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Could Credit Card Debt Be Next $950B Blowup?

Amid the sobering talk of a possible recession, there were two pieces of news last week that are cause for additional consternation. First, bond guru Bill Gross of Pimco warned that the subprime crisis could linger for another two years, wiping out another $250 billion in loan defaults through the end of next year on top of the $900 billion worth of current questionable collateralized debt obligations and subprime loans.

Then, a convincing article appeared in Fortune making the case for a potential second credit meltdown, this time involving the $950 billion in consumer credit card debt.

Banks, which have been reporting their worst quarterly results in six years, have begun warning about credit card delinquencies now that over-leveraged consumers don't have the home equity to pay down this debt. Citibank Chief Financial Officer Gary Crittenden told analysts that the bank has set aside $2.24 billion for possible future defaults, as Citi is concerned about consumers' high balances and cash advances.

Deutsche Bank banking analyst Michael Mayo recently wrote, "We are in a heightened state of alert to monitor a potential domino effect." Making matters worse, credit card debt is not secured, as mortgages are.

Much as the subprime crisis has hurt a wide variety of banks and asset managers invested in asset-backed securities, a similar calamity in the credit card industry would have the same kind of ripple effects-most certainly affecting hedge funds, pension plans and mutual funds. As it turns out, even many money market mutual funds were exposed to risky subprime paper.

But not everyone agrees that a crisis is imminent. Some analysts say that credit card delinquencies are low, whereas banks were foreclosing on mortgages for months ahead of the subprime crisis.

Others say that whereas asset securitization of subprime loans was not accurately assessed or understood even by the credit rating agencies, financial institutions have proven themselves adept at securitizing credit card debt.

"The performance in the core consumer [asset-backed securities] sectors is expected to deteriorate modestly, but not enough to cause substantial downgrades," said Kevin Duignan, a managing director at Fitch.

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