Debt Easy

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Like a Formula One race car, it looks sexy, travels dangerously fast, chews a lot of energy and can be uncomfortable to get out of. Almost everyone experiences it at some stage in life. The Spanish call it deuda; the Italians debito. For Germans, it's Schulden, not coincidentally from the same root as their word for guilt. In English, its silent b makes it tricky for young spellers. Debt.

Typically associated with honor, shame and mercy--or the lack of same--going into debt has come a long way since the days when Shylock demanded his pound of flesh in Shakespeare's The Merchant of Venice. Mortgages, car loans and bank overdrafts are the respectable norm for most families, with the repayment periods for some borrowings sometimes looming so large that it has become known as buying on the never-never. But a newer form of debt that might be called the never-ever is steadily becoming the popular way to get into the red. Better known as revolving credit, its purveyors have hungry looks directed at various parts of Europe.

Revolving credit is a form of personal debt that comes via those small plastic rectangles carried by 72% of adults in the U.S. and 49% in Britain. The U.K. figure has climbed dramatically in recent years, with about 1,300 different card products now slugging it out for market share. Continental Europe lags far behind these levels, but U.S. and British card companies are planning to change this. In their way is a web of cultural attitudes to debt, regulatory barriers and locals determined to protect their own lending systems.

"There is enormous demand for credit in Europe," says Scott Anderson, editor of Cards International, a biweekly trade publication. "You just have to channel that demand toward revolving credit cards." Others think the pickings are leaner. "The [Continental] credit card markets are unlikely to reach the scale of those in the U.K.," says Ian McEwen, of investment bankers Lehman Brothers. "There's profitable business to be done, but the market size has been way overestimated."

However big the cake, the companies fighting for a slice of it are all seeking a particular kind of borrower: one who can be relied upon to keep paying back, but not too fast, and not fully. These are the millions of people who allow debt to spill over, or revolve, from one repayment period to the next, letting it grow ever larger. Revolving credit is on the face of it more attractive than traditional loans. There is no cap-in-hand application to a bank manager, and the pace of repayment is flexible. Cards avoid some of the risks of cash; they are the currency for Internet trade and the main one for telephone and mail buying.

Their appeal is shown by the fact that in Britain credit outstanding on Visa and MasterCard credit cards at the start of August 1999 was about $43 billion, up about $8 billion on the previous year and almost double the 1996 figure. And though the Continent lags that growth, in June 1999 issuers of Visa cards alone were collecting interest on up to $2.4 billion in outstanding balances in Spain, up 14% since 1997, while Germans were carrying outstanding Visa card balances of $773 million, compared to just $278 million two-and-a-half years ago.

But there is a dark side to this apparent financial freedom. Unlike charge cards, which must be cleared each month, or debit cards, which are simply a way of accessing a bank account, credit cards, aside from an obligatory minimum payment, bring a choice each month: clear the entire debt--avoiding interest--or roll some or all of it over. The latter entails interest rates often around 20%, more than twice that on a typical bank loan. Card companies may increase the initial borrowing limit if minimum repayments are made--often without the client asking for it. It is this spin, both revolving and expanding, that can leave the unwary in quicksand.

About 5% of all U.K. cardholders get into trouble, according to Frances Walker of the Consumer Credit Counselling Service, a charity helping people with debt problems. Misuse of cards is often caused by poor budgeting, coupled with unexpected setbacks such as job loss, divorce or illness. Walker says the typical person seeking the charity's help is in his or her mid-to-late 30s and owes about $30,000, including credit card debt, to an average of nine different creditors. But the number of young people with credit card debt problems is growing fast. "We're getting people of 20 with more than $15,000 debts [of various kinds]," she says. "That's quite a lot considering that they've only had credit for two years. I think it's a trend that's going to continue."

But even though a percentage of clients will always bite off more debt than they can chew, fail to keep up the repayments and enter a spiral that can end in bankruptcy, charging interest rates in the high teens usually offsets those losses. An indication of how potentially lucrative it is to have lots of people owing you money can be seen from the number of cardholders who opt to revolve: in Britain, where there are now more than 41 million credit cards, about 30% of holders are always revolving their debt, while another 40% bounce between paying off and rolling over their balances. It is the interest on this fluctuating but continual borrowing--which typically blows out around Christmas--that gives card companies the bulk of their profits.

While Britons have had credit cards since 1966, it was the arrival a few years ago of a slew of American card companies that really ramped the plastification of Britain. It is these same U.S. firms--now with wide-awake British competitors--who want to promote revolving debt across the Channel. They include Delaware-based MBNA, Illinois-based Household Finance Corporation, Capital One from Virginia and the People's Bank of Connecticut. Arrivals last year included Chicago-based Bank One--one of the world's largest credit card issuers--and Morgan Stanley Dean Witter.

The Americans bring experience and marketing skills, and in Britain face few restrictions other than that cardholders must be over 18. They can tout their wares directly, or through what are known as teaser rates--low interest for an initial six months or so before a jump to the usual wham of 15% to 20%. Some astute borrowers now "card surf," moving to a new company when the initial rate expires.

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Card providers offer a multitude of other come-ons. Morgan Stanley, for instance, has a Platinum card which returns up to 1% cash-back on purchases. Others give cardholders frequent-flier points--the chance to earn free airline trips based on card usage. Another popular enticement is the chance to help a favorite organization via affinity cards, such as those for Manchester United Football Club, the WorldWide Fund for Nature, the Royal Geographical Society or the National Asthma Campaign. From the cardholder's point of view, however, goodwill can take a long time to show up: a recent look at an affinity program run by the Bank of Scotland in conjunction with the Guide Dogs for the Blind Association found that a cardholder wanting to generate a donation of about $40 during the initial 20-month period would need to spend about $11,510 using the card.

