End of Credit?

Sample American Express-type credit card featuring the Card Security Code on the front (circled in red). (Photo credit: Wikipedia)

Back about A.D. 2000, I briefly met a Chinese man who had an unusual reputation.  According to some, he’d owned a business that had prospered for 10 years—but which he secretly knew to be on the verge of bankruptcy.

Therefore, while his credit rating was still high, he applied for ten credit cards from ten different banks.  Each credit card had a $25,000 limit.  He proceeded to spend the limit on each credit card and rang up a bill of one quarter million dollars.  He didn’t repay one dime.

When the credit card companies came a-callin’ to ask when he’d pay his debt, he replied in writing by registered mail that he’d be happy to pay just as soon as the credit card company verified the alleged debts.  All collection efforts stopped and the Chinese man skated away with $250,000 in goods and services.

According to the story, the Uniform Debt Collection Procedures Act provides all debtors with the right to demand that their alleged debts be verified.  That means that if you claim I owe you, say, $10,000 I have to right to demand that you swear under oath to the debt’s existence and size.

So, let’s suppose that last March 22^nd (while running up $250,000 in credit card debt) our Chinese gentleman spent $108.22 on groceries, $1,972.98 on a new flat screen TV, $42.18 on booze, and $12.00 on parking.  Do you suppose a credit card company could find the grocery store cashier, the TV salesman, the bartender and the parking attendant who could verify under oath that on March 22^nd, that they distinctly remember the transaction in question and the Chinese gentleman being party to that transaction?

Assuming that such cashiers, salesmen, and bartenders could even be found and distinctly recalled each purchase by the Chinese gentleman, what do you suppose it would cost the credit card companies to find ‘em, put ‘em all on oath in front of a notary, and later, transport them to the court room whenever their testimony was required?

The logistical problems in verifying one large debt are challenging.  The logistical problems of verifying scores of individual transactions are almost impossible to overcome.

Thus, rather than attempt the impossible, once the Chinese gentleman asked that his debts be verified, the credit card companies ceased collection efforts.

The story illustrates an essential principle for the credit card industry:  The entire business model is absolutely dependent on customers voluntarily repaying their debts.   If customers stop repaying their debts voluntarily—and resist paying in court—the credit card industry will die.

 

•  In support of that principle, The New York Times recently reported (“Problems Riddle Moves to Collect Credit Card Debt”) that,

 

The same problems that plagued the foreclosure process — and prompted a multibillion-dollar settlement with big banks — are now emerging in the debt collection practices of credit card companies.

As they work through a glut of bad loans, companies like American Express, Citigroup, and Discover Financial are going to court to recoup their money. But many of the lawsuits rely on erroneous documents, incomplete records and generic testimony from witnesses, according to judges who oversee the cases.

Lenders, the judges said, are churning out lawsuits without regard for accuracy, and improperly collecting debts from consumers. The concerns echo a recent abuse in the foreclosure system, a practice known as robo-signing in which banks produced similar documents for different homeowners and did not review them.

 

The sheer volume of credit card transactions is so enormous that individual transactions are extremely difficult to accurately track, remember or record.  As a result, companies that provide credit can’t legally and efficiently collect the amounts due.

Implications?  Either the volume of credit card transactions must be limited to whatever number can be reliably tracked and enforced, or the very nature of credit card transactions must be modified to insure that efficient collection is possible.

If the nature of credit card transactions is significantly changed so as to make each credit card transaction more easily enforced, it seems certain that credit card transactions will become increasingly complex and difficult.  If CC transactions become more difficult, CC usage will decline.

How might the “nature” of CC transaction (or at least the use of “plastic”) be changed?

One way would be to give most people debit cards rather than credit cards.  Then, if you spend any money, it’s your money—not the credit card company’s money.  The CC company has nothing at risk in the transaction.  Virtually all liability for the transaction lies with the consumer.

Of course, if the CC company isn’t using its own money in the CC transaction, the CC company won’t earn a fee or interest.  CC company business and profits will decline.

More, the credit card has provided significant stimulus for the economy by allowing “impulse” purchases.  You see it, you want it, you say “What th’ heck—I’ll pay for it next month”—and you purchase it with your credit card.  Impulse purchases stimulate the economy.

