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House Bankruptcy Bill

Testimony of Robert Manning
Hearing on U.S. Credit Card Industry and Consumer Credit Issues,
Before the Subcommittee on Financial Institutions and Consumer Credit
United States House of Representatives, November 1, 2001

I would like to thank Chairman Spencer Bachus for providing the opportunity for me to share my views on the increasingly important topic of the banking industry’s policies in the shaping the rapidly growing and segmented structure of consumer credit markets. Along with Ranking Member Maxine Waters, who has highlighted the often crushing burden of high interest consumer loans to low-income families, many members of this Committee have earned a distinguished record in championing the interests of American households during the current period of unprecedented profitability of the banking industry. In particular, I would like to acknowledge the longstanding efforts of the Member from Buffalo who, due to my new academic appointment in upstate New York, may soon be competing for my vote in the next electoral campaign. Congressman John LaFalce has been a passionate and persistent advocate for working families by highlighting the increasing common excesses and questionable business policies of the credit card industry. Unfortunately, the central role of consumer credit in the consolidation and emerging conglomerate structure of banking industry as well as its bifurcation into first- and second-tier systems indicates that this committee is long overdue in its examination of the current policies of the credit card industry. This is especially important due to the growing significance of consumer credit and debt to the current recession and the role that they will play in the success or failure of various proposed economic stimulus programs. Furthermore, the marketing of high interest consumer loans to college students—before they begin full-time employment—has major implications to future trends such as asset formation, bankruptcy filings, retirement patterns, and even national saving rates.

.As an economic sociologist, I have spent the last 15 years studying the impact of U.S. industrial restructuring on the standard of living of various groups in American society. Over the last 10 years, I have been particularly interested in the role of consumer credit in shaping the consumption decisions of Americans as well as the role of retail banking in influencing the profound transformation of the financial services industry. In regard to the former, my research includes in-depth interviews and lengthy survey questionnaires with over 800 respondents. In terms of the latter, I have studied the rise of the credit card industry in general and the emergence of financial services conglomerates such as Citigroup during the deregulation of the banking industry beginning in 1980. The results of this research are summarized in my new book, CREDIT CARD NATION: America’s Dangerous Addiction to Consumer Credit and are updated on my web site at www.creditcardnation.com.


CREDIT and DEBT IN THE AGE OF AFFLUENCE:
Can U.S. Bankruptcy Reform Avoid the Recessionary Abyss?

The deregulation of the U.S. financial services industry over the last two decades has contributed to profound shifts in the use, cost, and access to various forms of credit. For U.S. financial institutions, this new legal environment has accelerated the concentration of the industry as well as fundamentally transformed its organizational and institutional structure. That is, it has shaped the emergence of a bifurcated consumer financial services system (traditional, ‘first’ tier banks and “fringe” or second-tier banks such as pawnshops, rent-to-own shops) as well as fostered the rise of “conglomerate” financial services corporations such as Citigroup (1998 Citibank-Travelers’ merger).1 In the process, the U.S. banking industry recorded eight successive years of record annual earnings (1992-1999) and registered very strong earnings in the first two quarters of 2001.2

One of the key factors in the dramatic turnaround in U.S. banking profitability in the 1990s has been its tremendous increase in the marketing of new “retail” or consumer financial services. Indeed, it was only 12 years ago that Citibank was virtually financially insolvent (low Tier One capital levels) and desperately seeking time from federal regulators to avert forced asset sales or even a merger; Citibank stock sunk to its nadir of less than $10 per share in 1989. Citigroup’s current success is largely attributed to the profound shift in the sale of higher cost, noninstallment loans such as revolving credit card and home equity loans. Through the economies of scale of the megabanks and the realization that small consumer loans at sharply higher prices could yield much greater returns than mortgages or business loans, the industry aggressively responded to structural economic change (U.S. industrial restructuring) and the contracting welfare state (declining social services) by explicitly marketing loans to consumers that could NOT repay them. That is, the profound shift from low-risk, installment consumer loans to higher risk and more expensive revolving consumer loans.

