By now we're pretty familiar with the concept of securitized debt, particularly mortgages that were packaged and sold as investments. These, of course, became problematic when the housing bubble burst, mortgage defaults spread, and mortgage-backed securities imploded.
But what about other types of consumer debt that are wrapped up with a bow and traded on the market? Could securitized credit card debt be the next crisis in the making?
U.S. consumer revolving credit debt (including credit cards) has risen 20 percent in the past five years from $799.8 billion in 2004 to $960.4 billion in 2008 according to the Federal Reserve. Preliminary numbers for January 2009 show that figure continued to grow to $961.3 billion.
The Nilson Report, a research group that studies consumer payment systems, projects outstanding consumer credit card debt will reach $1.177 trillion by 2010. And with that debt increasing, we could also see credit card payment defaults continue to grow. Reuters reports that U.S. credit card defaults are at a 20-year high.
Banks and credit card companies pay a hefty price for these defaults, and at the end of the day they are often forced to clear from their balance sheets -- or "charge-off" -- loans they deem "unrecoverable." The Fed reports the average charge-off rate for all U.S. banks has risen steadily over three years from 3.13 percent in the first quarter of 2006 to 6.25 percent in the last quarter of 2008, a near-record high. According to Reuters, some analysts are predicting that charge-offs "could climb to between 9 and 10 percent this year from 6 to 7 percent at the end of 2008." If that happens, losses could total $70 billion to $75 billion in 2009.
Why should we care that credit card companies may be suffering? As USA Today economic reporter Kathy Chu told All Things Considered's Melissa Block last fall, about half of all U.S. credit card debt -- around $450 billion -- is securitized.
As credit card defaults and charge-offs climb, returns on credit card debt securities shrink. According to Dr. Christian E. Weller, a Senior Fellow at the Center for American Progress and an Associate Professor of Public Policy at the University of Massachusetts Boston, this could lead to an implosion not unlike what happened with mortgage backed securities. He writes:
When the excess returns on the securitized funds -- earnings for investors -- shrink far enough because of a rise in defaults, the investors can ask for more cash from the credit card lender or, in extreme cases, demand their money back. The term liquidity crunch probably does not aptly describe what this would mean for credit card companies.
Of course this is all still speculation, but it's something we're keeping our eye on.