A quick read of a recent New York Times story could suggest a tidal move back into subprime lending. But a closer look reveals a major exception: before the crisis, consumers with weak credit were warmly invited to borrow on unsecured bank credit cards. No more.
Despite credit card loss rates and cost of funds at historic lows — and prime credit card marketing at near-record levels — major lenders don’t promote subprime cards. HSBC ("Orchard Bank") was an exception, but its portfolio was recently sold to Capital One (COF) — which no longer openly markets subprime. Just a few years ago, more than half its accounts were said to be subprime.
The message from the banking industry to those lacking excellent credit is that they're welcome to deposit money, usually without interest and subject to fees — but not to borrow it unsecured.
Yet, it is still possible to buy a home with only a few percent down, subsidized by the money-losing FHA. Subprime auto loans abound. There's approximately $1 trillion in unsecured student loans, often with poor credit.
So, it's possible to borrow $10,000 or $100,000 with partial, if any, security and with weak credit — but impossible or very difficult to find an unsecured credit card with a $500 line if you score down in the 600s. A college student can get a loan without parental involvement — but not, since the CARD Act of 2009, a credit card.
Is this because there are massive industries promoting the sale of houses, automobiles and college educations — but none promoting credit building? Probably. But there are also other reasons.
One factor is the widespread stigmatization of "subprime credit." Supposedly, lending to people with low scores caused the mortgage disaster. Wrong. Originating mortgages for speculators, for people with inadequate or unknown income, and lending with little or no down payment or even a negative one (in the case of RFC, now part of Ally, which allowed 115% LTV) drove losses, as did marketing of "creative" mortgages requiring little or no initial monthly payments.
No significant card issuer went broke or suffered continuing losses because of subprime cards. No major securitization failed because of subprime cards, although many supposedly prime mortgage securities crashed. When subprime cards were more readily available from major issuers, they didn’t generate a disproportionate number of consumer complaints or other evidence of possible deception or harm. And if high losses on unsecured lending hurts consumers, then let’s prohibit "deposit advances," which have far higher losses.
But for equity investors, a dollar earned from subprime lending is much less valuable than a dollar from prime lending. Subprime cards are far more visible than sub prime auto or home loans because cards are more widely advertised. Subprime terms (higher rate, annual fee) make them easy to distinguish. Hence a bank selling profitable sub prime cards might nonetheless lose stock value.
So, the remaining smaller, specialized issuers of subprime cards, such as Premier and Credit One, tend to be privately owned. For the majors, it's "I’ll do it only if I can avoid being seen doing it." According to that Times story, new subprime card credit is down 70% since 2007.
Second, enactments of the last few years have made it harder to earn returns on subprime cards. These new restrictions including constraining card over-limit fees, capping late fees, and putting a ceiling on first year fixed or periodic fees. Plus increased capital requirements for subprime.
The result, as any Economics 101 student could predict, is greatly reduced supply of this credit. Same as state usury ceilings cut availability of cards, specifically for people with weaker credit. We end-ran those, but we can’t end-run Washington.
As reported in this newspaper, the government aggressively applies an "effects test" punishing lenders for actions that have disproportionately adverse effects on protected classes such as women. Yet the government itself promulgates rules that would fail such an effects test. If late fees and annual fees have to be lower and capital higher, then the resulting credit contraction falls most heavily on women and other lower-earning groups, because reasonably profitable products adapted to their needs and risk level become less feasible. Are we trying to switch them all to "deposit advances?"
Raj Date, deputy director of the CFPB, stated recently that regulators should be sensitive to the impact of their actions on availability of credit. Absolutely right. He was too polite to add that the same applies to legislators — and bankers.
Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of First Deposit, later known as Providian.