Sources: FDIC, Census Bureau,,
An obscure legal loophole, discovered in 1978 and validated that same year by the US Supreme Court, changed forever lending and borrowing practices, and the housing market, in the US. Until that time, interest rates were a matter of states’ rights, and most states carried on a long-standing tradition of anti-usury laws designed to protect consumers from unconscionably high interest rates. In 1978, the Supreme Court, in the infamous Marquette decision, said that existing laws allowed lenders to charge borrowers anywhere in America the rate ceiling allowed in the lender’s state of incorporation, regardless of the rate ceiling in the borrower’s state, and that it was up to Congress to change the law to prevent ‘exporting’ of high interest rates. Congress did nothing, lenders flocked to Delaware and Nevada (the two states with no rate ceiling, which are still home to the companies that do half of all consumer lending in America) and in four short years virtually every state, to prevent exodus of financial institutions, had scrapped its interest rate ceiling.

There was at first bi-partisan celebration of this ruling. Free-marketers saw this as the removal of an unnatural impediment to business, the end of interference in the establishment of rates that truly reflect the lending risk. Liberals saw this as an opportunity for middle-class Americans to finally buy their own homes — prior to the removal of the interest rate cap, most lenders would only lend money to the rich, people who really didn’t need money and used it principally for investments. At the time, inflation was rampant and even the rich were paying high rates of interest on borrowings, so the dangers of eliminating anti-usury laws was unforeseeable.

A quarter century later, the consequences of this ruling are clear. In their well-reasoned and thoroughly-documented book The Two Income Trap (the Salon review of which I covered last year), Harvard Professor Elizabeth Warren and her daughter outline what has happened since 1978:

  • The proportion of Americans who own their own homes has risen a paltry 3%.
  • 140 million (70%) of adult Americans now admit they are carrying so much debt it is making their lives difficult and unhappy.
  • Bankruptcy rates for women have risen 662%. Foreclosure rates have risen 400%.
  • Having a child is now the single biggest predictor that a woman will declare bankruptcy.
  • One out of 7 families with children will declare bankruptcy this decade, and at least that many more should declare bankruptcy to make a fresh start but will instead out of ignorance or fear live with the constant horror of repossessions, hounding and threats from creditors.
  • More Americans each year declare bankruptcy than have heart attacks, get diagnosed with cancer, graduate from college, or get divorced.
  • Increased availability of credit has more than doubled the price of housing, to the point that after paying for housing and other essentials (and the other essentials have actually decreased in cost), the average two-income family has less disposable income than the average one-income family had a generation ago.
  • Families with children have driven up the price of housing in many areas with desirable public schools by as much 600%, and a recent survey indicates proximity to good schools is now the single largest determinant of US residential housing price.
  • Credit card debt balances have risen from $20 billion to nearly $800 billion, a forty-fold increase (see chart).
  • The average interest rate on Citibank mortgages is nearly 16%, ten points above prime, and interest rates on ‘sub-prime’ mortgages are much higher than that (Citibank and other lenders don’t divulge the breakdown). On an average home with an average mortgage, the ‘sub-prime’ borrower is therefore paying $500,000 more over a 30-year mortgage life than a prime rate borrower.
  • Visible minorities and those with limited education are twice as likely to be paying the high rates of ‘sub-prime’ mortgages as whites and college-educated people with the same incomes. The reason, according to one retired lender: Because the lenders know they can get away with the higher charges.
  • Credit companies including Sears, AT&T, GE, Macy’s, JC Penney, Circuit City, Radio Shack and GM are just some of the companies that have paid millions of dollars in fines for illegally hounding people after bankruptcy, and for illegally hounding descendants of deceased customers, to repay credit card balances. Most of these companies now make more money from finance charges than they do from selling products.

Even the FDIC, the government body that insures the banks, has expressed alarm at the unforeseen and, in human terms, tragic consequences of unregulated interest rates and credit. They acknowledge the direct correlation between the hawking of massive amounts of credit to everyone in the country at outrageous interest rate, and the rate of personal bankruptcies (see chart above — the blue line, left scale is the bankruptcy rate; the yellow line, right scale, is credit card debt). They even make it clear that it is the aggressiveness of lenders, more than interest rates per se, that leads to bankruptcies: In Canada, which has never had anti-usury laws, bankruptcy rates were always significantly lower than in the US, except for the brief period in the 1970s, when VISA and MasterCard and their agents began aggressively pushing credit cards in Canada for the first time, when the bankruptcy rate in Canada surged and briefly surpassed the US rate. After the Marquette decision, US bankruptcy rates surged back ahead, and rates in both countries continue to soar.

