The sub-prime market has collapsed, Alt-A and even prime loans appear to be in serious trouble in the United States, but surprisingly, there has been very little discussion of a potential collapse in the consumer credit market. That however could change soon.

Earlier this month Citigroup announced that it “lost $176 million in the second quarter packaging card loans into securities” after completing “fewer deals and [being] forced to mark down its own $9 billion stockpile of the debt instruments and other stakes the company amassed while selling them to investors.”

According to Bloomberg, delinquencies on the securitised portion have jumped by 16% since the end of last year to $2.16 billion as of June 30. What is most surprising is that delinquencies have increased by only 16%, especially given how lax banks appear to be in handing out credit to customers.

Last week, your correspondent received a letter from Citigroup offering an increased credit limit from $18,000 to $27,000. The letter helpfully noted that the increased credit limit could be used to purchase a new plasma television. No positive credit checks were conducted nor any further investigation as to earnings or capacity to repay the amount (Citi, like all other Australian institutions, are only able to conduct a “negative credit check”).

Many in a weak financial position have been tempted by the quick escape of credit cards. Not only are credit cards remarkably easy to obtain, they are also relatively cheap compared to other unsecured forms of finance. Most credit cards charge an interest rate of around 20% — by contrast, GE Money told Crikey that an unsecured personal loan of $27,000 would have an applicable interest rate as high as 34.95%. If the relatively low rates aren’t enough to entice the battlers into buying more stuff they can’t afford, The Age  reported yesterday that “Australian banks and other credit lenders employ ‘psychological manipulation’ to tempt consumers to increase their credit limits, according to a report that examines the language and design used in letters offering higher credit allowances.” Not only do financial institutions provide significant amounts of unsecured credit, they actively encourage customers to live beyond their means.

While the US mortgage market has collapsed due to banks lending to borrowers with poor credit risks and insufficient collateral, at least those borrowers had some collateral. A bank foreclosing on a property will often recover upwards of 50% of the money loaned. By contrast, credit card borrowers provide no security for their debt, nor do banks conduct anything like the investigation required for a prime mortgage or business loan.

In the US last month consumer credit rose another US$14.3 billion last month to US$2.59 trillion – that means every single American, man, woman and child, owes around US$1,000 on their credit card. Fair to suggest a lot of that won’t be paid back.

Peter Fray

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