The SV Blog

Television Messages

2010-11-06T23:27:00.001-04:00

I don't watch television often, but a recent evening spent in front of the tube gave a sad indication of where we are today. Three kinds of commercials came on over and over again: advertisements for Consolidated Credit counseling services, tax relief counseling, and law firms seeking class action clients for law suits against the manufacturers of various medical products. The common theme in all three is a quick fix for financial problems, the same motivation that makes gambling so attractive to so many.

Many people who were carrying debt while employed are now out of work and desperate for a way out from under their financial obligations. Personal bankruptcies have been rising steadily since 2005, and the most recent statistics show that in March of this year, filings hit just under 1.5 million for the previous 12-month period. Because, on average, one third of these filings were married couples filing jointly, approximately 2 million people were involved in personal bankruptcies last year. With that much financial misery around, merchants of the quick fix enjoy one of the few growth industries.

Not So Fugal After All

2010-09-25T15:01:00.001-04:00

For some months now there have been reports of declines in credit card debt, which have been interpreted as evidence of greater thrift and caution on the part of American consumers. The economy is in trouble, and in hard times card holders are keeping their credit cards close.

But gradually a different picture has emerged. Much of the decrease in total indebtedness appears to come from bank write-offs. Banks have begun to “charge off” debt they believe is unlikely to ever be repaid. Here Michelle Singletary report on this write-off phenomenon, poking a hole in the early analysis, and in today’s New York Times,Christine Hauser provides more evidence that, rather than a sign of greater self-control among consumers, the decline in credit card debt is an indication of the sad state of affairs at the bank:

A study released last week by Evolution Finance’s CardHub.com, calculated that financial institutions charged off about $20 billion each quarter from early 2009 through early 2010, about equal to the amount of the decline in outstanding credit card debt.

So will we ever learn to be more thrifty? There are plenty of reasons to hold back spending now, but the urge to swipe remains a powerful force. The psychology of spending in the contemporary world is largely unchanged by the current economic conditions. Furthermore, the broad cultural changes that would bring about different attitudes about spending, thrift, and consumption have yet to emerge. I wouldn’t hold my breath.

The Blockbuster Bankruptcy and the Physics of Spending

2010-09-24T00:11:00.001-04:00

Today the word came down that Blockbuster Video had filed for chapter 11 bankruptcy protection. A company founded in 1985 and once the dominant video rental company in the country had fallen. The reason, of course, was Netflix and the physics of spending.

In Going Broke: Why American’s Can’t Hold On To Their Money I identified the five most important variables in what I called, The Physics of Spending. Blockbuster became victim to two of these: Time and Effort.

When videos came almost exclusively in VHS format we travelled to the store to rent them. Mailing these bulky tapes would have been difficult, and no company ever attempted that approach. Blockbuster offered us a wide variety of choices and a quick turnaround—a few minutes to the store and back—in return for the effort it took to go out and get the video. Yes, we were sometimes frustrated when we discovered that all the copies of the video we wanted were rented or that the store did not have the movie we were looking for. But often there was something else on the shelf that was suitable.

When DVDs became the dominant movie format and Netflix discovered a simple way to mail disks, Blockbuster’s days were numbered. True, you had to wait longer to receive your video, but it took almost no effort at all. The video was delivered to your mailbox and could be returned in the out-going mail. Furthermore, the selection was much larger than your local Blockbuster could possibly offer, and the frustration of delay was mitigated by offering the option of ordering more than one video at a time. Eventually Netflix made it possible to watch some movies instantly on your computer for no additional cost.

In today’s consumer world, the effort variable often trumps the time variable. People will gladly wait for a purchase that saves them effort. Amazon.com and the entire world of internet shopping is proof of this principle. If you need more evidence, go to your local fast food restaurant at lunchtime. In most cases there will be a very long line of cars waiting to be served at the drive-through window. See, for example, the picture in an earlier blog entry called “Drive-through Windows, the Large Muscle Hierarchy, & Spending.” Many of the people in these lines of cars could get their food more quickly by parking the car and walking into the store. But they don’t. They would rather wait in comfort.

Much has been written about the brilliance of Netflix’s DVD shipping system and its software designed to recommend videos based on your prior ratings, but the primary cause of Blockbuster’s defeat was the ability to mail DVDs and the physics of spending. Less effort is worth the wait.

Lashing Your Credit Card to the Mast

2010-08-15T08:14:00.001-04:00

In the final chapter of my 2008 book Going Broke: Why Americans Can’t Hold On To Their Money, I gave a number of suggestions for staying out of debt. Some of them were tips for individual consumers, but others were government or business policy changes that would help consumers achieve greater self control and be more thrifty. One of these suggestions was to harness modern technology to help credit card users from getting into trouble. Drawing upon ideas of several other psychologists and economists, I proposed that consumers be allowed to voluntarily program credit cards to only work on certain days of the week or times of day. Certain purchases would always be allowed (e.g., medical facilities and gas stations), but other purchases would have to be put off to designated shopping days and times, thereby diminishing the likelihood of impulsive spending.

Now, MasterCard and Citigroup will for the first time introduce a similar program called inControl. In a New York Times article entitled “Your Card Has Been Declined, Just as You Wanted,” Ron Lieber writes about a program that is far more flexible and potentially valuable than the one I proposed in Going Broke. Cardholders will be able to set a monthly budget for restaurant dining, and after that budget has been exceeded, further purchases will be declined. Consumers could also simply set a figure for their total monthly disposable income and have the card shut off when that number has been met. Of course, the consumer can call the bank to have the limit removed, and there is no obstacle to going to an ATM to get cash from your credit card. But this kind of voluntary self-control device has the potential to help many people stay within their budgets.