In order to reduce institutional risk, high interest and riskier consumer loans have been increasingly resold on the secondary market as “securitarized” loans following the success of earlier “repackaging” of home mortgages and automobile loans. With about 55 percent of the approximately $600 billion in outstanding consumer credit card debt essentially syndicated through the sale of these financial instruments, the issue of rising consumer credit card delinquencies—from 4.4% in mid-2000 to 5.1% in mid-2001—is merely reflecting the concern of the few remaining industry leaders over the sustainability of their “cash cow;” Moody’s reports that the credit card securities that it tracks actually increased slightly over the last year—from an average annualized yield of 19.34 to 19.39 percent. Hence, in order to maintain its growth and earnings rates, the financial services industry has been forced to expand into increasingly riskier and marginal markets including college students, senior citizens, working poor, and highly indebted middle-class. In view of the lower “quality” of these loan portfolios and their rising “real” cost, it is surprising that the industry charge-off rates have not increased at a much higher rate.

The Explosion of U.S. Consumer Credit:
Long-Term Performance Enhancer or Short-Term Miracle Drug

Like an athlete who uses steroids to temporarily exaggerate muscle mass and to boost physical strength, the U.S. economy has been perilously inflated through the enormous increase of debt over the last two decades. Across all sectors of U.S. society (household, government, corporate), access to easy credit has led to a pervasive dependence on debt, much like American's addiction to low cost energy supplies. And, like the myriad of medical maladies that eventually afflict steroid abusers, the negative long-term consequences of societal debt have been neglected during the past decade of unprecedented U.S. economic growth.

Most Americans would be surprised to learn that total consumer debt, including home mortgages (over $6.5 trillion), exceeds the cumulative U.S. national debt ($5.7) trillion. And, like the sharp increase in federal borrowing that augmented the modest growth of federal revenues over the last 20 years (U.S. national debt totaled ($940 billion in 1981), consumers have become increasingly dependent on unsecured or revolving credit (about $55 billion in 1981) to compensate for stagnant real wages, increasing employment disruptions, and higher costs for big ticket items such as automobiles, college tuition, insurance, housing, and health/medical costs. Although the finance charges on the national debt have grown substantially (from $292.5 billion in 1993 to $362.0 billion in 2000), accounting for over 12 percent of the current federal budget, heavily indebted consumers are facing a more serious financial burden since their loans are more likely to be in the form of higher interest credit cards (average of over 15 APR) versus more modest Treasury bonds and Certificates of Deposit. (3-4%).

At the same time that one-stop financial shopping has provided greater convenience and lower prices for a small minority of U.S. households, the most economically disadvantaged or financially indebted are increasingly relegated to the second-Tier of the financial services industry (pawnshops, rent-to-own stores, payday-lenders) where interest rates typically range from 10 to 40 percent and more PER MONTH! Significantly, this fastest growing segment of the financial services industry features the participation of some of the largest First-tier banks such as Wells Fargo, Goleta National Bank, and Bank of America.3 To the dismay of most Americans, the deregulation of the financial services industry has led to record revenue growth and profits for banks while providing more complex pricing systems, less personalized service, and sharply increased costs to the majority of consumers. In sum, while U.S. wages in general and household income in particular have typically declined over the last two decades, the effective demand of American consumers has been enhanced by their access to increasingly higher cost credit.

This trend is especially significant since the U.S. post-industrial economy has been fueled by the growth of consumer related goods and services accounting for about 2/3 of America’s economic activity (Gross Domestic Product). As long as U.S. consumer demand has increased, stagnant real wages (from mid-1970s to late 1990s), declining labor benefits (health, pension), and the growth of temporary or "contingent" workers (from 417,000 in 1982 to 1.22 million in 1989 and to 2.65 million in 1997) have been obscured by the unprecedented extension of consumer (especially revolving) credit.

