Sources: FDIC, Census
Bureau, Cardweb.com, BankruptcyAction.com
An obscure legal loophole,
discovered in 1978 and validated that same year by the US Supreme
Court, changed forever lending and borrowing practices, and the housing
market, in the US. Until that time, interest rates were a matter of
states' rights, and most states carried on a long-standing tradition of
anti-usury laws designed to protect consumers from unconscionably high
interest rates. In 1978, the Supreme Court, in the infamous Marquette decision, said that
existing laws allowed lenders to charge borrowers anywhere in America the rate
ceiling allowed in the lender's state of incorporation, regardless of
the rate ceiling in the borrower's state, and that it was up to
Congress to change the law to prevent 'exporting' of high interest
rates. Congress did nothing, lenders flocked to Delaware and Nevada
(the two states with no rate ceiling, which are still home to the
companies that do half of all consumer lending in America) and in four
short years virtually every state, to prevent exodus of financial
institutions, had scrapped its interest rate ceiling.
There was at first bi-partisan celebration of this ruling.
Free-marketers saw this as the removal of an unnatural impediment to
business, the end of interference in the establishment of rates that
truly reflect the lending risk. Liberals saw this as an opportunity for
middle-class Americans to finally buy their own homes -- prior to the
removal of the interest rate cap, most lenders would only lend money to
the rich, people who really didn't need money and used it principally
for investments. At the time, inflation was rampant and even the rich
were paying high rates of interest on borrowings, so the dangers of
eliminating anti-usury laws was unforeseeable.
A quarter century later, the consequences of this ruling are clear. In
their well-reasoned and thoroughly-documented book The Two Income Trap (the Salon
review of which I covered last
year), Harvard Professor Elizabeth Warren and her daughter outline what
has happened since 1978:
- The proportion of Americans who own their own homes has
risen a paltry 3%.
- 140 million (70%) of adult Americans now admit they are
carrying so much debt it is making their lives difficult and unhappy.
- Bankruptcy rates for women have risen 662%. Foreclosure
rates have risen 400%.
- Having a child is now the single biggest predictor that a
woman will declare bankruptcy.
- One out of 7 families with children will declare bankruptcy
this decade, and at least that many more should declare bankruptcy to make a
fresh start but will instead out of ignorance or fear live with the
constant horror of repossessions, hounding and threats from creditors.
- More Americans each year declare bankruptcy than have heart
attacks, get diagnosed with cancer, graduate from college, or get
divorced.
- Increased availability of credit has more than doubled the
price of housing, to the point that after paying for housing and other
essentials (and the other essentials have actually decreased in cost), the average
two-income family has less disposable income than the average
one-income family had a generation ago.
- Families with children have driven up the price of housing
in many areas with desirable public schools by as much 600%, and a
recent survey indicates proximity to good schools is now the single
largest determinant of US residential housing price.
- Credit card debt balances have risen from $20 billion to
nearly $800 billion, a forty-fold increase (see chart).
- The average
interest rate on Citibank mortgages is nearly 16%, ten points above prime,
and interest rates on 'sub-prime' mortgages are much higher than that
(Citibank and other lenders don't divulge the breakdown). On an average
home with an average mortgage, the 'sub-prime' borrower is therefore
paying $500,000 more over a 30-year mortgage life than a prime rate
borrower.
- Visible minorities and those with limited education are
twice as likely to be paying the high rates of 'sub-prime' mortgages as
whites and college-educated people with
the same incomes. The reason, according to one retired lender:
Because the lenders know they can get away with the higher charges.
- Credit companies including Sears, AT&T, GE, Macy's, JC
Penney, Circuit City, Radio Shack and GM are just some of the companies
that have paid millions of dollars in fines for illegally hounding
people after bankruptcy, and for illegally hounding descendants of
deceased customers, to repay credit card balances. Most of these
companies now make more money from finance charges than they do from
selling products.