Lieber asks the obvious question:

Still, this is the sort of service that makes you slap your forehead and wonder why it didn’t exist before. It has the potential to solve the core problem with budgeting: it’s easy to make a spreadsheet and track what you spend, but it’s awfully hard to stick to the plan.

Of course, the unstated answer to Lieber’s question is that this program was not available before because consumers’ struggles with self-control and budgeting reaped enormous profits for the banks. As Lieber points out, Citigroup and other banking institutions are trying to boost their reputations in the wake of the financial meltdown, and consumer-friendly credit card programs are thought to be particularly attractive to banks at this time.

There is also good evidence that, given a chance, many consumers will make banking decisions that improve their self-control and make them more thrifty. Like Ulysses, who had his men tie him to the mast of his ship so that he could hear the sirens’ songs without being destroyed by them, many consumers will act to limit their choices in order to make it easier to be good.

For example, new Federal Reserve regulations implemented by the Obama administration that go into effect today forbid banks from automatically enrolling customers in overdraft protection programs that charge $35 or more for each overdraft. So banks are now forced to offer accounts without overdraft protection and must ask customers to opt-in: to choose to have no protection or to enroll in some kind of overdraft protection program. Interestingly, CNN is reporting “many customers are choosing to risk having their card declined rather than face a $35 overdraft fee.” This is a good trend which suggests that MasterCard’s inControl program will be embraced by many cardholders. Many consumers are willing to put voluntary limits on their spending, and finally, the banks are beginning to provide programs that have the potential to help cardholders achieve financial stability.

Nine Years of Lobbying Yields a Five Year Break

2010-07-05T18:04:00.000-04:00

In 2005, soon after George W. Bush’s reelection, a bankruptcy bill that had been pushed by the banking and credit card industries for nine years finally passed and became law. The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) introduced additional restrictions and requirements for individuals hoping to file for personal bankruptcy and was advertised as a protection against irresponsible borrowers that would safeguard the availability of credit for the rest of us. The new rules did have a substantial effect, momentarily cutting bankruptcies in half, but as time passed and the economy worsened, bankruptcies gradually edged upwards toward their previous levels.

Now comes the word there were 770,117 personal bankruptcy cases during the first half of this year and the American Bankruptcy Institute predicts a total of 1.6 million bankruptcies for all of 2010. In 2005, the year the new law was introduced, there were a record 2 million bankruptcies, but that was an artificial peak caused by a run to declare bankruptcy before the new rules went into effect in October of 2005. Prior to his highly atypical year, bankruptcies hovered around 1.6 million in 2003 and 2004. So now, a mere five years after the law was introduced, bankruptcies are back to their pre-BAPCPA levels.

What does this episode tell us? That the remarkably high bankruptcy rate in the United States is not a function of the easy process of declaring. The 2005 law made filing much more onerous. Rather, as Samuel Gerdano, excutive director of the ABI put it: "Years of rising consumer debt and low savings rates, combined with the housing and unemployment crisis, are causing bankruptcy levels not seen since the 2005."

Until these underlying problems are solved, tinkering with the bankruptcy laws will have little effect.

Cortney Munna Responds

2010-06-01T19:42:00.001-04:00

Cortney Munna, the debt-burdened NYU graduate featured in a recent New York Times profile and in my last blog post responds today to the more than 600 comments posted to the original Times article. She writes very eloquently and accepts responsibility for her plight, although she says she wants to fight to “re-write the rules of the student loan game as it relates to loan underwriting, counseling and the bankruptcy laws.”

She also points to the need for better information:

As far as why I let the debt amass as I did: Frankly, I was uninformed. For this, I blame myself and my family for not looking beyond the school for information, and I blame the school for not offering clearer information about the differences in lending sources.

In retrospect, it’s absolutely clear to me that I should have thought more about the cost of the education versus career prospects. I didn’t think of it as a purchase. It was always just the next step to take: Get into good school. Get decent scholarship. Work hard.

And have it all pay off in the end.

A Costly College Education

2010-06-01T08:01:00.002-04:00

The college commencement addresses have all been delivered, and new graduates are faced with the realities of a slower economy and no diminution in the accumulation of student debt. Ron Leiber of The New York Times recently profiled Cortney Munna, a 2005 NYU graduate who is carrying almost $100,000 in student loan debt. Today National Public Radio ran a story about Heather Lefebvre, a 2010 summa cum laude graduate of Brandeis University who is burdened with $85,000 in student loan debt.

This graphic, which accompanied the web version of the NPR story, shows that student debt is a growth industry. So grads are getting hit with more debt than ever and the worst economy any graduating class has faced in several years. To make matters worse, student loan debt cannot be discharged by bankruptcy.

Leiber’s article for the Times asks the question, who is to blame? After interviewing Munna’s mother, herself a student loan borrower, the lending agencies, and the NYU financial aid office, he finds no one willing to take responsibility for Munna’s predicament. As usual, blame falls back on the borrower, but is that entirely fair? Education is supposed to be an investment that will bring future benefits, both economic and non-economic, but does the return on investment justify the expense? The question is not whether college is a good investment or not. In general, college is a very good investment. The real question is whether the marginally better education obtained at expensive schools like NYU and Brandeis is worth the added debt for students who can must borrow. State schools are the workhorses of our educational system, and they are much less costly. Are pricy private schools worth it? Of course, few of the schools will answer this question realistically, so it is foolish to look for the pricier colleges and universities to provide wise counsel to students like Munna and Lefebvre. Meanwhile, we are constantly encouraging young people to reach for the stars and not settle for less than the best.

