October 2, 2022

Dear Congress – Thanks For Doubling My Credit Card Interest Rate

Congress Takes Bow For Credit Card Act of 2009

The Credit Card Act of 2009 was intended to curb certain practices of the credit card industry that were deemed abusive to consumers.  With a great deal of public fanfare, Congress passed legislation that provided the following benefits to credit card holders:

  • Credit card bills would be mailed at least 21 days before the payment due date
  • Customers would be given a 45 day advance notice of contract changes
  • An increase of the interest rate could be rejected by consumers who would then be required to cancel their card and pay off any existing balance within 5 years, possibly with a much higher minimum monthly payment
  • Payments would have to be applied to that portion of debt with the highest interest rate
  • Interest rates could not be raised on existing balances unless the borrower was more than 60 days delinquent
  • Prohibited “universal default” provisions and double cycle billing
  • Better disclosure of fees, card rules and interest costs

Senator Dodd of Connecticut, Chairman of the Senate Banking Committee, stated that “The new rules of the road established by the Credit Card Act will shield credit cardholders from widespread abusive practices”.   Whether or not the Senator (who faced an ethics probe relating to the special low rate mortgage he received from Countrywide) actually succeeded in providing any real benefits  to credit card holders remains questionable.

Credit Card Industry Response To Credit Card “Protection” Act

The credit card industry is not based on philanthropy – they seek profits and  have been exceptionally proficient in doing so historically.   Faced with huge losses from defaulting customers and the prospect of legislated profit limitations, the credit card industry reacted to these threats with the following changes:

  • Reduced or eliminated fixed rate credit cards; when interest rates increase, card rates will increase commensurately
  • Instituted annual fees, higher balance transfer fees, international transaction fees, higher cash advance fees, reduced award programs, slashed credit limits, canceled over $500 billion dollars in credit lines, summarily closed accounts deemed risky, raised monthly minimum payments and imposed strict standards for new credit cards
  • Increased interest rates by as much as 10 percentage points or more across the board, regardless of credit or payment history.  Unable to adequately assess risk or price accordingly, every credit card holder was assumed to be a potential default and charged accordingly – See Capital One Can’t Identify Their Low Risk Customers.

I have heard countless cases of people telling me that their card rates have been raised to 20% to 28% for purchases and cash advances.  Personally speaking, virtually every credit card I have has had the interest  rate increased substantially, with Capital One taking first prize by going from 8% to 17.9% on purchase balances.

Ironically, my General Motors credit card has actually dropped the interest rate from 14.15% in 2006 to a “low” 9.9% currently.  I assume that the low rate from General Motors has something to do with the fact that GM has an unlimited credit line with the US Treasury and does not have to worry about silly things like making a profit.

Why The Credit Card Companies Are The Biggest Winners Under The Credit Card Act Of 2009

What was supposed to be a major consumer protection act has turned into a future profit bonanza for the credit card companies.  Many credit card customers may go under financially but the credit card companies will do just fine, judging by the price performance of their shares and their actions taken cited above.  The credit card industry has adjusted their business model to the new reality and will prosper.

While the S&P 500 has increased by 52% since March of this year, the stocks of credit card companies have performed dramatically better.   Since March 2009 the stocks of companies such as American Express and Capital One have tripled in value even as write-offs of credit card debt hover in the 10% range and new restrictions on credit card companies become law.

“I Am From The Government And I Am Here To Help”

After bailing out the banking industry, our government (perhaps inadvertently) managed to provide even more help to the credit card industry.   Thanks for trying to help Congress – I feel much better now that I am paying 18% instead of 8%.

COF

COF

AXP

AXP

Disclosures: None

“Liar Loans” – RIP – October 1, 2009

Liar Loans To Be Prohibited

No income verification and stated income mortgage loans have been available to borrowers for many years.   As originally conceived, a no income verification loan was a sound product, offering highly qualified borrowers the ability to purchase or refinance a home quickly with minimal documentation.  Stated income mortgages are still being offered today to highly qualified borrowers by lenders such as Emigrant Mortgage.

What was once a legitimate mortgage product, however, morphed into the worst type of irresponsible lending during the national housing/mortgage frenzy of the past decade.  “Liar loans” became a product of destruction that allowed millions of totally unqualified people to borrow money who had little or no ability to service the loan.