As any economist knows, all incentives must be paid for--so users should keep an eye on the fine print of the contract. With Morgan Stanley's Platinum card, for example, there is a fee of about $24 on top of interest if minimum payments are late, and the same for exceeding the credit limit.

The problem for the U.K. and U.S. companies now targeting Continental Europe is that attitudes to debt are much more cautious, and rules vary on what is permitted. In Germany, for example, card promotions can face legal problems, as American Express found when a court ruled it couldn't advertise its frequent-flier-points incentive program. France has strict rules on how people are signed up, requires a credit check on applicants, and puts a cap on how much interest rates may rise in any year. Jean-Claude Nasse, assistant director of the Association of French Finance Companies--which represents about half the country's credit businesses--says: "In France, as in other Latin countries, the government just could not keep itself from getting involved in this activity, and so our business is regulated much more than it is in the U.S. or the U.K." There has also been "an active effort in France by consumer groups to depict revolving credit as too easy to obtain and dangerous to the consumer."

Jean-Marc Granier, of the Ministry of Economy's consumer unit, says most French people with credit cards prefer to pay via direct debit cards, but will use credit to exploit promotions and incentives. That's bad news for the providers because the users are not building up their debt. Another indicator of the French wariness of plastic is the average per capita use of checks: in 1996 it was 85, compared to 45 in Britain, 11 in Italy, 9 in Germany and 5 in the Netherlands.

Germans have even deeper dread of debt than the French. Steve Worthington, professor of marketing of financial services at England's Staffordshire University, says Germans tend to tie any credit to their regular bank check account. "I think they have a psychological scar about debt from the Weimar Republic days, and they are very wary of what they perceive as the American credit card." Providers in Germany also face competition from the "Dispo," or disposition, whereby banks allow overdrafts up to 11%--high, but a lot lower than for revolving credit. The standard is to allow customers up to thrice monthly income.

Barclays Bank has distributed just 900,000 cards in Germany since 1991. Amex spokesman Jim Tobin says, "Germany is behind the rest of Europe, but young people are beginning to understand credit." His company is pushing its Blue card, targeted at the 23-35 age group, with an advertising blitz on television and in magazines.

In Italy, resistance to debt is also strong. There were only 8.7 million charge cards and 2.4 million credit cards in circulation at the end of 1998, about one card for every five Italians. The average Italian charge card user makes about 10 transactions a year--more than the seven annual transactions made by Italian credit card users, but still only a sixth of the use of charge cards in the U.K. While younger people are adapting--and affinity charge cards with football clubs like Fiorentina, Parma, Lazio and Roma are a big success--many older Italians still prefer "real" money to plastic. "I'd feel I didn't have things quite under control and that I could end up owing loads of money, even if I didn't spend that much," says Luigi Mastrofini, a 53-year-old barber in central Rome. Others may be concerned that credit cards leave a trail which the tax man might follow; cash doesn't.

Despite these barriers, card companies have been making inroads, and many are planning campaigns using telemarketing, direct marketing and the Internet. MBNA's chief operating officer, Bruce L. Hammonds, envisages potential customers being able to log on to a central MBNA website, enter their country of origin, then learn about credit cards geared for their own conditions and regulations. In France, in September 1998, Barclaycard mailed credit card offers to 5 million households, selecting them after market tests.

As personal debt takes new forms, many European countries are updating their laws and increasing services to those who fall too far into it. In Germany, the Institute for Financial Services, a privately funded think tank, estimates that, for all their caution, about 2.6 million German households are "overextended." Severe bankruptcy laws were softened early last year with "consumer insolvency" legislation aiming to give hopelessly indebted people a fresh start--if they live seven years at subsistence level and can convince their creditors they have done their all to repay. A study in Cologne showed the cause cited most by debtors for their woes was job loss (20%), followed by reduced income, legal or financial inexperience, divorce and a failed attempt to start a business.

In France, a Commission for Overindebtedness has since 1990 been seeking solutions to the most serious cases, ranging from rescheduling repayments to bankruptcy. By the end of July 1999, it had examined a total of 800,000 cases. "You could say that in a nation of 60 million consumers, 800,000 cries for help isn't too bad," says the Ministry of Economy's Granier. "But those cases not accepted by the Commission--or never presented--darken the picture."

While U.S. and U.K. credit card firms predict a greater willingness by Europeans to go into debt, local lenders who had the field to themselves for years are not putting out the welcome mat. In France, for example, domestic finance and credit groups are struggling to hold the market dominance they established back when French banks regarded consumer credit as slumming. That is clearly no longer the case, and banks have forged partnerships with finance companies--such as the Banques Populaires with Cetelem or Credit Agricole's with Sofinco--to gain a foothold in France's tight market.

"Perhaps it is the inexplicably combative Gallic spirit, but there is an unreasonable, almost illogical level of competition between credit and finance companies," says the Association of French Finance Companies' Nasse. "Businesses are fighting tooth and nail for a limited number of clients." And this has led them to look outside. Cetelem and Sofinco, for example, have launched credit card services into neighboring markets including Italy, Spain, and even the crowded British market.

As the battle heats up, credit is both revolving and evolving. There are pitfalls, the prime one being borrowing more than income justifies. Consumers should also beware the lures of low initial interest rates and promotions, and remember that a sudden change in circumstances--such as job loss--could leave them out on a debt limb. For the judicious, however, credit makes it easier to manage one's own finances. Even Frances Walker, whose charity helps debtors who get in too deep, says credit "empowers people and enables them to do things." And those lenders eager to see debt revolve might bear in mind that a certain saying about merit also applies to money: Give credit where credit's due.

Reported by Bruce Crumley/Paris, Helen Gibson and Jennie James/London, Martin Penner/Rome and Steve Zwick/Düsseldorf