Business as usual

I got a letter through the post.  Apparently it came from BT, although actually the credit card it offers is provided by MBNA Bank Europe Ltd, and only branded BT.  Straight off the bat, that annoys me.  At every possible opportunity, I always tick the box to say that I don’t want to ‘from time to time receive information about special offers from our carefully selected business partners.’  I’ve certainly told BT this, but because, technically, the credit card offer is offered by a ‘partnership’ between MBNA and BT, it’s not covered – BT don’t seem to give you the option of opting out of their own marketing material.

That’s not what really gets me, though.  What gets me is the fact that they’re trying to encourage people to take on debt, in what seems to me like a hugely irresponsible way.

The ‘unique selling point’ of this credit card is that, instead of reward points or something similar, the incentive to make you sign up is that you get money off your phone bill.  They go big time on the advantages of this – they tell you about it in the letter, in a handy little reference table next to the application form, and again on a glossy card printout.  The table looks quite appealing – it shows that you could save up to £75 a year, or £150 a year if two people from the same household take out two separate credit card accounts.  That looks like a lot of money.  I pay about £230 a year on my phone bill, so £150 off (I’m assuming in this particular scenario that I have a partner – well, it’s no more unlikely than me passing a credit check…) would mean a saving of about 65%.

It looks less appealing if you actually pay attention to the details of the information in the rest of the table, but they try to make paying attention difficult.  In order to get the maximum £75 discount, you have to spend £750 a month on your credit card.  Those figures are carefully chosen – a part of your brain instantly thinks, wow, I’m getting 10% back.  But, of course, you’re not.  The discount is the annual figure, while the spending amount is the monthly figure.  In order to save £75, you actually have to spend £9000.  In percentage terms, that means anyone who went for this deal would actually be getting just 0.83% of their money back.

The advertised typical APR on the card is 16.9%.  I know the actual calculations are nothing like this simple (I’ve assumed the £9000 arrives all in a lump, when in reality it accumulates slowly over the year, and I also haven’t made allowance for any repayment of the outstanding balance each month), but as a very rough and ready rule of thumb, a balance of  £9000 will cost £1521 in interest.  The current LIBOR figure* (which is, again very roughly, what MBNA would pay to borrow the money from another bank) is 2.5%.  This means the same £9000 borrowing only costs MBNA £225.  Adding the £75 phone bill discount on top, that means the total cost to MBNA is £300, which means they are making a profit of £1221.  Taking account of the vagueness of my sums, and the other costs they will encounter, lets call it a profit of around about £1000.

This is, of course, basically money for nothing – all a credit card company does is act as a conduit for money, transferring it from the London inter-bank markets to a private individual.  Once upon a time, the credit card companies could have argued that their profits reflect the risk they are taking.  Credit cards are unsecured borrowing, and if one of their customers defaults, they have to take the cost of that out of their profits.  But that was before the banking market changed so fundamentally.

Now we all realise that what most banks and other financial institutions actually do is take the profits and distribute the bulk of them to their shareholders in the form of dividends, and then, when their customers start to default on their loans, go running to government authorities for state help.  MBNA is owned by Bank of America, so in this case UK taxpayers won’t end up solely responsible for any bad debt generated by this marketing campaign – US taxpayers are also at risk.  I’m sure auto-industry workers in Michigan, already struggling to make ends meet on reduced working hours, will be thrilled to know that their money is being siphoned off, not to pay for, let’s say, a comprehensive healthcare system, but so that British people can enjoy discounts on their phone bills.

I said in that last paragraph that this advertising campaign will generate bad debt.  I have no reason whatsoever to think that MBNA would be any more likely to attract bad debt than any other credit card company.  To a certain extent, in any case, bad debt is inevitable – a proportion of customers will always prove to be unable to meet their financial commitments, and that proportion will inevitably increase in a recession, when more people are at risk of losing their jobs.  But it’s not just that.