Like steroid abuse, the dramatic decline in the U.S. personal savings rate (from nearly 8.5% in the early 1980s to less than zero today) and the sharp rise in consumer debt could have long lasting effects on the U.S. economy. Since the end of the last recession (1989-91), the Federal Reserve reports that total installment consumer debt (credit cards plus consumer loans such as autos and appliances) rose from $731 billion in 1992 to about $1.6 trillion today. This includes a huge increase in unsecured credit card debt: from $292 billion in 1992 to over $700 billion today; net outstanding revolving consumer debt is about $600 billion. A remarkable trend since credit card debt was only $50 billion in 1980.4 Together with the sharp increase in stock market valuations during the 1990s ("wealth effect") and the corporate promotion of immediate gratification ("Just Do It" consumption) which inflated consumer expectations, Americans have tended to purchase more than they could possibly afford on their household income. As a result, the last 15 years have witnessed the mass marketing of an idealized ‘American Dream’ that is based on the fragile edifice of an enormous increase of consumer debt.

The steep rise in the share of household income allocated to housing has meant that there has been less discretionary income available for other personal or family needs. Although mortgage debt is the least expensive consumer loan, the unprecedented increase has squeezed the ability of households to pay for other purchases and/or finance an unexpected expenditure. As shown in Table 1, the mortgage share of disposable income has jumped from 18.5% in 1949 to 40.3% in 1967. Over the last 20 years, it has jumped from 44.7 % in 1979 to 55.3% in 1989 and 67.5% in 1999. When combined with the rise in other consumer debt (home equity loans, credit cards), the last 20 years—especially the last 10 years—has registered an incredible increase in average household debt. Between 1979 and 1989, total U.S. household debt as a percentage of disposable personal income jumped from 71.9% to 84.6%. Ten years later, 1999, total household debt had crossed a previously unimaginable threshold: it exceeded average discretionary income (103.0%). 5 Furthermore, it is important to note that some economists argue that the consumer debt burden has remained largely unchanged over the last three decades. This view ignores two important realities of contemporary American society: (1) the “real” cost of consumer credit has increased dramatically and (2) current measures of consumer debt fail to capture important changes. In regard to the latter, many important sources of consumer debt are not included such as car leases, payday loans, pawns, and rent-to-own contracts. Even so, nonmortgage consumer debt would not be so difficult to service if not for the dramatic rise in housing costs.

The key to understanding future trend in bankruptcy filings is the socio-economic groups that are having the most difficulty servicing their consumer debts. For instance, Table 2 reports stocks, other assets, total debt, and net worth by wealth class from 1962 to 1998. These statistics measure overall economic well-being as well as the potential financial vulnerability of some households to the fragile “wealth bubble” of appreciating housing and investment assets. Over the last 15 years, which includes the longest economic expansion in U.S. history, the bottom 40% of the U.S. wealth distribution registered a modest $8,300 increase in average total assets versus $19,900 in total debt--an overall decline of $3,600 in net worth. The experience of the middle 20% (40% above and 40% below) is instructive. During this period, stocks of this group rose $7,600 and other assets rose $17,600 versus an increase of $19,700 in total debt. The economic winners are those in the top 10% and especially the top 1%.6

Two other measures of financial distress as measured by the U.S. Federal Reserve Board are households with high debt burdens (40% or more of household income) and late payment (60 days or more) of bills. Between 1989 and 1998, the lower income, middle-class reported the most economic difficulty. For instance, the high debt burdens of modest income households ($10,000 to $24,999) rose from 15.0% to 19.9% while moderate income households ($25,000 to 49,999) rose from 9.1% to 13.8%; households with incomes over $50,000 increased marginally to about 5% while those under $10,000 rose from 28.6% to 32.0%. Similarly, late payments increased marginally among households with at least $50,000 annual income to about 4.4% (most increase since 1992) while the $25,000 to $49,999 group nearly doubled from 4.8% in 1989 to 9.2% in 1998; households with modest income ($10,000 to $24,999) remained unchanged at 12.3%.7 Together, these data show that during the recent period of robust economic conditions, the lower and middle income households utilized increasing levels of consumer credit while evidencing with mounting strains on their ability to service their escalating debt levels. This is consistent with the findings of Teresa Sullivan, Elizabeth Warren, and Jay L. Westbrook in their pathbreaking study, The Fragile Middle Class, Americans in Debt (2000).