One point that comes from these examples, is choice of major. Many of my liberal arts students come from wealthy families, and I know that they will be fine no matter what happens. But students like Munna and Lefebvre are not wealthy. Munna had an interdisciplinary major of religious and women’s studies, and Lefebvre was a double major in English and creative writing. I know many parents urge their children to diversify their majors, making certain that at least one major has the potential to lead to a job. If you are going to double major, choosing two quite different majors (English and biology, or religious studies and psychology) might improve chances of post-graduate employment. I was an English major, and I still believe that a basic liberal arts education is good preparation for both civic life and a wide variety of employment paths. But I went to state schools, emerged from college without debt, and benefited from good economic times. These things are not true for today’s graduates.

Desperate for Money in Oakland

2010-02-17T21:50:00.001-05:00

While checking my email and enjoying a Venti-sized Pike Place Roast at a Starbucks near the Oakland International Airport, I spied the sign above on a building across the street. Title loans are typically short-term loans at very high interest rates. For example, a 30-day loan at 25% interest is the equivalent of 300% APR. Some title loans have APRs of over 600%.

In return for fast cash with few questions asked, the borrower must have a car that is owned outright and must sign over the title of the car as security on the loan. If the principle and interest are not paid off on time, the borrower can usually roll over the loan to a new due date, but if he or she is delinquent on the loan, the borrower can lose the car.

Seeing a sign like this one led me to ask, “What kind of trouble must you be in to borrow against your car for cash in 15 minutes?” The patrons of this institution inhabit the dark corners of our economy, and lenders like this one are happy to take advantage of their desperation. Right across from Starbucks.

The morality of ditching your obligations

2010-01-14T07:08:00.003-05:00

In a piece entitled “Walk Away From Your Mortgage” by New York Times writer Roger Lowenstein makes an interesting point about the recent boom in foreclosures. The economy has gone into recession, and many people have lost their jobs and are simply unable to pay their mortgages. Furthermore, it is estimated that over 10 million Americans currently owe more on their mortgages than their houses are worth (this represents a quarter of all mortgages), and there is a trend towards people who could pay their mortgages simply walking away. This group, whose actual size is unclear, has been vilified in the press and by politicians of all stripes. Those who simply choose to walk away from their mortgages, not because they have to but because it makes economic sense, have been labelled irresponsible and immoral.

But Lowenstein points out an interesting contradiction. Businesses walk away from similar obligations all the time. The investment firm Morgan Stanley recently decided to stop making payments on five San Francisco office buildings simply because the investment did not make sense. As Lowenstein points out, “Nobody has said Morgan Stanley is immoral — perhaps because no one assumed it was moral to begin with.” Another argument for holding onto your home is that foreclosures bring down the prices of homes in the area. But oil speculators drive up the price of gas for all of us, and those who sell stock, decrease the value of other people’s savings and retirement accounts. All of our economic decisions are interconnected, but not all are infused with moral obligation.

So homeowners are expected to be moral, while businesses are free to be self-interested economic entities. Not homo economicus but corpo economicus. Furthermore, Lowenstein points out that those who walk away from their mortgages are not avoiding the consequences of their decisions. The consequence of not paying is written into the mortgage—surrendering the house—and homeowners who foreclose are suffering this consequence.

Finally, Lowenstein argues that homeowners should feel free to foreclose on a house that is worth less than the mortgage. Housing prices are not likely to recover for a long time, and throughout the financial world, it appears that moral motivations, social bonds, and social consciousness have decreasing influence on our decisions.

There is a sad reality to this article. One cause of our current economic crisis is the breakdown of local banking and personal relationships between mortgage issuers and homeowners, as well as between borrowers and credit card companies. Each has acted like the self-interested homo economicus of neoclassical economics, and often the self-interested action of one was at the expense of another—a kind of social zero-sum. But Lowenstein argues that, in this economic prisoner’s dilemma, there is no reason for the homeowner to cooperate when everyone else is defecting. Sadly, he has a point.

Pre-paid Debit Card Fees Soak Low-income Users

2009-10-06T08:58:00.000-04:00

I recently got a new cell phone, and after I sent in several pages of documentation, my rebate was mailed in the form of a pre-paid debit card. These financial products and their close cousins pre-paid gift cards are becoming ubiquitous. Gift cards can be purchased at the grocery store and many other places. Pre-paid debit cards are particularly popular with low-income consumers who are unable to open a conventional bank account or get a credit card. But as this New York Times article suggests there are many hidden fees and deductions that make this a very expensive form of banking. Recent credit card reforms passed since Barack Obama became President did not touch the pre-paid debit card market.

It is particularly concerning that some employers—including WalMart—have begun paying employees with prepaid debit cards. This policy must be a boon to the credit card companies, but it is no bargain for the employees.

Bankruptcies Top A Million

2009-10-03T09:12:00.000-04:00

The 2005 bankruptcy reform bill had a strong impact when it was first implemented, knocking down the rate of personal bankruptcies in the US to approximately a third of what it had been, but the basic problems of consumerism and easy credit where not touched by the bill. As a result, it was just a matter of time before rates would climb back up, and they have--quite steadily since the introduction of the bill.

