Monday, September 10, 2007

Will Credit Crunch Hit Other Kinds of Debt?

How will the mortgage mess affect people holding credit card debt and student loans?
Well, in the short term, subprime borrowers of all kinds (that is, people with poor credit) are apparently being targeted with more credit card solicitations than ever. "Direct-mail solicitations to subprime borrowers were 41 percent higher in the first six months of 2007 than they were in the first half of 2006. At the same time, solicitations to the most credit-worthy consumers fell by 13 percent. And the numbers are even starker when you look at June of 2005. "

As well, credit card delinquencies are up because people are finding it harder to use their home equity to pay off debt.

Like mortgages, lots of credit card debt, car loans and student loans are also packaged into asset-backed securities that are sold to investors, which does raise the specter that as the secondary market dries up, this kind of debt will be harder to get (or just more expensive.) The SF Chronicle says:

"I'm clearly hearing that bankers are being cautious, taking a second look, making sure they understand the risk they're taking," says James Chessen, chief economist with the American Bankers Association. For the riskiest customers, "it's naturally going to cost the borrower more," he says. But by and large, "for consumers with good credit, there has been no spillover effect" from the mortgage crisis, says Greg McBride, a senior analyst with

So: if you have bad credit, you will have the opportunity to get more credit , and more expensive credit. If you have good credit, you will have fewer opportunities to get credit that costs essentially the same as before. I think I know which side of the line I want to be on.

The Chronicle article also uncritically repeats threats from student lenders that with the $21 billion subsidy cut, they will just be forced to cut all discounts from loans. Because god forbid they should have to compete, actually compete, on price.


Adam said...

The cost of all of this debt is most closely tied to the Prime Rate, which is tied to the Federal Funds Rate. Sure, penalties and default interest rates are higher and they should be. They're negative consequences that do two things:

1. They assign the highest price to the riskiest customer thus offsetting the anticipated chargeoffs that will be incurred from this group of cohorts.

2. They act as a deterrent to overspending or skipping payments to help encourage fiscal responsibility.

Yeah, it sucks for those folks that don't get it or can't control themselves... but in the end education is what you get when you read the fine print. Experience is what you get when you don't. Either one should suffice as a means for prudent decision making in the future.

Anya said...

yes, but that doesn't really explain or excuse increased "push" marketing to subprime borrowers, whether for credit cards or mortgage loans. The National Consumer Law Center says a lot of subprime borrowers could have qualified for less expensive loans.

Jonathan said...

The problem is more broad than just sub-prime lending, it also has to do with "Alt-A" loans which often times were given to borrowers with excellent credit. The problem is these loans commonly have little or no income documentation, and often have a short-fixed rate period, after which the rate begins adjusting and become very expensive. We are fortunate at the moment in that rates are not higher they are - while delinquencies are currently on the rise, it would be much much worse if interest rates were increasing as well.

Adam said...

It's probably true that a lot of customers could qualify for better terms than the ones they were receiving. The fact of the matter is that consumer's (and probably a handful of shady lenders or brokers) did not do their due diligence in researching the product.

I manage a $50M pool of sub-prime loans and come across borrowers that could have found less expensive loans, however, they would have limited themselves in other areas which is why they chose to pay a high interest rate.

My inclination is to believe that many of the people who are having problems with ARM's were lulled into a false sense of security by unprecedented low interest rates. They were betting that these rates were "the norm" and therefore didn't worry about adjustments... or they figured they would be making enough money to afford them... or they figured they would sell before the loans adjusted (betting on a continuation of a strong RE market).

All of the above instances deserve nothing. It was an expensive piece of experience. The victims of predatory lenders need to sue. The taxpayers who can manage their money and take the time to read the fine print before committing themselves to $500k at "who knows % interest" should not have to bail them out.

The sad part is that if this throws the economy into a recession we'll still all end up paying something.

And, for the lefties, bailing out the homeowners bails out the predatory lenders and investors and encourages them to ignore risk when valuing and pricing debt in the future.

Let the chips fall where they may.

Anonymous said...

Thanks adam for you comments. It's clear that the writer of this blog should do less writing and more thinking.