In addition to the 12 months 0% on balance transfers (which is a pretty standard feature of credit card deals these days), this deal also offers 12 months at 0% on ‘cash transferred to your current account.’  Now, I wonder, what kind of people are going to be attracted by an offer of (temporarily) interest-free money paid into their current account?  Well, some of them may be perfectly responsible, of course.  But isn’t it fairly likely that a fair few of them will be people who’ve overspent at christmas, and now have a big unauthorised overdraft on their current accounts?  Or people who’ve found for whatever reason that they don’t have the money to make the mortgage payment this month?**

Some of these people may also be perfectly responsible – they may exercise an iron restraint over the year, and use the interest-free offer as a one-off method of getting their finances back on track.  But an offer like this will also appeal to people whose financial predicament is far worse, or to people who will persuade themselves at the beginning that this is going to be the moment at which they turn over a new leaf, but will ultimately end up not making the new start.  And, because this is a credit card, rather than a structured and limited form of credit like a personal loan, it’ll be child’s play to run up even more debt.  In fact, MBNA are offering a specific inducement to people to do so – the more you spend, the more you ‘save’ on your phone bill, after all.

The concern about companies encouraging people to take on debt they can’t afford used to be fairly one-dimensional.  It could have a devastating effect on the people concerned, of course – there have been more than a few cases of people committing suicide because they couldn’t see a way out of their financial difficulties – but the effects only had a limited range.  That’s not true any more.  The consequences of the sub-prime crisis in America proved that, when the stability of banks is measured not by how big their cash reserves are but by how risky their debts are, lending money to people who might not be able to pay it back is a really bad idea.  It brought the world financial system to the brink of collapse, and it’s triggered a global recession.

Credit card companies are not, I’m sure, sub-prime lenders, as such (I don’t think there are many left anymore).  I’m sure they have a scrupulous application process, and that they do everything they can reasonably be expected to do to make sure that they only lend to people who can afford the repayments.  But in the present climate, lending to anyone is a risk.  Major companies have gone bust, and plenty of economists are forecasting that more are likely to follow.  Even companies that are not under immediate threat of collapse are shedding jobs.  The person who has a well-paid job and an exemplary credit history today may well be unemployed and a bad credit risk tomorrow.

Under these circumstances, it seems to me that it’s irresponsible to the point of idiocy to encourage people to take on more debt, especially ‘open-ended’ debt like credit cards.  Given the record amount of consumer debt that exists in the UK at the moment, it must be the case that every credit card company has plenty of existing customers, and that lots of these will have large balances on their credit cards.  It ought to be perfectly possible for credit card lenders to sit-out the recession with their existing customer base, generating an income from the repayments made by people who already owe money, but not offering new or extended credit.

It’s hard to escape the conclusion that, in the present climate, lenders are only able to justify the risk of new lending because recent events have taught them that, if they encounter a significant problem with bad debt, state authorities will step in and bail them out.  (I think this is what economists mean when they talk about ‘creating a moral hazard.’)  On one level, this is obviously unfair – lenders can enjoy the short-term profits that result from a relaxed approach to lending without having to worry about the long-term risks, while tax-payers, on the other hand, carry all of the risk in return for none of the profits.  But there’s also, it seems to me, a more fundamental concern.

Most people would, I think, agree that irresponsible lending was a fundamental cause of the problems we’re currently experiencing.  It was the decision to lend money to people who had very little chance of ever paying it back that has led to the situation we now find ourselves in, with hundreds of thousands of people losing their jobs, and millions more struggling to get by.  Against this background, credit card companies encouraging people to take on new debt doesn’t just seem like a bad idea for the people concerned, it seems like a bad idea for the global economy.  It seems to me that it increases the likelihood that the banking system will be seen as unstable for longer, and until those problems are resolved, I really can’t see how the recession will bottom out.

 

 

* – The figure is the one quoted when I checked the link at 1345 on the 8th of January.  It seems to change fairly frequently.

