 The Wild Wild World of Wealth |  |
Yesterday, we received a generic notice regarding one of our credit cards. I usually toss these communications. More junk mail—who needs it? Our bank was informing us, however, that outstanding balances now carry an interest rate of 24.5 percent.
Yikes, I thought. Talk about dark money.
Our credit card issuer is a big powerful organization. It is profitable, and the balance sheet is strong. Presumably, it can borrow at rates below prime—3.25 percent according to The Wall Street Journal. A spread of 21.25 percent over prime, therefore, seems excessive.
Good thing we don’t carry any balances.
I told my wife, “Even in good times, few hedge funds generate returns over twenty percent. It’s a monstrous interest expense.” This observation begged the obvious question.
Who borrows at 24.5 percent?
Nobody wants to pay this rate. Some people might use credit card loans as a bridge. They need something now and have identified enough incoming cash to pay off their loans. Maybe—but I suspect credit card balances grow when people encounter unforeseen financial difficulties. A 24.5 percent rate only exacerbates their financial problems.
That’s why I question whether credit card issuers have a solid business model in this economy. Presumably, they lend money to people who can pay their bills. But people who can pay their bills don’t borrow at 24.5 percent. It’s the Catch-22 of credit cards. At these extreme rates, in these tough times when people are struggling to make ends meet, I suspect we have yet another train wreck in the making.
To be fair, credit card companies make money in ways other than lending. They charge transaction fees, for example, on merchants for processing payments. But the “leverage” works against banks when loans go bad. Here’s why:
Assume that merchants pay a 3.5 percent every time a transaction is processed. The bank issuing the card, the one holding the loan, receives about eighty-five percent of that fee, or 2.975%. (The other fifteen percent goes to the credit card brand, like Visa.) In good times, when people are spending money, this business is lucrative. That’s why so many credit card offers arrive in the mail.
But these are tough economic times. When a $10,000 credit card loan goes bad, the issuing bank must process transactions totaling $336,134 just to break even ($336,134 x 2.975% = $10,000). That’s a big number. I don’t like the implications for credit card companies, when the future is likely to bring more loan defaults and fewer transactions. Furthermore, I wonder if egregious interest rates will make problems worse for the banks by increasing the number of defaults.
As I said, we don’t borrow against our credit cards. But I plan to call the issuer anyway and ask them to reduce the 24.5 percent rate. Why not? We’re in a strong negotiating position. We don’t need the money. We’ll lose our position of strength if unforeseen situations force us to borrow. Better to negotiate now.
Moreover, I plan to ask the bank to outline their fees. It’s possible that something changed, and I tossed an important notice in the junk-mail pile. That 24.5 percent communication was a wake-up call.
Thanks for stopping by. You just can’t make this stuff up.
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