19.10.04

FULL EMPLOYMENT FOR LOAN SHARKS! I have finished The Two Income Trap (details or compare prices) and must confess to being less than impressed with its recommendations. Apparently one of the authors did some consulting for Citibank, and recommended that Citi could reduce its bankruptcy-related losses by not lending to families who are "obviously in financial trouble." This proposal did not go over well with the senior man at the meeting, who noted that the bank made most of its profits from precisely those borrowers. (That is consistent with one nugget I learned: in the credit card business, a "deadbeat" is somebody who pays off his outstanding balance in full each month, thus exploiting the grace period and paying no interest. The problem the bank has is generating sufficient interest income from its portfolio of credit cards ... where some people pay no interest because they are using credit cards as float, and others pay no interest because they are deadbeats in the old sense of the word.)

So what's the solution? Turn to page 144.
The consumer-credit monster could be beaten back if Congress would enact a simple provision into law -- a provision that wouldn't require the creation of vast new oversight committees or contentious battles in the Supreme Court. Congress could simply revive the usury laws that served the country since the American Revolution. Federal law could be amended to close the loopholes that let one state override the lending rules of another. Alternatively, Congress could impose a uniform rate to apply across the country. Such a provision would enable the states or the federal government to reimpose meaningful limits on interest rates.
I will leave it to the legal experts to determine whether or not such a federal law would be contrary to the "full faith" provision or the commerce clause of the Constitution. Let me turn to the economics, but first let me alert new readers to the Utopian Wonk style of writing excerpted above. I have been reading this sort of stuff for years, and the "if only we would do this our troubles would go away" style leaves me cool. There is more of that sort of utopian wonkery to come, but let us turn first to the usury proposal.

Authors Elizabeth Warren and Amelia Warren Tyagi correctly note that such an interest rate cap ought to reflect the prime lending rate or the underlying rate of inflation so as to avoid a repeat of the Regulation Q follies of the late 1970s and early 1980s. But their expectation of the reaction of the banking industry is, well, utopian wonkery.
The beauty of this approach is that it would help families get out of debt without costing taxpayers a dime. How would it work? By harnessing the energy of the marketplace. Lenders themselves would transform mortgage and credit card practices just by acting in their own best interest. Since they would no longer be allowed to charge exorbitant interest rates to families with marginal credit records, it would be unprofitable for lenders to pursue [meaning to offer credit] families in financial trouble. Instead, banks would once again have a reason to screen potential buyers carefully, making loans to those who can really afford to repay.
But not repay too quickly, as the portfolio of loans might turn into an asset that paid less than a Treasury note. That policy might also bring us back to those thrilling days of the 1890s, as laid out in The Ledger, a publication of the Federal Reserve Bank of Boston's economic education unit.
Could we get along without a lot of the things we buy on credit? Yes, but our lives would be very different. There would be far fewer households with multiple TV sets and full-blown entertainment centers; fewer island cruises and trips to visit a certain cartoon mouse during school vacations. But there would also be fewer washing machines, clothes dryers, home computers, air conditioning units, and a bunch of other things that we've come to regard as essential. Easier access to credit has meant that more consumers can buy more products and services, benefit from using them now, and pay for them out of future income -- buy now, pay later.
The article helpfully emphasizes the importance of the "pay later." Note also the Utopian Wonk tone of the paragraph, and be alert to the post hoc fallacy that the paragraph introduces. Its point: there are many more consumer goods in today's homes than there were in a 1960 house, let alone a 1930 house or a 1900 house ... these are modelled in the Boston Fed's education center. It is an empirical question, however, whether easy access to credit hastened the creation of thick markets that supported industrial-style production of these goods. On the other hand, Chinese manufacturers and big-box retailers strike me as likely losers from a national usury law.

And it's not as if consumers who would be denied credit by regulated banks don't have other options. Williams and Tyagi helpfully note that credit-card lenders use methods other than "Jimmy the finger-breaker" to salvage delinquent loans. That is a potential capstone paper in a money and banking class: do the crime statistics reveal any effects of credit card deregulation on convictions for loansharking. There is a rather polemical book, Walter Block's Defending the Undefendable (details or compare prices) that makes a case for the loanshark as someone willing to bear higher risks in order to provide credit to people who would not get money from The [Regulated] Establishment. The loanshark story was more compelling in the days when money lenders could discriminate along racial and class lines. But I digress.

The real folly in The Two Income Trap is this excursion into Utopian Wonkery:
Reregulation would help solve a litany of evils. The most important is worth its own headline: Limiting interest rates would halt the rapid rise in home foreclosures. With a lower ceiling on interest rates, lenders would lead the charge to reestablish an appropriate match between family income and mortgage size, which would have the effect of reducing the mass of families that are sucked into mortgages they have no hope of paying. Minority communities would no longer find themselves stripped of wealth by predatory subprime [referring here to higher-interest mortgages to more risky borrowers] lenders. And homeowners would no longer be suckered into second and third mortgages that promise to lower their monthly bills but that actually rob them of the family home.
Right. Some people might not qualify for home mortgages at all. And an interest rate ceiling does not preclude a secured line of credit ... any credit card company that offers you a home equity line of credit is offering a mortgage (in most cases a second or third, in my case it would be a new first, which is why I decline such offers) and there is no reason for policy makers to treat borrowing against home equity as illegal per se. But the real Utopian Wonkery is yet to come.
Interest rate regulation would take the ammunition out of the middle-class bidding war, helping to save families from the Two-Income Trap. Competition for the best neighborhoods would continue, but if no one could get a mortgage that ate up 40 or 50 percent of the family's entire income, then home prices would begin to settle down to Earth. To many economists, this is a scandalous notion, involving a reduction in Americans' "net worth." But that net worth isn't worth anything unless a family plans to sell its home and live in a cave, because the next house the family buys would carry a similarly outrageous price tag. Some families with weaker credit
histories or more modest incomes might find themselves limited to smaller houses, but they would also be far less likely to end up in a home that drove them into the bankruptcy courts. Moreover, as housing prices leveled off, more families would be able to afford a home without having to resort to a subprime mortgage. Reregulation of interest rates would bring relief to all families, not just those already in serious trouble.
The problem, as Warren and Tyagi noted in the promising beginning of their book, is that the competition for best neighborhoods is driven by competition for schools. A serious voucher and school choice program is more likely to pop the housing price bubble (where is that story about upscale neighborhoods objecting to vouchers account the capital losses they'd bring?) than a usury law. A usury law, on the other hand, will confine education-consuming parents of modest means to poorer schools. Warren and Tyagi find that a small price to pay for their avoidance of bankruptcy. Egad.

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