What Can a City Do?

Because subprime lending was not evenly spread around the country (or even around a state or city), individual neighborhoods are bearing the brunt of the meltdown.  When several homes in one community go into foreclosure, a neighborhood can rapidly shift from a safe, comfortable area with well-tended lawns to a place where no one wants to live.  Mayors are on the front lines in dealing with the fallout.

Like most academics, we at Credit Slips tend to talk about what the federal government could do to deal with the subprime crisis.  The feds have the power, if not the will, to make some big changes.  But what about mayors?  Can anything be done at the city level? This isn't an academic question, so put on your thinking caps and volunteer some ideas.  Here's mine: 

It's All Academic

A long-standing academic divide now separates two presidential candidates.  For nearly three decades, legal scholarship has been dominated a deductive, theoretical approach that analyzes incentives and assumes outcomes, with the rational actor playing the starring role.  The newer empirical approach is far more inductive, and data are often deployed to show that the rational actor is nowhere to be found.

In this morning's New York Times, David Leonhardt explains the key differences between presidential candidates Clinton and Obama using exactly this construct (although not these terms). 

Hidden Pricing

Credit Slips contributor Adam Levitin has an op-ed this morning in the Chicago Tribune that makes a terrific point:  Complex credit card pricing prevents consumers from knowing the true cost of credit and, as a result, prevents the invisible hand of the market from working its magic. 

In all the resistance to "regulation" of any credit product, it is easy to overlook the simple point that Adam drives home so forcefully.  Markets work on full information.  The implications are powerful:  If a consumer can't figure out the features of a product, then the market can't price those features appropriately. 

The Sandbag Plan

I've been struggling to understand the real point of the Administration's headline-grabbing plan to deal with subprime mortgages. Now, thanks to Bob, I've read it, and the plan seems to be nothing more than a guideline for when some lenders or servicers might let some borrowers extend lower interest payments for a while before the interest jumps up later. The loan on the house stays the same, even the family owes much more than the house is now worth--a circumstance that will cut off any refinancing option and any real resolution of the problem. The plan doesn't require any new laws or government intervention because no one is bound to anything. I can't quite figure out what the plan accomplishes that the lenders couldn't do without the plan--if they were in a mood to deal fairly with borrowers, acknowledge their losses, and start cleaning up the mess before it takes down the whole economy. So why trumpet a plan that doesn't do anything? CongressDaily (no link) found the answer: "'Totally will sandbag the bankruptcy stuff,' one lobbyist said of the White House announcement." So that's what the plan is designed to accomplish--kill off the bankruptcy proposal to deal with home mortgages.

Slick Deal on Subprimes

Later today George Bush will announce his administration's plan to deal with the subprime meltdown.  Instead of a change in the law, this is a voluntary deal negotiated with some large mortgage lenders and mortgage servicers.  If it works, it's a slick deal for the lenders.  But it may be too small to do any good.  The plan has two features that shape the whole deal: 

1) The lenders decide who gets the benefits and who doesn't. This seems to be the Goldilocks Game.  If the borrower is too cold (not credit worthy even for the teaser rate), no deal.  If the borrower is too hot (could pay on the reset), no deal.  Only borrowers who are just right (can pay currently, but can't pay more) will get the deal.  And the mortgage servicer decides who gets to be Goldilocks. 

2) No permanent solution.  People will have up to five years at teaser rates and then they are on their own. The only way this doesn't recreate the mortgage crisis down the line is if families can figure out on their own how to refinance into sustaintable (usually fixed) mortgages.  Refinancing means more people heading to mortgage brokers and more fees, etc. 

A Non-Bankruptcy Bankruptcy Solution?

The rumor mill is starting to sketch in details of a deal negotiated Treasury Secretary Paulson and a coalition of big lenders to stop the subprime mortgage meltdown by leaving borrowers in their current teaser rates longer.  The idea is that homeowners in trouble will be divided into three categories: those who can continue payments after an increase, those who can continue payments only on the teaser rate, and those who can't even pay the current teaser rate.  The plan is that first group pays, the middle group gets help, and the last group gets moved out. 

The economic idea behind the plan is that dumping all the foreclosed properties on the market at the same time will chase the market down further, further depressing prices in the real estate market, so holding people in their teaser-rate mortgages will stop the freefall in prices.  The tool looks a lot like something the Chapter 11 folks are familiar with:  a non-bankruptcy bankruptcy in which the parties negotiate something that has many of the features of a bankruptcy, but it is all handled privately.  As the plan emerges, there are at least three things to watch out for:

A National Conversation on Bankruptcy?

Bankruptcy isn't a very sexy political issue.  Don't get me wrong:  I think bankruptcy policy is critically important to working families.  In a world with inadequate health insurance, job insecurity, predatory lenders, family break ups and plain old financial mistakes, bankruptcy can be a family's last chance to get back into the economic mainstream. But no one sees bankruptcy in their future, and those who have been through it usually want to forget, so there is no special interest group for the protection of bankruptcy laws.

Today Senator Chris Dodd released a major policy statement entirely about bankruptcy.  The theme is that bankruptcy is a critical safety net for families.