Now with the added impact of unemployment and the economic decline, rates have taken off again. As the October 2nd Wall Street Journal article below indicates, we had over a million personal bankruptcies in the first nine months of 2009. A rate that is very close to that just prior to the 2005 bill and one that will likely bring us to 1.4 million bankruptcies by the end of this year.

In addition, the bankruptcy statistics always underestimate the pain by approximately 25 percent. On average, approximately a third of all personal bankruptcies are married couples filing together.

--------------------------

Personal Bankruptcy Filings Soar
By SARA MURRAY

Consumer bankruptcies topped one million for the first nine months of this year, the highest point since the system was overhauled in 2005.

The number of personal bankruptcy filings for the nine months rose to 1,046,449 as of Sept. 30, the American Bankruptcy Institute, an organization made up of attorneys, accountants and other bankruptcy professionals, said Friday, using data from the National Bankruptcy Research Center. There were 773,810 personal bankruptcy filings for the same time period in 2008.

September's filings reached 124,790, 41% higher than the same month last year.

The 2005 revamp was intended to make it harder for Americans to shed their debts by filing for bankruptcy. In that year, before the law took effect, there were 1.35 million bankruptcy filings in the first nine months.

But a tough economic climate has sent filings soaring again and ABI expects personal bankruptcies to exceed 1.4 million by the end of the year. "Bankruptcy filings continue to climb as consumers look to shelter themselves from the effects of rising unemployment rates and housing debt," the institute's Executive Director Samuel J. Gerdano said.

Write to Sara Murray at sara.murray@wsj.com

WSJ: Student Debt Grows Dramatically

2009-09-03T08:59:00.003-04:00

From the Wall Street Journal, Sept 3, 2009:

Students Borrow More Than Ever for College

Heavy Debt Loads Mean Many Young People Can't Live Life They Expected

By ANNE MARIE CHAKER

Students are borrowing dramatically more to pay for college, accelerating a trend that has wide-ranging implications for a generation of young people.

New numbers from the U.S. Education Department show that federal student-loan disbursements—the total amount borrowed by students and received by schools—in the 2008-09 academic year grew about 25% over the previous year, to $75.1 billion. The amount of money students borrow has long been on the rise. But last year far surpassed past increases, which ranged from as low as 1.7% in the 1998-99 school year to almost 17% in 1994-95, according to figures used in President Barack Obama's proposed 2010 budget.

The sharp growth is "definitely above expectations," says Robert Shireman, deputy undersecretary of the Education Department. "But we're also in an economic situation that nobody predicted." The eye-opening increase in borrowing is largely due to the dire economic environment, which is causing more people to seek federal loans, he says.

The new numbers highlight how debt has become commonplace in paying for higher education. Today, two-thirds of college students borrow to pay for college, and their average debt load is $23,186 by the time they graduate, according to an analysis of the government's National Postsecondary Student Aid Study, conducted by financial-aid expert Mark Kantrowitz. Only a dozen years earlier, according to the study, 58% of students borrowed to pay for college, and the average amount borrowed was $13,172.

The ripple effects for today's heavily indebted young people are becoming palpable. A growing body of research suggests that tough loan payments are affecting major life decisions by recent graduates, forcing them to put off traditional milestones—from buying a first home to even marriage and having children.

Also, the rising levels of borrowing may ironically be contributing to the accelerating cost of college, say some college-finance experts. Loans can give colleges an artificial sense of a family's ability to pay tuition. To some extent, that false sense of security gets built into the assumptions schools make when setting prices, say experts. The idea is that as prices rise, families borrow more and more, spurring prices to rise further, which in turn requires more borrowing. Barmak Nassirian, associate executive director of the American Association of Collegiate Registrars and Admissions Officers, says this phenomenon is playing a role in why tuition grows at about twice the rate of inflation. "Instead of imposing tougher choices" on college costs, he says, it's "easier to raise prices...because this additional loan amount is made available."

These and other impacts are likely to continue to spiral for future generations of tuition payers, college finance experts say. It is unclear whether we have seen the worst of it. Mr. Kantrowitz predicts the rate of increase will slow to 12% for the 2009-10 school year due mainly to what he expects to be a rebounding economy. On the other hand, Mark Zandi, chief economist for Moody's Economy.com, says he thinks unemployment rates will be at least as high as they are now, and housing prices will fall further, making it difficult for families to borrow against home equity.

"Growth in student lending can remain very strong, at least through the next school year," Mr. Zandi predicts.

The total borrowing limit for dependent undergraduates who take out federal Stafford loans—the most popular federal aid program—grew to $31,000 this past school year from $23,000. Raised limits in federal loans may have siphoned some borrowing away from riskier—and costlier—private loans, which are now harder to get due to the retrenchment of that business. The move away from these risky loans may be one bright spot in an otherwise frenzied student credit environment, Mr. Kantrowitz says.

Still, students cringe when they think of what they will owe by the time they graduate. Kordi Solo, a senior majoring in journalism at Central Michigan University, expects to owe about $60,000 in student loans by the time she graduates in the spring. She had hoped to owe much less, but her father, a construction worker, has been out of work since last fall. She worries about the ramifications that debt will have on her future—whether it is being able to afford health insurance or qualifying for future loans.

