We’ve been bingeing on plastic for the past decade, says Matthew Lynn, and the £54 billion we owe as a result is about to knock another hole in the banking system
One year on from the period of panic that followed the collapse of Lehman Brothers, you might be forgiven for thinking the worst of the credit crunch was over. The banking system has steadied. The stock market looks perky. The housing market is limping out of the convalescent ward.
The trouble is, you’d be wrong. The credit crunch has a nasty little sibling, with whom we are yet to be fully acquainted. Call it the credit card crunch — except it’s not so much a crunch as the financial equivalent of a full-scale pile-up on the M1. The British, like the Americans, have been bingeing on plastic for much of the past decade. Now, as unemployment rises and fresh credit dries up, many people will be unable to pay the enormous debts they have run up on their card accounts.
As a result, a lot of money now looks certain to be lost. It won’t just be the cardholders themselves who feel the pain. Credit card debt has the potential to inflict horrendous new losses on the financial system — losses that we will all end up paying for. Indeed, if the nub of the credit crunch was the reckless determination of the banking system to lend money to people who couldn’t really afford it, then the looming credit card crunch may yet prove to be its most extreme manifestation.
‘In both the first two quarters of this year, we’ve still been seeing increases in the numbers of people coming to us for debt advice,’ said Beccy Boden Wilks, spokeswomen for the National Debtline advisory service. ‘Our research shows that people don’t want to keep borrowing unless they really have to, but obviously a lot of people are still affected by the recession and don’t have much choice.’
True enough. Sadly, there aren’t many things in which the British economy can claim to be a global leader, but in one respect we have shown the world a clean pair of heels: bashing the plastic. Among Europeans, we have more credit cards in our wallets than any other nation: 2.8 per adult, up from 2.4 in 2004. The Norwegians were second with 2.3; the French, who still prefer cash, have just one.
It is no exaggeration to describe the last two decades as one long credit-card splurge. Back in 1992, according to Bank of England statistics, the British were borrowing around £2.8 billion a month on credit cards. By 2002 that had gone above £10 billion a month. It hit a peak in December 2008 — one last Christmas splurge — when we spent £12.1 billion of plastic money we didn’t really have. The monthly figure has fallen fractionally since then, back to around £10 billion.
Of course, credit cards are payment tools as well as borrowing tools: some cardholders pay off the balance at the end of every month. But the volume of credit-card debt is still rising. Indeed, in the latest monthly statistics, despite the slight fall in overall consumer debt, credit card debt outstanding still rose by £100 million. The total amount of debt owed on British credit cards is now £54 billion.
There are no real precedents for what will happen to that pile of debt during a recession. The last time our economy slumped, in the early 1990s, the total outstanding on cards was only around £10 billion. Defaults peaked at about 4 per cent of loans, then fell back to around 2 per cent. This time, however, it looks likely to be far worse. Credit card debt, having no asset backing at all, is more toxic than the dodgiest subprime mortgage. But it works in much the same way. The big banks bundled together millions of loans on cards and sold them as bonds. The six largest US lenders have issued $375 billion of credit card bonds between them. But after the credit crunch hit, that market collapsed, just like the mortgage-backed securities market. In the first three months of this year no new card-debt bonds were successfully issued.
It isn’t hard to understand why. In the UK, the ratings agencies Moody’s and Fitch both track repayment rates on credit cards as part of their task of assigning ratings to all those bonds. The figures are, to put it mildly, likely to make Mr MasterCard feel a bit queasy. In the US, delinquency rates passed through the 10 per cent barrier earlier this year, and now they have done the same in the UK. Moody’s ‘charge-off index’— what’s known in plain English as not paying the money back — has breached the 10 per cent mark for the first time, having risen dramatically in the past year.
And the outlook? ‘The economic indicators for the UK suggest that worse times lie ahead for the credit card sector,’ concluded Fitch in August, while Moody’s forecasts that with rising unemployment the charge-off index will pass 12.5 per cent next year and could even top 15 per cent. In simple terms, £15 of every £100 borrowed on credit cards isn’t going to be repaid, or about £8 billion of the £54 outstanding. It’s not surprising your credit card company is so keen to slip an extra tenner onto your account in obscure charges: it is drowning in a sea of bad loans.
Kieran Hines, of the market research firm Datamonitor, has noticed something very interesting about the figures on credit card lending. In the middle of last year, about the time the economy keeled over, the amount of spending on credit cards started to decline, but the total of card debt was still growing.
‘That tells you that this problem is going to get worse going forward,’ he says. ‘There must be a significant number of people out there who are still spending money every month on their card but not paying it off. The debt will just keep growing. There is a real element of risk in this for the banks.’
Unfortunately, that appears all too likely to prove true. There is little doubt that the banks are going to take a big hit. Only Barclays breaks out separate figures, for the cards issued by its Barclaycard division. But they tell a sorry tale. In August, it reported that bad debt charges had doubled in the past year, from £477 million to £915 million. Funnily enough, profits also edged up slightly, by 1 per cent despite the mounting bad debts. But that was because margins had been increased.
The average credit card now charges interest at 18 per cent compared with 17 per cent a year ago (and a lot of the cash-back deals that gave a bit of the profit back to the customer have been withdrawn), even though base rates have fallen to just 0.5 per cent. That trick helped out this year, but it won’t next. Base rates can’t fall any further, and card rates can’t be hiked much higher.
Indeed, the outlook for the market is bleak. The banks are not issuing cards in the way they once were, largely because they can’t raise cash in the bond market to fund card lending. Anyone maxed out on their cards won’t be able to transfer the balance elsewhere as readily as they once could. Unemployment will make keeping up payments ever harder. And once mortgage rates start to rise, as they must, many more people will be struggling with their debts. Meanwhile, the law now makes it easy to declare yourself bankrupt and walk away from unsecured loans: it is certainly possible that hundreds of thousands will do just that.
If that happens, the credit card crisis will show the financial system at its most dysfunctional. At its heart, the credit crunch was about the lenders loading more and more debt onto people who could not afford it and then hiding all the dodgy loans in complex securities spread throughout the financial system. It blew up over mortgages, and will blow up over credit card debt soon enough.
Where will the pain be felt? The banks will take serious losses, inevitably, and since the state owns stakes in two of th e largest, the taxpayer will take a hit as well. And a big heap of credit card debt has been repackaged and sold to pensions funds and unit trusts owned by ordinary savers.
Someone, somewhere has to pay for the credit-card-fuelled consumption binge of the last decade. Regrettably, it looks like all of us will end up footing the bill — and we won’t even be able to bung it on our cards.
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