to put food on the table and to pay for all other living expenses.

Even personal finance guru Suze Orman, who has built a career advising Americans to get out of debt and how to do it, is now advocating that consumers go into credit-card debt in order to make sure that they have eight months worth of cash on hand in case of an emergency.

“If you have an unpaid credit card balance not much saved up in emergency savings, I need you to listen up. My advice has changed. I want you to only pay the minimum due on your credit card balance, and instead, make it your top priority to build as much of an emergency cash fund as you can”  –Suze Orman

Because of rising charge-offs and growing credit card balances, banks have no choice but to raise credit card rates to reflect the increased riskiness of their borrowers.  Even if a person has been making payments on time in the past, there is no guarantee that they will continue to do so in the future, as they could soon find themselves drowning in their own consumer debt.

Legislation to restrict credit card rate increases must be carefully crafted in order to reflect the reality of the current situation that we are in.   Banks only give consumers credit cards because they expect to make money.  In fact, credit card lending has historically accounted for between 15 percent and 25 percent of pre-tax income at JPMorgan, Bank of America and Citigroup, according to Moody’s.  If a bank feels that it can’t raise its interest rate to a point where it properly reflects the creditworthiness of the borrower, it won’t lend to them at all.  A cap on credit card rates would lead to a contraction in consumer credit, taking credit cards out of the hands of the people who need them most.

Everyone generally agrees that we need to end abusive credit card lending practices, such as the need to read the really fine print in order to avoid getting slammed with unnecessary fees, and I commend the Obama administration for showing leadership on this issue.  What we don’t need is legislation driven by consumer outrage over higher credit card rates, that has the potential to drive banks to restrict credit card lending altogether.  That is our nation’s current dilemma.

Uncategorized banks, credit cards

It’s been over a week since Treasury Secretary Tim Geithner announced his Public-Private Partnership Investment Program designed to help the banks dump their “toxic assets”. As of late, the plan has received some much deserved criticism. Upon closer review, It’s my opinion that the plan won’t work in its current form because it fails to address one major question.

“What if the banks colluded to create a market price for these assets that is much higher than their actual value?”

Let’s not forget that we still have some very smart people working at this nation’s banks and they are working around the clock to find out the best way to take advantage of these new government programs. Although banks wont be allowed to bid on their own assets as part of the auctions, what is going prevent banks from setting up special entities to bid for them in the auctions or paying a hedge fun a “management fee” to bid for them on their behalf?

Let’s say that through this partnership a bank is able to sell an asset at 60 cents instead of the 30 cents that they probably are worth. If the bank only put up 5 cents worth of equity, the taxpayers would be on the hook for the remaining 25 cents of losses. If we didn’t have the partnership, and the government made the mistake of purchasing the assets at 40 cents, the taxpayer would only lose 10 cents.

Potentially, by using the “market” to price these assets, the taxpayer could stand to lose alot more money as opposed to a plan where the government would be the sole purchaser of the assets at “its” price. Its clear that the banks are incentivized to game the system to create a fake market for these assets.

The Financial Times reported yesterday that many banks that have received government aid are planning to participate in the auctions of each other’s assets.

The Khan Academy, a ‘not-for-profit organization, has posted the following great ‘chalkboard’ commentary on YouTube describing how the banks might game the system.

The fact that the banks are trying to purchase each others “toxic assets” is not surprising. None of them is going to write these assets down to their “real market value” which is why there has been little to no trading in the secondary market. If the banks were to sell or mark down their toxic assets to the “real market level”, many would be insolvent. In that scenario, the common shareholder is wiped out and those banks would have to be nationalized to prevent a collapse of the financial system — an area our government does not want to go.

So we are left with the Geithner plan, a plan that looks good on the outside but could have disastrous implications for taxpayers if these loopholes aren’t fixed. Until the govt is prepared to wipe out shareholders and nationalize the banks, the taxpayer is going to be holding the bag. Unfortunately, I don’t see any way around it.

Uncategorized banks, geithner, toxic assets

Legislation Author: House Financial Services Committee Chairman Barney Frank

As if the last bill passed by the House wasn’t radical enough, new legislation introduced by Barney Frank would give the Treasury the power to restrict the pay of all employees at institutions that have received a capital investment from the government. The Washington Examiner describes the plan as follows:

“the House Financial Services Committee, led by chairman Barney Frank, has approved a measure that would, in some key ways, go beyond the most draconian features of the original AIG bill. The new legislation, the “Pay for Performance Act of 2009,” would impose government controls on the pay of all employees — not just top executives — of companies that have received a capital investment from the U.S. government. It would, like the tax measure, be retroactive, changing the terms of compensation agreements already in place. And it would give Treasury Secretary Timothy Geithner extraordinary power to determine the pay of thousands of employees of American companies.

The purpose of the legislation is to “prohibit unreasonable and excessive compensation and compensation not based on performance standards,” according to the bill’s language. That includes regular pay, bonuses — everything — paid to employees of companies in whom the government has a capital stake, including those that have received funds through the Troubled Assets Relief Program, or TARP, as well as Fannie Mae and Freddie Mac.”

