Credit Where It’s Due

CREDIT WHERE IT’S DUE….This is sweet, isn’t it?

As subprime borrowers began to default on their mortgages in rapidly growing numbers this year, credit card issuers increased their efforts to sign up such customers with tarnished financial histories, according to a market research firm.

Direct mail credit card offers to subprime customers in the United States jumped 41 percent in the first half of this year, compared with the first half in 2006, according to Mintel International Group. Direct mail offers targeted at customers with the best credit fell more than 13 percent.

Well, why not? One of the things that constrains card issuers from preying too aggressively on poor credit risks is the knowledge that their victims might go bankrupt and not pay their bills. Banks have very sophisticated models for this kind of thing, and calculating their likely losses makes them think twice about just how hard they pitch their wares to the bottom of the market.

So what happens when you reduce their exposure to bad credit risks by passing a bill that makes it all but impossible for people to declare bankruptcy and stop paying their credit card bills? The answer is obvious: banks start pitching their cards even more aggressively to consumers who are even worse credit risks. This was an easily predictable consequence of tilting the playing field in favor of credit card issuers by passing the egregious 2005 bankruptcy bill, and it’s exactly what’s happened. Thanks, Congress.

UPDATE: Via Megan McArdle, Yves Smith offers up another potent possibility: that the subprime lending bubble was partly caused by the bankruptcy bill in the first place. After the bill passed, consumers who were desperate to avoid the new, more onerous bankruptcy provisions ended up increasing their use of subprime cash-out refis to keep themselve afloat:

Lew Ranieri, the so-called father of mortgage backed securities, has stated that the overheated phase of subprime lending started at the end of the third quarter of 2005 and extended through most of 2006. When did the new bankruptcy law take effect? October 24, 2005. There is no ready way to prove a connection between the new law and the explosion phase of subprime growth, but consumers became much more cautious in taking on credit card debt after the law became effective. And the ones that had above median incomes which would force them into a Chapter 13 (meaning they’d have to repay their debts) might be even more eager to tap home equity if they saw themselves at risk.

I don’t know how likely this explanation is, but it certainly has a lovely circular viciousness to it. Credit card companies lobby Congress to pass a bank-friendly bankruptcy bill. Consumers in financial trouble respond by avoiding extra card debt and instead tapping the subprime lending market. When that turns sour, credit card companies turn around and offer yet more card debt to desperate subprime borrowers, secure in the knowledge that their shiny new bill protects them from default. It’s almost too beautiful a theory to not be true.