Monday, May 11, 2009

Banks Are Stupider Than We Are

An article in the New York Times today says that banks are bracing for taking losses on their credit card customers. The banks might have to write off some debts they realize they will never be able to collect. Nowhere in the article are the dollar amounts of actual purchases separated from the dollar amounts of expected profit from late fees, finance charges, and finance charge hikes, and the many other punitive measures banks use to raise their expected profits from credit card holders. Nowhere does the article mention the transaction fees the banks have already collected from merchants for each purchase.

I wonder what Americans really owe? Is it $8,400, as Moody’s is quoted in this article? Or $9,000, the figure that various financial writers fling about? And how much of that $8,000 or $9,000 is actual purchases, and how much is the additional punitive fees banks add on?

This is meaningful because at some point, someone has to recalibrate bank expectations of profit from credit cards. We all know that finance charges and late fees have been minting money for card issuers for decades. If they are used to making, say, 70% profit on these cards, perhaps in the future, they should expect to make only 35%. I don’t know what percentage of profit banks routinely make on credit cards because most of the articles I pull up on the net are about the losses they expect to take this year. But a little probing reveals that some quote percentages such as 71% profit and a 24% loss. Compare that to the 1% or 2% profit that the grocery store industry typically nets. Or the 6% profit that publishing used to make. That’s right. Those figures are correct. Many large businesses make huge dollar amounts but only tiny percentages in profit. The banks have been making huge percentages ever since they got deregulation of finance charges.

But, and this is interesting, in searching for the figure on bank credit card profits, I have realized something else about them. If we think that individual consumers are stupid about credit, we now have proof that banks are even more stupid. Why? Because the banks are taking a bath on credit cards right now and in the foreseeable future. It’s all over the net. And nobody seems to realize that if the banks did not charge such fantastic and unfair fees, consumers, even consumers who have lost their jobs, might be able to pay them back. Well, duh.

Which brings me back to that $9,000 average credit card debt. What if it’s only for $2,000 in purchases? It looks a lot easier to pay back, doesn’t it?

Here’s the thing. We all know how credit cards work today. And we all know that credit cards were originally only issued to people who were wealthy or whose purchases were on an expense account and would be paid for by an employer. At that time, the banks collected their profit as fees from merchants. But then the banks changed their paradigm. They decided to make credit available to more iffy customers, including college students, which enlarged their customer base enormously. This drastically increased their percentage of failures, i.e., customer defaults. And it increased the banks’ internal costs of operation, since they now had to monitor and deal with many more customers. In other words, the banks took a solid business based on people who could pay and turned it into a precarious business based on people who might pay but often could not. And now that the economy is in a significant downturn, the folly of basing a business model on such a precarious concept (overloading individuals with debt and then milking them for finance charges) is self-evident.

So, yes, another instance of the banks being even stupider than we are.

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