A related indicator concerns the ability of consumers to pay for their credit card charges. Table 3 presents self-reports on credit card payments by age groups for the years 1995 and 1998 as compiled by the U.S. Federal Reserve Board from the Survey of Consumer Finance. The data is suggestive in terms of measuring economic stress since the proportion of credit card “deadbeats” or “convenience users” (zero balance) rose sharply—from 34% in 1995 to 42% in 1998. For example, all of the age groups—with the exception of those UNDER 35 years old--reported a greater proportion that “Almost Always Pay off Balance.” Similarly, only the 35-44 and under 35 years old groups reported an increase in “Hardly Ever Pay off Balance” whereas the groups over 54 reported the largest increase in paying off their credit card debts. This reflects both different generational attitudes toward debt (and receptivity to mass marketing campaigns) as well as the financial squeeze on younger households that are in the middle of their lifecyle.8 Not surprisingly, this was facilitated by the aggressive marketing of bank and retail credit cards to traditionally neglected groups such as college students and the working poor.

PRESERVING OR SUBMERGING THE U.S. MIDDLE CLASS:
The Rising Cost of Credit

Today, three out of five U.S. households are responsible for the approximately $600 billion in outstanding credit card debt. Among these "revolvers," credit card debt averages over $11,500 per household. Even the robust wage increases of the last three years do not compensate for the rising cost of financing personal debt; only home mortgage related interest is tax deductible. Hence, a four percent increase in the annual median income of U.S. family households (about $50,000) is nearly the same as the average cost of financing household credit card debt (16% excluding fees) or approximately $1,800. And, this does not include the tremendous growth of finance companies (over 24% APR) and the rising cost of "second-tier" consumer loans that typically range from 10 to 40 percent—per month. See Table 4.

The enormous profits of the latter explain the recent entry of the largest "first-tier" banks into providing second-tier financial services. For instance, Wells Fargo formed a joint venture with Cash America (largest U.S. pawnshop company) in 1997 to develop a state-of-the art system of automated, payday loan kiosks. In September 2000, Citigroup purchased Associates First Capital Corp ($31.1 billion)—the largest publicly traded U.S. finance company—with one of the most notorious business reputations as “predatory lender” in the ‘subprime’ consumer markets. Within six months, the Federal Trade Commission (FTC) had filed a complaint in federal court with “systematic and widespread abusive lending practices.”9 Overall, credit card interest charges, penalty fees, and second-tier finance costs could total over $125 billion in 2001. This is an enormous transfer of income to an industry that has defiantly slashed jobs, cut wages, and raised consumer prices in sharp contrast to the promised benefits arising from federal “de-regulation.”

In terms of stimulating a more rapid economic recovery during the current “consumer-led” recession, the effect could be a significant reduction in the effective demand of U.S. households as the purchase of goods and services is subordinated to the payment of rising finance charges attributed to previous consumption. This is especially important in terms of the current impasse in reconciling the U.S. Senate and House versions of the Consumer Bankruptcy Reform Act which would limit the use of Chapter 7 (discharge of unsecured consumer debts). During my February 2001 testimony before the U.S. Senate Judiciary Committee, I argued that mounting levels of consumer debt as rising “real” rates would invariably push the U.S. economy into a recession. Moreover, the banking industry’s demand to reduce the incentive for consumer bankruptcy (by sharply limiting the ability of indebted consumers to liquidate their debts) is not justified in terms of the pricing structure of high interest, revolving consumer loans as well as the unexpected social events (medical expenses, job disruption, divorce) that typically precipitate consumer filings. The credit card industry’s pressure to impose a repayment plan belies its responsibility in encouraging consumers’ to increase financial liabilities beyond their ability to cope with unexpected financial crises. And, in terms of declining consumer confidence (lowest in 7 years) and generalized economic decline, more stringent bankruptcy laws would exacerbate and prolong the ongoing economic recession. The credit card industry argues that the modest rise in loan delinquencies merits the tightening of its underwriting criteria to consumer households and small businesses. Yet, the greater power of retail banking in extending loans and reducing interest rates may have an even larger impact on the “quality” of outstanding loans by reducing consumer buying power and indirectly slowing the growth of the national economy. Furthermore, as evidenced by the last recession, a substantial number of convenience users (at least 30%) will become debt dependent during the economic downturn which reduces the proportion of financial “deadbeats” as well as increases the number of profitable “revolvers.”