Debit cards provide no “impulse” purchases.  It’s just like using money in your wallet or in your bank account.  If you use your debit card out now, your saving will be diminished now.  (Takes all the fun out of shopping, doesn’t it?)  Less impulse purchasing tends to slow the economy.

 

•  “I would say that roughly 90 percent of the credit card lawsuits are flawed and can’t prove the person owes the debt,” said Noach Dear, a civil court judge in Brooklyn, who said he presided over as many as 100 such cases a day.”

Ninety percent?

If 90% of all current credit card transactions can’t be proved, then the credit card system may be, as a whole, so flawed that it can’t survive.  Anyone investing in a business model that’s exposed to a 90% collections failure is likely to lose their investment.

If it’s true that 90% of all CC transactions can’t be proved, then the CC business model may be doomed and we may soon see the end of most credit.

But if credit ends, there’ll be less currency in circulation.  As M3 declines, the tendency towards deflation and economic depression should increase.

 

•  Last year, American Express sued Felicia Tancreto, claiming that she had stopped making payments . . .  Ms. Tancreto contested . . .   Judge Dear dismissed the lawsuit, citing a lack of evidence. The American Express employee who testified, the judge noted, provided generic testimony about the way the company maintained its records. The same witness gave similar evidence in other cases, which the judge said amounted to “robo-testimony.”

 

“Generic testimony” probably corresponds to the CC companies’ inability to prosecute the Chinaman.  No one who was actually party to each transaction (clerks, salesmen, cash register operators) remembers the Chinaman and can swear under oath that the Chinaman actually bought a dozen fresh clams on March 3^rd.   Result?  Nothing’s left for evidence but some accounting clerk who can swear that the AmEx records are generally believed to be accurate—but who has no direct, personal knowledge or memory of any individual transaction.

American Express and other credit card companies defended their practices. Sonya Conway, a spokeswoman for American Express, said, “we strongly disagree with Judge Dear’s comments and believe that we have a strong process in place to ensure accuracy of testimony and affidavits provided to courts.”

 

Can the AmEx employee truthfully testify that the AmEx accounting procedures are rigorous and accurate?  Probably so.  But the AmEx employee cannot have personal knowledge of each of the hundreds of transactions that, in sum, created the defendant’s alleged debt.  There is virtually no possibility that the vast majority of alleged debts can be verified by anyone present at the time the debt was entered into—except the defendant.

Even the defendant probably won’t clearly remember all of the debts he allegedly incurred.  Credit cards are all about “impulse” purchases.  Who remembers all of their impulses? If the debtor does remember all of his CC debts, he probably still won’t testify against himself.

Without some third party who has direct, personal knowledge of each transaction—and is willing to appear in court to be cross-examined on his knowledge—it becomes almost impossible to enforce most credit card debt.

 

Interviews with dozens of state judges, regulators and lawyers, however, indicated that such flaws are increasingly common in credit card suits. In certain instances, lenders are trying to collect money from consumers who have already paid their bills or increasing the size of the debts by adding erroneous fees and interest costs.

The problem, according to judges, is that credit card companies are not always following the proper legal procedures, even when they have the right to collect money. Certain cases hinge on mass-produced documents because the lenders do not provide proof of the outstanding debts, like the original contract or payment history.

 

The first problem is that in this computer age, it’s easy to store and retrieve a digital record of a transaction on a hard drive.  But that digital record is not the “original contract” (on paper) or the other actual documents carrying an actual signature.  At law, copies of documents have no real authority.  The only document that counts is the one with the actual, wet-ink signature.

So, when it comes time to litigate a debt, it’s easy to find the digital record of the transaction—but where the heck can we find the “original contract” or other actual documents?   Could they be in the pile in the back room with the other hundreds of thousands (or even millions) of other “original contracts”?  If so, how do we find the particular “original” on which our lawsuit depends?

The second fundamental problem is that banks, eager to earn fees from credit cards, formerly issued them to everyone who had a pulse.  The issuance of credit to virtually everyone was similar to the “sub-prime mortgage” mess where banks issued mortgages to people who couldn’t possibly repay the debt.

In the case of credit cards, the banks issued credit cards to people who often didn’t have much moral fiber.  If times got tough, these credit card holders saw no reason not to exploit the credit cards and then leave the banks holding an uncollectable debt.