Due to the mortgage industry’s excesses and irresponsible behavior, the “liar loans” are scheduled for legislative extinction on October 1, 2009.  The new regulations will apply to a newly defined category “of higher-priced mortgages” and the following restrictions will apply:

Prohibit a lender from making a loan without regard to borrowers’ ability to repay the loan from income and assets other than the home’s value.

Require creditors to verify the income and assets they rely upon to determine repayment ability.

The rule’s definition of “higher-priced mortgage loans” will capture virtually all loans in the subprime market, but generally exclude loans in the prime market.  To provide an index, the Federal Reserve Board will publish the “average prime offer rate,” based on a survey currently published by Freddie Mac.  A loan is higher-priced if it is a first-lien mortgage and has an annual percentage rate that is 1.5 percentage points or more above this index…

The new rules take effect on October 1, 2009

No Income Loans To Become Niche Product

The new rules  severely limit the interest rate that can be charged on a stated income prime loan to only 1.5% above the average rate on a prime mortgage.  Given the higher lending risk involved in approving a mortgage without income verification, I would expect that after October 1st, stated income loans will become a niche product, offered by only a few lenders to highly qualified borrowers.

The new rules will make it much more difficult to borrow for those who cannot verify income.   Considering the financial havoc that can result from liar loans, the mortgage industry should welcome the new restrictions which impose proper responsibilities on both lender and borrower.

Mortgage Refinances Drop 11% As Rates Remain Low

Refinances Decline as Rates Stabilize

The latest weekly survey from the Mortgage Bankers Association showed a decrease of 6.3% in mortgage loan applications.   Application volume compared to the previous year increased by 16%.

The interesting aspect of the latest weekly numbers is the decline of 10.9%  in the number of mortgage refinances.  The percentage of refinances to total mortgage applications declined by 2.9% to 53% of total mortgage applications.  With rates hovering at close to all time lows, reduced refinance activity seems to indicate that most borrowers have already taken advantage of the current low mortgage rates.

Have Mortgage Rates Bottomed?

The perfect mortgage borrower can still obtain a rate of around 5% on a thirty year fixed rate mortgage.  In addition, borrowers have had numerous opportunities over the past four years to refinance in the high 4’s or low 5% range.  Unless a borrower is applying for a cash out refinance, there would be little benefit to refinance a mortgage today with a rate of 5.5% or less.

If mortgage rates remain in the low 5% range, expect to see continued declines in the refinance sector of the mortgage market.  In January of this year, the amount of refinances hit a peak of 85% of total mortgage applications as borrowers rushed to take advantage of low rates .

Since it is usually not worth the time and cost of refinancing unless the mortgage rate can be lowered by at least a point, I would not expect to see another mortgage refinance boom unless mortgage rates decline to the low 4% range.  Considering the recent Federal Reserve report which indicates a slower pace of economic decline and an unchanged Fed monetary policy, mortgage rates may have bottomed at this point.

The Fed’s Contribution To Ponzi Schemes

12% Returns – “Guaranteed”

You don’t know whether to laugh or cry every time another Ponzi scheme comes to light.

July 28 (Bloomberg) — The U.S. Securities and Exchange Commission said it halted a $50 million Ponzi scheme near Detroit that raised money for a real-estate investment fund and targeted the elderly.

A federal judge in Michigan agreed to freeze assets after the SEC sued John Bravata, 41, and Richard Trabulsy, 26, claiming they lured more than 400 investors by promising 8 percent to 12 percent annual returns, the agency said today in a statement. Of $50 million raised since May 2006, less than $20.7 million was spent on real estate, the SEC said.

“Investors thought they were investing in a safe and profitable real-estate investment fund, but instead their money was being used to pay for luxury homes, exotic vacations and gambling debts,” said Merri Jo Gillette, director of the SEC’s regional office in Chicago.

The defendants allegedly lured investors by saying the fund offered “safer returns” for individual retirement accounts. More than half the proceeds raised by BBC Equities were conversions from investors’ IRAs, the regulator said.

This should sound very familiar since all Ponzi schemes rely on the same ridiculous promises – very high rates of return with virtually no risk.  The promoters of this latest Ponzi scheme promised returns 1200% higher than what is available on a 2 year treasury note with virtually no risk.  400 hundred “investors” took the bait, apparently believing that 12% returns were available with little risk.