Hostage Value

The secured transactions course nearly always includes a discussion of hostage value, and the bankruptcy course offers the antidote.  But the subprime mortgage market is giving us a new teachable moment.   

Because foreclosures in Massachusetts have tripled in the last year, the governor set up a $250 million rescue fund to try to help families get out of crazy mortgages and into affordable, fixed mortgages. The Globe reports today that so far not one single family has qualified for the rescue.  Other states with similar funds are also reporting dismal results. There are many reasons for the failure, but a critical problem is the hostage value of the house. 

How Profitable Will the Customer Be?

If you ever wondered just how profitable credit card lending can be, take a look at what a savvy business will pay for the chance to lend money to people already in financial trouble.

According to Nilson Reports, HSBC just sold its subprime credit card operations (338,000 accounts) in the UK to SAV Credit for $796,000,000.  SAV paid an average of $2,355 per account.

Newsflash: The Law Matters!

In its role as a big-time mortgage servicer, Deutsche Bank has carefully instructed the courts that the rules requiring the foreclosing party to demonstrating standing (e.g., the movant holds the mortgage and the note) were just too old fashioned to survive in the hip world of SIVs.  Unfortunately for DB, the federal judge in the case just wasn't hip enough.  The rule, said the court, is the rule.  If you try to foreclose, come up with the documentation that shows you are legally entitled to do so.  The court then dismissed 14 foreclosure motions. 

Gasp!  The law matters.

The piece on the front page of today's NYT is important for at least three reasons:

Predatory Lenders Unite!

At last, a website for predatory lenders! A place to get together to swap ideas about how to maximize profits, tips on racial profiling, and ways to get around the new laws insulating military families from payday lenders. There is a handy fee calculator, so a novice predatory lender can make sure it getting the most out of its predatory loans. There's even a blacklist.

Most of all, this site combats the public's misunderstanding that predatory lending is bad.

Check it out. The site is wicked.

Counting Medical Bankruptcies

About half of the families filing for bankruptcy do so in the aftermath of a medical problem (various calculations range from 46% to 63%.  Since my coauthors and I published a handful of academic papers on this, there has been a lively debate about whom to count among medical bankruptcies.  Those with big medical debts are counted, but measurement can be tricky as debt migrates to credit cards or home equity lines of credit.  Similarly, some people will pay the doctor, then put groceries on the credit card.  Others may have medical debts paid by insurance companies, but several weeks of lost time from work puts them under water.

But none of these ways of counting would cover this family that turned up in our bankruptcy sample.  Here is an excerpt from the telephone interviewer's side notes:

What Does a Broker Say?

One advantage to posting on CreditSlips is that I get a lot of people who try to help me understand things.  I had a long, interesting conversation yesterday with a person who has been a mortgage broker and who current trains mortgage brokers. He said, "If I go to Macy's and they have a shirt for $60, and I go down the street to Sears and they have the same shirt for $40, it is up to me to figure out that I should buy the $40 shirt. Why is it different with a mortgage broker?" 

Why indeed?  In fact, as we talked, he--the broker--came up with five big differences:

Hate Mail

Last Tuesday I published an Op-Ed in the Boston Globe about mortgage companies that pay brokers to sell higher priced mortgages to customers. (E.g., a customer qualifies for a 6% mortgage, but the mortgage company pays the broker a higher fee to sell him a 7% mortgage.) I called the payments "bribes" paid by the mortgage companies to the brokers to boost mutual profits at the expense of the homeowner. I was in good company. The Vice-President of the Fannie Mae Foundation called them "kickbacks." After the op-ed was published, I was flooded with hate mail. It was so bad that when there was no let up by the end of the third day, I thought I might have to change my email address.

Some of it was funny ("your stupid"), weird ("I thank God my son went to BU instead of Harvard"), or silly ("you must be a Communist"). But most of the correspondence fell into three main buckets:

Points for Tough Gals

Lisa Scottoline is one of my all-time favorite mystery authors. Not only does she write about tough women, she also locates all her stories in Philly. Yeah, I'm an Okie, but years of teaching at the University of Pennsylvania altered my chromosomes so that I yearn for cheese fries and I can now pronounce Schuylkill. (In fact, I can now shout "Yo, get that heap off the Schuylkill" when my mouth is stuffed with cheese fries.  My Okie family does not know this about me.)

So it was a special pleasure to see my gal Lisa take on credit cards. She writes about rewards programs. But the part that caught my eye was that she couldn't get a real, grown-up American Express card, but she could get and use a big-time American Express Business Card. Same Lisa, same income, same FICO, but Business Barbie Lisa can have a card that Regular Paycheck Lisa can't get. Why would that be so? 

Deathstar Arbitration

Arbitration may seem like the Andy of Mayberry form of dispute resolution--folksy, cheap and fair.  The data suggest, however, that it is Darth Vader's Death Star--the Empire always wins.  A new report from Public Citizen shows that the consumer loses in 95% of arbitration cases--dominance that would have made the Emperor proud.

