Why High Credit Card Rates Could Be Good News for Investors
According to LowCards.com, the average credit card rate has barely budged over the past year. But it's actually worse than that.
Credit cards now charge 14.34% in interest annually, according to LowCards.com's Complete Credit Card Index. The Federal Reserve reports a similar figure: 13.22% for interest-bearing credit card accounts. Either way, the average rate is up sharply from 11.64% when the CARD Act went into effect in May 2009.
For those who don't remember, the pro-consumer CARD Act introduced new rules for banks designed to prevent, or at least reduce, their unfair credit practices. Among other things, the law requires issuers to give 45 days' notice before changing terms, and caps fees at 25% of the card's initial credit limit.
Now banks appear to be using higher overall interest rates in order to make up for income lost as a result of the CARD Act.
The federal funds rate at which financiers loan money to each other on a short-term basis -- sometimes overnight -- still hovers around 0.25%. The prime rate, upon which most consumer loans are based, sits at just 3.25%. So banks seem to be enjoying fat margins on the consumer lending business.
Consumers Feed the Beast
Banks' good times could go on for a while. According to the Fed, revolving consumer credit (i.e., credit cards) rose more than $4 billion in August, up 5.9% year over year. And consumers have added debt in four of the past five quarters.
New data from Thomson Reuters and the University of Michigan shows that consumers are as confident as we've been in five years, which is great news for retailers, manufacturers, and, of course, banks.
"Consumers have, all things considered, been spending reasonably well," Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities, told Bloomberg. He cited rising stock prices and a stronger residential real estate market as keys to our renewed confidence.
There's just one problem: Rising real estate and stock prices offer nothing more than paper gains. Only on those rare occasions when we sell a home or dispense of a large stock position do we realize generous profits. So where's the spending coming from? Look again at the Fed data: It's credit cards.
Smart Money Moves, Even If You Don't Have Credit Card Debt
Some will find this pattern disturbing or even depressing, and understandably so. Unemployment is improving, but remains at 7.8%, while growth in U.S. gross domestic product, or GDP -- often used as a barometer for the overall health of the economy -- puttered along at 1.3% in the second quarter, well below the 1.7% economists had expected previously. It takes a special kind of confidence (ignorance?) to feel good about numbers like that.
What to do? Certainly not panic. Economic conditions may be volatile, but most prognosticators see accelerating economic gains in the year ahead. Working a few extra hours to earn money to pay off what you owe might make the windfall -- if it comes -- even more fruitful.
For those who've already paid off their balances, adding exposure to some of the big names in consumer banking might make sense.
Rising debt balances combined with hefty interest rates have Wall Street expecting big profits from the likes of American Express (AXP), Bank of America (BAC), Citigroup (C), and JPMorgan Chase (JPM):
|Metric||American Express||Bank of America||Citigroup||JPMorgan Chase|
|Current quarter EPS estimate||$1.09||$0.0||$0.97||$1.20|
|Full-year EPS estimate||$4.41||$0.41||$3.98||$4.74|
|Current P/E ratio||13.70||9.90||10.30||9.50|
Source: AOL DailyFinance
What do you think of these banks right now? Is there a better way for investors to play our national addiction to debt? Make your voice heard by leaving a comment in the space below.
Motley Fool contributor Tim Beyers didn't own shares in any of the companies mentioned in this article at the time of publication. The Motley Fool owns shares of Citigroup, Bank of America, and JPMorgan Chase. Motley Fool newsletter services have recommended creating a write covered strangle position in American Express.