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Investors Quietly Flee Credit Card Debt


Lenders, borrowers hit hard by new restrictions.

The American consumer's last bastion of cheap credit may finally have been overrun.

During the housing boom, it was easy to run up a big credit card bill, then pay it off with a cash-out refinance or home equity line. When banks ratcheted back loan guidelines following the collapse of the mortgage market, there was a reversal of fortune: Paying the mortgage with plastic was the only way to get by.

Now, the jig is up. A slumping economy and higher fuel prices have chewed through the last of consumers' discretionary dollars.

Buyers of securities backed by credit card debt are becoming skittish and demanding higher returns on their investment. This depreciates the value of the investment and forces issuers to hold onto bonds longer, since deals take longer to sell.

Big lenders like American Express (AXP) and Bank of America (BAC) are having to fork over higher interest rates to keep investors happy. That means less profit for them - and less of a cushion as loans go sour. Just ask Citigroup (C), who reported a second-quarter loss on assets backed by credit card debt.

A common misconception about credit card securities is that they're structured to handle high delinquency rates, and are therefore safer bets. Indeed, some argue that years of historical data show cardholders rarely default en masse, and that delinquency patterns are well understood. Of course, they said the same thing about mortgage-backed securities.

Asset-backed securities, or ABSs, are structured based on historical data and expectations of future cash flows. Since credit cards typically carry a higher default rate than, say, mortgages, their ABSs are designed to absorb these losses.

Deals therefore go sour not when delinquencies increase in an absolute sense, but instead when they deviate from historical norms. For more on this subject and the coming wave of prime mortgage-backed securities defaults, see The Next Subprime.

Lenders will be forced to cut back credit lines to stem the bleeding, and comprehensive new regulations will further inhibit consumers' ability to borrow on the cheap.

Many are already calling this the dropping of the credit crisis' other shoe; in reality, this has been going on for a while. Credit card defaults have been inching up for months, as results from American Express, Capital One (COF) and Discover Financial (DFS) have shown. The only difference now is that it's getting mainstream media attention.

But here's the kicker: With mortgage debt, at least lenders can seize the house as a last resort.

Not so with credit card debt: Just try repossessing a flatscreen TV.
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