Homeowners who may be edging towards foreclosure could have used these lines as a last resort, while others who were financing businesses or college educations will now face foreclosure in increasing numbers. The banks, though, get to avoid a greater loss now and start the process of taking back these properties, hoping to make more money on them in the long run through sales on the open market.
Apparently, the next target for the restriction of credit may be credit cards, and consumers in increasing numbers will be receiving notice that their limits have been severely reduced. Credit cards have been treated much the same as mortgages, in that they have been heavily securitized and sold off to hedge funds and other investors. Banks sell the right to third parties to collect the payments on the debt, which gives them more capital to show on their balance sheets, which allows them to make more loans with fewer questions, which they can in turn sell to investors.
Now that certain parts of the banking industry look as if they are failing, though, banks are attempting to limit their losses on consumer credit, like mortgages and credit card lines. They are already targeting the homeowners and general public to make profits through other methods since giving out more loans is likely to generate more defaults. Securitizing debt and selling it to pension funds and hedge funds is no longer as profitable, as these funds are becoming more nervous about the toxic debts they already own.
On the surface, the reason for cutting off HELOC and credit card lines is that the entire economy is experiencing a credit crunch. Banks are taking losses and writedowns on their mortgage debt, so they have less money to lend to consumers for smaller purchases. But this excuse is beginning to wear a little thin, as the Federal Reserve has been providing generous bailouts to the banks in the form of Treasury Securities, and allowing the banks to move their bad debts off the books and into the vaults of the Fed.
Banks are also able to create their own money out of thin air in the form of debt, including mortgages and credit card charges. Although there are some reserve requirements, most regulations are essentially worthless, and allow banks to create as much money in the form of credit as they wish. The money "loaned" for a credit card transaction does not even exist until the charge occurs; the bank simply creates the debt out of the consumer's promise to pay. So the excuse that consumers will be cut off from their credit card lines because the banks simply do not have enough money to pay is a specious argument and a fraudulent misrepresentation of how money works.
It should be no surprise that cutting off access to credit lines or reducing the amount of money available will cause many people to find themselves very quickly over the limit. Although they are over only the new, reduced limit, the banks will charge fees and increase interest rates on this debt. When simply creating loans and making money from collecting interest is no longer profitable, the banks have found that aggressively going after fees is a wonderful alternative.
Thus, the banks can increase the rates of current customers and generate more revenue through fee collection. Without having to make better lending decisions, or create any more money out of credit at all, the banks are attempting to increase profits at the expense of their customer base (which is, quite honestly, held captive by the process of creating money as credit out of nothing). Of course, the conditions that trigger these extra fees and push people further into debt servitude have been created by the lenders.
Consumers, especially homeowners already facing their own financial hardships, should do whatever possible to avoid falling into these kinds of traps. If they can pay off credit cards or reduce their limits to a manageable level, the tricks of their creditors may not be as devastating in the long run. But everyone should be aware that the banks, now that they are being burned slightly by the fallout in the mortgage market, will be coming after them more directly in the form of more fees, higher interest, and more aggressive attempts to bleed homeowners of any remaining assets.