U.S. Credit Card Trap

Thu, Aug 13, 2009 - 1:00am

With U.S. household net worth down US$14 trillion since the peak in 2007, Congress has belatedly started to act concerned about the financial condition of the American consumer. In May, legislators passed the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act to great fanfare. The law does end some of the worst abuses, prohibiting an increase in interest rates if a customer is late paying a different company, disallowing most retroactive rate hikes, and banning fees if the bank neglects to credit a payment.

However, if you have revolving balances on your credit cards, this is no time to relax. The law does not take effect until February 2010, giving credit card issuers a window to jack up fees and interest rates. It also fails to set an upper limit on these charges at the federal level. As financial institutions can incorporate in states without legal limits, major credit issuers can continue to charge any rate they wish as long as they disclose it. This permits banks to borrow from the Federal Reserve at a fraction above 0%, paying ridiculously low yields on deposits, while charging their credit card customers many times that percentage. For example, Wells Fargo is currently paying a laughable 0.05% on savings accounts in my area, with a $300 minimum balance.

The newest proposal debated in Congress is the formation of a Consumer Financial Protection Agency, which would allegedly protect the public from unscrupulous lenders. Politicians claim that fraud and risky financial behavior “fell through the cracks” in the regulatory system, even though many of these same individuals advocated for fewer controls a decade ago. Why should citizens believe that the same bureaucrats who failed to stop Bernie Madoff's Ponzi scheme will act in their best interest?

It's naïve to expect the U.S. government to take aggressive action against financial institutions, as both political parties receive ample campaign contributions from banks like Goldman Sachs. After all, Congress voted to make punitive changes to the bankruptcy laws in 2005, parroting the industry propaganda that many borrowers ran up their credit cards and then declared bankruptcy in order to avoid repaying their debts. In contrast, Elizabeth Warren's data shows that 90% of bankruptcies are caused by family breakup from death or divorce, job loss, or health problems, not conspicuous consumption. The real gamers of the system were not borrowers, but the banks themselves.

The law, written by card issuer MBNA, made it more difficult and expensive to discharge debt, and limited the assets that could be protected from collection by unsecured creditors like - you guessed it - credit card companies. Sheltered by legislators, underwriting standards dropped on all sorts of consumer loans after the passage of this law. The banks were able to continue their pyramid scheme of packaging poor quality debt as AAA rated securities, selling it to trusting investors, and using that capital to make even more bad loans. Ratings agencies like Standard & Poors were complicit in the scheme, using the banks' own models to evaluate these derivatives.

When this house of cards finally came tumbling down, it wasn’t the consumers who were helped, but rather the banks who cynically gambled with shareholders’ capital. Legislators allowed institutions to get “too big to fail” by eliminating protections like the Glass-Steagal Act in 1999, then threw trillions of dollars at these same banks when they later became insolvent. As Allan Sloan puts it, Wall Street’s attitude is “heads I win, tails I get bailed out.” Even sadder, the American taxpayer is still vulnerable to further “rescues,” as the mega-banks have not been chopped into manageable pieces, and they are still permitted to takeover their smaller insolvent rivals.

In reality, there is no need to create additional agencies or new burdensome regulation. There are plenty of laws against cheating and stealing on the books, just a lack of enforcement. For example, the FBI could have prosecuted financial crimes but much of the agency was diverted to fighting terrorism after 9/11. The CFTC pretends it doesn’t see the obvious manipulation in the precious metal markets, while the SEC has resisted prosecuting naked short sellers.

While Congress intervenes overtly in the credit markets, the Federal Reserve is acting as a debt pusher behind the scenes through the Term Asset-Backed Securities Loan Facility, or TALF. As this initiative is administered by the Fed, it lacks even minimal Congressional oversight. When the credit markets froze last year, the Federal Reserve designed this program to give loans to investors who want to buy consumer debt instruments. The Fed's intervention increases the moral hazard in the economy by creating an artificial market for these derivatives. If lenders did not have a market for consumer debt, they would have to cut credit lines and close accounts. This would force fiscal austerity even in people reluctant to slash discretionary spending. However, beneficiaries like Cabela’s, a sporting goods company, are now marketing additional credit to customers, backstopped by Federal Reserve guarantees.

Chairman Ben Bernanke claims that TALF and similar bailouts are “emergency programs” that will be terminated soon, but their influence is already warping the business environment. Subsidies choose winners and losers, swamping any competitive advantages. Large corporations have an advantage over smaller companies, as they can afford to fill out the paperwork and lobby for access to bailouts. This crushes new innovative businesses, dampening job creation.

Despite the Federal Reserve's disastrous stewardship, Congress plans to convert it into a “super-regulator,” giving it even more control over the U.S. economy. The Fed already has few checks on its power, as it is a private entity, not part of the government as many believe. In addition to driving monetary policy, it would gain “sweeping new authority to regulate any company whose failure could endanger the U.S. economy and markets.” This change would “sidestep most jurisdictional disputes” and centralize the economy under the direction of an unelected non-governmental body run by the banks.

The Democratic leadership intends to push this through Congress quickly, in what I think is a reaction to Dr. Ron Paul’s successful Audit the Federal Reserve campaign. He already has enough co-sponsors to pass his bill in the House of Representatives if it were allowed to come to a vote, but party leaders have blocked it. If the Fed gets to captain the economy, it can refuse to account for its actions as a matter of national security.

For years, the American people have passively allowed the banks to rake in obscene profits on the backs of the taxpayer. Finally, we are seeing some grassroots resistance to thisblatant favoritism, with “tea party” protests and angry constituents confronting their representatives at formerly placid town hall meetings.

Unfortunately, this awakening is too late to prevent the destruction of the U.S. dollar. The debt bubble has already burst, and the attempts by the Fed to reflate it have created an enormous burden on the U.S. taxpayer. Since I first detailed the bailouts last October, obligations have ballooned from approximately US$2 trillion to an incredible $23.7 trillion according to Neil Barofsky, the special inspector general of the Troubled Asset Relief Program (TARP).

Don't expect any government agency to protect you from the coming hyperinflationary depression in the U.S. Now is the time to reduce your debt, sell off unwanted assets, and live below your means. During times like these, paper assets have historically performed poorly, so move your savings into hard assets like the precious metals instead.

Copyright © 2009 Jennifer Barry

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