Eye on the Recession: Coping With the Credit Card Crisis

By Menachem Lubinsky

There was actually some good news on the economic front recently as a new report indicated that the average credit card debt of American consumers has come down somewhat. I am sure that you have heard ads that promise to significantly reduce your credit card debt. They are obviously playing on a well known fact: Americans are trying to creep out from under a crushing credit card debt even as the credit card has emerged as the key method of payment for consumer goods and services. While there are many dimensions to the credit card issue, there is no escaping the fact that credit cards are directly related to the recession and to an eventual recovery.

While no one should feel bad for the credit card companies with their exorbitant interest rates and astronomical profits, this has not been an easy time for them. They have had to face an increasing number of personal bankruptcies and are beseeched with requests to renegotiate debt. Recognizing the difficult economic climate, they were also forced to adjust credit limits downward out of fear that growing insolvency by people affected by the recession may end up in default. A customer who owed a credit card over $25,000 received notice from the company that their $30,000 credit limit had been reduced to $10,000. But within a month after the card was cleared up, the company wrote to invite them to increase their limit to $40,000. Said the customer: “When I needed them most, they reduced my limit and when I needed them least, they increased my limit.”

Americans clearly recognize the dangers of accumulating debt on credit cards but may be helpless in the face of a growing dependency. Technology (namely on-line) has made the credit card the major method of payment. Incentive like accumulating points for free travel and other amenities has created a generation of what one financial expert calls “the points generation.” Financial advisors advise that the best way of dealing with credit cards is to treat them like bills, meaning that they are paid in full as soon as the bill arrives. What forces many consumers into an untenable financial position is when they use the credit cards as a lending bank. Many financial experts say that the current credit crunch has forced more Americans to use the maximum credit available to them on credit cards.

A bankruptcy lawyer relates that he recently filed for a Chapter 11bankruptcy on behalf of a business with debt of $347,000, more than $145,000 owed on credit cards, most of it on personal credit cards. He says that in the last two years alone, the company accumulated more than $90,000 on the cards, particularly when the bank it has been doing business with for 25 years cut their line of credit by 70%. Business had dropped by more than 50%, causing the business to go into tailspin, which was directly related to the recession.

I recently read that the average credit card debt per household with credit card debt is $15,519. With an average APR of 14.67 percent (Federal Reserve, May 2010), you can imagine what affect interest payments are having on these households and why it has become so difficult for many families to climb out of debt. It was interesting to note that more Americans are using credit cards for such necessities as education and food, a sign of the economy but also in many ways a warning sign. The inability to borrow money through banks is why many families carry multiple credit cards with the average family carrying 3.5, as of yearend 2008, according to the Federal Reserve. The U.S. credit card 60-day delinquency rate is 4.18 percent and the default rate a staggering 11.17 percent (Source: Fitch Ratings, May 2010). It is because of this default rate and the increase in personal bankruptcies that credit card companies are now more inclined to negotiate. One financial advisor told me that he negotiated $43,000 in credit card debt to $11,500 in several installments.

A Brooklyn storeowner said that the recession had a direct affect on his sales with credit cards. “Many people who used to shop with cash or checks are instead buying with credit cards, causing me to lose a few percent on margins that I can ill afford to reduce.” In this economy, he pointed out, raising prices was not an option. He complained that some people challenge the sale later, causing an undue delay in payment by the credit card company. He recalled that his father, from whom he inherited the store, had not accepter credit cards. “Imagine if I did that today,” he said, “I would most likely loose many customers.” He said that the first question he frequently hears from new customers is whether he accepts credit cards.

Financial counselors say that one of the biggest risks in the overuse of credit cards is to lose perspective on what you can afford. They say that some people who fall victim to impulse buying have no idea on how they will be able to repay a purchase with a credit card other than to figure that “something will materialize.” It is this blind faith in the unforeseen that often sinks consumers into bigger debt. Obviously, a recovery will no doubt help many consumers either pay off their credit cards or at least renegotiate debt. That is why the report of reduced balances on many American credit cards was such a welcome sign, but as the statistics indicate, only a drop in the bucket.