Knowing exactly how many potential investors had to be solicited in order to get 400 to sign up would provide some interesting insights on investor behavior.  Do a significant percentage of individuals fall prey to smooth talking con men promising returns that would normally imply high risk?   As we have seen from the Madoff Ponzi scheme, many wealthy and sophisticated investors succumbed to the lure of high returns with low risk.

Desperate Search For Yield Due To Fed ZIRP Policy

This latest Ponzi scheme may be unique in that the perpetrators targeted the elderly.  Con men have a natural instinct to prey upon the most vulnerable and offer them what they need the most.  Many elderly investors who previously depended on interest income from savings have seen their incomes reduced to virtually zero as the Fed has forced rates at the short end to near zero.

Super low cost funding from saver deposits have resulted in huge lending spread profits for the banks.   A Fed zero interest rate policy (ZIRP) is the silent unpublicized part of the bank bailout.   In this zero sum game, the banks are the winners and the savers the losers.  How many financially prudent savers have been forced by the Fed’s policy of zero rates to take high risks (in search of yield) that has resulted in catastrophic losses?

Savers who must have income to survive have been forced by the Fed to assume more risk with longer maturity and/or riskier asset classes.  Some savers, in their desperate search for yield, have wound up losing everything to Ponzi scheme operators.

For retired savers searching for higher yields and who can tolerate price fluctuations, consider allocating some assets into a diversified selection of blue chip companies that pay dividends.  Here are some companies to consider, with stock symbol and dividend yield listed.

Altria Group                           MO              7.2%
Kraft                                    KFT              4.1%
Merck                                   MRK            5.1%
Home Depot                          HD              3.5%
AT&T                                   T                   6.4%
Philip Morris Intl                  PMI              4.6%

Disclosures:  No Positions

Payday Lenders – Predators or Saviors?

Payday Lenders Serve The Financially Inept

One of the fastest growing lending businesses in the country has been “payday lending”.  Without the hassle of a credit check or application, a payday lender will give an employee a cash advance to carry him over to his next paycheck.  There has been huge consumer demand for payday loans as reflected by the growth of  payday storefronts to 25,000 today from zero in 1990.  Convenient locations and quick easy cash entice consumers to take a one week loan on a $300 paycheck for a $50 fee.

Payday lenders argue that the credit losses, overhead costs and the complexity of  administering millions of small loans require them to charge high fees to stay in business.   When Pennsylvania capped interest based fees on payday loans, the payday lenders disappeared from the State.

Responsible Lending.org has characterized payday lending as predatory and forcing borrowers into a vicious cycle where each loan is paid off with another loan resulting in huge fees to the borrower.  Effective annual interest rates can exceed 800%.

A full three quarters of loan volume of the payday lending industry is generated by borrowers who, after meeting the short-term due date of the loan, must re-borrow before their next pay period

Repeat borrowing of what is marketed as a short-term loan of a few hundred dollars has long been documented, but this report verifies for the first time how quickly most payday lending customers must turn around and re-borrow after paying off their previous loan.

Payday lenders generate loan volume by making a payday loan due in full on payday and charging a sizeable fee—now nearly $60 for an average $350 loan. This virtually guarantees that low-income customers will experience a shortfall before their next paycheck and need to come right back in the store to take a new loan. This churning accounts for 76 percent of total loan volume, and for $20 billion of the industry’s $27 billion in annual loan originations.

Payday lenders argue that they are lenders of last resort and provide vital credit that cannot be obtained elsewhere.  If payday lenders cease operating, how would those who had relied on the payday loan get by?

North Carolina provides an example of how consumers fared after payday lending was closed in 2006.   Here are the results of a study done by the Center for Community Capital:

Researchers concluded that the absence of storefront payday lending had no significant impact on the availability of credit for households in North Carolina.  The vast majority of households surveyed reported being unaffected by the end of payday lending.  Households reported using an array of options to manage financial shortfalls, and few are impacted by the absence of a single option  – in this case, payday lending.

More than twice as many former payday borrowers reported that the absence of payday lending has had a positive rather than negative effect on their household.

Payday borrowers gave first-hand accounts of how payday loans are easy to get into but a struggle to get out of.

Nearly nine out of ten households surveyed think that payday lending is a bad thing.

As was the case with aggressive no income and sub prime mortgage lending, many people will borrow money despite onerous fees and high rates.   Financially desperate consumers giving up 15% of their next paycheck to have money a week early are clearly not helping their financial situation.  The government cannot prevent people from making foolish financial decisions, but in the case of payday lending,  tougher regulation seems necessary to protect the financially inept.