A lot of people would say that refusing to pay your credit card bills is morally wrong, and I’d agree with them.  I’d also say that banks being “bailed out” as “too big to fail” is also “morally wrong,” but whatcha gonna do?  Sometimes the banks rip off the public.  Sometimes the public rips off the banks.  We live in immoral times.  We have become an immoral people who can’t be relied on to voluntarily repay our debts.  We are therefore unworthy of credit—and credit will therefore be withheld.  As credit is restricted, the credit card industry will tend to wither or even die.

 

•  “Lawsuits against credit card borrowers are flooding the courts, according to the judges. While the amount of bad debt has fallen since the financial crisis, lenders are trying to work through the soured loans and clean up their books. In all, borrowers are behind on $18.7 billion of credit card debt, or roughly 3 percent of the total.

 

 3% isn’t so bad.

$18 billion isn’t so much (at least not relative to the whole US economy).

Still, that seemingly small debt has to mean that, in the future, fewer people will be allocated credit and the amount of credit allocated will be reduced.

More, although only 3% of credit card debt currently winds up in court, judges guestimate that 90% of all credit card accounts can’t be proved by the credit card companies.  That means that 90% of the people paying credit cards could “beat the rap” if they cared enough to learn how.

The whole credit card scheme is ultimately based on the honesty and integrity of the card-holders.  Again, so long as the card-holders voluntarily repay the debt, the credit card industry can continue to function.  But if the card-holders refuse to repay, banks may be unable to compel payment in as many as 90% (currently about $560 billion in credit card debts).

The economy can easily absorb a 3% loss ($19 billion) of credit card transactions.  But the economy might be shaken by the loss of 90% of credit card transaction ($550 billion).

 

•  Many judges said that their hands are tied. Unless a consumer shows up to contest a lawsuit, the judges cannot question the banks or comb through the lawsuits to root out suspicious documents. Instead, they are generally required to issue a summary judgment, in essence an automatic win for the bank.

[Therefore] The errors in credit card suits often go undetected, according to the judges. Unlike in foreclosures, the [CC] borrowers typically do not show up in court to defend themselves. As a result, an estimated 95 percent of lawsuits result in default judgments in favor of lenders. With a default judgment, credit card companies can garnish a consumer’s wages or freeze bank accounts to get their money back.

 

But as consumers go deeper into debt and unemployment, they’ll have more time to actually contest the credit card debts in court.  As they do, the number of default judgments favoring the CC companies will fall, the cost of prosecuting credit card debts will rise, and banks will become increasingly reluctant to make credit available to consumers.

In the future, if you want credit, you’ll have to be something more than a mere “consumer”—you’ll have to show evidence that you have been, are, and are likely to continue being, a “producer”.

As the banks increasingly eschew mere “consumers,” we may see a revival of respect for the only people able to access credit:  producers.

As we regain our respect for producers (and lose respect for “consumers”) the nation’s system of values may change.  Our economy may evolve from “consumer-based” to “producer-based”.  Even our political system may shift from “entitlement-based” to a system based on equal rights—and equal responsibilities.  People might have to work to receive welfare.  Subsidies might disappear.

Credit cards might die, but “Tis an ill wind that blows no good,” hmm?

 

•  Banks make their money by lending.  As it becomes increasingly difficult for banks to collect debts, banks will not only suffer losses in revenue, they’ll lend less.  Result?  The stream of credit available to the public and the fees and interest that would otherwise accrue to the banks will shrink.

Three implications:

1)  Whatever stimulus (QE3) the Federal Reserve wants to provide to the public will be at least partially offset by diminished access to credit card debt;

2)  Banks will make less money in the future and therefore be increasingly prone to fail;

3)  As banks restrict access to credit, the economy will tend to slow, recession will be prolonged, depression will become more likely.

America’s decreasing access to credit will not, by itself, cause an economic collapse.

But diminished credit is another “leaf in the breeze” that shows which way the economy is heading. We’re losing confidence in our economy and in our individual ability to make good on our debts.  In addition to virtually all the other “leaves” that we can see “blowing in the wind,” it’s hard to avoid the conclusion that our economic “wind” is blowing from prosperity and towards depression.

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