The Public Citizen report follows an earlier jaw-dropping report this summer from the Christian Science Monitor showing that the most frequently chosen arbitrators ruled against consumers and for the companies 98.4% of the time.  After serving as an arbitrator, former judge Richard Neely described arbitration as full of "Godless bloodsuckers."  (Gee, Judge Neely, tell us what you really think.)  Several academic pieces of condemned the current use of arbitration clauses as well. 

Pre-testing Makes Perfect

Anyone who does empirical work knows the importance of a pre-test.  This is the time to figure out that a question is ambiguous, that a survey is too long, or that the survey plan will systematically miss certain people.  Katie Porter can tell her tales about pre-testing the 2001 Consumer Bankruptcy Project in a cold Boston courthouse (and nearly giving up on empirical work before she started).

The Census Bureau is no exception. They have to work the kinks out of questions, survey techniques, and the newest technology just like the rest of us.  They get one shot every ten years, and they need to make it right.  Mistakes would echo through federal funding for local economies, representation in Washington, and just about every other study that involves the American population.

So it was a show-stopper for me this morning to learn that the Census may not have the money for a pre-test.  Congress can't agree on a new budget, so it plans to hold spending "level" at the old dollar amounts.  That may sound fair in most cases, but "level" funding means no new money to cover the cost of pre-testing the 2010 census.

Theory v Data: The Substitution Hypothesis

Economists often take the position that they would be glad to help poorer families, but that such efforts would either be a waste--or would make things worse.  In the area of credit regulation, for example, the constant pitch from some academics (and echoed by the banking lobbyists) is that any constraints on credit cards, for example, will result in driving the country's most vulnerable citizens to far more dangerous lenders.  The theory, called the substitution hypothesis, has been in vogue for two decades, helping to checkmate any serious effort to rein in predatory lending practices. 

The theory sounds plausible, but a little evidence can shake up a lot of ideas.  Angie Littwn has a terrific new piece that directly challenges the conventional wisdom regarding the substitution hypothesis, showing, for example, that those without credit cards simply have less total debt than those with credit cards--not that they take on "worse" forms of credit if they don't use credit cards.  But the really unexpected zinger in Angie's paper is that, according to the families she studied, there were no credit options worse than credit cards.  In other words, in the words of these struggling families, credit cards are as bad as it gets.

Visualizing Bankruptcy

The variations in how people learn always amazes me.  For some, a wordy explanation makes the brain smile.  For others a mathematical formula sings out loud.  For me, a good graph is better than a good glass of wine--interesting, complex, and just a surprising hint of color.

So I was tickled to see Lynn LoPucki's new, post-amendments Bankruptcy Visuals are out.  Lynn has developed the most amazing single-sheet graphic on bankruptcy that I've ever seen.  He has one for Chapter 7, one for Chapter 13 and one for Chapter 11, each showing a case from start to finish.  The visual has an explanation of what happens at each juncture, complete with Code cites, which makes it a kind of one-page review of all of bankruptcy.  But the part that makes it special is that by getting it all on one page and putting the pieces in chronological order, the relationships between the parts are all visible at once.  The complexity--and the simplicity--of the system come to life.

The Poop on Foreclosure

A couple bought a house at a foreclosure sale, but when they got inside they learned it was full of live animals, dead animals and animal poop.  The buyers are scrambling to get out of the deal, but, at least from the news report, there are no obvious grounds for reversing the deal.

The story is pretty gross, but it highlights something that lots of people don't realize: A homeowner is entitled to stay in possession of the home until after the foreclosure sale.  No one --not the bank or the potential buyers--have any right to enter the house to see if the room arrangement is pleasing, the plumbing is functional or there isn't poop several inches deep on the floor. 

As the subprime market continues its downward trend, think about the poop.

Onion Soup

Angie Littwin pointed out The Onion's pseudo-survey of what people who are trapped in subprime mortgages are planning to do. Great sport, but what ARE families going to do?  For all their fulminations, most of the Washington crowd is focused on developing regulations to stop the next credit bubble--not to help millions who will be hurt by this one. 

Bankruptcy law is the final arbiter of debtor-creditor rights, but it is always tough to teach this particular asymmetry in the law:  If a corporation can no longer afford the mortgage on its factory, it has powerful tools to rewrite the mortgage in bankruptcy.  But if a homeowner is in exactly the same trouble following an interest rate hike, those same tools are unavailable.

Arbitration First-Hand

In our running discussion of arbitration, the data are useful, but sometimes it helps to get the flavor of how an arbitrator makes a decision. An attorney forwarded this email to me, which I post with permission of the author:

Had a very interesting experience today. Responded to an arbitration claim by FIA Card Services f/k/a MBNA denying client agreed to arbitration and disputing amount owing.  Requested an in-person hearing and client paid $250 fee for the hearing. Originally the hearing was scheduled at a location more than 3 hours away from my office. I objected and it was rescheduled about an hour away. The arbitration was Harold Curry. I showed up at 12 noon. At 12:45 no one from FIA appeared or called. The arbitrator called NAF to find out what he should do and left a message that was not answered. Mr. Curry and I went into an office and talked a while. I pointed out to him that the claim was based on breach of contract, but no contract was ever produced, so he could not possibly determine the parties' obligations or damages. He asked me what my client owed MBNA. I told him I did not know and that it was not my job to help MBNA establish damages. If they were so concerned, they could have shown up for the arbitration hearing. He admitted that they never show up and he has never had an attorney show up before. Just before I left, he suggested that we might reschedule. I told him I would not agree to rescheduling and that I believed he had no choice but to find an award in favor of my client. This made him extremely uncomfortable and he indicated he would need to talk to someone at NAF first. I reminded him that he was supposed to be impartial and he told me he would give me his decision in a few days.