Zack Leshetz, a 30-year-old lawyer in Fort Lauderdale, Fla., has $175,000 in student loans from his seven years in college and law school. Lately he has had his eye on the real-estate market. "Everyone says that it's a great time to buy a house," he says. But that is not an option right now, he says, thanks to $800 a month in payments—and another chunk of student loans in forbearance, which means payments are halted while interest accrues. "I find myself living paycheck to paycheck," he says.

He has also been engaged since March, but has held off on marriage. "There's no way I can pay for a dream wedding, or even just a regular wedding," Mr. Leshetz says. "I feel like I'm putting my entire life on hold."

"There are no guarantees about how easily you'll be able to pay off your student loans," says Lauren Asher, president of the Institute for College Access and Success.

These students' experiences are mirrored in research by Mathew Greenwald & Associates Inc. for investment-management firm AllianceBernstein LP. In a 2006 survey of 1,508 graduates under age 35, 39% of college graduates say it will take them more than 10 years to pay off their household's education-related debt. The survey says that this has caused a delay in certain key "rites of passage" associated with adulthood. Forty-four percent of respondents said they delayed buying a house because of their student loans, while 28% delayed having children.

"Loans have gone from being the exception to being the norm for most students," says Mr. Nassirian. He laments that, rather than fixing the problem of sticker price, policy makers typically tweak student-aid programs to make it easier for students and families to continue to borrow more.

Attacking the problem of cost is thorny because it is politically difficult to get all the interested parties -- which include federal and state governments, foundations and private institutions—to agree. "There are so many stakeholders, different explanations at different schools as to what's happening with cost, that it becomes politically dicey," says Christine Lindstrom, higher-education program director for U.S. Public Interest Research Group, which advocates for consumers. Also, colleges can be big employers in congressional districts, making it challenging for politicians who represent them to also take them on. "You're not going to win friends if you're alienating them," she says.

Some Republicans made attempts at controlling tuition increases when they held the majority in Congress. Rep. Howard P. "Buck" McKeon of California championed legislation in 2003 that would have penalized colleges for raising tuition too much by taking away federal subsidies. Though the bill died, he plans to continue pursuing the issue in the upcoming Congress, a spokeswoman says.

Some recent graduates say they wish they had known more about the consequences of debt before taking it on. Lillian Russell graduated from law school at the University of Pittsburgh last year with $181,000 in debt from her seven years in school. She has spent much of the past year looking for work. In recent weeks, she found a job clerking at a small law office. While she settles into her job, she has deferred payments on most of her federal loans, though interest continues to accrue.

"I wish I had considered the long-term impacts of what I was getting into," Ms. Russell says. When she entered school, "the idea was I'd take out the loans, get a job, and pay it back," she says.

It seemed straightforward. But as the economy has soured, "I feel like it's shifted a lot of my life goals," says Ms. Russell, from buying a house to starting a family. "I'm really concerned about handling this obligation while taking on new ones."

Write to Anne Marie Chaker at anne-marie.chaker@wsj.com

Mortgages Drifting in the Tide

2009-03-07T10:19:00.001-05:00

On March 5th the New York Times printed this graphic showing the percentage of loans in default for various types of mortgages—ranging from conventional “prime” mortgages to “subprime”—as a function of the current ratio of all the mortgages on the home to the value of the home. The dancing waves at the 100%-level separate the houses that are “underwater”—valued at less than the amount owed on the mortgage—from those that have equity beyond the value of the loan.

The graphic is based on data from November 2008 to January 2009, and it accompanied an opinion piece by John D. Geanakoplos and Susan P. Koniak arguing that the best plan for solving the mortgage crisis would not be the interest payment reductions proposed by the Obama administration but reductions of principle. The argument proposed by Geanakoplos and Koniak is more radical but has merit, but I am struck by the orderliness of the graphic and the underlying debate about choice and personal responsibility hidden within it.

The axes of the graph are arranged in an unusual fashion so that those most underwater can be shown at the bottom of the graph. Four lines indicating different types of mortgages stream down from the upper left-hand corner, the point that represents a paid-off mortgage. The lines taper off to the right as they fall, as if they are blowing in a gentle breeze or slowly drifting in the tide. As the line moves to the right, more people are in default on their loans. The prime mortgage line hangs fairly tightly to the left. Even when their loans represent over 200% of the value of their homes only 4% of these homeowners are in default. In most cases, these borrowers had good credit ratings and a down payments when they bought their houses, and the overwhelming majority have maintained their good records.

But the subprime mortgage line on the far right is the most interesting. For some, these loans and the banking institutions who offered them are the source of our recent economic problems. The banks sold shady and deceptive loans to people how could not afford them, and the drifting line on the right is the result. High levels of defaults that caused the foreclosures, that caused the banking meltdown, that cause the stock market crash, that caused the layoffs, etc, etc. But look more closely at the subprime line. At the very worst point on the lowest point, people whose homes are worth less than half the value of their loans are defaulting at a rate of approximately 12%. A high rate, indeed, but flip it over. More than eight-eight percent of all people in these desperate circumstances are paying there mortgages on time.

The bankers would say borrowers who default on their loans are the ones who bear the responsibility for failure. These homeowners signed on the bottom line and then welched on their promises to pay. The subprime mortgage industry (many representatives of which have now gone out of business) argued that, had they not introduced these subprime mortgages to the public, many people would be denied the benefits of homeownership. Look at the 88% who are still in homes and still paying.

But this right-most line begs the question, at what cost? Is it fair for the majority to benefit at such a severe cost to the other 12%? Are these good enough odds? As it turns out, the answer is no. These mortgages were fragile enough that when bundled together into securities investments, they eventually fell apart. It turns out that subprime loans are a bad bet. Unable to weather a down-turn in real estate prices. Eight-eight percent may sound good, but it is not good enough.