** – Actually, I’ve just looked at the small print, and it turns out that the balance and cash transfers aren’t even free.  Both of them carry a 3% ‘handling fee,’ which is a lot like a 3% annual interest rate, except it’s all taken up-front, so you have no chance of reducing what you pay by reducing the balance owed.  I guess ‘discounted APR with extra strings attached for 12 months’ wouldn’t have looked as attractive in the headline figures, although it might have seemed more accurate.

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12 Responses to Business as usual

  1. lsnduck says:

    The banks and other financial institutions need to take on a lot of the responsibility for the current situation. What would also help would be a better informed general population who can give due consideration to financial decisions.

    All of the cash type transactions have traditionally had big admin fees on them. You also need to be careful about varying interest rates between cash and purchase transactions, as well as the order in which the card provider reduces your debt when you only partially pay off your bill. It is a mess (and MBNA have a reputation of making it all worse than other providers).

  2. Mail Preference Service and Telephone Preference Service work well for cutting out most of the junk…

    Agree about the ghoulish irresponsible usurious gits! D

  3. Zoe says:

    Aethelread for Chancellor of the Exchequer. You heard it first here…

  4. what most banks and other financial institutions actually do is take the profits and distribute the bulk of them to their shareholders in the form of dividends,’

    This is inaccurate, what they do is pay their employees massive bonuses, and then pay a mediocre dividend :).

    I don’t think the current crisis is due to bad debt per se – bad debt is ok if you are able to estimate the percentage of bad debts that are likely to occur and set money aside for this (I think this was one of the first subjects I studied in basic financial accounting). In addition, there needs to be an incentive for the estimator of the risk and to estimate it correctly.

    Borrowing on the LIBOR market is a very low-risk endeavour, you have a slightly higher chance of not getting your money back than if you draw directly on the Treasury, but only slightly.

    The problem is the repackaging and selling on of the loan and with it the risk, such that no-one gives a toss any more.

    So, let’s say Michigan AutoWorkers Bank loans GBP 1 million to MBNA for a 3 month term using the 3-month LIBOR rate (forget the FX part where MAWB converts dollars to sterling, not relevant).

    MBNA loans this money out to its credit card holders. Now, right now, MBA must pay MAWB back at the end of the term regardless of whether or not its customers have repaid. It carries the risk, and so puts in place suitable (for it, not necessarily for the public) rates of interest and internal accounting procedures to ensure they don’t get caught short.

    Let’s say now that once it has made the credit card loans, MBNA is able to sell or repackage the debt, such that it can pass it along to someone else. This is the banking equivalent of selling a GBP 20 M&S voucher to someone for 18 quid because your aunt gave it to you and you don’t like M&S. The title of the loan passes to the new buyer, and the credit card holder’s payments are sent to this buyer. They do this so that after lending the money out they make a profit – not as much as if they waited for it all to be paid back, but enough to make it worthwhile.

    If this buyer is an investment bank, they can create a special purpose vehicle (separate legal company entity) to whom title of all these sold on loans is passed. We now have Morgan Stanley SPV #999 ltd., which owns that GBP 1 million of credit card loans. The actual value of the loans varies depending on the risk model calculations (which essentially calculate how likely each loan is to be late or default and gives you a GBP number somewhere under 1 million but hopefully not too much).

    Next step…. the SPV issues a bond, with a reasonably high yearly rate, eg 9%. The yearly payments on the bonds, as well as the final redemption, are paid from the cash received from the credit card holders. Various complicated things are done to the bonds to make them supposedly less risky, and they are sold on to, say, MegaHedgie hedge fund. Who sells them to another bank. Who use them to create yet another asset pool to create an SPV to….

    They had layer upon layer of this, with no incentive for anyone to worry about repayability.

    It wouldn’t surprise me if this was still happening, or alternatively, the card issue you describe may be the expectation of crucifying lotsof hard up people with massive interest charges and being just general evil bastards.

