Could this be the new subprime crisis?

published 21 September 2007

Tired of worrying about subprime mortgages? "Here's something new to consider": $900bn of US credit-card loans, says Martin Hutchinson on Breakingviews.com. Signs of stress are mounting. Unpaid balances rose at an annual rate of just 3.7% up to 2005; in the second quarter of this year, the rate was 8.4%.

Meanwhile, bond rating agency Moody's has reported that credit card companies wrote off 4.6% of payments as uncollectable between January and May, a 30% year-on-year increase. It's likely to get worse; according to Merrill Lynch's David Rosenberg, overall balances on credit cards jumped by an annual rate of 11% in May and June, showing that distressed homeowners are turning to their credit cards. "The lender of last resort as banks pull in their horns is the credit card." All this presages a jump in credit-card delinquencies over the next year. "The next shoe to drop" in this subprime mortgage fiasco "is probably going to be the credit-card business".

It's not just that the squeeze on overstretched borrowers bodes ill for already weakening consumption. The trouble is that, like subprime mortgages, credit-card receivables are often packaged up into securities and sold on, with many now held in Collateralised Debt Obligations (CDOs). These will also include some of the £50bn owed by UK credit-card holders. A jump in missed payments could affect the CDOs in the same way as rising mortgage delinquencies hit subprime-backed derivatives. And since these CDOs have been used as collateral against other debts in the market, "that could spark a fresh wave of contagion", says Ian Dey in The Sunday Telegraph.

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But that's not all. The $300bn car loan market again, these loans have been sliced and diced into derivatives hasn't been looking too good either, notes Suzy Jagger in The Times. Arrears levels at the smaller lenders (those who made fewer than 40,000 subprime car loans last year) doubled to 14.6% between 2005 and 2007. Once US consumption slows, "prepare for a crisis in credit card and car finance CDOs", says Wolfgang Munchau in the FT. Once corporate bankruptcies start rising, we'll "probably hear about problems with collateralised loans obligations" (debt securities backed by pools of commercial loans). The deep credit market offers significant potential for contagion.

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