Creditors Trash Talk Debtors, But How Do They Really Feel?

"Revealed preferences" is a great term from economics.  It means pay attention to what actors do, not to what they say.  Creditslips' own Katie Porter has put together a fascinating study of bankruptcy and the credit industry in her new paper, "Bankrupt Profits: The Credit Industry's Business Model for Post-Bankruptcy Lending." She uses revealed preferences to inform the debates on bankruptcy abuse.  She says, in effect, stop listening to what the credit industry says about the opportunism or moral slackness of people who file for bankruptcy.  Instead, look at how the card issuers treat people who are bankrupt. 

Creditors talk the talk, but do they walk the walk?  Katie's got the numbers.

From 20% to 2000% in One Generation

Usury laws have been the workhorse of consumer protection, a tradition that intertwines both moral and economic principles.  The laws reach back to Colonial times in the US and centuries before in Europe.  Now Chris Peterson offers an empirical study of what has happened to usury laws in a single generation.

Instead of spending more time lamenting credit card companies' escape from usury regulation via Marquette, he focuses on what has happened to usury laws within the states.  After all, the multi-billion dollar payday lending industry now operates at the state level.  Peterson compares the state of usury laws in 1965 with what they look like today.  In one generation, in many states, this historic form of consumer protection has gone to hell. 

Making Numbers Count

The minimum wage reset yesterday.  What will that mean to millions of American families?  We can all read the numbers: minimum wage hasn't kept pace with increases in the cost of living.  But the Center for American Progress restated the numbers in more meaningful terms.  How long does a minimum-wage worker have to work to make enough money to buy dinner for a week?  To pay for electricity for a week?  To buy a gallon of gas? 

By restating income in terms of what an hour's worth of work bought back in 1997 and what it buys today, CAP shows the impact of increasing the minimum wage.  Perhaps more telling (and easier to see) is the number of hours that low-wage workers must work in order to buy food, power and gas.  Hamburgers for a week for a family of four (no ketchup, no mustard, no desert) took 13.61 hours of work just before the change. 

Mormons Go Bankrupt

For the past several years, Utah has had the dubious distinction of having one of the highest bankruptcy filing rates in the country.  In 2004, for example, nearly one in every 41 families in Utah filed for bankruptcy--about twice the national average.

This is especially surprising because people in Utah have higher rates of education.  Moreover, the Mormon church preaches the importance meeting financial responsibilities and warns against debt.  So why are so many people in Utah in financial trouble?  The practices of Mormons have come under fire:  early marriage, large families, and the effects of tithing. But a new study says no:  Mormons in Utah are slightly less likely to file for bankruptcy than non-Mormons.  The researchers (and my former students), Jim Wright and Zeke Johnson, say the problem lies elsewhere.  In a stroke of good timing, the Urban Institute just released a study that adds more heft to the Wright/Johnson analysis.

Stacking the Deck

Senator Russ Feingold and Representative Hank Johnson have introduced legislation to stop the fine-print, mandatory arbitration clauses that show up in millions of credit card agreements.  Once a dispute arises, if both parties want to go to arbitration, that's fine. But the company cannot hide an arbitration clause deep in the fine print of the credit card agreement, then require arbitration when they want to squeeze a customer for money the customer says she doesn't owe.

Why is this such a big deal? Arbitration sounds like a cheap, fair way to settle disputes. But a study from the Christian Science Monitor shows another reason: the arbitrators are beholden to the repeat players (credit card companies) that pay their fees. The top ten arbitrators ruled for the customers just 1.6% of the time, while arbitrators who weren't depending on arbitration fees (those who decided 3 or fewer cases a year) ruled for the customers 38% of the time.

Bankruptcy Judges and BAPCPA

Yesterday the House held a hearing on Medical Debt and Bankruptcy. Donna Smith, a smart, thoughtful woman forced into bankruptcy by medical problems was the star witness. (She was also featured in Michael Moore's SICKO--see it!) My co-author Dr. David Himmelstein from the Harvard Medical School was terrific, as was Mark Rukivana from The Access Project. I also testified, mostly about our studies and other people's studies on medical bankruptcy.

But I learned something new. During the Q&A, Professor Todd Zywicki testified that one of the key lobbying groups opposing the 2005 bankruptcy bill was the bankruptcy judges, who with bankruptcy attorneys balanced out the influence of the credit industry lobbyists. Why would the judges lobby strongly against BAPCPA? He said flatly, "Bankruptcy judges just want more bankruptcy."

Professors and Pickets

Richard Michael Fischl, a professor at the University of Connecticut, wrote "The Other Side of the Picket Line," about the SEIU's organizing effort at the University of Miami last year (when Fischl was a Miami law professor). He explores what it means to teach classes in the middle of a janitorial strike, focusing on the question of whether he should move classes off-campus so that neither he nor his students would be forced to cross a picket line to get to class. The piece is layered and nuanced, and Professor Fischl makes a number of points that make it clear that he is a dedicated and thoughtful teacher.