The authors take great pains to demolish the myth, perpetrated to this day by neocons like William Buckley Jr., that it is consumers’ inability to budget and restrain themselves from making reckless purchases that is behind the skyrocketing bankruptcy rate, and that a lot of people just declare bankruptcy to discharge their personal responsibility for undisciplined spending behaviour. Compared to 1978, the average American family spends (inflation-adjusted) 21% less on clothing today, 22% less on food (grocery & restaurant combined), and 44% less on furniture and major appliances than they did, although their (mostly-two-income) family take-home has risen 70% relative to the (mostly-one-income) take-home of the early 1970s. Where has the extra money gone? First and foremost to skyrocketing housing costs (up 100% on average, up to 600% in areas close to the best schools). What else is way up in cost? Health insurance, transportation (to and from two jobs instead of one), pre-school, after-school-care and college tuition are all up from 100% to 500% in cost since the 1970s. Over 90% of all personal bankruptcies are due to three causes: job loss, medical problems, and divorce. The pervasive myths of reckless overconsumption and the immoral debtor are not only untrue, they are cruel deceptions perpetrated by corporatists to mask the real cause of skyrocketing debts and bankruptcies: Reckless lending, usurious and unconscionable interest rates, and cynical mortgage consolidations designed to facilitate foreclosure and expropriation of homes for corporate profit.

One lending analyst has broken the 18% annual charge commonly charged today on credit cards into these four components:

  • 7% for true interest, the cost of borrowing in a low-inflation world
  • 5% for administration costs (which are much higher than for mortgages because of the volume of transactions) and fraud costs (which the credit card companies are legally bound to pay, and which are soaring)
  • 3% for defaults — the cost of people who skip town, die or declare bankruptcy before paying their balance (did you know that if you die, your beneficiaries are under no obligation to pay off your credit card debt?)
  • 3% for ‘the opportunity cost of the early payment period’ (the losses the lender incurs when people pay off their cards on time)

So when you carry a balance on these cards, you are subsidizing three groups — card defrauders and identity thieves, bankrupts, and those who pay their balances in full each month. It is easier and cheaper for credit card companies to get you to pay for these costs than to improve security over credit card abuse, exercise more discretion in lending to those who can’t afford to repay, and get early-payers to pay their share of the administrative burden of credit card management. And that doesn’t include the other unregulated add-on costs: late-payment fees, balance transfer fees, transaction charges and other service charges, which a recent study showed are increasing by 20% every year. Late payment fees (charges when you don’t pay a specified minimum of your credit balance each month) alone are up 300% in the last decade.

As I mentioned at the end of my last economic post, one fourth of all new mortgages are now debt consolidation loans, mostly at high rates. These diabolical schemes often make things worse, and they’re being falsely sold as the panacea for families in financial trouble. They complete the cycle that is wiping out the American middle class, which looks like this:

  1. You want to put your children in a good school, so they won’t have to struggle like you did. So you pay the outrageous price, inflated by all the other parents with the same aspirations, for a home in the ‘right’ area.
  2. To pay for it, you both need to work, and one of you has to work two jobs. The ‘right’ area is not near your work, so now you need two cars, day-care, and a lot of other new expenses.
  3. You just qualify for the huge mortgage, but because of the risk you have to pay a much higher-than-prime rate: Citibank’s average 16%.
  4. You can just barely make the payments. And with tuition for university going up by double-digits for the 5th straight year, and youth unemployment through the roof, the dream of putting your kids through college is starting to look out of reach.
  5. Suddenly, one of you loses their job. Or gets sick. Or one of your parents gets sick, or children gets sick, so one of you has to stay at home to look after them. Or the stress breaks up your marriage and now you have two households to pay for.
  6. With the drop in income and/or increase in costs, you max out your credit cards, and the effective interest rate with penalties goes from 18% to 28%. You miss a mortgage payment and late fees and charges push its effective cost above 20% as well.
  7. In desperation, you consolidate your debts with a new mortgage, taking advantage of the increase in the value of your home. You end up with a mortgage larger than what you paid for the house, at a higher interest rate, but at least the credit cards are clear.
  8. You swear you’ll tear up the credit cards, but the only way you can pay for the medical bills, the transit pass, the gasoline bills, is on credit. You have no cash for heat, phone and electricity, so you draw cash on your credit cards to pay them, too. Some of the things you bought for a house on a ‘no payments until 2004’ basis are coming due, so they get rotated right back onto the credit cards. Soon they’re maxed out again.
  9. Ashamed and afraid and too ignorant to declare bankruptcy, you borrow from family and friends to pay creditors. You stop paying for life insurance, and sell family heirlooms in garage sales or on eBay. You’re crying all the time. The phone rings with creditors non-stop, threatening to take back your Sears Posturepedic, the kids’ Christmas toys. They even talk to your kids and tell them in condescending tones that their parents are bad people.
  10. And finally, you become one of the statistics on the blue (or if you’re a Canadian, the red) line on the chart above. You’ve probably lost your home, your marriage, the respect of your children, your friends (who you never repaid), your health. Everything. And all you were trying to do was put your kids in a good school.