Ironically, despite the high fees charged by payday lenders,  it turns out that investors fared no better than the payday borrowers.  Earnings have generally been trending downwards and stock prices have declined significantly.  New State or Federal fee restrictions on the payday lending industry would crush loan growth and profits.  Investors in QCCO and AEA are likely to face continued disappointing returns.

qcco

aea

Disclosures:  No positions.

Bonds Sell Off, Credit Ratings In Doubt & Mortgages ReDefault

Every day there are many great posts on the web.  Here are some  from the past week  that merit a full read.  The listing order  is random.

Ok, I’m Done With Being Nice

Karl Denninger does not play nice in his counter point to a NY Times article about “mortgage relief” tax dollars going to those who were fiscally irresponsible and should have never owned a house in the first place.  The really galling part of the Times story was their tacit approval of the sense of entitlement exhibited by those who deserve nothing.

Bond Binge Hangover

With a lot of hysteria over the increase in long interest rates recently, this is a good measured analysis that looks at the history of rates and the implications for investors holding bonds.

Obama’s Deficits Put US Credit Rating At Risk

The huge US deficits and debt won’t matter until it does matter.  No one doubts that the US will pay on obligations, but what will they pay with?  Markets perceptions of risk can change quickly, upsetting any perceived economic recovery.

The State Vs. Federal Schism

The growing budget deficits on a State level have been getting some serious notice lately but have not reached the crisis stage.  How exactly does the Fed monetize this problem?  If the States have to cut budgets enough to match spending with drastically declining tax receipts, this will more than wipe out any stimulus spending at the Federal level.

A Tale of Two Depressions

Some great charts with not so great implications for the world economies.  The policy response this time is different but will it make any difference?

Fed In Foreclosure, Mortgage Rates Battered

Some discussion on the Fed’s losing battle to manipulate rates lower by buying treasuries and mortgage debt.  Investors are not amused and are voting  with an avalanche of sell orders in the long government debt markets.  So what does the Fed do next?

Geithner – “I am not a crook”

“Chinese assets are very safe”

This remarkable assertion regarding the safety of US debt securities held by China was made by Timothy Geithner, US Treasury Secretary, during his visit to China.   That Mr. Geithner felt compelled to make this statement probably reinforced the unease China has about the finances of the United States.  If the Chinese assets were actually “safe” and everyone knew it, there would have been no need to say that they were safe.

Mr. Geithner’s denial brings to mind another famous denial made by Richard  Nixon during the Watergate affair – “I am not a crook”.  We all know how that turned out.  If it wasn’t obvious that everyone knew Nixon was a crook, he would not have had to deny it.  If US assets are really safe, Geithner would not have to say that they are safe.

Almost a Vaudeville Act

Mr Geithner’s “Chinese assets are very safe” line was  greeted with loud laughter by the student audience he made his remark to.   The laughter speaks for itself regarding the credibility given to Mr. Geithner’s assurances.  Perhaps our Treasury Secretary should have countered the laughter by saying, “I am totally serious about this”.

At the same time, the President and Chairman of the Federal Reserve were very publicly proclaiming that the US deficits would be cut, future spending would be “disciplined” and that fiscal imbalances would be addressed.  These remarks probably confused the Chinese as they watch the United States implement programs that require trillions of dollars a year of new deficit spending.  You can say you will do something but what really counts is what you actually do.   Words are a cheap commodity while confidence is precious.

The recent remarks by Geithner, Obama and Bernanke promising fiscal restraint may have something to do with the following chart.

10 Year Treasury

10 Year Treasury

Courtesy: Yahoo finance

Despite the Fed’s massive purchases of mortgage and treasury securities,  price action in the long term treasury market clearly indicates more sellers than buyers, with rates nearly doubling since late last December.  Rates at 3.75% on the 10 year treasury are certainly not a disaster, but if all the powers of the Fed and Treasury to lower interest rates are failing, then maybe things aren’t so “safe” after all.

The Futility Of Lower Interest Rates, Obama Motors, “Atlas Shrugged” Sales Surge & Confidence Mounts

As stock markets surge, GM’s future is suddenly bright and consumer confidence soars, here are some recent blog posts worth the read with some alternative insights.

