The topic for this entry was generated by a recent conversation that I had with an individual who was unwavering in his assertion that folks should pay their debts in full, regardless of how long it would take or the costs to a family’s wealth and security. I would like to ponder on the implications of this perspective.

First, let’s crunch some numbers. Based on data from the Consumer Bankruptcy Project (2001), the average filer of Chapter 7 had a median annual income of right around $20,600 and a median unsecured debt of approximately $27,200. What are the implications of this debt-load? Best case scenario is that the interest on these debts will be around 18%. If the debtor pays the minimum of approximately 3 percent monthly, it will take right at 28 years to repay this debt, and will result in around $27,000 in interest paid to the lenders. At least initially, monthly payments will be just over $800. We know that the majority of filers are 35-44 years old (Sullivan, Thorne and Warren 2001), so the debtor will be approximately 68 years old, maybe 70, before the debt is repaid (assuming that no additional unsecured debt is accrued).

From these facts evolve two pretty important questions. First, how are families affected by a lifetime of servicing debts like this? For example, how in the world will they be able to put away money for their children’s college expenses when so much is going toward debt repayment? My guess is that they won’t be able to save for college. So, their children will leave college buried in student loan debt. Further, if they are like many American families, the house has probably been refinanced a couple times and will not be paid off before retirement, thus leaving them quite vulnerable to foreclosure. Rather than making larger mortgage payments, the family has spent hundreds of dollars each month bolstering the wealth of the lending industry. And what about saving for retirement? If there is a monthly outlay of $800 to service debts, will there be anything left for the 401K? Doubtful. And if not, then these folks will enter retirement with essentially nothing in savings. Which leaves them quite vulnerable and quite likely to end up dependent on social programs.

Second, what does this type of perpetual indebtedness mean for the distribution of wealth in our country? Rather than building their own wealth through homeownership, retirement accounts, and higher education, these families are financing the massive wealth accrual of the lending industry. If it were just a couple families who were experiencing this type of wealth transfer, then there would not be much cause for alarm, but millions of families are experiencing this wealth stripping. Their wealth is sifting through their fingers and falling directly into the laps of the credit card companies, who are accruing massive wealth. So, rather than a society of families who have invested in themselves, and as a result have modest wealth and are financially stable, we now have families that are much more likely to have negative wealth and are exceedingly vulnerable—and more likely to eventually need the help of social services.

So, to return to the comment that precipitated this entry. Does it make sense to chain indebted families to decades or lifetimes of debt repayment? I don’t think so. We would be better off encouraging them to grow their own wealth, rather than transfer it to the already gluttonously wealthy.

References

Sullivan, Teresa A., Deborah Thorne, Elizabeth Warren. 2001. "Young, Old and In Between: Who Files for Bankruptcy?" Norton Bankruptcy Law Advisor. 9A:1-10.

Several years ago, Lucette Lagnado wrote a series of Wall Street Journal articles on the use of formal debt collection techniques for debts owed to hospitals by patients.  That series probably helped set off a chain reaction of Congressional hearings, state legislative initiatives, lawsuits, and self-regulation measures by the hospital industry. As Bob Lawless has reported, the Boston Globe is nearly done with a set of investigative reports that broaden and deepen the inquiry regarding debt collection practices in Massachusetts, framing each article so far on a major institution or actor that shapes the debt collection process (e.g., debt collection companies, small claims court, and — perhaps the most intriguing — the constable).  Like the Wall Street Journal series, the Globe investigation apparently has been a wake-up call of sorts, this time to the Massachusetts court system.

The Globe investigation comes at a time of reawakened interest among debtor-creditor scholars in the use of formal collection procedures for consumer debts (including some important systematic in-the-trenches studies being conducted now by Rich Hynes at William and Mary and separately by Sidney Watson and colleagues at Saint Louis University).  In the past several decades, many scholars have assumed that the formal judgment collection process was too expensive and cumbersome for relatively small consumer debts, and largely have focused their research energies elsewhere (e.g., federal bankruptcy, or laws that regulate informal collection techniques such as phone calls or letters).  With technology that facilitates spreading default risk and encouraging debtor repayment through other means, one might have expected even less use of the arcane formal process by repeat player claim holders today than a decade or two ago.  The Globe investigation does not study changes over time, but it does invite the question of whether technological developments and innovation in the credit and collection industries actually have increased, rather than decreased, the use and cost-effectiveness of arcane state collection procedures.

Readers of this blog will want to take a look at a four-part series from the Boston Globe called "Debtor’s Hell." In the words of the Globe, this series is an "investigation into the world of
consumer debt in the United States found a system where debt collectors
have a lopsided advantage, debtors are often treated shabbily by
collectors and the courts, and consumers can quickly find themselves in
a life-upending financial crisis." The Boston Globe‘s series comes on the heels of a July 5 article in the NY Times ($) about possible regulatory responses to increasingly aggressive debt collection practices.