May 22 (Bloomberg) -- Jack Krupansky declared bankruptcy three and a half years ago. Now he worries the credit-card legislation Congress passed this week will make his banks, including Barclays Plc, penalize him as a riskier borrower.

“This legislation could boomerang and hurt the same people it’s designed to help during the credit crunch,” said Krupansky, 55, a freelance software developer in New York.

The “bill of rights” that U.S. President Barack Obama signed today is intended to protect cardholders from excessive fees and last-minute contract changes. It also may prompt banks to slash available credit by as much as $90 billion to avoid risk, said Robert Hammer, chief executive officer of R.K. Hammer Investment Bankers, an adviser to card companies.

That reduction could choke off a consumer-led recovery and hurt retailers struggling amid the longest recession since the 1930s, said Andrew Caplin, an economics professor at New York University. Consumer spending accounts for 70 percent of the U.S. economy.

“The bill may stop various forms of abuse, but it will also stop some various forms of credit,” Caplin said. “If the economic recovery is going to rely on consumer spending, it will be a long wait.”

In 2007, purchase volume on all U.S. consumer and commercial credit cards equaled $2.11 trillion, up 8.4 percent from 2006, according to the Nilson Report, the Carpinteria, California-based newsletter.

Cardholders Spend More

“When people walk into stores with credit cards instead of cash, 90 percent of them spend more,” Britt Beemer, founder of America’s Research Group, said in an interview. “Apparel, which is in the dumpster already, is going to be hurt the most. Nonessential, big-ticket items like TVs and electronics could certainly be impacted a lot.”

Available consumer credit contracted by a record $11.1 billion in March, according to a May 7 Federal Reserve report. The drop was equivalent to a 5.2 percent annual rate, the biggest since 1990.

Reckless lending -- and the attendant defaults -- led to the reductions in credit, said Josh Frank, senior researcher at the Center for Responsible Lending in Durham, North Carolina.

“The impact on available credit has been greatly overstated as an industry tactic to scare people to be against the bill,” said Frank, who supported the legislation.

Credit-card companies will still be able to price according to risk, said Gail Hillebrand, a San Francisco-based attorney for Consumers Union. The legislation will ensure that the cost of borrowing money is disclosed at the outset instead of luring risky borrowers with a low introductory rate, she said.

‘Undiscussed Consequence’

The interest will be too high for some -- and in other cases, banks simply won’t issue cards, said Hammer. He estimated that as much as 10 percent of the $934 billion in U.S. card loans would disappear.

“The unintended, unpleasant, undiscussed consequence of this legislation is that banks will cut credit to reduce exposure to future loan losses,” Hammer said.

Card companies will have to recover from defaults and recoup the costs of complying with the new legislation, said Karen Garrett, an attorney focusing on bank regulation and payment products at Bryan Cave LLP in Kansas City, Missouri. Borrowers who pay off their balances every month may be assessed annual fees and lose rewards programs, Garrett said.

“You’ll see a reduction in credit available to subprime customers, and even those in the near-prime range where the card companies have a hard time gauging what the risk is,” said Scott Valentin, an analyst at Arlington, Virginia-based FBR Capital Markets Corp.

Predatory Lending

Low to moderate income workers, first-time borrowers and consumers with poor payment histories may have to turn to predatory lending or other loans that aren’t tied to rating companies, which prevents the building of credit history, said David John, a senior research fellow at the Heritage Foundation, a Washington-based research group.

Krupansky is concerned the legislation will trigger a reduction in his $8,000 of available credit. He’s already seen his Frontier Airlines-branded Barclay’s card reduced by almost half.

He uses it and cards from McLean, Virginia-based Capital One Financial Corp. and HSBC Holdings Plc of London to pay for groceries, airline tickets, hotel reservations and online subscriptions.

The legislation may backfire as issuers raise interest rates over the nine months before the law takes effect, said Curtis Arnold, the founder of CardRatings.com, a Web site that reviews credit cards.

‘Wild West’

“The credit-card industry had been the Wild West and now the sheriff is coming to town,” Arnold said.

The average interest rate charged on credit-card balances was 13.5 percent in February, according to a Federal Reserve report in March.

Wayne Wells, who works as the lead operation technician in a paper mill in Columbia, South Carolina, uses his Capital One card to pay monthly bills because he gets a paycheck sporadically. Wells, 50, said if his interest rates increase, he’ll use his card only for emergencies and switch to debit.

The law would prohibit increasing a consumer’s rate on existing balances based on late payments to another lender, a practice known as “universal default.” It would require banks to apply payments to balances with the highest interest rates first.

‘Cannot Help Recovery’

It also would mandate 45 days’ notice before raising rates and prohibit retroactive increases on existing balances unless a consumer was 60 days late with a payment. Companies would have to restore the lower rate if a cardholder stayed current six months after a late payment.

Retailers such as Minneapolis-based Target Corp. stand to lose a chunk of revenue from their private-label credit-card programs if they have to rein in penalty fees, said George Whalin, president of Retail Management Consultants in Carlsbad, California.

Charges for paying late or exceeding a card’s limit bring an estimated profit margin of 60 percent to 70 percent, Whalin said. “A lot of that’s going to go away.”

The average American has more than five credit cards, a number that should decrease after the legislation becomes effective, said David Robertson, president of the Nilson Report.

The credit-card legislation will reduce the number of individuals who have access to cards and discourage the use of credit cards for those who have them, which “clearly cannot help the recovery in the near term,” said Martin Feldstein, an economics professor at Harvard University in Cambridge, Massachusetts, and a former head of the National Bureau of Economic Research.

Collapsing Model

“Just like subprime mortgage lending, card companies were profitable while risky borrowers were extended credit,” said Ben Woolsey, Austin, Texas-based director of marketing and consumer research at CreditCards.com, an online resource for credit-card users.

The five biggest card issuers, New York-based Citigroup Inc., JPMorgan Chase & Co. and American Express Co., Charlotte, North Carolina-based Bank of America Corp., and Capital One, could have $72.3 billion in credit-card losses, according to the U.S. stress tests completed this month to determine whether the banks would require additional capital to withstand further deterioration of the economy.

Those losses would wipe out their collective $49 billion in net income from credit-card operations for the four years since 2005, based on data compiled by Bloomberg.

“They made money on late payments, but now that so many borrowers have crossed the line and defaulted, that model collapses pretty quickly,” Woolsey said.

To contact the reporter on this story: Alexis Leondis in New York aleondis@bloomberg.net.

Last Updated: May 22, 2009 15:42 EDT