    BTW you have a really good grasp of financial matters for someone who doesn’t work in it. (I say this not to be patronising – I work in investment banking so this stuff is part of my job, you just pick it up after a while of being surrounded by it 40 hours a week – but I know sod-all about the cardboard box industry for example).

    I am of course required to add the disclaimer that I am not taking about my employer above, I intentionally never talk about anything specific to them anywhere online, instead I use examples provided by friends in other banks, or just general industry chat, as I like my job and JSA isn’t particularly generous these days.

  5. cb says:

    The thing that really worried me about your mailing (!) was the offer of 12 months 0% of cash transferred to your current account. I think it scared me as I would have jumped at the offer with both hands a few years ago when I got a bit ‘credit card’ happy and saw it basically as free money. Now, about 10 years later, I’ve just about paid it off and of course, you have to take personal responsibility but you’d think in the current climate there might be a bit more responsibility from the lenders.

  6. aethelreadtheunread says:

    Thanks for the comments.

    lsnduck – you’re absolutely right to stress the fact that individuals have responsibilty for checking out the details of any financial commitments they make. This is something i was very bad at when i was younger, and i have the diabolical credit record to prove it. Perhaps there should be a government health warning on all forms of loan agreement – it could read ‘Borrower beware! Remember the lender is only in this to maximise their profits.’ :o)

    abysmal musings – i don’t seem to get too much in the way of junk mail, actually. Well, apart from leaflets from the local evangelical church, but they’re delivered by hand. My mum used the mail preference service, though, and she found it reduced a lot of the junk.

    Zoe – Aethelread for Chancellor of the Exchequer

    I just don’t have the eyebrows for it. Think about it. Alistair Darling – weird eyebrows. Norman Lamont – weird eyebrows. Dennis Healey – weird eyebrows…;o)

    DD R – BTW you have a really good grasp of financial matters for someone who doesn’t work in it. (I say this not to be patronising

    Thank you – i don’t find it patronising at all, i take it as a huge compliment. :o) In the interests of full disclosure, i should say that i did work briefly in the financial sector, although only as a very lowly administrative assistant in retail banking. It was enough for me to spot that retail banks word like anti-Robin Hoods – they take charges from the poor, and give rewards to the rich – but not really enough to get my head round special purpose vehicles and the rest (which, btw, you do a brilliant job of explaining).

    I had assumed that it was the sub-prime mortgage loans in the States that were at the root of the problem, but after reading your explanation, i guess it was the way those debts were passed around the world anonymously so that no-one knew who was exposed to the bad debts that was really to blame. I know simple solutions usually don’t have a hope in hell of working – but might making institutions legally (and financially) responsible for the risk rating they put on bonds solve the problem? Or is it just the case that the layers and layers of repackaging get so complicated that it would be literally impossible to expect anyone to be able to know for sure? In that case, i guess you could make the repackaging of debt much harder to do – but that would presumably kill the markets stone dead.

    Oh, and some day you have to set up a hedge fund and call it MegaHedgie – that’s just too good a name to go to waste… ;o)

    cb – well, as i mentioned in my reply to lsnduck, i definitely used to fall into the “Woo-Hoo! Free Money!” camp myself. Unfortunately, and unlike you, i am nowhere near paying it back, or being able to afford to pay it back. But i did learn my lesson, which is, i guess, something, and i now have a credit rating so bad i doubt i could even get a contract mobile phone, which means at least that there’s no danger of anyone suffering the consequences of lending more cash to me. :o)

  7. bankruptcy says:

    The government and many private, foundation programs provide debt grants for financial relief that you never have to repay. These are not exactly easy things to find or qualify for, but if you are resourceful you can get money to help you pay your bills.

  8. Yep – basically there was no incentive for anyone to actually care about what would happen if people really did default, and so lip service was paid to the principles of careful management but that was it.

    The lenders made all the loans, and didn’t give a toss about repayments, because they could sell them on, and those who repackaged them were busy effectively selling them on and on and on and didn’t care either.