More Adventures in Debt

2009-02-22T21:42:00.000-05:00

Buying gas today, I noticed a sticker on the pump: “Now you can prepay with your credit card at the pump.” All self service pumps are designed to accept credit cards, so why would you prepay a fixed amount of money rather than just swiping your card and pumping? My guess is more people are bumping up against their credit limits. They know they have just a little room left on the card, so they want more control over the amount they spend. Rather than having to watch the mounting total and time the shutoff to the desired expenditure, prepaying guarantees that you hit the right amount. Furthermore, some people with just a small amount of juice left on their cards or who risk the possibility of having the purchase denied might rather prepay, wait to see whether the purchase is approved, and then either pump with confidence or move on.

As mentioned in my previous post, “Pay with Two Credit Cards,” in today’s economy, merchants need to make special accommodations for the growing number of people in trouble with debt.

The Detritus of Consumption

2008-12-09T08:47:00.001-05:00

An unanticipated effect of the economic downturn: recyclables with no place to go. As the economy tanks, the demand for recyclable cardboard, plastic, and metal has fallen away. According to a front page article in yesterday’s NY Times, the market for junk has collapsed at a far more drastic rate than the stock market. On the West Coast, mixed paper that was bringing in $105 a ton in October now sells for $25. The recycler that Harvard University sends its junk to used to pay $10 a ton but now charges $20 a ton.

Our recycling system is a house of cards built on consumerism, a system that puts all its energy into the front end of the purchasing sequence. The crucial moment is when the shopper lifts the bottle of juice off the shelf and into the shopping cart. The more the bottle weighs, the fewer units will be sold. Fifty years ago, Sylan Goldman, a grocery store owner in Oklahoma, noticed his customers left the store when their hand baskets were full. To subvert this limitation, he mounted two hand baskets on a folding metal frame and thus was born the shopping cart.

Manufacturers and retailers understand the physics of consumption. The physical effort of a purchase strongly affects sales. For people in cars, drive-thru windows are easier than walking. So when it became possible to package products in inexpensive, light plastic containers, manufacturers switched. Glass bottles were ditched in favor of plastic “recyclable” containers, many of which now overfill our landfills. Business people know that maximizing consumer convenience maximizes profits. Furthermore, the life of the container after the product has been consumed has no affect on the manufacturer’s bottom line. Unless producers are required to bear the cost of recycling or storing used containers, this is a negative externality: a cost of production borne by someone else.

Interestingly, the Times article notes that demand for glass has not declined. According to Wikipedia, glass and aluminum are much easier to recycle than plastics. Both can be recycled indefinitely. Perhaps this is the moment to bring back reusable and recyclable glass and aluminum containers. They would have the dual effect of decreasing consumption—at this point in our history, a very desirable goal itself—and reducing the size of our junk heaps.

The Myth of Establishing Your Good Credit

2008-10-23T07:58:00.000-04:00

One of the standard maxims mouthed by personal financial advisors is the need to establish your good credit. Young people are advised to get a credit card and use it, being careful to pay off the balances regularly, with the goal of creating a good credit record. The person who fails to do this is said to risk not being able to get a house in the future or achieve any number of other goals.

This has always struck me as crazy advice. First, it puts young people at risk of doing the opposite—getting into trouble with credit cards—in the name of a rather abstract goal. Second—and most importantly—for many years now there has been little problem getting credit. Indeed the problem has been the availability of too much credit. At the end of the housing boom, people were able to get home mortgages without having any assets or income, and anybody can get a credit card with a shockingly high credit limit. When I interviewed debtors for Going Broke, many told people me they continued to receive credit card offers after declaring bankruptcy and had little trouble getting credit. So why is it so important to establish good credit? Perhaps this was a valuable goal in the bygone era when lenders actually cared about the credit worthiness of their customers, but a loan is no longer a social bond. It is merely a product to be sold for a short-term gain.

Given the recent credit crisis and Wall Street tumble, one might assume this picture had changed. Not so. The latest installment in the New York Times debt series documents the continuing—and perhaps increasing—practice of preying upon people who have recently declared bankruptcy. Using sophisticated data mining techniques, banks are targeting people who have experienced recent debt problems with credit card offers. If there is a credit freeze, it has not hit individual consumers. Consumer debt is still a profitable engine for many banks, and the industry is discovering ever more innovative methods of finding vulnerable potential customers.

The Paulson Bailout Plan: A Profiles in Courage Moment

2008-09-23T08:27:00.001-04:00

This may be the most important vote since the authorization of the Iraq war, and in many respects, the atmosphere is similar. Congressional leaders have been churned up by a worsening economic picture and the drama of last Thursday’s emergency meeting with Henry Paulson and Ben Bernanke, where lawmakers were told there was a serious risk of massive failures within days and that casualties could go beyond the banking industry to large “brand-name companies.” Senator Christopher Dodd described it as “as sobering a meeting as any of us have ever attended in our careers here.”

Furthermore, this is an election year, and Congress is set to go home and resume campaigning at the end of the week. So a plan to save the economy and bailout the financial firms that got us into this mess will be hammered out very hastily in the heat of emotion. And, like the Iraq war vote, decisions made this week will haunt us for years.