The piece set me thinking about credit cards. Credit Slips bloggers are professors, most of us at universities that get big bucks from permitting credit card companies access to our students with on-campus solicitations, mailing lists, dorm mailboxes, noticeboards, etc. So what if a group--say PIRG--organized a student protest? What if they made a demand on the administration to rid our campuses of these lenders? And what if they organized a boycott or called for a general student and faculty strike? Where would we stand?

More Risk in the Mortgage Market?

The big financial news this week-end is Bear Stearns' decision to put $3.2 billion into its struggling hedge fund to try to stave off collapse of both the fund and the mortgage securities market.  An academic paper,  "How Resilient Are Mortgage Backed Securities to Collateralized Debt Obligation Market Disruptions," presented early this spring at the Hudson Institute suggests that the mortgage market has been structurally realigned, and that the whole system is far riskier than rating agencies, regulators or investors have perceived.  If the paper is right, Bear Stearns has taken the financial equivalent of striking up the Titanic band to play "Nearer My God to Thee."

Warning: This Card Stinks

A friend of mine asked me a question.  In keeping with Angie's post on state laboratories, I thought I'd pass it along for collective wisdom:

• I realize that states have little practical authority to regulate credit card practices because it is the regulatory rules of the bank's home state - not the consumer state - that apply.  But I was wondering whether the same is true of consumer warnings.  Could NY, for example, require that credit card solicitations in their state include warnings - for example, saying "This product includes rules that New York State believes are unfair to consumers"? 

Debt Burden

LendingTree has just released a new debt survey showing that 48% of Americans are worried about their debt loads, and that 20% expect to be stuck with credit card and other non-mortgage debt for the rest of their lives. Lending Tree tries to put a happy face on some of the data (most people "perceive themselves as some day being debt free"), but I didn't feel any better when I read it.

But overall the descriptions are quite reasonable, and LendingTree deserves kudos for their detailed reporting.  They give numerical responses on all their questions, broken out by age.  It is a treasure trove for all the data jocks who frequent this site. 

Student Loan Scandal Fallout

Among the many wonders of the 2005 bankruptcy amendments is the provision that for-profit student loan agencies would get the same protection of non-dischargeability as government lenders.  No one seems to know where the amendment came from and no one seems to recall any evidence of abuse that would cause these for-profit lenders to get treatment usually reserved for domestic support recipients and the taxing authorities. 

In the wake of the scandals over loan company payoffs to college officials, higher education experts are taking a closer look at BACPA.  In a document that was leaked last week, the lobbying strategy of for-profit lender Sallie Mae was exposed.  Educational policy expert Bob Shireman has started asking questions about those strategies, particularly as they relate to bankruptcy. 

Warning: Your Toaster Will Explode

Americans for Fairness in Lending (AFFL) is urging people to write Congress to say, "Disclosure is not enough."  AFFL is criticizing what CreditSlips' own Bob Lawless called the "weak gruel" of the Federal Reserve's new credit card restrictions.  The group says the Fed's disclosure approach isn't enough.  After all, disclosing abusive practices isn't the same as stopping abusive practices.  AFFL wants regulation, and they don't want Congress to hide behind the Fed's new gruel to avoid the problem. 

There is, of course, a huge policy divide between those who think regulation is needed in many areas and those who think free markets will provide the best results, so long as there is adequate disclosure.  But when I saw the AFFL petition, I didn't have to think about the big policy question.  I just thought bout exploding toasters. 

Entrepreneurial Studies

Last week Bob Lawless posted Entrepreneurs Among the Bankrupt.  As his co-author (or co-conspirator) on a study of bankrupts who are self-employed, I paid particularly close attention to what he had to say.  My first thought was that publishing his doubting remarks about whether there is a coherent (even if incipient) field of entrepreneurial studies will probably not get him invited to more conferences on entrepreneurial studies.  My second thought was that he is probably right.

I was first struck by how loose is the definitiion of "entrepreneurial studies" when I talked with Stuart Gilson at Harvard Business School about our doing a joint study of failed entrepreneurs.  Stuart loved the topic, and over lunch we agreed that we should study only "small start-ups."  Just as the waitress brought the Gaucho Chicken with fries, Stuart asked, "Should we limit our sample to $5 to 10 million inital capitalization, or go to something like $50 million?"  When I explained that median debt (a good measure of size in bankruptcy) was about $153,430 in 1994 business bankruptcy cases, we just stared at each other.  While Stuart talked about angel investing and venture capital, I speculated that a lot of the failed entrepreneurs in bankruptices we financed on credit cards and the spouse's job at an insurance office.  We drifted apart.

Senate Thinks About the Middle Class

For those of us who care about credit issues, yesterday's Senate Finance Committee hearing, called by Senator Baucus, was instructive.  The title: "Can the Middle Class Make Ends Meet?" I testified, along with a Brookings fellow, a social worker specializing in pediatric oncology, and the president of a tax-cut foundation.  Three of us thought the middle class was in trouble, and the fourth thought that thanks to tax cuts the middle class was doing great and the with more tax cuts they would be even better off.  (You can guess who took what positions.) 