So what are the answers? As the authors explain, they’re very simple: Congress needs to reinstate anti-usury laws, capping interest rates at a uniform rate, closely tied to the prime rate, across the country. Any and all fees would be added to the interest rate and the total would have to stay below the cap. And consumers need to look before they leap, and keep their debt-load below the level that would allow them to handle that debt if they were suddenly hit with a job loss, a sick or injured family member, or a divorce.

What are the chances of it happening? In the US, at least, it’s remote. The financial services industry is one of the largest campaign contributors to political candidates, and they are fiercely opposed to any re-regulation, which would have a catastrophic effect on their profits. They are, in effect, legally stealing from the poor and middle-class of America. The authors show how powerful this lobby is with a story about Hillary Clinton. Because America’s unconscionable lenders want to keep the screws on their poorest and most profitable customers, they have twice tried to ram through Congress a bill that would make bankruptcy declarations much harder to make, allow secured creditors to circumvent bankruptcy protection entirely, reduce the priority of family support payments over credit card debts, and require credit cards to be paid off along with mortgages, thereby making it easier for foreclosure before bankruptcy. These lenders contributed $60 million to various politicians to get their support. The authors, and other groups representing the poor, were able to convince Hillary to get her husband to veto the bill. But with MBNA bank the largest contributor to the Bush campaign, the bill was reintroduced, and now-Senator Hillary Clinton, beholden to bankers who contributed $140,000 to her campaign, supported it the second time. Only a fierce lobby, some of whose members were opposed not to the bill but rather to riders that had nothing to do with bankruptcy, managed to block it again — for now. Both John Kerry and John Edwards opposed the bill, and have promised to pay more attention to bankruptcy law if they are elected, so there is some room for hope.

What are the chances that Americans will follow the authors’ advice and rein in their spending, not on luxuries, but on the home they raise their children in, and allow for a contingency like loss of a job, a serious illness or injury, or divorce when they do up the family budget? Pretty remote. It’s like asking people to give up the American Dream. Even if, for many, it is destined to become a nightmare.

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  1. Dave,Thanks for a great post and a great political analysis.Best,Joe

  2. Rajiv says:

    A very interesting discussion of debt from The Mathematical Economics of Compound Rates of Interest: A Four-Thousand Year Overview Nine changes of the watery star [the moon] hath beenThe shepherd

  3. Rajiv says:

    Here is a repeat of the poem since the line breaks did not comeNine changes of the watery star [the moon] hath beenThe shepherd

  4. Rajiv says:

    Nine changes of the watery star [the moon] hath beenThe shepherd

  5. Johnny Nemo says:

    When corporations can flee without consequences to the location with the most lenient laws, the “race for the bottom” is inevitable, as your post so ably demonstrates.As your hero and mine, John Ralson Saul, writes: “Real competition […] can only be produced by thoughtful and tough regulation.”

  6. Doug Alder says:

    “fraud costs (which the credit card companies are legally bound to pay, and which are soaring)” I can’t speak for the US Dave but I can say pretty certainly that is not true here in Canada and I doubt it is true in the US. Here is how it works in Canada1. Fraud artist uses a stolen or phony credit card to puchase goods/services either in person or over the web from a business.2. Business submits transaction electronically, CC company approves transaction3. 90 days later CC company discovers this transaction was fraudulent and charges hte amount back to the business that accepted the charge. Money is immediately taken from that business’ credit account with the card issuer (Visa/MC/Amex)4. Business has no recourse unless they can prove that the card was legitimate at time of purchase and owner is trying to escape charges. To add insult to injury CC companies threaten to stop accepting credit cards from companies that complain too much or who accept too many fraudulent orders. Apparantly businesses are supposed to be able toidentify fraudulent cards when the CC companies own electtronic databases can’t.

  7. Michelle says:

    Fantastic post. I find it interesting that the road to financial hell begins with the search for a good school for the children. Perhaps if we start with some reforms in that arena, some of the rest will follow. I pay a higher mortgage than what I originally intended due to the search for a “better” school. What ended up happening was I pulled my son out of the still inadequate school and am now working two jobs so I can send him to private.

  8. Chui says:

    Where is the cheapest state to live in? Somewhere where food is cheap, it’s warm all year round, and rental is inexpensive?A friend who lived in a yacht told me that the cost of living is pretty low, but you can’t work.

  9. Susan Hales says:

    Don’t know if it is the cheapest, but down here in God-forsaken Alabama where the entire Nation knows the schools are inadequate, there are few good jobs and the cultural mix is pretty predictable, the housing and the tax rates are favorable and an enterprising knowledge worker could live very inexpensively. In Mobile, where I live, the schools are the worst in the state and most of the families have moved over to the other side of the bay to get better schools, creating a huge traffic situation since the jobs are mostly still in Mobile. The housing costs are piteously low and there is a vacancy rate that makes even rentals competitive. Of course, I’d bet you weren’t even considering Alabama, though you could live here on your Yacht also, at least during the non-hurricaine season. Come on down, I’ll show you around.