Even the FDIC, the government body that insures the banks, has
expressed alarm at the unforeseen and, in human terms, tragic
consequences of unregulated interest rates and credit. They acknowledge
the direct correlation between the hawking of massive amounts of credit
to everyone in the country at outrageous interest rate, and the rate of
personal bankruptcies (see chart above -- the blue line, left scale is
the bankruptcy rate; the yellow line, right scale, is credit card
debt). They even make it clear that it is the aggressiveness of
lenders, more than interest rates per se, that leads to bankruptcies:
In Canada, which has never had anti-usury laws, bankruptcy rates were
always significantly lower than in the US, except for the brief period
in the 1970s, when VISA and MasterCard and their agents began
aggressively pushing credit cards in Canada for the first time, when
the bankruptcy rate in Canada surged and briefly surpassed the US rate.
After the Marquette decision,
US bankruptcy rates surged back ahead, and rates in both countries
continue to soar.
The authors take great pains to demolish the myth, perpetrated to this
day by neocons like William Buckley Jr., that it is consumers'
inability to budget and restrain themselves from making reckless
purchases that is behind the skyrocketing bankruptcy rate, and that a
lot of people just declare bankruptcy to discharge their personal
responsibility for undisciplined spending behaviour. Compared to 1978,
the average American family spends (inflation-adjusted) 21% less on
clothing today, 22% less on food (grocery & restaurant combined),
and 44% less on furniture and major appliances than they did, although
their (mostly-two-income) family take-home has risen 70% relative to
the (mostly-one-income) take-home of the early 1970s. Where has the
extra money gone? First and foremost to skyrocketing housing costs (up
100% on average, up to 600% in areas close to the best schools). What
else is way up in cost?
Health insurance, transportation (to and from two jobs instead of one),
pre-school, after-school-care and college tuition are all up from 100%
to 500% in cost since the 1970s. Over 90% of all personal bankruptcies
are due to three causes: job loss, medical problems, and divorce. The
pervasive myths of reckless overconsumption and the immoral debtor are
not only untrue, they are cruel deceptions perpetrated by corporatists
to mask the real cause of skyrocketing debts and bankruptcies: Reckless
lending, usurious and unconscionable interest rates, and cynical
mortgage consolidations designed to facilitate foreclosure and
expropriation of homes for corporate profit.
One lending analyst has
broken the 18% annual charge commonly charged today on credit cards
into these four components:
- 7% for true interest, the cost of borrowing in a
low-inflation world
- 5% for administration costs (which are much higher than for
mortgages because of the volume of transactions) and fraud costs (which
the credit card companies are legally bound to pay, and which are
soaring)
- 3% for defaults -- the cost of people who skip town, die or
declare bankruptcy before paying their balance (did you know that if
you die, your beneficiaries are under no obligation to pay off your
credit card debt?)
- 3% for 'the opportunity cost of the early payment period'
(the losses the lender incurs when people pay off their cards on time)
So when you carry a balance on these cards, you are subsidizing three
groups -- card defrauders and identity thieves, bankrupts, and those
who pay their balances in full each month. It is easier and cheaper for
credit card companies to get you to pay for these costs than to improve
security over credit card abuse, exercise more discretion in lending to
those who can't afford to repay, and get early-payers to pay their
share of the administrative burden of credit card management. And that
doesn't include the other unregulated add-on costs: late-payment fees,
balance transfer fees, transaction charges and other service charges,
which a
recent study showed are increasing by 20% every year. Late payment fees
(charges when you don't pay a specified minimum of your credit balance
each month)
alone are up 300% in the last decade.
As I mentioned
at the end of my last economic post, one fourth of all new mortgages
are now debt consolidation loans, mostly at high rates. These
diabolical schemes often make things worse, and they're being falsely
sold as the panacea for families in financial trouble. They complete
the cycle that is wiping out the American middle class, which looks
like this:
- You want to put your children in a good school, so they
won't have to struggle like you did. So you pay the outrageous price,
inflated by all the other parents with the same aspirations, for a home
in the 'right' area.
- To pay for it, you both need to work, and one of you has to
work two jobs. The 'right' area is not near your work, so now you need
two cars, day-care, and a lot of other new expenses.