Its unbelievable that such legislation has already passed a vote in the House Financial Services committee by a vote of 38-22. The bill is scheduled to be voted upon by the House later this week.

What are our elected officials doing in the House of Representatives? They are clearly out of control and need to be reigned in. Barney Frank seems to be the main offender in my opinion. Its a good thing most of the banks plan to give back the TARP funds anyway.

Let’s hope the House comes to its senses and rejects the latest measure to stick a pitchfork into Wall Street.

Full text of the Washington Examiner article can be found here.

Uncategorized banks, bonuses, wall street

Lloyd Blankfein of Goldman Sachs, Kenneth Chenault of American Express, Kenneth Lewis of Bank of America and Edward Yingling of the American Bankers Association walk down the driveway at the White House.

The nation’s most prominent Bank CEO’s were in Washington again today, this time for a lunchtime meeting with President Obama to discuss important issues such as limits on executive compensation.

The CEO’s attending were the following:

Jamie Dimon, JP Morgan Chase
Ken Chenault, American Express
John Koskinen, Freddie Mac
Ronald Logue, State Street
Robert Kelly, BONY-Mellon
Rick Waddell, Northern Trust
James Rohr, PNC
Lloyd Blankfein, Goldman Sachs
John Mack, Morgan Stanley
Vikram Pandit, Citigroup
John Stumpf, Wells Fargo
Cam Fine, Independent Community Bankers
Edward Yingling, ABA
Richard Davis, US Bank
Ken Lewis, Bank of America

The consensus from the CEO’s after emerging from the meeting is that it was very informative and they will do as a group what they feel is best for the country and what will help to get our economy back on track. No CEO made any earth shattering comments following the meeting, but they did give some insight into some important issues.

On Executive Compensation:

• There was consensus that compensation policies went too far and need to be reformed. The interests of individual employees must become more closely aligned with the interests of the Firm as a whole. Several firms have already begun to reform these policies by increasing the percentage of stock in bonus packages and longer vesting schedules. There was no direct comment on the 90% tax on bonuses passed by the House.

On Returning TARP Funds:

• No firm will return TARP funds until the government bank stress tests are completed in April. Some banks expressed the desire to return TARP funds but did not set any timetable for doing so and will be coordinating with the Treasury department. These banks also feel that the return of TARP funds is in the “best interest of the taxpayer” as those funds could be deployed elsewhere in the economy.

On the Public-Private Partnership:

• Looks like not much was said on this in the meeting. It doesn’t appear that Goldman and Morgan Stanley will be selling assets into the program as it only applies to assets held on the bank level. Remember, Goldman and MS are recently converted investment banks. It seems that they have the majority of their assets at the holding company level which don’t seem to qualify by the way John Mack was speaking.

On Profitability:

• Both the CEO’s of JP Morgan and Bank of America indicated that March was a tough month for their trading books.

Uncategorized banks, obama

Alas!, the details of the long awaited Public-Private Partnership Investment Program aka “Geithner bank bailout plan” were released today by the Treasury. Compared with the debacle a couple weeks back when Geithner first introduced the plan, but failed to provide any concrete details, the markets responded very well to this latest announcement with the major averages trading to their highest levels in more than a month. The Dow closed up almost 500 points!

The plan targets two types of impaired assets sitting on bank balance sheets: Legacy Loans and Legacy Securities. Through the use of FDIC debt guarantees, TARP money, and the Fed’s TALF program, the government intends to provide financing to private investors wishing to purchase these impaired assets from the banks. By allowing private investors to make use of leverage, the plan is likely to create higher prices for the assets. Assets would be sold to the highest bidder with the government and the private investor taking equal equity stakes and sharing in the returns.

The public-private partnership solves two pressing issues. First, it sets a “market price” for the assets through the auction mechanism. Second, as opposed to an RTC like entity, the taxpayer is not responsible for all the potential losses from the asset purchase.

In my mind, the plan faces two major hurdles. One is the willingness of Congress to go along with it. As we witnessed last week, Congress seems unwilling to support any actions where it feels taxpayers are bearing an undue share of the risk when compared with the potential upside. In this plan, the taxpayer only has 50% of the upside, but through FDIC debt guarantees, TARP funds, and the TALF, the taxpayer could be on the hook for a disproportionate share of the potential losses.

The second hurdle is the question of whether the banks will actually sell these impaired assets at the “market price”. Presumably investors will try to bid as low as possible to guarantee attractive returns, whereas many banks have not been very aggressive in writing down the value of these legacy assets. Selling the assets would lead to large realized losses and many banks may choose to hold onto the assets and sell them at higher prices in a few years. No one wants to be selling these assets at fire-sale prices if they can avoid it.

Regardless of the potential hurdles, the plan is unquestionably a good sign for the markets. The problem facing our banks is that there was no market for these toxic assets, and this plan creates one. Already some of this country’s largest bond managers Pimco and Blackrock have indicated their willingness to participate in the program. If everything moves forward smoothly, the auctions are likely to start in a couple of weeks. This is another important step on the road to economic recovery.

Uncategorized banks, geithner, rally, toxic assets