The amount of money at stake is staggering. $700 billion is more than the cost of the war in Iraq to date, more than the entire 2009 budget for medicaid and medicare, more than the 2009 budget for social security, and just under the 2009 military budget. It represents $2000 for every man, woman, and child in the country--above and beyond what we already pay for the actual services of the federal government. And for what? To keep us all from being damaged even more than we have already by the irresponsible business practices of the financial industry we are bailing out.

The great majority of our leaders failed us in the Iraq authorization vote. They made political decisions based on the emotion of the moment. Let’s hope they do better this time. If this deal does not go far enough to reign in the unfettered business practices that got us here, then our leaders must have the courage to walk away. This time, the administration cannot be given a blank check. The deal must provide strong oversight and powerful safeguards against future crises, or we must be willing to say, “No deal.”

Homeownership & the American Dream

2008-09-09T07:35:00.001-04:00

Home ownership is perhaps the most tangible symbol of the American Dream, but in recent years it has been oversold. Many people who later wished they had remained renters were sold enticing low-interest mortgages. Thanks to an economic downturn, insufficient regulation of the mortgage lending and mortgage investment industries, and good old fashion overconfidence in the security of real estate investments, many of those same people are now headed back to rented dwellings, but too often their path will run through foreclosure.

As the graph below suggests, the US experienced a rapid acceleration in home purchases beginning in 1992 and topping out at 69 percent in 2003. Since that time the rate has declined to the present 68 percent, and it may drop further. Recent history suggests the line may have been pushed up too high, and the current economy is making a correction.

There is no reason why the American Dream should be dependent upon home ownership. Internationally homeownership rates vary widely and are not particularly tied to standards of living. For example, Germany, a country that enjoys a standard of living (measured in GDP per capita) of $23,819, has a homeownership rate of 42 percent, whereas in Slovenia (GDP per capita of $19,200) 82 percent of people own their homes. Several of the countries of old Europe (e.g., France, Denmark, Austria) have homeownership rates that are over 10 percent below those of the United States.

Owning your own home is a greater financial risk than many thought, and too much risk can make the dream—when defined as owning your own home—a bad bet. But happiness and security can come in different shapes, and life in a rented home can be just as happy as life in a mortgaged home.

Joe Biden & MBNA

2008-08-25T08:57:00.002-04:00

I am a strong supporter of Barack Obama’s campaign, and I am very pleased with his selection of Joseph Biden for Vice President. Biden will bring needed experience, respect, and fire to the campaign. But Joe Biden is from Delaware, the home of MBNA, the credit card giant, now owned by Bank of America.

All politicians have warts of one kind or another, and as a citizen it is all but impossible to find a political leader with whom you always agree. But as someone who is concerned about Americans who struggle with debt, I find Biden’s stance on bankruptcy reform particularly troubling. He has been a consistent supporter of the credit card industry’s efforts to make bankruptcy rules more stringent and to make the process of declaring personal bankruptcy more onerous and more expensive. After nine years of lobbying, the banks were able get a new, tougher bankruptcy bill through Congress, and President Bush signed it into law in 2005.

Barack Obama voted against the bankruptcy bill and has been a steady opponent of the credit card industry, but Biden’s stance on this issue is a blemish on an otherwise very respectable voting history. Unfortunately, now that the economy is in a tailspin and foreclosures are bursting out all over, the hurdles imposed in the 2005 bankruptcy bill are making life even more difficult for many debt-burdened consumers who could use the second chance that bankruptcy is designed to provide.

To make matters worse, there is at least the appearance of an improper relationship between Biden and MBNA. Today, the NY Times is reporting that Hunter Biden, the senator’s son and an attorney, worked for MBNA for from 2001 to 2005, a period that coincides with the credit card industry’s bankruptcy lobbying effort. The Obama campaign is defending this messy bit of Biden history, but it is a troubling episode that provides yet another example of the pernicious influence of big money in our government.

Appearance on The NewsHour with Jim Lehrer

2008-08-22T18:25:00.006-04:00

As part of series conversations on the economy, I appeared on the Monday, August 18th edition of The NewsHour with Jim Lehrer. A transcript of the interview, as well as audio files and streaming video can be found here.

Exporting Credit Card Debt

2008-08-10T09:06:00.002-04:00

I am often asked why credit card debt is such an American problem, and my usual answer is that, with some exceptions, other countries haven’t caught up with us yet. We lead the pack in indebtedness. The latest installment in the NY Times series on debt shows how the rest of the world is catching up. For some time, the UK and its former colonies (US, South Africa, and Australia) have had debt problems, but now credit cards, and the problems associated with them are spreading to Asia and Latin America. The article highlights problems in Turkey and South Korea.

Few American exports have proved as popular as credit cards. In just a generation, they have gone from a totem of Western affluence to an everyday accessory in Brazil, Mexico, India, China, South Korea and elsewhere. More than two-thirds of the world’s 3.67 billion payment cards circulate abroad.

The world map displayed below shows an expanding pattern of debt. Most of the light areas that have no debt are third-world countries where poverty is so desperate that credit cards would have no purpose. As time passes, this map is likely to go in one direction only: toward darker shades of green and increased credit card debt. It is troubling to think of a future world economy in which every developed nation has a citizenry strapped with debt and chained to their jobs in an effort to meet their monthly obligations. Is this an export the rest of the world really wants?

Pay With Two Credit Cards

2008-07-29T08:41:00.000-04:00

Today I ordered an accessory from the Apple Computer website and noticed something I had not seen before. During the checkout process a “pay with two credit cards” button appeared. Curious, I clicked the button and discovered an option that allows customers to split the cost of their purchases across two credit cards with the flexibility to decide how much of the total to put on each one.