Hence, by refusing to share the financial pain during its unprecedented period of pecuniary gain, the credit card industry has eschewed federal involvement in setting interest rates but not in collecting its unsecured debts. In this way, the banking industry is seeking to distort the disciplining influence of unfettered markets by reducing the cost of extending loans to its most risky clients. Ironically, Members of Congress have been swayed by the credit card industry’s “need” to “federalize” its debt collection agencies while arguing against the “federalization” of publicly necessary airline security systems.

Not only are most U.S. households being squeezed by mounting mortgage and consumer debt, but the "real" cost of “prime” consumer loans has risen dramatically since the de-regulation of financial services in 1980. For instance, the real cost of corporate credit (prime rate) has increased only marginally (2.5%-3.0%) whereas the real cost of consumer credit card debt has almost doubled (less than 6% to over 11%) since the early 1980s--not to mention soaring penalty fees (about 30 percent of all credit card revenues). In comparison, the cost of automobile loans has varied more closely with the prime rate as the Big Three auto manufacturers have subsidized this rate to stimulate auto sales. See Figure 1.

Today, the ninth rate cut by the U.S. Federal Reserve during the year has driven the Federal Funds (overnight) rate to a 40 year low—from 6.5 to 2.5 percent. Even so, with the cost of borrowing at historic lows for the credit card industry, most variable rate accounts have quickly reached their “floors” of 13-14 percent and thus the banks’ reduced cost of borrowing has not being passed on to consumers not to mention rising penalty fees (approximately 25-30 percent of total industry revenues). Of course, these “sticky” interest rates contrast sharply with strict consumer policies where a one-day late payment can precipitate “escalator” clauses that double or even triple consumer interest rates (a notorious policy of MBNA) or delayed submission of favorable payment reports that would lower credit scores and eventually interest rates. In addition, the credit card industry has redefined its clients’ relationship—from specific companies to the entire financial services industry—so that negative financial information can be used to increase consumer costs through higher interest rates, penalty fees, balance transfer transactions, etc. For example, I have received numerous consumer complaints that “guaranteed fixed 9.9% rates” have been unilaterally changed by Chase because of “unfavorable” information from accounts with other credit card companies.

While the industry has been refining the art of targeting clients that are least likely to repay their loans, the alternatives to consumers have been rapidly dwindling. For example, in contrast to descriptions of the credit card industry as highly competitive with 6,000 competitors, the reality is that the last decade has witnessed a dramatic consolidation of credit card issuers. In 1977, the top 50 banks accounted for about half of all U.S. credit card accounts. The impressive revenues of most credit card portfolios have precipitated massive mergers and acquisitions over the last decade. For instance, Bank One’s acquisition of credit card giant First USA in 1997 was followed by Citibank’s purchase of AT&T’s credit card subsidiary--the eighth largest in 1998. Today, the top ten card issuers control over three-fourths of the credit card market and nearly 70 percent of the over 1.3 trillion in credit card charge volume. Not surprisingly, competition for clients is less likely to be expressed in the form of lower prices. Indeed, it is striking that the average cost of consumer credit card debt (interest and fees) had risen over the last five years until the succession of rate cuts over the last 8 months.