- You just qualify for the huge mortgage, but because of the
risk you have to pay a much higher-than-prime rate: Citibank's average
16%.
- You can just barely make the payments. And with tuition for
university going up by double-digits for the 5th straight year, and
youth unemployment through the roof, the dream of putting your kids
through college is starting to look out of reach.
- Suddenly, one of you loses their job. Or gets sick. Or one
of your parents gets sick, or children gets sick, so one of you has to
stay at home to look after them. Or the stress breaks up your marriage
and now you have two households to pay for.
- With the drop in income and/or increase in costs, you max
out your credit cards, and the effective interest rate with penalties
goes from 18% to 28%. You miss a mortgage payment and late fees and
charges push its effective cost above 20% as well.
- In desperation, you consolidate your debts with a new
mortgage, taking advantage of the increase in the value of your home.
You end up with a mortgage larger than what you paid for the house, at
a higher interest rate, but at least the credit cards are clear.
- You swear you'll tear up the credit cards, but the only way
you can pay for the medical bills, the transit pass, the gasoline
bills, is on credit. You have no cash for heat, phone and electricity,
so you draw cash on your credit cards to pay them, too. Some of the
things you bought for a house on a 'no payments until 2004' basis are
coming due, so they get rotated right back onto the credit cards. Soon
they're maxed out again.
- Ashamed and afraid and too ignorant to declare bankruptcy,
you borrow from family and friends to pay creditors. You stop paying
for life insurance, and sell family heirlooms in garage sales or on
eBay. You're crying all the time. The phone rings with creditors
non-stop, threatening to take back your Sears Posturepedic, the kids'
Christmas toys. They even talk to your kids and tell them in
condescending tones that their parents are bad people.
- And finally, you become one of the statistics on the blue
(or if you're a Canadian, the red) line on the chart above. You've
probably lost your home, your marriage, the respect of your children,
your friends (who you never repaid), your health. Everything. And all
you were trying to do was put your kids in a good school.
So what are the answers? As the authors explain, they're very simple:
Congress needs to reinstate anti-usury laws, capping interest rates at
a uniform rate, closely tied to the prime rate, across the country. Any
and all fees would be added to the interest rate and the total would
have to stay below the cap. And consumers need to look before they
leap, and keep their debt-load below
the level that would allow them to handle that debt if they were
suddenly hit with a job loss, a sick or injured family member, or a
divorce.
What are the chances of it happening? In the US, at least, it's remote.
The financial services industry is one of the largest campaign
contributors to political candidates, and they are fiercely opposed to
any re-regulation, which would have a catastrophic effect on their
profits. They are, in effect, legally stealing from the poor and
middle-class of America. The authors show how powerful this lobby is
with a story about Hillary Clinton. Because America's unconscionable
lenders want to keep the screws on their poorest and most profitable
customers, they have twice tried to ram through Congress a bill that
would make bankruptcy declarations much harder to make, allow secured
creditors to circumvent bankruptcy protection entirely, reduce the
priority of family support payments over credit card debts, and require
credit cards to be paid off along with mortgages, thereby making it
easier for foreclosure before bankruptcy. These lenders contributed $60
million to various politicians to get their support. The authors, and
other groups representing the poor, were able to convince Hillary to
get her husband to veto the bill. But with MBNA bank the largest
contributor to the Bush campaign, the bill was reintroduced, and
now-Senator Hillary Clinton, beholden to bankers who contributed
$140,000 to her campaign, supported it the second time. Only a fierce
lobby, some of whose members were opposed not to the bill but rather to
riders that had nothing to do with bankruptcy, managed to block it
again -- for now. Both John Kerry and John Edwards opposed the bill,
and have promised to pay more attention to bankruptcy law if they are
elected, so there is some room for hope.
What are the chances that Americans will follow the authors' advice and
rein in their spending, not on luxuries, but on the home they raise
their children in, and allow for a contingency like loss of a job, a
serious illness or injury, or divorce when they do up the family
budget? Pretty remote. It's like asking people to give up the American
Dream. Even if, for many, it is destined to become a nightmare.
|
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