Two of the nation’s biggest banks, Citigroup and JPMorgan Chase, announced that they are setting aside almost $6 billion between them to cover potential defaults on consumer loans. The news caused markets to cloud and rekindled fears that the economy is on the verge of a recession.
Prompted by a wave of home foreclosures and nearly $100 billion in write-downs, the mortgage crisis was initially contained to the financial services and home construction sectors. The bad news is that consumers (those likely affected by foreclosure) are also struggling under credit card debt, auto and other loans.
Falling home prices means consumers can no longer draw from the equity in their homes for extra cash. Fearful bankers are making matters worse by tightening lending standards, thus making consumer loans both expensive and scarce.
The industry’s new conservative lending standard will make it difficult to boost consumer spending even with pending tax credits and another interest-rate cut because banks are likely to keep rates high on credit cards and other consumer loans to hedge against loss.
Affirming the bearish sentiments, Citigroup’s CFO, Gary Crittenden, said the bank is looking at raising rates on its credit cards to “protect itself from a potential surge in late payments.”
In order to cover problem loans, a bank can boost reserves by socking away money. Such an approach, however, eats into earnings. Money Citigroup set aside for future consumer loan losses cut its fourth-quarter earnings by 50 cents per share and, overall, Citigroup suffered a total loss of $1.99 per share or $9.83 billion. If consumers continue to retreat and if more subprime problems surface, the nation’s banks could suffer as will the economy.