Second, the enactment of the 1998 Financial Services Modernization Act has precipitated a new trend in the formation of consumer financial services conglomerates. For instance, the 1998 merger of Citicorp with Traveler’s Group has created a new role for consumer credit cards: compiling consumer information files. Credit cards provide a lucrative revenue stream for conglomerates such as Citigroup as well as strategic information for the cross-marketing of other financial services such as insurance, investment services, student loans, home mortgages, and consumer loans. By combining different sources of consumer activities from various corporate subsidiaries (e.g. Traveler’s Insurance, AT&T credit cards, Solomon Smith Barney investments), plus the forging of strategic partnerships with specific corporate retailers, these conglomerates are developing increasingly cost-effective marketing campaigns for persuading customers to use their credit for purchasing products from members of the conglomerate’s extended corporate family.

It is not surprising, then, that the major credit card associations recently have begun marketing credit cards to teenagers with the required financial contract signed by their parents or guardians. This card program is ostensibly designed to help promote financial responsibility by encouraging parents to discuss financial purchases/budgets with their minor children. Of course, financial education could be promoted through the use of debit cards or personal checks. Indeed, the key objective is to promote credit card use at an early age, especially purchases through virtual internet shopping malls. Furthermore, this credit card program facilitates the collection of consumer information at an earlier age as well as the direct marketing of teenagers without the filter and/or confusion of distinguishing the purchases of children from their parents. By issuing credit cards in a teenager’s name, companies are seeking to shape consumption behavior and corporate loyalties at an earlier age while minimizing the influence of their parents.

Third, the growth of subprime credit cards has led to outrageous financial terms for the most naive and inexperienced market of the working poor. With annual percentage interest rates of over 30 percent and costly hidden charges, even large issuers have been formally reprimanded and even sued over duplicitous advertising. For example, the sixth largest credit card issuer, Providian National Bank, agreed to an out-of-court settlement for a record $300 million in June 2000. According to the U.S. Comptroller of the Currency, John D. Hawke Jr., We found that Providian engaged in a variety of unfair and deceptive practices that enriched the bank while harming literally hundreds of thousands of its customers. They include a “no annual fee” program that failed to disclose that the card required the purchase of $156-a-year plan credit-protection plan; customers who complained were informed that the plan was mandatory unless a annual fee was paid. Other entrants into the subprime credit card market offer variations on the classic “bait and switch” where “pre-approved” credit cards lead to “secured” cards or high cost consumer (finance company) loans. For the most vulnerable, the initial “pre-approved” offer of “financial freedom” becomes a duplicitous game of “how high can you go.”

For those who desperately seek a credit card as a bank account of last resort, the terms that are required of subprime applicants especially the working poor include unwanted educational materials and high membership fees with little available credit. This is illustrated by the conditions of the United Credit National Bank Visa. It’s direct mail solicitation declares,

“ACE VISA GUARANTEED ISSUE or we’ll send you $100.00! (See inside for details.)” For those who bother to read the fine print, and a magnifying glass would be useful in this case, the terms of the contract are astounding, “Initial credit line will be at least $400.00. By accepting this offer, you agree to subscribe to the American Credit Educator Financial and Credit Education Program. The ACE program costs $289.00 plus $11.95 for shipping and handling plus $19.00 Processing Fee a small price to pay compared to the high cost of bad credit! The Annual Card Fee [is] $49.00... For your convenience, we will charge these costs to your new ACE Affinity VISA card. [They] are considered Finance charges for Truth-In-Lending Act purposes.”

Unbelievably, an unsuspecting applicant could pay $369 for a net credit line of only $31 at a moderate 19.8 APR. It is no wonder that those households who are most desperate for consumer credit often give up on the financial services sector after they realize the exploitative terms of these contracts.

A final issue concerns the trend of consumer financial services conglomerates of replacing traditional, low cost consumer and small business loans with higher cost substitutes. For instance, in low-income neighborhoods, this may result in the closing of a first-tier bank branch and its replacement with high cost, finance companies (such as Citigroup’s newly acquired Capital Associates) or second tier “fringe banks” such as check cashing outlets, pawnshops, and rent-to-own stores. Imagine major money center banks pointing to their subprime credit card or “payday” loan portfolios in inner cities as evidence for satisfactorily achieving their Community Reinvestment Act (CRA) obligations.

