Yesterday, Treasury Secretary Paulson announced a major shift in strategy for the federal government’s financial rescue plan. Treasury now would make $50 billion available for lending to companies making credit card, automobile, and student loans. The idea is to jump start consumer lending sector, although I am not sure to what end. There is no doubt that the consumer lending sector has frozen up along with the other credit markets. What concerns me is that the Treasury’s latest plan seems an attempt to return us to the same policies that got us to where we are today.
For those of us who grew up in the 1970s, the explosion of consumer
debt is one of the greatest social shifts for our generation. Our
parents borrowed but only episodically. Homeowners planned for a day
when they would pay off the home mortgage and perhaps have a
celebration where the mortgage document was burned. We were among the
first college students who were able to get credit cards, but credit
limits were low. As an undergraduate, I remember getting a Visa card so
that I would have it for an emergency and being terrified about
possibly being responsible for the $500 debt I could incur on it.
We now live in a society where a segment of America is permanently indebted. Although
estimates vary, the best available data suggest a little under half of
Americans carry a balance on their credit card. Homeowners have
borrowed out of their home equity and no longer plan to retire mortgage
debt. As a nation, we now over $13 trillion on our credit cards,
automobile loans, and home mortgages. Even after adjusting for
inflation and the growth in population, that is more than three times
the amount owed in 1980.
I am not yearning for the good old days. A lot of good has come from increased access to credit markets. Rather, our borrowing binge always has been unsustainable in the long run, and the long run is here. We tried to have a housing policy on the cheap. Instead of paying to put people into homes, we let them borrow. We tried to have economic growth on the cheap, using consumer borrowing to pay for that growth. After the September 11 attacks, President Bush urged Americans to continue spending to keep the economy strong. The bills have come due for all this borrowing. In the documentary Maxed Out, fellow Credit Slips
co-blogger Elizabeth Warren puts it in military terms, asking where is
the exit strategy for all this consumer debt? The global financial
crisis seems to be the exit strategy that we have made for ourselves.
With yesterday’s news, my question for Secretary Paulson is to explain to us why we need to jump start the consumer lending sector. Sure, no consumer lending at all would be bad, but is that really the concern? Consumer lending has not completely dried up. Consumer loans are just harder to get, albeit much harder to get it in some instances. Why is that a bad thing? Is the Treasury’s goal to return consumer lending industry to its go-go level before the financial crisis? If so, do we really want to continue to stimulate the economy with tomorrow’s dollars rather than paying for it now? The bill will just come due again some other day. Letting the consumer credit markets to continue to founder will mean that Americans will borrow less, will own less, and will have lower economic growth in the near future. We will have to live in that world unless we want economic growth on the cheap today that our children will pay for tomorrow.
Comments
12 responses to “Do We Want More Consumer Lending?”
The follow-up question is whether there is an exit strategy besides chapter 7? I spend my days talking to people who never should have had credit cards or who should have had their credit cards canceled six months ago. At this point, some of my clients are so dependent on consumer credit that they look confused when I tell them to pay cash at Sam’s Club.
I have long meandering conversations about how not to use a credit card for 90 days – See Section 523(a)(2)(C) – but sometimes still get hit with my favorite question, “Can I pay you with a credit card?”
What I’ve seen is that people put so much effort into making minimum payments on $40,000+ of consumer debt that they have to keep using consumer debt to cover expenses. Then of course there is the client that has always banked with X Bank and they’ve always been so nice to her that she wants to reaffirm her credit card through X Bank – I’ve had a couple of these and they are hard to talk down from their love of X Bank.
As I’ve been telling people for years, all credit does is change the point on the time-line in which someone gets something.
But the problem is a substantial portion of our consumers have been artificially inflating the economy via easy-to-obtain (but expensive) credit.
Weaning the economy off that giant consumer-driven bubble may be painful for providers of goods and services, but the reality is they have been relying on artificially inflated consumer demand.
The only real losers in the long run are the credit providers. And it would appear they’re determined to mitigate those losses with taxpayer money.
David-“I have long meandering conversations about how not to use a credit card for 90 days – See Section 523(a)(2)(C) – but sometimes still get hit with my favorite question, “Can I pay you with a credit card?”
That is so funny in that we get that all the time here in the office as well. I’m like, uhhhh no! Your filing bankruptcy! Then its well do you take check card?
My question: Does anyone think that inflation is higher or growing at a faster pace because of the easy credit card lending?
We saw that same thing in housing. Prices shot up because of all of the easy credit.
I obtained a credit card from Bank of Hawaii TWENTY SIX YEARS AGO! I’ve been an excellent customer – sometimes having a balance, usually not, always paid on time and always paid over the minimum. They now use FIA Card Services to manage their accounts.
I used a convenience check in August of 2007 and have paid off 40% of the debt in the last 15 months on time and above minimum. I received a notice last week that they’re DOUBLING my interest. The rep I spoke to last week said “Well, you’re not using the card much. It’s obvious you’ve been in pay-down mode for some time now so we just decided to make it official.”
The rep I spoke to today acknowledged that I have never paid late, gone over the limit or paid less than required. He said that they have the right to change the terms anytime they want for any reason they want. How stupid does a company have to be to throw away an excellent customer of 26 years?!?!!??
Well, here’s MY change of terms: they can write me a letter of apology, return my card to the terms THEY offered ME or they will never see another cent.
They’ll spend hundreds of dollars trying to convince me to pay the debt, they’ll sell it for 40 cents on the dollar to someone I won’t pay who will sell it for 12 cents on the dollar to some lawyer and I’ll settle with him for 45 cents on the dollar.
