The next meltdown: Credit cards?

"The good news for us is that we have the strength to get through this, but the bad news is that the earnings recovery does take a while," says Bank of America spokesman Bob Stickler. "We are prudently adjusting our underwriting standards to adapt to changing economic conditions."

Likewise, American Express, which caters to wealthier borrowers, upped its provisions for credit card losses from $810 million to $1.5 billion in the latest quarter, a sign that even upscale consumers are having trouble.

"We have enhanced our credit models and continue to prudently manage our risk by scaling back some card acquisition efforts and reducing credit lines where appropriate," an American Express spokeswoman says.

Like 'Boiler Room'

The industry's practices during the lending boom are coming back to haunt many credit card lenders. Cate Colombo, a former call center staffer at MBNA, a big issuer bought by Bank of America in 2005, says her job was to develop a rapport with credit card customers and advise them to use more of their available credit. Colleagues would often gather around her chair when she was on the phone with a consumer and chant: "Sell, sell."

"It was like 'Boiler Room,'" says Colombo, referring to a 2000 movie about unscrupulous stockbrokers. "I knew that they would probably be in debt for the rest of their lives."

Unless, of course, they default. Responds Bank of America spokeswoman Betty Riess: "The allegations do not reflect our practices. The bank has nothing to gain by extending credit to people who do not have the ability to pay us back."

Regulators and politicians are trying to curb some of the industry's abusive practices by limiting interest rate increases, abolishing certain fees and cracking down on questionable billing practices. Under rules proposed by the Federal Reserve, a borrower would have a 21-day grace period before being hit with a late fee, instead of the few days offered by some companies now.

A similar plan working its way through Congress would allow banks to increase rates only on consumers' future purchases -- not existing balances. And under both proposals, credit card companies would have to allocate account holders' payments equally to balances with different interest rates. Currently, companies first apply payments to the debt with the lowest rate, which means it takes longer and makes it costlier for consumers to pay off their debt.

The Senate isn't expected to vote on the matter until early next year. The Fed's proposed rules, currently being reviewed by the industry, could take effect around that same time. But lenders seem to be preparing for the worst-case scenario: an outright ban on some practices.

To get ahead of rules that would hamper their ability to re-price accounts, for example, many companies are jacking up interest rates. A survey of major issuers by advocacy group Consumer Action found that 37% of companies had raised rates across the board, even for borrowers with relatively pristine credit records. "In anticipation of a federal crackdown, card companies are scouring their portfolios and tightening credit," says Tower Group's Moroney.

Even consumers like Michael Polemeni, who miss only a single payment, can find themselves in the crosshairs of credit card companies. The independent computer specialist relied heavily on his credit cards for child-support payments and business expenses. Polemeni generally made more than the minimum payment each month, carrying a balance of about $2,000. But in July he missed a payment, and Providian, owned by Washington Mutual, jacked up his rate from 9% to 30%. "I was shocked because I am a very good customer," say Polemeni, who paid off the full balance immediately. WaMu didn't return calls for comment.

Not everyone will be able to pay down their debts like Polemeni. And that could make for a vicious cycle: As credit-card companies raise rates, more consumers fall behind on their payments, which then hurts the issuers. Says Innovest's Larkin, "We are going to see the banks massively hit."

This article was reported and written by Jessica Silver-Greenberg for BusinessWeek.

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