The Credit Card Crunch.

In my Money Week column this week, I've been writing about the looming credit card crunch, and why it is bound to end unhappily. Here's the piece....

Stand in the middle of any High Street in Britain this weekend, and you see hundred of people handing over small strips of plastic, and, in exchange, taking home bags full of toys, clothes, books, games, and all the other things they plan to give to their families on Christmas Day.
But then pause to think about a sobering statistic.
One in every ten of the pounds spent on all those credit cards won’t ever be paid back. It isn’t money in any meaningful sense of the word, just a kind of elaborate con trick.
The UK, in common with many other countries, is sleep-walking into a credit card crunch. Much of the country is still spending wildly on credit cards, living way beyond its means, and indulging in a fantasy prosperity, wilfully encouraged by irresponsible bankers.
Sometime soon, there will be a Dubai moment – a point where everyone realises that the whole edifice is built on sand, either the real or the metaphorical kind. When that happens, there will be a nasty hit to consumer spending, and a lot of red ink for the banks. And the flimsiness of the UK’s economic boom of the last decade will be painfully exposed.
Credit card debt is now a huge part of the British economy. It is no exaggeration to describe the last decade as one long exercise in bashing the plastic. In 1992, according to the Bank of England, the British were borrowing around £2.8 billion a month on credit cards. Now that is above £10 billion a month. It hit a peak in December 2008 – one last Christmas splurge before the credit crunch hit, perhaps – when we spent £12.1 billion of plastic money we didn’t really have.
Of course, credit cards are a way of paying for things as well as a way of borrowing money. At least a few of us pay off the balance every month. But the balance of credit card debt is still rising. The latest monthly statistics, published on Monday, showed a slight decline in overall consumer debt, but despite that, credit card debt outstanding still rose by £134 million. Overall, the amount of debt owed on British credit cards is now close on £60 billion.
We don’t know precisely how that will play out in a recession. In the last downturn, in the early 1990s, only about £10 billion was outstanding on credit cards, and defaults peaked at 4%, before dropping back to 2%. But, so far, the signs aren’t good. According to the ratings agency Moody’s the charge-off index – the technical term for bunging it on the card, then not paying the money back – hit an all time high of 11.8% in September. It has doubled since the first quarter of 2008. Nor does the agency reckon the outlook is very encouraging either. It warns that a splurge of Christmas spending may well trigger another spike in bad debts in the early part of the New Year. And the expected rise in unemployment – forecast to rise steadily through next year – will push even more people to the point where they can no longer make the payments on their cards. Don’t be surprised if the rate at which people are reneging on their debts ticks steadily up to 13% or 14% as 2010 progresses.
The conclusion is simple. Whilst the majority of people continue to keep their debts under control, a significant minority are clearly spending money they don’t have, and have no serious prospect of earning either.
The law makes it alarmingly easy to rack up debts, then walk away from them. When you credit card debts become unaffordable, simply declare yourself insolvent. Figures for the latest quarter show personal insolvencies up year-on-year by 28%, and now running at the highest level since records began in 1960.
If anyone thinks that situation is sustainable, they need to find a psychiatrist and fast. It is crazy, and the sooner people realise that they better.
So far, the banks have just about managed to get away with it, by passing the costs to the responsible customers. As interest rates have tumbled, the rates charged on credit cards have barely changed, pushing the margins up to 15% or more between what it cost the bank to access the money, and what they charge people for borrowing it.
That has allowed them to maintain their profits despite the hammering they are taking on bad loans. Barclaycard, for example, managed to increase its profits slightly this year, despite a doubling of bad debt charges.
The trouble is, that was a one-off. Sooner or later, the banks are going to be drowning in a sea of unpaid loans. They aren’t going to be able to keep passing the cost onto the rest of the customers in higher interest rate and higher charges. And the wholesale markets are going to take fright. Just like sub-prime mortgages, credit cards debts are bundled up and sold around the world. But who exactly is going to want to own British credit card debt, when one pound in ten doesn’t get re-paid, and you have no legal sanction against the debtor, nor any kind of asset you can call on?
At some point, this bubble is going to burst. Many credit card lenders will simply have to withdraw from the market – in much the same way the most of the self-cert, buy-to-let mortgage lenders have done. The rest will have to drastically curtail their lending, insisting on better credit records, and perhaps even demanding security for their loans.
That will be a big hit for the British economy. Right now, at least a billion a month of consumer spending is plastic money that is simply magic-ed out of thin air. Add to that the fact that one pound in every four the government spends is money that is similarly magic-ed from inside a computer at the Bank of England, and the extent to which the British economy exists in a twilight zone of pretend money becomes painfully clear. At some point it will disappear – and when it does, the results won’t be pretty.