Home Consumer debt Bank and Fed credit card turmoil hits hard spot

Bank and Fed credit card turmoil hits hard spot

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Are Americans finally realizing it as they pay off their credit cards in record amounts? So far $ 25 billion a year in lost interest income for banks!

Through Wolf Richter for LOUP STREET.

There has been a lot of fuss in the banking industry and at the Fed over Americans daring to pay off their credit cards – practically stimulus abuse, so to speak. In the five quarters since the fourth quarter of 2019, Americans have paid off their $ 157 billion credit card balances. “One of the most puzzling changes in debt balances,” the New York Fed said. Credit cards are extremely profitable for banks. The Fed cracked down on interest rates with all its might, but credit card interest remained surprisingly high.

According to the most recent data from Federal Reserve, banks charged an average of 15.9% interest on credit card balances which were in fact assessed interest. This is a drop of 1.2 percentage points from the record in May 2019 (17.1%), but well above historical levels (red squares in the graph below).

In comparison, the average yield on corporate bonds rated BB, the upper end of the junk-bond range (my cheat sheet for business credit ratings) fell to a record low of 3.2% in February, according to the ICE BofA BB US High Yield Index, and has barely risen since (black line). When it comes to making money with consumers in debt and strapped for options, there is no such thing:

Based on the average interest rate charged on credit card balances of 15.9%, that $ 157 billion repayment of credit card balances that consumers have somehow engineered is $ 25 billion a year. year in lost interest income for banks!

This is why banks are pushing so hard to get consumers to borrow again on their credit cards. And that is why the New York Fed, which is owned by financial institutions in its district, finds this reimbursement so “disconcerting.” We’re talking about $ 25 billion a year in banking income.

The bank collects a fee from the merchant every time a consumer purchases something with a credit card. The bank also collects interest from consumers who carry balances on their credit cards and do not pay them off every month. It is this second part of the equation that we are talking about here.

The interest rate can exceed 30% for consumers who cannot pay their credit cards. If they had enough money to pay off their credit cards at that rate, they would. But they are stuck. Consumers who pay off their credit cards each month are often offered lower interest rates, but they don’t need to borrow on their credit cards. Banks also offer teaser rates of 0%, then after a set period – after the consumer has recharged their credit card and can no longer pay it and is therefore blocked – the teaser rate drops to 29.9%.

Call it the credit card crush.

In the world of debt, “spreads” measure investor appetite for credit risk. Spread can be measured as the difference in yield between a category of corporate bonds, such as investment grade bonds rated A (relatively low risk of default) and Treasury securities of equivalent maturity (risk of default). default close to zero because the Fed may print the government out of trouble).

These spreads between high risk and low risk debt have narrowed and are currently near their all-time low. The exception is credit card interest.

The spread between credit card interest rates (high risk consumer debt) and yields on high risk BB rated bonds (high risk corporate debt) has widened, and in the last decade has doubledfrom a difference of around 6 percentage points on average in 2010/2011 to more than 12 percentage points currently.

The average yield on BB-rated bonds fell from around 7% in 2010 to 3.3% on average in early 2021. The average credit card interest rate on balances with assessed interest increased over the same period from about 14% on average to 16%. Hence the widening of the spread:

Credit cards have been carefully shielded from the Fed’s interest rate crackdown. This profit center is just too important for the banks.

Using a credit card for 2% cash back or earning frequent flyer miles or whatever is a smart thing to do, as long as you don’t have to pay interest on the pay.

But paying off those credit cards and not having to pay usurious interest rates is a much smarter thing to do. Maybe Americans are finally getting smart about the credit card bustle – hence the $ 157 billion paydown.

Interest on credit cards will always be higher than mortgage interest because credit card debt is unsecured debt while mortgages are secured debt. Thus, for banks, credit cards carry greater risk, and interest must compensate for this risk. But not the kind of interest that banks charge for credit cards.

The credit card crush involves this element: When a bank charges 25% interest on a credit card, the high interest charges increase the risk of default because the borrower is unlikely to be able to pay the interest. Charging 4% interest would greatly reduce the risk of default. But that wouldn’t be part of the credit card hustle and bustle.

The irony is that the Fed has been pushing to crack down on corporate debt rates. It is aggressively cracking down on mortgage rates, including buying mortgage-backed securities. He lowered the interest rates that all types of borrowers have to pay. The Fed has moved heaven and earth to wipe out the income streams of savers and bond investors.

But at the same time, the Fed is flogging to get Americans to borrow more on their credit cards and pay that usurious interest. And instead of pushing to lower bank interest rates on credit cards, the Fed gets angry when consumers start reacting to the credit card turmoil by paying off the amounts they owe. But for now, the Fed assumes it’s only temporary.

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