Federal Reserve Says Banks Not to Blame for Increase in Bankruptcy Filings

In July 5, 2006

When Congress passed the bankruptcy reform bill last year, they included Section 1229, which asked the Federal Reserve Board to conduct a study to determine whether the “indiscriminate” extension of credit to consumers had contributed to the increase in bankruptcy filings.

The report is a treasure trove of fascinating little tidbits of information. Here are a few examples:

1. In 2004, 71% of American families held general-purpose credit card accounts, up from 16% in 1970.

2. 56% of families carry a balance on bank-type credit cards, and 24% hardly ever pay balances in full.

3. As of 2004, outstanding debt on credit cards was $645 billion.

4. An average of 8.9% of families were late at least 60 days on a debt in 2004.

5. Profitability of credit card banks is nearly double that of commercial banks.

6. More than 5.2 billion credit card solicitations were mailed in 2004, up from 2.7 billion in 1995.

7. The response rate on credit card solicitations has dropped from 1.4% in 1995 to 0.4% in 2004.

There’s a lot more in the report, but the above gives the flavor of the type of data published by the Fed about the credit card industry.

Predictably, the report produced by the Fed concludes that the credit card banking industry is not to blame for the increase in bankruptcy filings. Specifically, “…this review finds that as a matter of industry practice, market discipline, and banking agency supervision and enforcement, credit card issuers do not solicit customers or extend credit to them indiscriminately or without assessing their ability to repay debt.”

Did we expect anything different from the Federal Reserve? Not really. Frankly, the study was simply not deep enough to penetrate the real issues at hand. If the banks are so good at determining repayment ability, then why do I keep talking to people who have far more credit than annual income? Why do the credit card banks make more than 30% of their profit from the delinquent status of their customers (late fees or penalties)? Since the only income data they gather is what’s on the application, how on earth do the banks determine ability to repay in the first place?

To be sure, the report does state that “…certain specific industry practices of late have been deemed by regulators to potentially extend borrowers’ repayment periods beyond reasonable time frames and have been the subject of extensive supervisory attention and guidance.”

Translation: It takes 20 or 30 years (if not longer) to pay off balances via minimum payments, which results in a situation most of us would simply call “highway robbery.” So the Office of the Comptroller of Currency has forced the banks to increase their minimum payment levels and bring down the repayment period.

Where the Fed report gets really interesting though is the conclusions regarding the bankruptcy trend. After citing several economic studies, some of which contradict each other, the report states that “…the longer-run trend in bankruptcy filings is historically related to a number of factors, including an increase in revolving consumer credit use and, perhaps, a decline in the stigma associated with bankruptcy. It also appears that the decision to declare bankruptcy is typically triggered by unforseen adverse events such as job losses or uninsured illnesses.”

Oh, so THAT’s why all those people file bankruptcy every year? I never knew it was because they have more debt, they lose their jobs, or they get injured. How could we have known?

Seriously though, the Federal Reserve report clearly shows a correlation between consumer bankruptcy filings and the inflation-adjusted amount of revolving credit per household. At the same time, it concludes that the credit card banks have nothing to do with this. So if I have this correctly, the Fed is saying that increasing consumer debt has contributed to the increase in BK filings, but the banks do a good job of managing credit risk so the increase in debt which led to the increase in bankruptcies is not their fault. Am I missing something here?


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