In my Wall Street Journal column criticizing the bankruptcy mortgage modification proposal I argued that one of the major unintended consequences of the proposal would be a predictable spillover effect of dragging other consumer credit into the vortex of the mortgage mess, exacerbating losses in the credit card industry.
Sure enough, just a few days later, the Wall Street Journal reported (may be subscriber-only, if so this link has some excerpts from the article) that the credit card industry is expecting massive unexpected losses if the proposal goes through:
Issuers of plastic will be looking at even larger losses on credit-card loans if a proposed change in bankruptcy legislation, backed by the Obama administration, goes through.
Bigger losses would raise borrowing costs for these companies, translating into higher rates for consumers, making it tougher for Americans to tap what has been one of the easiest places to get credit.
"Anytime there's a change in bankruptcy law that accelerates bankruptcy filings, it severely affects credit-card losses," said Scott Valentin, an analyst at FBR Capital Markets. "And right now card companies aren't in a healthy financial condition to absorb these losses."
The White House is calling for a controversial provision to allow bankruptcy judges to rework the terms of mortgages in court. The change in legislation would allow Chapter 13 bankruptcy judges to lower interest rates, extend the loan maturity and change the principal amount owed on the mortgage to reflect the home's market value.
As a result, "more homeowners struggling with mortgages will file for bankruptcy," said Neil Crane, an attorney at the Law Offices of Neil Crane, a consumer bankruptcy specialist with offices in Connecticut.
A rise in bankruptcies will increase charge-offs, or, credit-card loans deemed uncollectible for plastic issuers such as Citigroup Inc. (C), JP Morgan Chase & Co. (JPM), American Express Co. (AXP), Bank of America (BAC), Capital One Financial (COF) and Discover Financial Services (DFS). This is because accounting rules dictate that these companies write-off credit-card payments owed to them within 60 days of being notified of a borrower's bankruptcy filing.
Bankruptcies historically have accounted for roughly 30%-50% of credit-card charge-offs, according to a JP Morgan report last month. Under the proposed legislation, particularly vulnerable to bankruptcy filings are homeowners with underwater loans, that is, where borrowers' mortgage debt exceeds the value of their homes. This is because the new rule would allow a judge to decrease the loan balance to reflect a home's current market value.