Broke Borrowers Are Best

Last night, I watched a movie called Maxed Out. Buried beneath all the Hollywood docu-drama, I found the seed of a fantastic investment idea. Let me explain...

Maxed Out is one of those Michael Moore-style documentaries about evil credit card companies and how they ruin people's lives for profit. It shows you how fabulously profitable credit card lending is, how much power these companies hold over their customers, and why Congress encourages them.

In one scene, you see a credit card company marketing its services on a college campus. In the next, a lady tells the story of her indebted son. "He ended up owing so much money to credit card companies he hanged himself in his dorm."

In the past, I've written: Lending money to rich people is a very smart idea: They can always afford to pay you back.

Last night, watching Maxed Out, I realized this statement is completely and utterly wrong. Lending to rich people is a bad idea. They always pay you back. Lending money to poor people is much more profitable. They can't pay you back, so you've got them in your pocket for the rest of their lives.

A Harvard Law School professor interviewed in the movie reveals this paradox. Warren tells two stories.

In her first story, the professor has a discussion with a vice president from Mastercard. The VP tells her the credit card industry's favorite customer is the guy who has already been through bankruptcy. "He can't go bankrupt again," he says, "and he already has a taste for credit, so we know he'll be making minimum monthly payments to us for the rest of his life."

In her second story, the professor says she was invited to give a presentation to a roomful of Citibank credit card bankers. With slides and data, she spent two hours showing them, if they'd screen out the riskiest 5% of their customers, they'd halve their bad debt losses.

At the end of her presentation and after a few questions, the division's head honcho puts his hand up and says, "Interesting presentation, but if you cut out those five percent, you cut out all our best customers and we lose our profits."

The credit card business is very simple. You lend money, unsecured, at high rates of interest. All the profits come from the poorest, most vulnerable customers with the worst credit ratings.

So here's my idea...

Protect your money in a recession by investing in credit card companies. Credit card companies are already fabulously profitable. Given the paradox I found in Maxed Out, credit card companies should perform well during recessions, too.

America has the most heavily indebted population of any country... and as the Mastercard VP said: Americans already have a taste for credit. In other words, if there's a recession in America, you should consider adding credit card issuers alongside your tobacco, alcohol, casino, and firearm stock portfolio.

Good investing,

Tom

P.S. If you'd like a jumping off point for further research on specific credit card companies, you can do worse than take a lead from Warren Buffett. The legendary investor owns nearly 13% of American Express.