Sources: FDIC, Census Bureau, Cardweb.com, BankruptcyAction.com
An obscure legal loophole, discovered in 1978 and validated that same year by the US Supreme Court, changed forever lending and borrowing practices, and the housing market, in the US. Until that time, interest rates were a matter of states’ rights, and most states carried on a long-standing tradition of anti-usury laws designed to protect consumers from unconscionably high interest rates. In 1978, the Supreme Court, in the infamous Marquette decision, said that existing laws allowed lenders to charge borrowers anywhere in America the rate ceiling allowed in the lender’s state of incorporation, regardless of the rate ceiling in the borrower’s state, and that it was up to Congress to change the law to prevent ‘exporting’ of high interest rates. Congress did nothing, lenders flocked to Delaware and Nevada (the two states with no rate ceiling, which are still home to the companies that do half of all consumer lending in America) and in four short years virtually every state, to prevent exodus of financial institutions, had scrapped its interest rate ceiling.
There was at first bi-partisan celebration of this ruling. Free-marketers saw this as the removal of an unnatural impediment to business, the end of interference in the establishment of rates that truly reflect the lending risk. Liberals saw this as an opportunity for middle-class Americans to finally buy their own homes — prior to the removal of the interest rate cap, most lenders would only lend money to the rich, people who really didn’t need money and used it principally for investments. At the time, inflation was rampant and even the rich were paying high rates of interest on borrowings, so the dangers of eliminating anti-usury laws was unforeseeable.
A quarter century later, the consequences of this ruling are clear. In their well-reasoned and thoroughly-documented book The Two Income Trap (the Salon review of which I covered last year), Harvard Professor Elizabeth Warren and her daughter outline what has happened since 1978:
Even the FDIC, the government body that insures the banks, has expressed alarm at the unforeseen and, in human terms, tragic consequences of unregulated interest rates and credit. They acknowledge the direct correlation between the hawking of massive amounts of credit to everyone in the country at outrageous interest rate, and the rate of personal bankruptcies (see chart above — the blue line, left scale is the bankruptcy rate; the yellow line, right scale, is credit card debt). They even make it clear that it is the aggressiveness of lenders, more than interest rates per se, that leads to bankruptcies: In Canada, which has never had anti-usury laws, bankruptcy rates were always significantly lower than in the US, except for the brief period in the 1970s, when VISA and MasterCard and their agents began aggressively pushing credit cards in Canada for the first time, when the bankruptcy rate in Canada surged and briefly surpassed the US rate. After the Marquette decision, US bankruptcy rates surged back ahead, and rates in both countries continue to soar.
The authors take great pains to demolish the myth, perpetrated to this day by neocons like William Buckley Jr., that it is consumers’ inability to budget and restrain themselves from making reckless purchases that is behind the skyrocketing bankruptcy rate, and that a lot of people just declare bankruptcy to discharge their personal responsibility for undisciplined spending behaviour. Compared to 1978, the average American family spends (inflation-adjusted) 21% less on clothing today, 22% less on food (grocery & restaurant combined), and 44% less on furniture and major appliances than they did, although their (mostly-two-income) family take-home has risen 70% relative to the (mostly-one-income) take-home of the early 1970s. Where has the extra money gone? First and foremost to skyrocketing housing costs (up 100% on average, up to 600% in areas close to the best schools). What else is way up in cost? Health insurance, transportation (to and from two jobs instead of one), pre-school, after-school-care and college tuition are all up from 100% to 500% in cost since the 1970s. Over 90% of all personal bankruptcies are due to three causes: job loss, medical problems, and divorce. The pervasive myths of reckless overconsumption and the immoral debtor are not only untrue, they are cruel deceptions perpetrated by corporatists to mask the real cause of skyrocketing debts and bankruptcies: Reckless lending, usurious and unconscionable interest rates, and cynical mortgage consolidations designed to facilitate foreclosure and expropriation of homes for corporate profit.
One lending analyst has broken the 18% annual charge commonly charged today on credit cards into these four components:
So when you carry a balance on these cards, you are subsidizing three groups — card defrauders and identity thieves, bankrupts, and those who pay their balances in full each month. It is easier and cheaper for credit card companies to get you to pay for these costs than to improve security over credit card abuse, exercise more discretion in lending to those who can’t afford to repay, and get early-payers to pay their share of the administrative burden of credit card management. And that doesn’t include the other unregulated add-on costs: late-payment fees, balance transfer fees, transaction charges and other service charges, which a recent study showed are increasing by 20% every year. Late payment fees (charges when you don’t pay a specified minimum of your credit balance each month) alone are up 300% in the last decade.
As I mentioned at the end of my last economic post, one fourth of all new mortgages are now debt consolidation loans, mostly at high rates. These diabolical schemes often make things worse, and they’re being falsely sold as the panacea for families in financial trouble. They complete the cycle that is wiping out the American middle class, which looks like this:
So what are the answers? As the authors explain, they’re very simple: Congress needs to reinstate anti-usury laws, capping interest rates at a uniform rate, closely tied to the prime rate, across the country. Any and all fees would be added to the interest rate and the total would have to stay below the cap. And consumers need to look before they leap, and keep their debt-load below the level that would allow them to handle that debt if they were suddenly hit with a job loss, a sick or injured family member, or a divorce.
What are the chances of it happening? In the US, at least, it’s remote. The financial services industry is one of the largest campaign contributors to political candidates, and they are fiercely opposed to any re-regulation, which would have a catastrophic effect on their profits. They are, in effect, legally stealing from the poor and middle-class of America. The authors show how powerful this lobby is with a story about Hillary Clinton. Because America’s unconscionable lenders want to keep the screws on their poorest and most profitable customers, they have twice tried to ram through Congress a bill that would make bankruptcy declarations much harder to make, allow secured creditors to circumvent bankruptcy protection entirely, reduce the priority of family support payments over credit card debts, and require credit cards to be paid off along with mortgages, thereby making it easier for foreclosure before bankruptcy. These lenders contributed $60 million to various politicians to get their support. The authors, and other groups representing the poor, were able to convince Hillary to get her husband to veto the bill. But with MBNA bank the largest contributor to the Bush campaign, the bill was reintroduced, and now-Senator Hillary Clinton, beholden to bankers who contributed $140,000 to her campaign, supported it the second time. Only a fierce lobby, some of whose members were opposed not to the bill but rather to riders that had nothing to do with bankruptcy, managed to block it again — for now. Both John Kerry and John Edwards opposed the bill, and have promised to pay more attention to bankruptcy law if they are elected, so there is some room for hope.
What are the chances that Americans will follow the authors’ advice and rein in their spending, not on luxuries, but on the home they raise their children in, and allow for a contingency like loss of a job, a serious illness or injury, or divorce when they do up the family budget? Pretty remote. It’s like asking people to give up the American Dream. Even if, for many, it is destined to become a nightmare.