This is a great guest post from Steve. Steve Sildon is the Research Director for Credit Card Assist. Steve writes about a variety of news-related credit card topics, provides tips and advice on how to distinguish the best introductory 0 APR and balance transfer offers as well as analysis of various cash back and airline miles rewards programs.
Meredith Whitney has sounded the alarm on Wall Street about the next phase in the credit crisis and the news isn’t good for consumers. Whitney, a prominent banking analyst and Wall Street veteran recently left her post as the Managing Director of Oppenheimer & Co. to start her own firm, Meredith Whitney LLC, and she believes that the next shoe to drop in the ongoing credit saga will be credit cards.
Whitney estimates that roughly $5 trillion (yes, that’s trillion with a “t”) in available credit lines currently outstanding but that only $800 billion has been drawn upon that total available credit, even with the recession well into its second year. These credit lines are revolving though, and believe it or not, most of the outstanding credit is paid off and drawn down repeatedly, month over month. Credit cards, while much maligned, serve a critical role ineveryday commerce in the U.S. that is now being threatened.
Back in August of 2008, Whitney estimated that roughly $2 trillion dollars of available credit on credit cards would be “expunged” or squeezed out by the end of 2010. After observing draw downs by card issuers of nearly $500 billion in the fourth quarter of 2008 alone, Whitney is now revising her estimates to over $2 trillion in credit card line reductions in 2009 and an additional $2.7 trillion reduction in 2010. That’s a grand total of $4.7 trillion in total credit card lines being eliminated from the system entirely by year’s end in 2010 for a total contraction of nearly 60% in available credit, severely threatening any hope of near-term economic recovery.
Some experts contend that recalibrating the credit markets by getting rid of all of this credit is long overdue. Undeniably, card issuers have been over zealous in their estimates of credit-worthiness in the past 20 years. FICO scores, so heavily relied upon by lenders and card issuers, have turned out to be fairly unreliable in predicting the credit worthiness of consumers. With unemployment running well below 6% and the economy running at full steam, credit lines were extended with lax underwriting standards and far too much confidence. The simple fact is that giant credit lines were being extended to people who didn’t need them, couldn’t afford them, and had no business having them in the first place.
Card issuers have responded by pulling back significantly — for the vast majority of cardholders, slashing credit lines dramatically across the board. The problem, however, is that many of the most creditworthy borrowers are also having their credit lines slashed or even eliminated entirely. In this economic environment, limiting credit lines for “at-risk” borrowers will continue to rise and should be expected in a healthy lending environment. But cutting the credit lines of the most creditworthy customers who do have the means to borrow and do have the means to repay is a looming threat to the economic recovery that has to be dealt with to stave off the deepening recession.
As Whitney accurately describes it, the credit card has evolved into a “cash-flow management tool” for the American consumer over the past few decades. About half of all consumers are “revolvers” who don’t pay off their card balances in full, carrying a balance over from one month to the next, and 90% of all credit card holders in the U.S. revolve a balance at least once a year.
Whitney describes unused credit card balances as “what-if reserve” funds that U.S. consumers have come to rely upon considerably. “What if” I lose my job or “what if” my car needs a new transmission? Consumers have relied heavily on their unused credit lines as emergency reserve funds and many have leaned on them as one of the only remaining sources of liquidity. The truth is that contrary to popular belief most consumers in the U.S. haven’t maxed out their credit cards. In fact, at the end of 2008, the percentage of total credit being utilized was a mere 17% at the end of 2008. But overall, credit utilization is now spiking (due in part to sharply reduced available credit) and the economic environment has forced many credit card issuers, fearing rising defaults, into shutting down credit lines en masse.
The fact is that card issuers are making the problem much worse by cutting credit lines on people who have the ability to pay their bills. Whitney is worried about an even deeper downturn in our badly weakened economy brought on by cutting off the most creditworthy customers, badly worsening the already severe decline. “If credit is taken away from what otherwise is an able borrower, that borrower’s financial position weakens considerably. With two-thirds of the U.S. economy dependent upon consumer spending, we should tread carefully…”
What can average consumers do to protect themselves from this particular crisis? As credit availability continues to get wrung out of the system, the average consumer must do everything possible to maintain existing credit card accounts by keeping their accounts active and, above, all, in good standing. Cardholders have to avoid giving their card issuers any reason at all to shutter or significantly alter their accounts. While that certainly doesn’t guarantee that you won’t be affected, it is one of the only things that creditworthy consumers can do to limit the fallout and avoid being victimized by the crisis.
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