Thursday, July 16, 2009

The Red Queen's Advice

As I read today’s news, I was struck by the item reporting the much higher than expected quarterly profits by J.P. Morgan Chase. The headline was JPMorgan profit jumps, but warns on credit cards. The essence of the article was that the investment banking business was doing surprisingly well, but that the consumer mortgage and credit card losses were accelerating. No surprise there. The methods used by banks to manage credit card risk have always displayed a curious brand of logic from a consumer perspective, but in the current economic environment, it’s taken on the extremes of a Lewis Carroll story. As long-time customers who, on the whole, have always paid their bills lose income and begin to struggle making payments, bank risk rises, so card interest rates and minimum payments increase for the universe of cardholders to attempt to offset the collective losses to the bank. The minimum payments can actually double for some customers. Entire new groups of cardholders who were previously able to make their monthly payments are no longer able to make the newly increased payments and begin to fall behind. Bank losses increase and interest rates and minimum payments continue to rise stressing the next tier of cardholders. So it goes, ad infinitum. As the Red Queen said, “Now, here you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”

Over many years of relative stability, many people have mistakenly learned to think of credit card debt in terms of a fixed and predictable payment and developed what they thought were manageable budgets on that basis while ignoring the large amount of underlying debt they were carrying. The fallacy of that thinking has been a painful lesson for many. I sometimes wonder if a radically different response from a maverick bank could be more effective in the long run. What if they identified financially stressed cardholders with high balances that had reliably made payments for a long time and offer them an opportunity to estabish a fixed payment at a more reasonable rate that they could budget for and set it up on an automatic withdrawal. The lower rate could apply more of the payment to principal while still making payments on time giving the bank predicatble income and the consumer a pathway to decreasing their debt. It would not cover the losses from those who were absolutely unable to pay their cards, but would preserve an entire group of historically good customers from sinking further into debt and risking more defaults. Such a radical bank might even find that these customers appreciate their action and become fiercely loyal to that bank when better times return. It could amont to exchanging a smaller amount of physical capital for a greater amount of social capital and clearly differentiating that bank from its competitors...Or, perhaps I’ve just watched too many reruns of It’s a Wonderful Life for my own good.

1 comment:

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