Short Capital One

Credit card defaults could rise to 10% in the next quarter, as borrowers throw in the towel and stop chasing lifestyles they can't afford.

This is likely just a preamble for 2009, when default rates could spike much higher, according to Innovest Strategic Value Advisors. But even the 10% figure is much higher than previously anticipated, and credit cards could follow mortgages as the next great calamity.

Article Controls

The reasons for the expected rise in defaults are manifold, according to Innovest. New credit cards will be harder to come by as banks try to rebuild their tattered balance sheets. This will make it harder for leveraged consumers to roll their balances over to new lenders. Meredith Whitney, the widely-quoted analyst from Oppenheimer & Co., noted that the U.S. credit industry could pull back as much as $2 trillion over the next 18 months because of risk aversion and changes in regulations.

The surprise is that the credit card industry's own belated attempts to whip itself into shape are causing the damage, according to Laura Nishikawa, an analyst at Innovest. She noted that credit card issuers are helping drive debtors into default by reducing credit lines, limiting access to home credit lines and, as mentioned, killing roll-overs. Nishikawa said these measures have had unintended consequences and are driving customers away from paying their bills.

Partly to blame for the upcoming correction, of course, is the credit card lifestyle. According to Innovest, since 1999, as wages have stagnated credit card debt outstanding has risen by almost 80%. It's only gotten worse as access to home equity lines have been shut down. Rather than stop shopping people have simply put their purchases on plastic.

Walter Todd, a portfolio manager at Greenwood Capital Associates was quoted by the Calgary Herald in late November, noting that there has never been this much consumer debt with unemployment nearing 8%: "It's hard to run a model because it's never happened before."

The worst is yet to come, Innovest says, because 2006's bankruptcy reforms have caused a delayed reaction in defaults. The firm expects the full tide of defaults to roll in early in 2009. Happy inauguration, President Obama.