While the senators focused mostly on specific issues like paying for college or the impact of a medical problem, everything said in that room (except maybe the tax cut stuff) was also about credit.  Rising debt, falling savings, bankruptcy, aggressive credit marketing, aggressive collection--it all plays out against the background of what's happening to the middle class.  If families could still afford to put away 11% of their incomes in savings, as they did in 1972, then the credit and bankruptcy issues we discuss would be very different.

Wife Beaters and Bankrupts

A quarter page advertisement in the New York Times shows a young man and woman laughing, (a boyfriend-girlfriend sort of moment), under the headline "GET THE WHOLE STORY ON HIM, BEFORE IT IS TOO LATE."  The advertiser, Intelius, promises to check out two things:  1) Bankruptcy, and 2) Domestic Violence Convictions. 

At the same time, Katie Porter unearthed the CapitalOne 10-K warning investors that future business might not be so rosy if "social factors" such as "the stigma of personal bankruptcy" decline.

So there it is:  A huge credit card company says it may see spiraling losses if more people decide to abandon all moral conviction, and a background search company reminds America that guys who file bankruptcy and beat women are on par with each other--shoot, maybe they are the same guys.

Corporate America has a message:  bankruptcy is about moral depravity.  It isn't about medical debt and job loss, not about ex-spouses who die or who run off.  and it certainly isn't about anything the lenders might have done--like high fee mortgages with introductory teaser rates or credit cards with interest rates that quadruple when a customer is late paying another creditor. 

Income Pain: Inequality, Volatility or Just Too Litte?

David Leonhardt's story in the New York Times this morning is about two widely used measures of middle class squeeze:  income inequality and income volatility.  He points out that inequality has increased shaprly over the past 20 years, but that a new report from the GAO suggests that volatility may not have increased.  He uses this certainty/uncertainty dichotomy to suggest that policies should be aimed toward the thing we're sure has increased (inequality) rather than the thing we're less sure has changed (volatility).  According to the GAO, one in five people experiences a drop of 25% or more of their income each year, a proportion that was about the same in 1980, and, by implication, not an issue worth worrying about. 

I applaud Leonhardt for asking for more hard data and always cross-examinging the data available, and I suspect Jacob Hacker will have something to say about the GAO report.  But for now, it is the policy claim that puzzles me.  From my perspective, the harm to middle class families is the combination of stagnant incomes combined with rising costs. That combination means that volatility hurts more today than it did in the 1970s when families could put aside 11% of their pay in savings, when consumer debt was less than 2% of income and when two-parent families had a worker at home who could go into the workforce in a time of crisis.  When a family has no savings, no back up worker, and is loaded with debt, every income disruption is more painful--and more dangerous. 

A Conservative Talks About Credit Cards

Yesterday Professor Charles Fried, the elegant, eridite former Solicitor General of the US and former Supreme Court Massachusetts Supreme Court Justice, sparred with eminent philosopher and law professor Cass Sunstein and Harvard economist Ed Glasser in a faculty forum over "the Nanny State."

The discussion was lively and engaging, but Fried's remark on credit cards stopped me in my tracks. Fried was aggressive in his defense of unregulated consumer choice. He poo-poo'd the idea of regulating much of anything in order to protect people from themselves, following the classical conservative position that people should be free to make as many choices as possible. But Fried made a point of mentioning why current credit card practices are morally reprehensible. I'm not a perfect reporter, but I tried to scribble down what he said:

"Credit card issuers make a profit from trying to get people to hurt themselves. That isn't about consumer choice. That's just reprehensible."

Why Do Subprimes Fail?

In all the back and forth about subprime mortgages, most news reports miss a central fact:  Many of the families that have subprime mortgage could have paid a mortgage with less onerous terms.  For examples, some families who were sold teaser rate mortgages that escalated from 2.9% to 12.9% may be in trouble even though they could have made payments on 7.9% mortgages.  Other families were told they qualified for $400,000 mortgages, which they could not manage once the introductory rates ended, but they could have managed $200,000 mortgages.  Practices like yield spread premiums encouraged mortgage brokers to steer others to subprime mortgages that they couldn't pay when their credit qualified them for prime that they could have paid.  In other words, the loan product itself caused part of the problem, not just the fact that the loan was made to someone with low income or damaged credit.   

Sharp businesspeople like Herb and Marion Sandler and Martin Eakes built strong companies lending money to people of modest means, many of whom had credit trouble.  But they didn't put their borrowers into loans they couldn't afford.  The whole idea behind their lending model was to put them in loans they could afford--and to keep the default rates low.   

A significant part of the problem in the subprime market is not simply that too many dollars were put into the hands of working families and people with bad credit.  The problem is that too many exploding products--products that were designed from the beginning to become unaffordable--were sold around the country. 

From Liar's Loans to Liar's Ratings?

We're all watching the subprime mortgage meltdown and the ancillary predictions about whether it will drag the economy directly into a recession.  But I'm losing sleep over a very different concern:  What if there's no recession because the rating agencies don't tell the truth? 

