The Ghost of Bailouts to Come

Story Highlights:

• Along with the auto bailout, this week saw sweeping changes in consumer credit, aimed at protecting consumers from increased rates and surcharges.
• Future decreased credit is likely.
• It's premature to judge any effects on the economy or stocks, though history suggests limited fallout.

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From snow in Las Vegas to ice skaters in Central Park, holiday cheer's in the air. And winter revelers aren't the only ones making merry—after Congress said "Humbug!" to an auto bailout, the Bush administration played a reformed Ebenezer Scrooge, extending US car makers a lifeline. "Ah GM, $9.4 billion for you! There there Chrysler, don't cry, here's $4 billion for you! Pay me back? Bah, show me you're viable by March 31st, and you'll have plenty of time…and another $4 billion in February! Don't spend it all in one place!"

Friday's bailout announcement went largely as expected (you can see our past cover story on the bailouts for more). Far more nuanced and less ballyhooed is Thursday's news the Fed and Office of Thrift Supervision approved what Ben Bernanke calls "the most comprehensive and sweeping reforms ever adopted for credit card accounts." The purpose? To make credit card terms "fairer and simpler." In the spirit of Jacob Marley, mankind's common welfare is the name of the game.

The specs seem innocuous, even generous: Extending repayment time to a minimum 21 days; protecting consumers from unexpected charges; eliminating "unfair" rate increases, two-cycle billing, and over-limit fees; and limiting the fees that reduce available credit to subprime consumers. Sounds great, no? After months of petitioning, Main Street finally gets its tuppence.

But in the end, it'll probably get its comeuppance instead. These measures will likely result in decreased profitability of credit card lending—"saving" the consumer at the expense of the lender…except lenders won't bite. Credit card companies, like the unreformed Scrooge, lend for profit, not charity. If the government tries to limit their means of profiting, consumers will ultimately pay the opportunity cost. No sympathy there—"Are there no prisons? No workhouses?"—so consumers will likely get squeezed through decreased credit extension…not the best-timed move, considering credit is still somewhat frozen. Pressure lenders when they're already under pressure? Doesn't bode well at first blush.

But, as Scrooge asked the Ghost of Christmas Yet to Come, are these the shadows of things that must be, or are they the shadows of things that might be? The effective date is January 1, 2010, so it's premature to pass judgment. Yet we can estimate the potential effects by comparing consumer lending to GDP to see whether reduced available credit (purchasing power) will materially disrupt the US economy.

Today's outstanding consumer debt is roughly $2.6 trillion, which seems huge as 19% of total GDP. But the size of the market alone isn't the best indicator. A better way is to look at activity relative to GDP. Do this, and the influence of consumer lending is revealed as tiny—total lending activity during Q2 2008 accounted for just 0.75% of economic activity. Said another way, less than 1% of GDP was financed by consumer lending—during a quarter when annualized credit card activity was down 15% from the same period in 2007, yet GDP still rose 2.8%. Most importantly, even if consumer lending growth turns negative, which it might, stocks won't necessarily suffer. Last time this happened, in 1991, stocks gained 17% on the year.

It's still too early to tell whether these changes will be a turkey twice the size of Tiny Tim in the worst or best sense—or somewhere in between. Maybe it will lead to more bailouts, but maybe not. So take heed, rise, and tread slowly—in investing, cooler heads often prevail.