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Toward a World with Rational National Consumer Credit Public Policies

posted by david lander

The current economic downturn started in the consumer credit area. One of the glaring failures during the build up of the factors that led to the current mess was the lack of sufficient economic or sociological analysis from within the academic communities. There are simply too few funded prestigious institutions that study consumer credit issues. It is interesting that law school bankruptcy professors who operate outside of funded centers and may or may not have credentials in economics and sociology have provided a significant percentage of the analysis that does exist. The current economic recession is hurting many many people and will hurt many more before it comes to rest, but perhaps one benefit to which it could give rise would be more regular and effective analysis of the micro and macro economic and sociological issues that inhere in the supply and demand sides of the consumer credit world, including housing finance, car finance and credit card debt. Such an analysis might lead to a more well informed public and more well informed legislators and other public policy makers. We need this in the United States and the rest of the world. 

As a starting point let’s think about the spending and borrowing habits of both Americans and of the hundreds of millions of potential likely consumers and spenders in China and India and other emerging Asian economies. Ronald Mann has written insightfully about the preferences for debit or credit cards in Japan and Korea and perhaps now it is time to look at China and India, particularly since the numbers of people who will have either money in their pockets or credit available to them is so staggering.

This is an especially interesting (and troubling)  time to speculate on these topics since the U.S. consumer, whose spending beyond her income fueled the world economy for a decade or two, has retrenched. Culture, legal framework, lack of safety net and inequality of income combined in the U.S. to allow/encourage/require  U.S. consumers to incur obligations pretty far beyond their likely ability to pay. What about the apparent inability of many households to take control of their own destinies. Did people not know what was happening to them financially? What kept them from making "better" decisions?  The recent and inevitable bursting of that bubble and the integrally-related real estate bubble may serve as a longer term regulator the next time around or it may be forgotten over time until the bursting of the next bubble. 

Landeraccounts1_3 CLanderaccounts2onsumers in developed Asian nations such as China, Korea, Singapore and Taiwan have, not surprisingly, proven to be fairly different from one another in their cultural and legal attitudes toward spending and paying in currency other than cash. In discussing international differences, an interesting place to start is national saving rates. The charts to the right show current-account balances for seven countries. The current-account balance represents how much saving a country sends overseas.  High-saving countries have positive current-account balances, and vice versa.

The US runs a chronic current-account deficit, as does the UK and Australia.  Canada did for awhile, but has turned itself around and now runs a surplus.  Japan, Germany, and China run large and growing surpluses.  Other data show the same thing:  The US, UK, and Australia are low-saving countries, while Japan, Germany, China and now Canada are high-saving countries.  At the same time, the low-saving countries tend to have more sophisticated consumer-credit sectors.  There may be a chicken-or-the-egg problem here, but the correlation is fairly strong, as far as I know.

Do other countries really want to go down the same road the US has traveled?--  There may be a cultural component to saving, but a sophisticated consumer-finance sector probably can, over time, offset much of the cultural resistance that might exist.

The twenty first century “miracle” now underway in Asia has already created an extraordinary increase in spending power for tens of millions of people.  Even a cursory examination of consumer demand for products, vacations or whatever demonstrates the power of these developments.  The question for speculation is whether the culture, legal framework, lack of safety net and distribution of income will promote, discourage or be neutral to the (over)extension of credit and use of credit in China and India.

In 2003 an economist at the FDIC, looking at bank safety in the shadow of the collapse of the Korean consumer lending and borrowing systems, listed the following factors as the fuel for our Consumer Lending Revolution:

  1. deregulation and the lifting controls on interest rates;
  2. advances in credit scoring sophistication;
  3. the development of the general purpose credit card;
  4. risk based pricing; and
  5. securitization as a means of bringing investors’ money into the supply

A sixth ingredient suggested by many is the American proclivity to borrow and spend, or the need either to spend beyond their means in order to provide necessities or failure of income to increase to meet basic survival needs such as safe housing and a sound education. 

Ronald Mann has examined a dozen or so countries and compared their use of credit cards with debit cards and perhaps with higher tolerance for high rates and for higher debt service tolerance.

So, what would we tell an Asian legislators or a new members of the U.S. Congress or a State Legislature as they confront the prospect of increased borrowing by their constituents. What has worked in the US and what has failed? How should the U.S. experience between 1990 and 2005 influence their decisions?

What level of "consumer protection" should they provide; should they control the price of consumer credit? How can they develop a disclosure system that is effective? what should their bankruptcy rules be?  Are there certain types of credit extensions that are so avaricious that they should be outlawed?  What should their rules for discharge of indebtedness be?  Do they need an effective governmental regulator watching over the system? Can American or Chinese or Indian consumers fend for themselves in the modern "financial jungle". Should "teaser" rates and other such marketing devices be outlawed or should we let those who understand them benefit and those who do not understand them suffer? Are these problems simply too hard for the average person to figure out?  Is it like prescribing drugs--i.e., should be left to a doctor?  And can the "financial doctors" be trusted?