And the hit to my credit score? Give me a break. With the economic tsunami hitting consumers and all the foreclosures, defaults, bankruptcies and late pays piling up everywhere, Fair Isaac isn’t going to be worth the paper he’s written on in 2 more years.
Pound sand FIA.
To get back to Bob’s original point, the difficulty of course is that the U.S. economy is now heavily weighted toward consumer goods and services, which have long been supported by borrowed money. If consumers as a whole suddenly began living on a pay as you go strategy, the U.S. economy and the jobs that are supported by consumer spending, would begin a downward spiral the likes of which … you get the picture. Washington has decided that that scenario is worse than having half the citizenry addicted to credit. I’m not sure I disagree.
Thomas- If what you say is true, that citizens being addicted to credit is better than the loss of jobs in the consumer market, then I have darn good job security! Working in consumer bankruptcy firms will be like having a nursing degree. You will be able to find work no matter where you go in this Country and in other countries. Do you think we are paying more now for consumer products because of the ease of credit?
Professor Lawless and Mr Perkins have nailed the dilemma very succinctly. It is a lesser of two evils question. Deleveraged economy would be a good state but the process of doing so is painful after generations of leveraging up. The more gradual we can make the change the less pain along the way but the longer the fix takes. I think this is not a question of rational decisionmaking but one of recognizing the limits of human psychology to handle rapid, fundamental change. I have observed that sharp change – deregulation of an industry or re-regulation of it – lways leads to financial dislocation and this is another one of those sad periods.
Actually a cut in consumer credit does not affect jobs here as much as in China, and the third world countries now manufacturing our consumer goods. When the majority of our consumer goods are made elsewhere, we should not be worrying about creating consumer demand here but the countries that do produce need to worry about stimulating consumer demand.
With plenty of blame to spread around (overleveraged consumers, overzealous credit card companies offering teaser rates to anyone with an address, etc, etc), we are in need of solutions before this giant house of cards comes apart.
I am not a lawyer or an accountant – I was in corporate banking and capital markets for two decades before retiring to be home with my two children – but here is my general idea: rather than the credit card companies charging the usurious rates that preclude principal repayment, they should reduce rates to somewhere around 10%. Of that 10%, they should apply roughly 8% as credit card finance charges (still a very nice spread over cost of funds), and apply the balance to a savings account that could build over time. The consumer may not have access to the savings account until the principal is paid off, and it could be used to offset any credit losses by that consumer. While the numbers may need tweaking, it seems to me that this would provide relief to consumers who do want to pay off their debt as it helps them set new habits for savings. The savings would increase the banks’ deposit base as well.
The money saved by the consumers could either go back into the economy or repay principal (banks could provide incentive for the latter by offering more attractive rates either on the credit balance or the savings account).
We cannot change overnight the fact that our economy has been built on the backs of consumers, and with decreasing disposable income, the odds of consumers being able to add to their savings (much of which has been wiped out by the markets) is improbable.
@carolyn t
I do not think the cost of capital for credit card companies / operations would allow them to stay in business for very long lending at what is effectively an 8% rate (the other 2% being essentially an interest-free loan that becomes part of the cost of capital). I would be most curious about whatever analysis you have on that notion. Assume say a 5% default rate with no recovery on those defaults, which is modest of course and less than current run rate.
Although I agree we need a nationwide usury rate and it would be more useful than the paperwork producing laws that keep proliferating with little benefit. I suggest 1500 bp above comparable Treasuries might be a good starting point.
The consumers in trouble are, for the most part, ones who made bad choices either in spending beyond their means or not saving for a rainy day. Why would we want to give them the ability to make more bad choices? By limiting their credit more than those who have made good choices, we can increase the likelihood that credit grantors will be repaid, decrease the default ratios, lower bank costs and thus lower interest rates in general and especially for those who make good choices.
And sheepdog is correct that most of the effect is/has been for countries we are importing from like China. Let them bail out the the consumers!
I disagree with mark t that stretching out the painful period would result in less pain. Just like with pulling a bandaid off, quick and over with!
Most Americans, excellent FICO scores or not, are struggling to pay the debt they have. Excessive debt and the inability to pay it is what got us here in the first place. As important as the interest revenue streams to banks may be Americans are learning that paying a high premium to obtain material goods is not in their best interest. So it’s not only that the banks are currently hesitant to lend but consumers are now reluctant to borrow. And rightfully so.
How long did the banks think consumers were going to take their shifting tactics to increase interest rates? They employ legal think tanks for the sole purpose of finding and creating contract law to maximize the returns from borrowers in the form of increased payments. And consumers are expected to play along continue the cycle for them to insure their revenue stream?
The banks are losing money for two reasons right now:
1. Their unchecked greed as they lent to high risk borrowers combined with their attack on existing customers through perpetual rate increases.
2. The realization by consumers that borrowing during a time of stagnant wages and job losses is not in their best interest.
There is no real solution for the banks here. Some banks continue to offer 0% financing on vehicles for “qualified buyers” yet no one is buying. This combined with constant demand for relief from high student loans, credit card and mortgages should be an visible indicator where the consumer mindset is.
Paulson’s solution: Make banks lend again. Who wants to borrow? Over the next decade we will see a dramatic shift towards a cash and carry economy. Every personal finance adviser in the public and private sector is singling the same song “reduce personal debt”. With this being the public education policy the banks will have no alternative but to change their business model…or fail.