Citigroup (C) plans to increase fees on credit cards and it willaffect nearly 15 million of the bank’s customers. The action leaves the federal government in a bind. It owns options to 34% of the firm’s shares which means that the Treasury should want the bank to do extremely well for its stockholders. On the other hand, the Administration has been a strong supporter of programs to cut credit costs for consumers.

According to the FT, “Citi’s rate increases emerged on the day the government proposed legislation to create a new regulator with sweeping powers on consumer protection.”

It is hard to blame Citi for the move. Credit card default rates track the unemployment rate, as a rule of thumb. That means that 10% of card holders will not pay their bills. The largest credit card issuers, mostly big banks, are faced with massive write-offs just as they are recovering from their mortgage-backed securities losses. Combined with more write-downs on commercial real estate, LBO loans, and corporate credit, financial firms will have to book reserves which could force them to go to the capital markets to raise additional money just as they believed that they had put their balance sheets in order. Some of the banks may even have to turn back to the federal government to borrow new money and potentially have a bigger portion of their equity owned by Washington.

The credit card dilemma is another example of the complications which come from the government owning companies while regulating their industries. The car firms have faced a similar problem as they have taken government loans and equity investments while fighting new regulations to improve the gas mileage that their vehicles get. Congress and the Administration are asking the auto industry to do something which is not in the best interests of shareholders because of its costs.

Unemployment is likely to rise above 10%, and with part-time workers looking for full-time work and the chronically unemployed factored in the numbers is closer to 15%. Banks cannot afford to support what are likely to be tens of billions of dollars in losses as overleveraged customers walk away from obligations. The government has no programs to assist these consumers, nothing similar to its plan to make mortgages more affordable.

Citi has raised it credit card rates. Other financial firms will have to follow suit. The recession has taken too large a bite out of the consumer’s pocketbook for there to be another alternative.

Douglas A. McIntyre

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