This should be a springtime of joy for credit card companies. On Wednesday, President Bush signed the new bankruptcy bill, which they helped to write. Short-term interest rates are on the upswing, which means they can jack up interest rates from, say, 13 percent to 17 percent, without customers asking too many questions. And with employment growing modestly and new unemployment claims down, credit card delinquencies should be on the decline.
But all is not tulips and nectar over at MBNA, the largest independent issuer of credit cards. Yesterday it reported a poor quarter and ratcheted down earnings expectations for the year. Its stock sank to a two-year low. Credit card giant Capital One Financial had a better quarter, but its stock has been slumping lately, too. Bad news for the credit card companies may be better news for us. There are signs at both companies that consumers may be responding to higher rates by doing something almost completely unexpected and practically un-American: paying down credit card debt.
The credit card industry presumes, based on happy experience, that Americans will borrow more money each quarter to support their spending habits, regardless of the direction of interest rates, and that enough consumers will be happy simply to pay off just enough debt to allow them to borrow more. But last quarter MBNA, to its apparent shock, found that "results were further impacted by unexpectedly high payment volumes from U.S. credit card customers," and that "the payment volumes were particularly higher on accounts with higher interest rates."
In other words, customers didn't respond to rising rates by continuing to pay the minimum and going deeper into debt; they paid down the principal more rapidly than expected. A detailed breakdown of MBNA's business shows that between the fourth quarter of 2004 and the first quarter of 2005 (i.e., between Dec. 31, 2004, and March 31, 2005) domestic credit card loan receivables—balances outstanding—fell from $13.9 billion to $10.9 billion in the U.S. alone. Meanwhile, U.S.-managed loans—balances outstanding plus receivables that MBNA has securitized and sold—fell sharply from $80.2 billion to $74.8 billion, down 6.7 percent.
Dig into Capital One's report and you can see inklings of something similar. In the first quarter, Capital One's U.S. card-loans receivable fell to $46.6 billion from $48.6 billion in the fourth quarter of 2004—a 4 percent decline.
What gives? It turns out many customers are having entirely rational reactions to rising interest rates (and perhaps the new bankruptcy law). They're taking the sometimes painful steps necessary to reduce credit card debt before it gets too onerous. Perhaps MBNA was caught short because it has taken consumers so long to wake up. For nearly 20 years, consumers were schooled to believe that interest rates generally fell and that any increases were short-term blips. Now, the Fed has boosted rates seven times recently, and we've entered a period in which interest rates will likely rise or remain stable—but not fall.
Credit card companies have been operating in an era of falling interest rates so long that they may have forgotten that when interest rates rise, people either seek to pay down debt or look for cheaper sources of financing. MBNA and Capital One have to contend with banks and mortgage lenders offering cash on better terms. How many pieces of mail do you receive each week from finance companies offering to transfer outstanding credit card balances at lower rates—at least for a few months?
There's another wrinkle in the complex interest-rate climate that may hurt credit card companies. Interest rates on credit cards tend to respond to moves in short-term interest rates, which means they are rising. But mortgage rates respond to moves in long-term interest rates. And those rates remain remarkably low. Since long-term rates are steady, it now makes more sense for people who need cash to turn to a home-equity line of credit rather than to an MBNA card.
At the margins, some Americans seem to be using their slowly growing incomes to reduce credit card debt rather than to buy new stuff. (That could be one factor behind March's weak retail spending report.) Of course, MBNA and Capital One shouldn't fret too much. Credit cards are so beloved in American homes they are practically family. It will take a lot more than higher interest rates to wean us from them.