Especially disconcerting is the application of this policy to the small business sector. Today, the number one source of start-up financing for small businesses is credit cards followed by home equity loans. Aspiring entrepreneurs--especially women and minorities--are routinely denied small business loans and encouraged to assume higher cost, credit card debt. As one owner of a computer supply company explained, "I wanted a business loan [from Wells Fargo] but all I got was a[nother] credit card instead." This trend has potentially serious consequences as credit cards have dramatically changed from the credit of last resort to the initial source of start-up financing. Since small businesses are the primary source of net job growth in the U.S. economy, this trend could have severe repercussions during the next economic downturn. That is, small entrepreneurs may not be able to survive unfavorable economic conditions after exhausting their high cost lines of consumer credit at the same time that the economy needs to generate more jobs. This restrictive corporate lending policy could exacerbate an economic slowdown and possibly contribute to a recession. The current bankruptcy reform bills could exacerbate the plight of small businesspeople by requiring asset liquidation after the expiration of the 179-day reorganization period if the company is unable to begin paying its creditors. It could also lead to dual bankruptcies: business and consumer as entrepreneurs try to survive on their personal lines of credit.

The increasingly important role of banks in restricting the financial lifeblood of small businesses during the current recession is contrasted by the increasingly sophisticated efforts to encourage students to incur increasingly higher levels of debt at earlier ages; in the late 1980s, banks began marketing to college seniors who “had one foot out the door and in the labor market” for feature that underclassmen were too irresponsible and would not pay their credit card debts. As banks realized that students would use summer savings, student loans, parental assistance, and even other credit cards to service their debts, student credit lines steadily increased over the 90’s. As the profitability of market became apparent, banks began offering multimillion dollar deals with college administrators for “exclusive” marketing of Alumni “affinity” cards. Today, the rapidity of this impact on bankruptcy rates is staggering.

Nationally, young adults 25 years-old and younger have experienced a dramatic rise in their bankruptcy rates. This is especially significant in view of the overall decline of nearly 15 percent in bankruptcy filings between 1998 and 2000. In 1995, with a near record level of nearly 900,000 bankruptcies, less than 1 percent of bankruptcy filers were 25 years old or younger. When U.S. personal bankruptcies peaked at 1.4 million in 1998, young adults comprised almost 5 percent of the total. This proportion of bankruptcy filers has jumped sharply, as recent college graduates cope with rising student loans as well as credit card debts. Note, the divergent trend of rising bankruptcy rates among young adults has occurred during a period of economic prosperity. With a slowdown in the U.S. economy and sustained rise in student debt levels, the analysis of bankruptcy subgroups and future age cohorts will be instructive. In particular, there is a paucity of data on the experience of recent college graduates in their accumulation of personal debt after leaving school and before they begin their first job. Previously research has shown that this period can lead to a disproportionately large amount of debt that may not be able to be serviced in later years. This issue is especially important since the bankruptcy reform bill will retain the nondischargability of student loan debt—even the amount that includes consumer debt like credit card balances. This could lead to multiple bankruptcies among the youngest age cohorts.

The most striking result of the enormous increase in revolving or noninstallment credit/debt (primarily credit cards) is that earlier “good” consumer loans are transformed into “bad” debts after households cross the threshold of the ability to service their financial obligations. For example, students with little financial experience/economic reserves that can not find a well-paying job—especially during a recession—may not be able to pay for their student loans AND revolving debts. This has major implications for repayment of federally subsidized student loans during the recession. More importantly, households that are barely able to financially survive during the best of times with large liabilities are too often incapable of coping with unexpected financial crises. The most recent research cites medical expenses followed by job disruptions and family crises (divorce, widowhood, parental care) as the most important factors that push Americans into the financial abyss of bankruptcy.10 Furthermore, “easy credit” policies have been a disaster for small businesses where previously “good” loans to consumers can become “bad” after the assumption of large credit card debts. It is for these reasons that the Age of Affluence produced a perplexing relationship between unemployment and bankruptcy rates during the early years of banking deregulation.