The emblem of the subprime mortgage meltdown has been Liar's Loans--high-interest mortgage loans for which the borrowers could fill in any numbers, and the mortgage companies wouldn't check.  In other words, bad information.  Now, from Gretchen Morgenson at the New York Times, comes a paragraph that makes me wonder if Liar's Ratings are coming next:

Nevertheless, some investors wonder whether the rating agencies have the stomach to downgrade these securities because of the selling  stampede that would follow. Many mortgage buyers cannot hold securities that are rated below investment grade — insurance companies are an example. So if the securities were downgraded, forced selling would ensue, further pressuring an already beleaguered market.

I get the part about the stampede, but I'm enough of a market purist to believe that when quality fails, the rating agencies MUST downgrade.  If they do not, then ratings are not giving a genuine mark of the quality of securities.  At that point, all confidence in the American markets will dissolve.

Guess Who's Coming to Lunch?

Judge Martin Isgur attended a Houston debtor's counsel luncheon in which the speaker, MMI's CEO menionted the company's policy against hiring any person who had filed for bankruptcy.  It is easy to imagine the thought bubble over Judge Isgur's head: "525?"  So the judge launched an investigation.  In re Credit Counseling in the Southern District of Texas, No. MC-07-301 (Bankr. S.D. Tex. 2/15/07).

Eric Van Horn, a former student of Jay Westbrook and now an attorney with Diamond McCarthy, emailed to point out the irony:  The same Congress that wanted to limit judicial discretion in dealing with the parties in court (e.g., creating automated tests for substantial abuse and disposable income), told the judges to get out there and police those credit counselors.  Sec. 111(e) authorizes the district court (and therefore the bankruptcy court?) to launch an independent investigation based on whatever he learns wherever he learns it.  Here, lunch results in an investigation.

You Are Pre-Approved--8 Billion Times

In 2005, Congress gave the credit industry what it wanted:  tighter bankruptcy laws.  In 2006, the credit industry responded by mailing out 8 billion credit card solicitations--up 30% from 2005.  Larry Ausubel and others predicted during the debates over the bankruptcy laws that if Congress made it tougher to go bankrupt, then lenders would engage in riskier lending as they tried harder to get people to borrow. 

What kinds of risks are the card companies willing to take on?  With about 110 million households in the US, that's about 73 card offers per household.  If the average card offers is about $5,000 in pre-approved credit, that about $365,000 in offers for every American household--or about $1000 a day, every day of the year. 

The Bankruptcy Solution

What problem does bankruptcy solve?  It gets rid of some debts.  It gives a debtor a chance to deaccelerate a home mortgage.  It provides a framework for renegotiating a car loan.  It stops collection calls.  But does it put the debtor back on her feet?  In other words, after we have performed the magic incantations of bankruptcy, what happens to the families that were in terrible trouble?

In the first-ever detailed, empirical study of post-bankrupt families, CreditSlips' own Katie Porter and Debb Thorne provide an answer to that question.  (Katie and Debb are much too modest to toot their own scholarly horns here, so I'll talk about the piece without their advance knowledge.) 

They ask how many families are managing their post-bankruptcy bills reasonably well, and the answer is not good.  A year after bankruptcy, about one in four families was struggling to pay basic expenses.  The likelihood of post-bankruptcy recovery was tied to reasons for filing.  When debtors had serious income problems from unemployment, medical problems or old age, they were far less likely to be among those successfully rehabilitated in bankruptcy. 

Loading the Numbers

Promising to "explode the myths of populism," the Third Way issued a new report today with rosy statistics about the prosperity of the middle class.  The problem is that the stats are loaded. 

The lead statistic is that median income in the US is "around $70,000, not the $45,000 that most progressive economists cite."  The numbers cited by "progressive economists" are plain old Census numbers, not some flukey, small-sample study.   What Third Way doesn't say in the press release is that they arrived at the new $70,000 number by cutting out all young earners and all old earners.  Since those age groups tend to have lower incomes,  income for the remaining subset increases.  This is just a third-grade math trick: cut out those who make less money, and the median rises.  Third Way might have added that if you cut out those who earn more money, the "median" income is lower.  Either way, cutting out wide swaths of the population doesn't change the fact that the family in the middle earns $45,000. 

A New Voice

Tomorrow marks the debut of a new journal:  The Harvard Law and Policy Review.  I am pleased as punch  because my students founded the journal.  But I'm also pleased because they have a vision to integrate policy and academic debates that I believe in.  So far, the journal is off to a good start, with Charles Schumer weighing in on separation of powers and Patricia Wald responding.  In addition to a senator and a circuit court judge, the other participants include scholars from political science, law, private foundations, and a variety of other experiences and backgrounds.  There's even room for online commentary from readers. 

What particularly excites me is that the journal features middle class economic issues front-and-center.  Grouped together as part of a discussion on reducing the price of opportunity, the journal has pulled in Jacob Hacker for a piece on the new economic insecurity, Michael Lind on the smallholder society, Michael Barr focusing on savings, and a piece from my coauthors and me on paying for college. 