Why lower interest rates are not effective monetary policy

If too much debt caused the financial crisis, why are governments world wide trying to force more debt on an over leveraged world?  Japan’s policy of rock bottom low interest rates did not prevent Japan’s “lost decade” of economic growth and results for the  rest of the world will be no different now.  Why low interest rates do not improve the economy.

We are all now GM shareholders but don’t spend the profits yet

Now that the government, aka known as “the people” own General Motors, can we expect to see a quick turnaround that has eluded GM management for decades?  If GM cannot come up with products at a competitive price that buyers in a free market will purchase, the huge taxpayers subsidies will have been nothing but “stimulus waste”.

Atlas Shrugged book sales continue strong

The truths in Atlas Shrugged continue to promote big sales of a book written half a century ago.  Government policies continue to protect and save the least productive while killing the overall economy.  Our present political system almost guarantees the continuation of self destructive governmental economic policies.

With no signs of real economic recovery in sight, consumer confidence grows

Is the increase in consumer confidence in the economy justified?  Although we seem to have avoided the economic collapse widely feared just several months back, what has really changed?  Balance sheets and incomes have not improved and job losses continue.  Do not expect a “V” shaped recovery.

Mortgage Rates Skyrocket As Fed’s Rate Manipulation Fails

Markets Will Ultimately Determine Long Term Interest Rates

Treasuries continued their sell off today as the yield on the 10 year benchmark bond climbed to 3.72%, a stunning increase from the recent lows just over 2% in late 2008.  Investors have become concerned that record amount of debt sales and quantitative easing by the Treasury that may lead to inflation.

10 Year Treasury

10 Year Treasury

Courtesy Yahoo Finance

Further contributing to the huge bond selloff today were comments by Marc Faber that the US might enter “hyperinflation” based on the Fed’s super low rate policy, huge increases in government debt and massive liquidity injections into the banking system.

Mortgage Rates Explode Upward

The yield on the 10 year bond has been climbing since early January, gradually putting pressure on mortgage rates.  Until recently mortgage rates did not jump dramatically since the spread between the 30 year fixed rate mortgage and the 10 year treasury narrowed.

Some analysts have speculated that the  Fed was able to manipulate mortgage rates lower over the short term through purchases of mortgage backed securities.  Today, the Fed discovered the limits of  establishing artificial price points.  The Fed may be able to manipulate rates in the short term, but the markets will ultimately set the price of money based on the reality of  US financial conditions.

Bloomberg – The difference between yields on Fannie Mae’s current- coupon 30-year fixed-rate mortgage bonds and 10-year Treasuries had been narrowing. It was at 0.92 percentage point today, down from as high as 2.38 percentage points in March 2008, according to Bloomberg data. The Fed’s purchases drove the spread to 0.70 percentage point, the lowest since 1992, on May 22. The yield gap jumped from 0.71 percentage point yesterday.

“Many investors who felt MBS spreads were too tight thought it might be time to take chips off the table,” Credit Suisse’s Swaminathan said. “This is something we anticipated would build up” as many mortgage-bond holders who were previously wary of lightening their positions on the view the Fed buying would continue to support the market finally decided to act.

“The last two months have been quite abnormal” as mortgage rates generally held in a range between 4.5 percent and 4.75 percent even while Treasury yields began climbing, he said.

Today, the “abnormal” pricing situation was shredded.  Major banks sent out multiple mortgage rate increase notices as the day progressed.  Here’s an example of how mortgage rates have increased with one large bank over the past couple of days.

Mortgage Rates In The 4% Range Disappear

On Thursday, May 21st, a prime mortgage borrower could have obtained a 30 year fixed rate of 4.75% with a half point fee.  On May 27, the equivalent rate for a prime borrower is 5.375% with a half point fee.

To obtain the 4.75% rate today, a borrower would need to pay approximately $5,400 on a $250,000 loan to buy the 4.75% rate.  The monthly payment difference on a $250,000 mortgage loan at 5.375% vs. 4.75% amounts to $96 or $1152 per year.

Are 6% 30 Year Fixed Rate Mortgages Coming Soon?

So much for Mr. Bernanke’s grand experiment of buying mortgage debt with printed money.  If the spread between mortgage bonds and the 10 year treasury widen to the spread of 238 basis points seen in March 2008, the 30 year mortgage rate will be over 6%,  even if the 10 year treasury remains at 3.72%.