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Credit card securitization encourages fee-based profit model – from a sister-site of angry card holders

New Credit Rules was started in response to an outrage by Amex – the retroactive reduction of small business owner Kevin Johnson’s line of credit – in spite of a perfect payment history. Below is an article I found on his site explaining the financial approach, the method behind the seemingly mad abuse of customers by the credit card industry. You won’t be surprised to hear, I bet, that they’re raking in the dough.

Credit card securitization encourages fee-based profit model

One of the major reasons for the current economic downturn is securitization, the process of pooling and selling to investors certain assets which have regular repayment schedules like mortgages and credit card loans.

For example, a mortgage company may pool its 30-year fixed-rate mortgages of homeowners with a credit score of 750 and above, and therefore create a mortgage-backed security with a seemingly safe investment rating of AAA. For simplicity, let’s say the first two years of payment coupons from all the pooled mortgages adds up to be $200 million. The mortgage company may sell to a buyer, a money market fund perhaps, the first two years of coupons for $180 million. While it may seem like a $20 million loss to the seller, it could be a quick gain for a company unwilling to wait two years for their money. Moreover, this deal lessens the seller’s risk. As for the buyer in this case, such a purchase is a great short-term investment, especially one with such a high rating and unlikelihood of default. Some investors even go as far as selling bonds based on these assets in the secondary market.

The system works beautifully as long as people pay their debts. However, pandemonium occurs when a large number of homeowners, as in this example, default on their payments due to a job loss, an excessive lifestyle, a medical emergency, etc. As a result of massive defaults, mortgage-backed securities (those pools of mortgages mentioned earlier) become “toxic” as they quickly lose value. In addition, falling home values further decrease the value of the securities. Everyone involved takes a hit.

Credit card securitization

Credit card securitization works in a similar way except for one major difference that fuels the new fee-based profit model. The biggest difference is that credit card companies don’t completely sell-off their relationship with the debtor to the buyer; instead, they still have means to profit from that debt. Credit card expert Adam Levetin, a law professor at Georgetown University, explains the major difference: “While card issuers sell off most of the default risk, they keep any upside that comes from inflating their fees and rates… If the higher fees and rates cause more defaults, it is investors who bear the loss. If the higher fees result in more income, however, it is the card issuer, not the investors, who benefit.” Simply put, credit card securitization can be extremely profitable –and at a much lower risk for issuers.

As a result of the popularity of credit card securitization, companies have implemented all types of new fees. There is the cash advance fee, balance-transfer fee, late-payment fee, over-the-limit fee, additional card fee, expedited payment fee, etc. The list goes on. Levetin cites the following statistic that makes the case quite clear: “The rise of these fees has a 99 percent correlation with the growth of securitization.”

In conclusion, credit card securitization is the culprit for outrageous fees and an increasing number of angry consumers. Last year, revenue from these fees totaled $12 billion. When considering the long list of fees, the actual interest rate that consumers pay is unbelievably high. So, while rising interest rates, decreasing credit limits, and increasing horrific customer service are obvious and immediate concerns, the underlying model of credit card securitization must be changed. Otherwise, consumers will continue to be extorted.

Posted by Kevin D. Johnson at 9:25:06 AM in Credit Card Policies