The United States has become a nation of card holders. The 1983 Survey of Consumer Finances found that only 42 percent of households had a general purpose credit card, such as a MasterCard or Visa. The most recent survey found that two-thirds of Americans, the large majority, had one.
This wider distribution of credit cards, what some have called the Democratization of credit, surely has benefits. The new card holders get a convenient form of payment and a line of credit, while the banks earn fees and interest. Democratization may have a downside, however: higher risk.
Bank are now writing off credit card loans at the highest rate in 25 years (Chart 1). At the beginning of 1995, banks charged off just 3.5 percent of their credit card loans per year. The charge-off rate is now near 6 percent. The high rate of charge-offs is out of line with the state of the economy (Chart 2). While job growth did slow in 1995, charge-offs rose far out of proportion and continued rising even after job growth rebounded in 1996. Even the slowdown in 1989, which ended in a recession, did not create as much bad debt as the relatively mild slowdown in 1995. It is this steep rise in bad debt, right in middle of an expansion, that makes us think the new borrowers applying for and receiving credit cards are somehow riskier.
This paper investigates how the mix of credit card holders has changed in recent years and how those changes affect the risk of delinquency. Our data are from the Survey of Consumer Finances, which is conducted by the Federal Reserve Board every three years. We use the surveys from 1989 and 1995, the most recent. Data from 1995 may seem outdated, but it is actually ideal for our purposes. Credit card loans need to “season” about 18 months before they go bad, so the charge-offs this year and last year partly reflect the risk characteristics of the 1995 vintage of borrowers. Economic conditions were also very similar 1989 and 1995 (Chart 2), which reduces the risk that any differences we find are due to business cycle effects. The period between 1989 and 1995 was also one in which banks were marketing their cards especially aggressively, so we want to know if the borrowers taking them up were riskier (Chart 3).
We find that the new card holders are different, and potentially riskier. They tend to earn less, and as result, they owe more relative to income. They are also more likely to work at relatively unskilled blue-collar occupations. Personal characteristics have also changed; the new card holders are more likely to be single, more likely to rent rather than own their home, and have slightly less seniority at their current job. Even attitudes have changed; card holders are more willing to borrow for vacation or cover living expenses when their income is cut.
Which of these changes translate into higher risk? To answer that, we estimate how a household’s profile affects the probability that they were delinquent on any payment in the year before they were surveyed. We find, not surprisingly, that debt burdens are very important in predicting delinquency risk. More surprising is that occupation also matters; delinquency rates are higher among unskilled blue-collar workers, possibly because those occupations are more cyclical. Some of the personal characteristics and attitudes that have changed, such as marital status and job tenure, also imply somewhat higher risk.
Before we start, we want to note the goal of this paper is to assess the risk of the new borrowers, not to take credit from them, or from the banks willing to lend to them. Our analysis is positive, not normative. As long as banks raise spreads to cover any extra risks they are taking, and as long as borrowers understand the price they are paying, both the lender and borrower benefit from the new credit.
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