Credit Card Bailout for Financially Irresponsible

The Financial Services Roundtable and the Consumer Federation of America have joined forces to promote a credit card debt settlement plan involving debt write-offs and extended repayments.

There once was a time when forgiving and forgetting involved making amends with someone who had wronged you. Sadly, in light of the current economic crisis, forgiving and forgetting has taken on a whole new meaning.  Now, it's something that over-burdened debtors are hoping for to solve their financial problems.

Don't worry if there's no debt forgiveness plan designed just for you-one's probably on the way. There are loan modifications for at-risk borrowers, government loans to insurance companies and automotive manufacturers, and risky asset purchases for financial companies. The next bailout proposal may involve credit card debt settlement; a new plan would have card issuers manage past-due balances through a combination of debt forgiveness and repayment.

Mortgage crisis redux

The five major U.S. credit card issuers carry more than $630 billion worth of credit card debt. Based on current trends, the research firm Innovest Strategic Value Advisors estimates that card issuers will absorb $41 billion of bad debt losses this year, and twice that amount next year.   

Since card issuers pool most of these debts and sell them off as securities to institutional investors, rising defaults will ripple through the financial industry, just as bad mortgages have. Investors will share in the pain, before tiring of the risk and pulling their money out completely. Funding for the industry will tighten, and credit card debt will become scarcer and more expensive for everyone concerned.

Current law restrictive

Current law doesn't allow card issuers to offer debt forgiveness in concert with a long-term repayment plan. The new proposal seeks to loosen those restrictions. Card issuers want the flexibility to write off up to 40 percent of a cardholder's balance, while allowing the remainder to be paid off by the cardholder over time.

Card issuers stand to benefit if this program can keep their cardholders out of bankruptcy. In a bankruptcy filing, the court has the authority to forgive unsecured debt, including credit card balances. When that happens, the card issuer gets nothing.

Bailout nation

This plan, like all other bailouts, is intended to help the economy cut its losses. That may be one outcome, but additional consequences are likely to come into play. Excessive credit card debt is often the result of irresponsible spending and budgeting behaviors. Bailing out consumers who don't know how to prioritize their spending dilutes the importance of the "promise to pay" that's inherent in every credit card transaction. A cynic might argue that this type of bailout just ends up being a convenient way to save 40 percent on stuff like exotic travel and designer clothing.

Soon, borrowers may ask credit card companies to forgive the debt and forget the balance, and those card companies may actually comply. But this will be no solution if those borrowers forgive themselves for over-spending, and forget about all the trouble it caused.