This counterintuitive trend is illustrated in Figure 2. During the 1982-83 recession, the increase in consumer bankruptcies began to diverge from the unemployment rate. That is, from 1985-89, unemployment declined while consumer bankruptcy increased. During the 1989-91 recession, the bankruptcy rate rose closely with the unemployment rate but then is diverged sharply during 1994-98 as bankruptcies spiraled upward (record 1.4 million in 1998) while the unemployment rate fell below 4 percent. Although bankruptcies dipped to nearly 1.2 million in 2000 with the continued slide in the unemployment rate, the sharp rise in the first two quarters of 2001 (before the onset of the recession) suggest that a new consumer bankruptcy record may be established this year. It is the profound change in the attitudes and use of consumer credit that have contributed to unrealistically high levels of debt that have made large segments of the middle-class and working poor so vulnerable to unexpected financial crises. The most important concern the shaping of consumer attitudes toward “easy credit” BEFORE becoming engaged in full-time employment. This policy, which my current research describes as “Generation N Debt,” may profoundly influence future consumption patterns, standard of living, intergenerational wealth transfers, retirement patterns and even national saving rates. At the same time, the overreaction to the perceived short-term loss of “easy profits” by the banking industry via more restrictive lending policies may reduce the power of the Federal Reserve in counteracting a decline in national economic growth.

The following case-studies illustrate the influential role of credit card marketing (and, indirectly, the impact of banking deregulation), the inability of highly leverage households to cope with unexpected financial difficulties, and the growing use of consumer credit to compensate for declining worker compensation and the reduction of social services due to the contraction of the welfare state. It is the reluctance of the credit card industry to share the financial pain as well as the gain during this period of national economic uncertainty that merits even closer attention to their business practices.

Continue to Part 2

  1. See Robert D. Manning, CREDIT CARD NATION, (New York: Basic Books, 2000), Chapters 3 and 7. (return)
  2. The FDIC Quarterly Banking Profile, “Commercial Bank Performance—Second Quarter 2001,” pp. 1-2 at www.fdic.gov. (return)
  3. The key statutory provision that has led to the sharp growth in joint ventures between second-tier “check-cashers” and first-tier banks is Federal preemption in the regulation of federally chartered banks. See Jean Ann Fox, “States Grant Payday Lenders a Safe harbor from Usury Laws,” (Washington, D.C.: Consumer Federation of America, 1999) (return)
  4. See Robert D. Manning, CREDIT CARD NATION, (New York: Basic Books, 2000), Chapters 1 and 2 (return)
  5. Lawrence Mishel, Jared Bernstein, and John Schmitt, The State of Working America, (Ithaca: Cornell University Press, 2001), p. 276. (return)
  6. Lawrence Mishel, Jared Bernstein, and John Schmitt, The State of Working America, (Ithaca: Cornell University Press, 2001), p. 268. (return)
  7. Lawrence Mishel, Jared Bernstein, and John Schmitt, The State of Working America, (Ithaca: Cornell University Press, 2001), pp. 280-82. (return)
  8. See Robert D. Manning, CREDIT CARD NATION, (New York: Basic Books, 2000), Chapter 9. (return)
  9. Federal Trade Commission, “FTC Charges One of Nation’s Largest Subprime Lenders with Abusive Lending Practices,” at www.ftc.gov/opa/2001/03/associates.htm. (return)
  10. Melissa B. Jacoby, Teresa A. Sullivan, and Elizabeth Warren, “Rethinking the Debates over Health Care Financing: Evidence from the Bankruptcy Courts, New York University Law Review, Volume 76, No 2 (May 2001), pp.pp.375-418; Teresa A. Sullivan, Elizabeth Warren, and Jay Lawrence Westbrook, The Fragile Middle Class: Americans in Debt (Yale University Press, 2000); and Elizabeth Warren “The Bankruptcy Crisis,” Indiana Law Journal, Volume 73, No 4 (Fall 1998), pp. 1079-1110. (return)

 

 


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