Every ounce of effective consumer protection will constitute an interference with the market and in most cases effective limits on interest rates will exclude a group of consumers from borrowing and buying what the borrowing will allow and will keep a group of investors from earning a higher return on their money. 

Keeping some consumers from borrowing will be keeping them from making mistakes that will cause them damage; keeping others from borrowing may keep them from buying the car they need to take a job opportunity which will propel them to a better life. 

Public policy makers must understand the micro and macro sociological and economic impacts of consumer lending and they must understand the field of behavioral economics in order to make an informed decision.  So, how might this occur?

As one very modest step, a handful of law school professors around the country have tried to offer a course which would equip students to be effective public policy makers and users. It includes sections on the history of consumer lending,  a look at the positive and negative, micro and macro economic and sociological benefits and detriments, a look at behavioral economics  and finally the history of those remedies that have been tried and perhaps some that have not.  Putting together such a course requires some law and some sociology and some economics and some behavioral economics so there are not many places where it is taught.  The best such course might be part of a public policy program and it might include students from each of the relevant subject areas. 

Well, even if there are not many such courses, one would hope that there would be places where people research and write about these areas. Unfortunately, they are few and far between. One of the amazing things about Lendol Calder’s fine work “Financing the American Dream: A Cultural History of Consumer Credit” is that it is the first such work in many many years and there has been little or no follow up in the ten years since its publication or the sixteen years since the doctoral thesis on which it was based was submitted. 

Let’s look quickly at where the existing work in this area is being done. The field of consumer and family economics was pioneered by E.Thomas Garman and others and is currently represented at many schools.  A look at Jing Xiao’s 2007  Handbook of Consumer Finance Research provides a look into this world.  However, for a number of reasons the work in this field has not attained the level of respect which the study of the field requires. There is an institute at the University of Arizona devoted to consumer credit but it was funded and takes its name from one of the consumer credit counseling agencies that was appropriately lambasted in Congress. The Center for Social Development at Washington University has done considerable work around the concept of the individual development account. The Harvard Joint Center for Housing Studies has made important contributions and there are very effective advocacy groups such as the Center for Responsible Lending, The Consumer Federation of America and the Financial Services Roundtable, Demos, and the Center for American Progress.

One of the odd developments is the disproportionate amount of research that law school bankruptcy professors such as Elizabeth Warren and the other regulars on this blog are doing on the bankruptcy population. Professor Warren has been mentoring Harvard students and young professors at other university and the result is a new crop of bankruptcy professors that are working on these issues along with professors such as Patricia McCoy and Kathleen Engle  The University of Michigan has it Survey of Consumer Sentiment. In the field of sociology George Ritzer has done important work as has Juliet Schor and Teresa Sullivan. Fed economists especially at the Philadelphia Fed and William Emmons at the St. Louis Fed have been important contributors at one level. Yet the effort is much too small when compared with the rapid development of these issues and their impact. Something is lacking.

In order to understand the void and its impact let's look at the build up  of mortgage debt, both prime and sub prime that was a major contributor to the current recession in the U.S. and other countries.  As U.S. consumers began to reduce the level of increase in their credit card borrowing and to replace it with home equity loans only a scant handful of observers studied or researched or wrote on this topic.  Although there was little careful examination some observers including Fed Chairman Greenspan practically gloated about how brilliant it was that consumers had figured out how to coax money out of their otherwise unexciting houses--a veritable goose laying golden eggs!  The mindset was that this was virtually risk-free cashing out of the productivity miracle that had befallen us--and tax-deductible, to boot.

On the research side, there were a half dozen articles by Fed economists which noted and remarked
upon these extraordinary increase in refinancing and commented briefly upon the increase of home equity extraction and there was literally no evaluation of the impact of this home equity extraction. Professors Erik Hurst and Frank Stafford  wrote one piece in 2002 on the micro economic impacts of sub prime borrowing which was not much noticed or commented upon.  FDIC economists wondered out loud whether the consumer home borrowing revolution would lead some place problematic.  Professor Steve Fazarri and Barry Cynamid in a recent piece was the first academic economist to note the potential macroeconomic impact of the consumer lending revolution.  At the beginning of the current foreclosure crisis one commentator reviewed the extent of sub prime borrowing and concluded that the number of such distressed borrowers was too small to lead to the tipping point.  No one but Kathleen Engle and Patricia McCoy commented on the explosion of supply and the development of securitization vehicles which fueled the sub prime mortgage explosion. 

Would it have made any difference? Would people at the Fed or in Congress or other regulatory bodies paid attention?  We will never know because other than the Hurst article no such articles were published by any prestigious economic journal during the five years of the build up of the bubble. 

