Credit card balances generate a continuing stream of income. Asset-backed securities are sold to investors, backed by these revenue streams. Investors may not get what they bargained for. Generally the biggest asset-backed securities are backed by home equity loans, auto loans, and credit cards. Here is how credit card asset backed securities can be inflated, defrauding investors in the process:
Bubba applies for a credit card and gets one with a $300 credit limit at 10 percent interest. They charge Bubba $99 for issuing the card, $99 as an annual fee, and Bubba can actually buy one tank of gasoline without going over the limit. Bubba gets a bill, pays it immediately, and the payment gets procesed one day after the due date. Bubba’s rate goes to 29.99 percent, he gets a $39 late fee, a $39 overlimit fee, and a bad attitude. The bank, however, has a false $350 credit card asset, rolls it into an asset-backed security along with 100,000 other cards like Bubba’s, and sells $35 million as asset-backed securities. The problem is there are no assets to back the security. There is no collateral. Recognizing that they have been scammed, twenty percent of the Bubba account holders don’t even send a second payment. After six months forty percent of the Bubba accounts quit paying. The rest pay off the account immediately and talk bad about the bank for the rest of their lives.