Credit Spiral

So, say you’ve had a good relationship with a credit card company and been paying off substantially more than minimum payment over recent months. You’ve also completely paid off other credit cards in recent months. You then get a notice from the credit card company saying they’re reducing your credit limit, right before Christmas. Would you be more than a little miffed?

Well, I certainly was. The behavior of a certain large company surprised me today as I have always tried to maintain the best possible business relationship with that particular company. On inquiring, we were told that it was primarily because of the fall in the value of our house leading to a less positive debt ratio report from a credit rating agency, and that this could not be challenged because it was company policy.

This is, of course, precisely the sort of generic modeling that led to the credit problems in the first place. By relying more on actuarial models of risk than on an informed judgment based on an established business relationship, at least partly because of governmental concerns about possible bias in the lenders’ decision-making, the credit problems spiraled out of control. If you don’t know who is a risk and who isn’t, you’re reduced to making ill-informed general decisions that affect people on essentially an arbitrary basis (and if that isn’t prejudice, I don’t know what is).

The result? I am suspending my business relationship with that credit card company. Although I won’t mention your name, you have lost a customer. A customer with a record of good payment. Therefore, your reliable income stream will be reduced. You will have less reliable income with which to fund your other activities. And that is a situation that would have been avoided with a more informed approach to risk management.

The credit problem spiraled out of control one way. It could easily spiral out of control the other, if this is anything to go by. Companies reducing credit availability to those who can repay is one way to increase the general liquidity crisis at an individual household level.

Meanwhile, the United Kingdom has just increased its credit limit to about a trillion dollars. And credit card issuers are queuing up for a bung from the American taxpayer. Because, after all, getting tax money from politicos on a “you scratch my back, I’ll scratch yours” basis is so much easier than working out the messy business of effective and efficient risk management.

The answer to such ineffective forms of risk management is, of course, competition. I shall be looking around for someone else to replace this particular line of credit (still quite substantial) who has better risk management techniques, preferably ones based on an individual relationship. Yet the prospect looms before us of new regulations designed to keep these old, inefficient, socially harmful firms in a dominant market position, at least partly so that governments can earn a return on their ill-advised investments in them.

Boy, do I feel like the Forgotten Man today.