    The necessary regulation exists, it just wasn’t applied. The solution would involve finding a way to make it financially unpleasant for each party in a non-opaque way to have someone default, and also to increase the capital adequacy ratios of banks.

    BTW there is an interesting article on the NYT’s site about risk management, it features Naseem Nicholas Taleb, who, despite being an arrogant prick, has a lot of interesting ideas. Bear in mind that Taleb’s side of things is only 1 mind you.

    I also recommend the article by Michael Lewis that is doing the rounds.

  9. Mandy says:

    Hmmmm…

    I know someone who ran up £40,00 worth of debt and because they were on benefits was never going to be in a position to repay it. It did get to the point where they weren’t able to pay much of anything and they filed for bankruptcy.

    You can look at personal responsibility, you can look at the responsibily of those providing loans but, I think, when it comes to people with mental illness you also have to look at how that illness can affect them and I don’t say everyone with mental illness shouldn’t have access to loans but for some, and when they are in certain states of their illness, providing a loan can be the worst thing that can happen (especially if loans keep being provided).

    Okay so a bank can’t double guess when someone is in an acute state but surely it isn’t a mathematial quandry to comprehend that someone on £80 – £90 per week isn’t likely to be able to repay several loans (and more so the interest that gets added on the more they don’t pay).

    And yes when people are in acute states, they can lie about their situations but then who is responsible for checking what is truth and what is lies.

    The answer I guess is that everyone should be taking more responsibility rather than less but someone needs to be in a position to take responsiblity and when they can’t then I think there should be mechanisms that prevent them getting into serious debt and I am not talking only about people with disability now….I think a big part of the recession is people (across the board – governments, financiers, industries and individuals) not taking responsiblity as and when they could and should have.

  10. aethelreadtheunread says:

    Thanks for the extra comments, and sorry for the delay in replying – i’ve been rather tied up answering comments over on the Christine Maggiore thread.

    bankruptcy – thanks for the info.

    DD R – i rather like the phrase ‘financially unpleasant’. I know you just mean something that costs them money, but my warped mind can’t help but conjure up images of somebody doing something nasty with a roll of pound coins… :o) From my position of comparative ignorance, it does seem as though the regulators rather fell asleep on the job. I suppose maybe they just shared the belief that the house of cards would never collapse.

    Mandy – i absolutely agree with you about it not being fair to hold people who are experiencing an acute state responsible if they go wild with a credit card or run-up debt another way. I don’t really know what the solution would be, though, that didn’t involve mentally ill people having to tell their banks they were ill, which is not something i’d be comfortable with. I guess they could make the 21 day ‘cooling off’ period mandatory – ie you have to wait three weeks and confirm you want the credit before they’ll give it to you. But i can’t see that being popular with most people.

    The case of the person you know is quite shocking. I always thought that the system of credit checks was meant to highlight people who were taking out a lot of credit in a short period of time, even if they were doing it with different banks. Apart from anything else, it’s supposed, i thought, to be one of the protections against ID fraud. Anyway, i hope the bankruptcy is working out ok for them – i had a friend who had to go bankrupt, and he was really scared about the prospect of it, but in the end he just found it a huge relief.

  11. On the subject of the house of cards collapsing…

    ‘You may very well think that, but I couldn’t possibly comment’.

    Sorry, couldn’t resist…

  12. Mandy says:

    Hi again A

    There is that area of disability discrimination which the banks could use to say that they cannot ask about disability…also there is a serious question as to whether or not people should have to declare they have mental health problems. After all as Deedee has shown, some people with MH problems (past or present) hold down jobs and jobs that bring in a salary which the banks want to get their hands on.

    What surprises me..and certainly in relation to the person who had to go bankrupt, is that the banks did minimul checking and were more than willing to keep loaning them money and also didn’t pay much attention to the amount of debt they were running up on credit cards.

    After a fraught year, and following all the bankrupty procedures, the person is much happier now and I am glad for them. Fretting everyday about how you are going to try and cover interest repayments from welfare benefits isn’t much fun.

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