Other than the Harvard Joint Center for Housing Studies the great universities in the United States have simply not invested sufficiently in the study of these areas. It is not easy because they are interdisciplinary but it is necessary that a way be found. Steven Lea and others in the United Kingdom have been leaders in the areas of behavioral economics and this field has attracted some prestigious scholars in the US from the law and economics world.  It is perhaps even more crucial that the great universities in China and India and Korea and Singapore and Japan and the rest of Asia devote resources to this area so that the decisions of the policy makers will have the benefit of such insights and information which research and writing will provide. Such an effort might be useful both in the US and around the world.


"Is it like prescribing drugs--i.e., should be left to a doctor? And can the "financial doctors" be trusted?"

I was thinking about this issue the other day - the relationship between complexity of the subject matter and the responsibility of the expert/professional.

There are actions that a doctor or a lawyer can't do - regardless of disclosure, regardless of consent. Kind of a dumb example, but say I thought body piercing was passe and I wanted to take the next step up to finger removal. If a doctor performed a finger removal surgery for me - despite disclosure of the risks and my consent - the doctor could still lose his or her medical license, and probably sued for malpractice if I later changed my views on cosmetic finger removal.

Lawyers have the same type of constraints - in most states, no matter the level of disclosure and the fact that informed consent was given, drawing up a will with yourself as a beneficiary will, in most circumstances, get you in licensure problems.

Why? Looking beyond my dumb examples, it is because of the complexity of the subject matter involved, and the inequality of understanding between a "lay person" and the professional. Engineers and accountants run into similar issues.

So, where does consumer finance fit in this continuum? Historically, personal finance was much simpler, and therefore more readily grasped by citizens without specialized knowledge. The problem is, all kinds of consumer credit transactions have gotten more complex in recent years. And our (U.S.) laws hasn't really responded to that change. At the same time, I think it is fair to say that basic math skills in America - the most basic tool for understanding financial transactions - have eroded. If you've had much experience watching cashiers trying to make change, you know what I'm talking about.

I don't think you can make lenders into fiduciaries, but I do think that the disclosure/consumer choice model that we, for the most part, have been operating under is failing apart.

There just isn't enough time in the day to understand the rules our credit cards operate under, if we could figure it out from the disclosures we're provided.

The existence of 60% interest car loans, and 365% payday loans are just symptoms of a deeper problem: a need for the law to catch up with the reality of consumer finance.

It ain't George Bailey's world anymore.

You ask, "Would it have made any difference? Would people at the Fed or in Congress or other regulatory bodies paid attention?"

I suggest broadening your question to include other audiences (news media, non-profits who counsel and educate, consumers themselves, students of course, et al.) -- that is other audiences who might have benefited from the work of academics and universities.

Then ask, "Would it have made any difference?"

And, with this larger set of audiences, I think the answer is, "Yes. It would have made at least some difference to some people."

Maybe the question should be phrased more like, "Would people at the Fed or in Congress or other regulatory bodies paid attention" - BACK THEN?

I believe Professor Porter's frequent flyer miles alone may be testimony to whether or not Congress or regulatory agencies are paying any attention these days.

Too little too late, though. For instance, Sen. Clinton's office was made aware of Fairbanks Capital Corp. back in 2003. When she invited me to her Predatory Lending Policy roll out during her Presidential campaign in August of last year she acted as if Mortgage Servicing Fraud and Fairbanks were all brand spanking new to her.

Same thing for Sen Schumer. His office was made aware of Fairbanks in 2002, I believe. And yet, May of this year he seemed genuinely surprised by Professor Porter's testimony at his Judiciary sub-committee hearing. I have the letters to both Senators' offices from their constituents/Fairbanks' victims as evidence.

It is going to take more than Congress or regulatory agencies to get things back on track. Average American people are going to have to take a stand and fight for themselves and for those around them. Otherwise, this isn't going to work. And for those people to take a stand, it would make a HUGE difference if they had an accredited, academic pool of research upon which to draw for support of their legal positions. Not everyone gets to be a college/university professor.

Most of the clients who come into our consumer bankruptcy office these days are overwhelmed by student loans, for which, at present, there is no viable solution in bankruptcy. This undischargeable obligation poisons any fresh start. Of particular concern are the people in their fifties for whom a six figure student loan obligation they have never been able to pay down makes it completely impossible to make any provision for retirement.

The almost total silence of academic economic analysts on this issue makes any so-called leadership in this department suspect. Unaffordable debt is funding these people's salaries.

-I want to correct the name of Steve Fazzari's co author on an article mentioned in this post. The article is by Barry Z. Cynamon and Steven M . Fazzari. The title of that article is "Household Debt in the consumer Age: Source of Growth -- Risk of Collapse." It will be published the "Journal Capitalism and Society."

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