In my view, economic issues of the kind we commercial law folks discuss have been second-class citizens:  not as sexy as multi-billion dollar corporate finance twists nor as profound as interpreting the Constitution.  Sure, the bankruptcy debates went public, but generally commercial law has been regarded as something for technocrats (read: boring).  Serious policy debate designed to appeal to a broad audience either in the academy or the public needed to focus on other subject areas. 

This has been a mistake.  The economic issues that are buffeting the middle class--and the legal policy decisions that assist or retard that buffeting--are of central intellectual, economic, and political importance.  Our stuff matters.  In their first issue of HLPR, the editors seem to agree. 

I don't know what the journal will take on next, but focusing on economic opportunity in the first issue gives me hope.

A Non-Contingent Thank You to David Moss

It has been a treat to read David Moss's posting this week on income-contingent lending in higher education.  He introduces an idea we haven't been talking about, and he offers a rich intellectual history to put it all in context.  Financing college through ICL is a creative policy idea worth talking more about.

For those who would like to get to know David's ideas better, I recommend his book, When All Else Fails:  Government as the Ultimate Risk Manager.  Bob mentioned it, but I want to bait the hook with more information:  The book ties together flood insurance, product liability, central banking and bankruptcy--truly fascinating stuff.  David has a truly original mind.   

Because David and I teach at the same university, I have the pleasure of regular lunches at the Border Cafe (in this case, the "Border" signifies the half-way mark between the Business School and the Law School).  David always makes me think about new things--even though I always order the same gaucho chicken.  His guest posts on CreditSlips have been equally invigorating.

Thank you, David. 

Who Gets Protection?

Two numbers summarize US consumer protection policies for financial products:  1) The SEC is considering a modification of a rule so that hedge funds cannot sell their high-risk investment devices to 98.7% of all Americans.  2)  An estimated one in five recent subprime home mortgage borrowers will lose their homes.  There it is:  When you might lose your investment in stocks, the SEC imposes suitability rules that prevent brokers from selling high-risk products to all but the most sophisticated investors.  But when you could lose your home in a refinancing, federal regulatory agencies have largely left consumer to the wolves. 

Investors get protection because the government decided a long time ago that there would be more confidence in the market if the repeat players (the brokers) bore some obligations to their customers not to steer them to high risk investments. Over time, the market has evidently agreed and regulations to protect consumer investors have been strengthened.   But high risk mortgages reflect the opposite mindset.  The home is the largest single investment the typical middle class family will ever make, but it's "buyer beware" in the subprime mortgage market.

Economic Model Almost Working or Broken?

A growing body of research suggests that humans make decisions that are not entirely consistent with the picture of an economically rational actor (e.g., in an experiment, econ students spend more when they use credit cards than when they use cash).  A new study by Sumit Agarwal, Chunlin Liu, Nichaolas Souleses, and Souphala Chomsisengphet uses data from a credit card company that offered two cards:  one with a higher interest rate and no annual fee and a second with an annual fee and lower rate and the subsequent borrowing.  They then studied the paying behavior of the customers to test consumer rationality in this limited sphere.

Agarwal, et al, report that consumers get the right answer about 60% of the time--that is, those who borrow little or no money correctly take the no-fee card and those who borrow more money over a longer time correctly pay a fee and take the lower interest rate option.  Of those who make the sub-optimal choice, some make changes later (as the experiment permitted), but the net errors were substantial, costing many consumers hundreds of dollars even in this limited test.  Agarwal and colleagues note that "a small minority of consumers persists in holding substantially sub-optimal contracts without switching."  (I would report the percentages, but I can't quite figure them out from the table.)

Do these data support the notion legal policy can be shaped by the presumption of economic rationality, or do the data support a call for more regulation?  After all, a majority of consumers get the decision right, and an even larger majority get it right after they first lose some money.  On the other hand, a 40% error rate is pretty staggering, particularly in light of the authors' note that this is an "especially simple decision" that may have limited applicability in more complex decision making.

One in Five

One in five families spent more than 10% of their annual income on health care in 2003, says a new report in the Journal of the American Medical Association.  That's 48.8 million people younger than 65 (people over 65 were excluded from the study) living in families that spent at least 10% of their take home pay on medical care, an increase from 1996 to 2003 of 11.7 million people.  If that news isn't bad enough, consider the subset of people living in families paying more than 20% of their income on medical care--18.7 million people, or 7.3% of the under-65 population.  About two-thirds of these people had health insurance.

Earlier the Kaiser Family Foundation announced that nearly one-quarter of Americans are having trouble paying medical bills, and that 15% of families have been contacted by a collection agency about medical bills they cannot pay.

Debb Thorne, Melissa Jacoby and I, along with our Harvard Medical School coauthors David Himmelstein and Steffie Woolhandler, have written in a medical journal and a law review  about the impact of medical problems on bankruptcy filing.  If our 2001 findings were applicable in 2004, then about 800,000 families filed for bankruptcy following a serious medical problem, and about three-quarters of those families had health insurance when they first filed. 

The JAMA report is entirely consistent with our findings, but it raises a haunting question:  with the 2005 bankruptcy amendments pushing filings down to around 600,000 total this year, what has happened to families with unpayable medical bills?