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Waiting for the other shoe to drop: The looming credit crisis

Posted Dec 1st 2008 6:00PM by Bruce WatsonBruce Watson RSS Feed
Filed under: Columns, Recession, Financial Crisis

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I still remember when I realized that a real estate crisis was on its way. My wife and I were contemplating buying a home in Roanoke, Virginia, and began talking to a mortgage broker. When we saw the final offer, we realized that, if the real estate market continued on a stable path, and if the (then marginal) neighborhood continued to have a declining crime rate, and if the price of gas didn't go up, and if neither my wife nor I became seriously ill, then we would be great. In five years, when the rate went variable, we would refinance and everything would work out beautifully.

That was in 2004.

Thinking about it, my wife and I soon realized that those were a lot of ifs; while we wanted the house, we knew that we couldn't base our financial future on a deck of cards. After turning down the offer, I thought more and more about it and began to get worried. If a lot of people were buying into the kind of mortgage that my wife and I had declined, and if they had similar expectations about refinancing when their rates went variable, then it seemed likely that the mortgage industry was sitting on a major time bomb.


Somewhere along the line, it has become clear that the housing market is only the tip of the credit iceberg. After all, while only a relatively small percentage of the population decided to buy into the real-estate boom, most adults have credit cards. Worse yet, all of the excesses of the mortgage market are mirrored in the credit card industry. For example, the tendency of some borrowers to exaggerate their income and downplay their expenditures has been blamed for a large percentage of the bad mortgages out there. By comparison, credit card forms allow applicants to claim household income as a grounds for repayment. Thus, applicants can legally pretend that their roommates' or parents' incomes influence their ability to pay a debt.

More importantly, most of the information on a credit card application is unverified. The applicant can claim any rent or salary that he or she wishes, comfortable in the knowledge that the company will not be able to check it out. Ultimately, the qualification for a successful application seems to lie in having a good credit history. However, as Joe Nocera pointed out in the December 1 New York Times, credit history doesn't really translate into ability to pay debts.

Perhaps the biggest danger lies in the way that the credit card companies have tried to manipulate their consumers. Using flashy balance-transfer offers to draw customers in, many subsequently raise rates or use a variety of questionable methods to levy fees. Added to this, many companies base credit limits on credit score, which means that some customers find themselves with credit limits that far outstrip their resources. This, in turn, encourages a sort of "Peter Principle" of credit: customers are promoted until they reach their level of insolvency.

Years of easy credit and aggressive marketing have left many consumers stretched to their absolute limits. In the face of a declining job market, an ugly housing market, and inflation, many consumers are likely to find that, as much as they might prize their good credit, they prize food even more. Given a choice between the two, they'll buy dinner and leave the Visa to stew. If credit card companies show the same ineptitude and intransigence demonstrated by Lehman, Bear Stearns, AIG, and the rest of the recent Wall Street losers, it's going to be a long, cold recession.

Tags: AIG, Bear Stearns, BearStearns, Credit cards, CreditCards, featured, financial crisis, FinancialCrisis, Lehman Brothers, LehmanBrothers, New York Times, NewYorkTimes, recession

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