Credit Card Issuers Are Going To Give Us The Next Blow To Our Collective Stomach

I was reading a story at SeekingAlpha.com this morning and came across an interesting paragraph. The author was writing about de-leveraging versus deflation (story here). But in the middle of that story, he took a breath and talked about credit scores and consumers. The author wrote that “consumers have to be thinking about defaulting.” After all, the author wrote, Americans protect their credit score for one reason: to obtain future credit. If credit is tight, and there is little hope of getting more credit in the future (because limits have been slashed and because lenders aren’t offering as much credit), why shouldn’t the consumer just default? The author left it at that and said that he’d revisit the question in the future. But I think it’s a good question — worthy of exploring today.From the story: Credit card companies are tightening limits prodigiously. Teaser rates are all but gone. Home equity has dried up. The consumer has driven two-thirds of our economy for at least the last few decades, and now the consumer is dead. There’s another aspect to this that I won’t go too deep into: the American consumer protects his or her credit score for one reason — to obtain future credit. But the consumer also knows that loans have dried up — not just today, but for the very distant future as well. You know these consumers have to be thinking about defaulting; if they can’t get loans anyway, why would they not default on thousands of dollars in unsecured credit card debt? I plan on writing more about this in future articles, but suffice it to say, I think credit card companies are going to give us the next blow to our collective stomach, and it’s going to hurt.I think the author is on to something. If the consumer is tapped out (spending), and the consumer is maxed out (borrowing), why not default? There are millions of consumers who fit that description. Indeed, if your credit cards are maxed out, your score has already taken a big hit. Your utilization ratio, for example, is already through the roof. There may not be much of a credit score to protect. Still, the author said that consumers protect their credit scores so that they can get more credit in the future. The word “protect” typically indicates that you have something worth preserving. I’d argue that those who have a score worth protecting are not likely going to default. In fact, those with a score worth protecting are probably those who have developed good borrowing habits. I’d argue that these aren’t the people we should worry about. (Amendment: I should have mentioned this in my first draft, but didn’t. Having good credit is also important for job seekers and house hunters. Try to land an important job with a trashed credit report. You’ll see just how important it is to protect your score.)I haven’t talked to the author of the article, but my guess is that he’s specifically talking about the consumer who is maxed out and tapped out. These borrowers are probably very close to throwing in the towel. And when that happens, the “credit card companies are going to give us the next blow to our collective stomach, and it’s going to hurt,” which is just what the author wrote. Is there any way out of that scenario? I don’t think so. Even if the consumer had access to capital today, we’d just be putting off the inevitable. More borrowing would just lead to more debt, which would only delay the timing of the pain. At some point, the consumer will have to pay the price, which is when the banks will pay the price, too. On Monday, I wrote about a two-tier recovery (story here). That’s where banks only lend to the most creditworthy and everyone else gets shut out. That seems to be happening now. If millions of consumers are thinking about throwing in the towel, then a two-tier recovery makes a lot of sense. It’s the safest play for the banks. And it limits the amount of bad debt that will ultimately be written off. If it’s inevitable that the credit-card issuers are going to get hammered (and I think it is), the only thing left is the timing. The banks seem to be doing their part: they are slashing limits and extending credit cautiously. All that’s left is for the consumer to do his or her part: grabbing the towel and throwing it in.