The large banks that are struggling this year are hardly the innocent victims of an economic bubble. They were right in the thick of it. The focus of the bubble was financing for consumer discretionary spending. That sounds like something important when you put it that way, but what that really means is “people spending money they don’t have for things they don’t really need,” and when you say it that way, it doesn’t sound so valuable, and the people who were pushing it don’t sound so innocent.
The excesses of the bubble centered around credit cards. Banks typically spent $1,000 on average to acquire a credit card customer. After putting so much money in up front, there was a lot of pressure to make money from the credit cards, yet most credit cards were never used. A consumer who reluctantly accepted a credit card only to let it sit in a drawer for six years didn’t provide a profit opportunity for banks.
So the banks that were convinced that their profit depended on pushing their credit card business as far as it would go (that’s the way people think in a bubble) ended up relying on the most confused and disorganized cardholders. They must eventually have realized that was what they were doing — how else do you explain the $109 late fee? — but they never quite addressed the issues of ethics and business planning this raised.
Meanwhile, this approach was a marketing disaster. The customer who was assessed a $109 late fee on a $29 purchase just because the bank failed to send out the original billing statement was usually a customer who never wanted to deal with that bank again. That was part of the thinking behind the public opposition to the bailout of the banking industry. “Finally, we’re going to get rid of some of those bandits and crooks,” people were thinking. “Not so fast, suckers,” was the response as Paulson, Bush, and Congress kicked them in the teeth yet again.
But banks shouldn’t think they have won a big victory by just keeping their doors open. The pool of consumers that banks relied on for their highest profit margins — profit margins that turned out to be illusions — aren’t exactly eager to fall for the same tricks again. Meanwhile, federal regulators made an initial step toward cracking down on credit card fraud by banks with new regulations adopted late in December. More regulations are likely to follow, to prevent banks from profiting from identity theft, to cite just one example. The era of “gotcha” banking is ending, and as banks are asked to show that they can make an honest living, not all of them will prove to be up to the task.
This Week in Bank Failures returns next week.