The splitting of online purchases may be more common than I am aware, but this is the first I had seen this option. Of course, Apple sells items that can cost several thousand dollars and, as a result, will often be out of reach for someone with a modest credit limit. Young college students purchasing a computer might not have enough juice in their accounts to handle the bill. But I suspect this payment option is also an indication of the kind of debt-juggling many consumers undertake on a daily basis. By offering the card-splitting option, Apple makes it possible for the buyer who is near the limit on several credit cards to cobble together enough credit to float the purchase of a new iPod or laptop. People who are living this close to their credit limits may represent a relatively small segment of the potential sales market, but from Apple’s point of view, allowing card-splitting is a very simple way to increase sales. Unfortunately, for the consumer who struggling to managing temptation and debt, this system removes one more natural barrier to indulgence.

PS Curiosity has its costs. After clicking the “pay with two cards“ button it took me several minutes to escape from that detour and pay for my item with a single card. Caveat emptor.

Free Markets, Banks, Personal Responsibility, & Self-control

2008-07-28T10:19:00.003-04:00

In his column today, Paul Krugman makes the point that the housing bill passed last week and due for Presidential signature this week does not fix an important underlying problem. The bill provides a way for some homeowners to avoid foreclosure by refinancing their adjustable rate mortgages with smaller fixed rate loans, and it will provide additional support for the mortgage backers Fannie and Freddie Mac. But, in a piece called “Another Temporary Fix,” Krugman argues that future problems will not be avoided until and unless new banking regulations are introduced:

The back story to the current crisis is the way traditional banks — banks with federally insured deposits, which are limited in the risks they’re allowed to take and the amount of leverage they can take on — have been pushed aside by unregulated financial players. We were assured by the likes of Alan Greenspan that this was no problem: the market would enforce disciplined risk-taking, and anyway, taxpayer funds weren’t on the line.

And then reality struck.

From a psychological point of view, it is interesting to think about banking regulation and self-control. The pro-business free-market view places great stock in personal responsibility. We are all on our own, and those who fail fail because it is their own fault. In one sense, they are supposed to fail because they are responsible and no one else should have to take the blame. Certainly this is the conservative view of personal debt.

But sometimes personal failures have public effects. Call me a cynic, but I believe there would not be a housing bill but for the fact that the housing crisis affects us all. Everyone’s equity goes down when the real estate market collapses, and foreclosures at the rates we’ve seen are having a profound effect on the economy as a whole. In contrast, personal consumer debt and bankruptcy is a much more private phenomenon. We had over a million personal bankruptcies per year for many years, and yet all those individual tragedies were almost invisible. Now because, innocent people are being affected, politicians have the moral traction to get a bill passed. Of course, many the debtors who face bankruptcy are also innocent victims of a volatile economic environment, but that is another story.

Krugman’s column suggests that businesses, specifically banks, have failures of self-control, too. In a free market environment, failures of corporate responsibility are likely to occur, and regulations are justified to protect us all from the troubles these failures bring. Recently, new financial institutions have sprouted up outside the bounds of existing regulations, and it is, in fact, these institutions that have been source of many of our current woes. Rather than being quietly fixed by the wisdom of the marketplace, these failures have had powerful reverberations throughout the economy.

Problems of self-control abound, for individual consumers and for banks. The current crisis suggests that external controls can be very helpful for banks, just as they are for the rest of us. It is much easier to do the right thing if the environment pushes you in that direction. Where there are inadequate natural constraints in the marketplace, regulations can play a very valuable role, and recent events have reaffirmed the importance of banking regulation.

NY Times Debt Series

2008-07-19T15:17:00.001-04:00

Tomorrow’s NY Times features a very good series on personal debt and, in particular, the changes in lending practices that have earned millions for the banking industry and socked consumers with enormous levels of debt. Some of the interesting bits include:

Average credit card interest rates have risen from 17.7 percent in 2005 to 19.1 percent last year.

Average late fees rose from $13 in 1994 to $35 today.

In the same period, the fee charged for exceeding your credit limit rose from $11 to $26.

In 1957, 42 percent of families had no debts; today 24 percent of families have no debts.

In 1957, 53 percent of homeowners had no mortgage debt; today 31 percent of homeowners have no mortgage debt.

The story includes the case history of a woman who lost her home and an interactive calculator for determining how your level of debt compares to the national average.

Gas & Housing Prices

2008-07-15T08:08:00.002-04:00

In Going Broke and in this blog (see the July 7 post below) I have described the post-World War II expansion of suburban lifestyles and the popularization of single-use zoning and single-family homes that were many miles down the interstate from work. Sprawl made us dependent upon our cars to satisfy any need that was outside the house, but the wide use of automobiles also reduced the physical effort of traveling to the marketplace by providing us with moving chairs to sit on in climate-controlled environments. In addition, the popularization of drive-through windows meant that many purchases could be made without getting out of the car. The effects of these trends can be seen in our waistlines and bank balances.

Then came the gas crisis. Suddenly our car culture has become very expensive, and as this video from the urban development group CEOs for Cities shows, gas prices have affected housing costs in suburbia. For many years, houses far out from the city center were cheaper than houses close in. In most areas, that may still be true, but the high cost of gas is turning that equation on its head. The gas crisis did not cause the mortgage crisis, but growing transportation prices have undoubtedly worsened the mortgage crisis in some suburban areas.