  10. Susan Hales says:

    Dave, just re-read your last paragraph, and I have to ask one question. What American dream? It’s “been done gone!”

  11. Jon Husband says:

    Nice new picture, Dave. And … I’d comment more on this post, but I think you know where I’m coming from and (most of) the choices I’ve made so far.

  12. Dave Pollard says:

    Thanks everyone. Doug: I misspoke. The point I was making is that if someone puts a phony charge on your card, you as the card-holder weren’t liable. It never occurred to me that the CC companies, who charge vendors an arm and a leg on each transaction, would go back and hit up the innocent vendor. These guys really are sleezy — if they can’t get one innocent victim, they’ll get the other. It’s even worse than I thought.

  13. Derek says:

    The administration fee is also covered by the vendor who pays between 2% and 5% (or in some industries, as high as 25%) cut to the CC company for the privilege of running the transaction through their network.I’d hate to think my paying off my CC bill every month was impacting other consumers.BTW, arizona is somewhat cheap to live in. My philosophy on the school thing is that its up to the parents, not the teachers, to determine the quality of education the student gets.

  14. Life Tenant says:

    Great post. Dave, you’re on a roll! Reaganite ideology teaches that regulation is always evil, so deregulation makes us more free, but individual consumers can be overwhelmed in financial markets which involve highly complex products and services, to the point where freedom becomes largely freedom to be fleeced. And worse yet, the most powerful players in the market in question have disproportionate power to rig what regulatory constraints remain to their advantage, as with bankruptcy laws.

  15. Dave Pollard says:

    Derek: Amen. If we *all* paid our CC balances each month the theft by the CC companies from the poor would be exposed, and stop. In Canada, a lot more card-holders do so, which is why debit cards have been such a success there relative to credit cards.Subdude: Exactly. The corporatists keep saying the market is ‘perfect’, while it’s the market’s imperfections (consumer ignorance, oligopolies) that make the obscene corporatist profits possible.

  16. Cheng says:

    I came to see your blog after reading the Two Income Trap book over the weekend. With expereience of helping thousands of homeless families and hear their stories, I think the bankrupcy data is just “afterwards” analysis. The true reason people become bankrupt is not that they are searcing for good school. (otherwise, how you explain the majority who buy a houses in good school district area and still fine and not go bankrupt?) The real reason I believe is that most people who eventually went bankrupt are people who “use their last penny, or even streach over that.” Why? every driver all know that if you want to change lane, you have to slow down and let more room to car in front of you before accelerate and change lane. If you run out of your last little room, there is no way you can easily accelerate and change lane. Any IC chip all have normal operating threshold, and once you run across that it will break down. So, one just can NOT try to “optimize” their resources or capacity.So, the problem for these people is that they tend to try to “optimize”, and they leave NO redundency on their means. When one make $50,000 a year, one could choose to spend $50,000 a year, so no money left for emergency, but many of them not even spend all $50,000 they make, they may even borrow extra $20,000 to spend. If one makes $50,000 and save it in the bank and only spend the interest, say, 10%, $5,000 and make another $50,000 next year and save it and now will have $10,000 to spend, 10 years later, s/he can spend $50,000 and yet has all s/he has made saved in bank, total $500,000. Many poors or barely homeless came to me that they could not pay the bill of heat of a few hundred dollars, and I told them to shut down the heat. I told them I did not turn on heat during winter, and my house is only 47 degrees. So, the way to be able to keep safe is NOT to overspend. Nothing wrong with TWO incomes. I bought a condo at high market, and I use one income to pay off mortgage, and later move to big house, and I still insist to use one income to pay off the mortgage, so what’s wrong with two incomes? The wrong thing is that one “over spend”, if one always spend 20% of the income, there is no reason to go bankrupt, right? Credit card is a great thing if one paid off the balance always. It is a great means if one is responsible. It is just like fire, if one is not handling fire responsible, fire will burn down, otherwise fire will give you heat and light.The solutions I got is much easier than ask congress to pass any law.1. Do NOT have kid till you own a home FREE of mortgage, weather a condo or a huge house. I learn this from son of a millionaire at college, and it worked great! Why? because once you have a kid, you will be likely having less income, e.g. wife not working, and more expense, child care, clothes …etc.2. Only use the interest of your hard earned money, NOT the money you make. That way, the money you make from job will never gone. so, when you are sick or laidoff, your money will continue to generate interest for your life.3. At real estate price low, use some of your money to buy condos and rent them out, so you will live partially on rent than all interest that will be less vurnerable to low interest rate.

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