The Rest Of The Iceberg

It should come as no surprise to anyone who's read my pieces for even as little as a year that the real economic crisis is still to come: credit card debt:

“The administration — which scheduled the meeting at the request of some issuers — has promised to address credit card practices that Summers recently blamed for coaxing consumers ‘into paying extraordinarily high rates that they wouldn't have paid if they knew what they were getting themselves into.’”

The trouble is this. People ran up their credit cards, secure in two pieces of information. First, they could always get a home equity loan to pay off the credit cards, which would also allow them to deduct mortgage interest. Second, the price of houses would always go up, so there would always be more room to refinance the house, and gather in more cash to pay off bigger credit card balances.

Keep in mind that a lot of the problem with the mortgage industry was that people who simply shouldn't have had mortgages got mortgages because banks wanted to throw money at them.

Why? It's not just the interest income, you see, but the fees a bank can charge. Late with a payment? We'll tack on $50. Missed a payment? That's $100.

And then they tightened the rules about when a payment was late and when it was missed. It used to be, if your payment was postmarked before the due date (like when you file your taxes, still) you were presumed to have made a payment to an agent of the company (e.g. the post office).

Now, payments have to physically be received in the office of the lender, and usually by some arbitrary time (say, 2 PM). Doesn't matter if your payment is in the office, so long as they haven't recorded it, they didn't receive it.

You can imagine what that's created.

And that was mortgages. For credit cards, it gets even worse.

A decade or so ago, I held a Fleet Bank Mastercard. I had a really nice rate, 4.9%, and made payments faithfully. One day, I dunno, it was raining or maybe we had a blackout, anyway, my payment was delayed in the mail and was late.

My 4.9% rate climbed up to 26.99%! Now, I was lucky. I had a good record, good credit history, and was able to point out it was a one time occurence, so they dropped my rate. The only reason I noticed it, to be honest, was that on my next statement the late payment fee was charged and as I was disputing that, I looked at the rate information.

Now, banks can do that to me even if my payment record is perfect. Even if ALL my payments to all my cards and on all my loans is perfect.

How? I could be late paying my phone bill. Or electricity. Or cable, even.

Here's a pro economic tip: when a bank starts tacking on fees like there's a sale on them, you can bet your boots that sector of their business is hurting badly. Which means credit card defaults are alarming the hell out of the guys in the pinstriped suits.

There's roughly $1 trillion in credit card debt out there. There's $6.5 trillion or so of mortgage debt.

The rub is, the $6.5 trillion is secured by a house. A piece of property. Something of value. The total losses if every loan collapsed might be something on the order of $500 billion (assuming all the houses eventually get sold).

That $1 trillion in credit card debt is unsecured. If every credit card suddenly became a bad debt, that's a trillion bucks out the door.

You see the problem, I'm sure. In fact, credit cards are even riskier than mortgages because every and any damned fool was offered one, even college kids.

The banks will not give this up easily, and certainly not without a fight.

Olly Olly Ox Unfree!

The dynamic of the American economy is a quasi-free market.

Or rather, it was.

The underlying mechanism of a free market goes something like this: I have a need, say, food. Company A determines there's money to be made in supplying me with food, but only at a price a) I'm willing to pay and b) they can actually make some profit at.

If Company A is the only game in town, they can charge pretty much whatever they want, because they know I need to buy food. Company B realizes there's a boatload of money to be made in food, so it opens up a store and competes with Company A. This drives down the price, since Company B and Company A will now engage in a war for my business. It's not a profit until someone actually earns it.

The rational consumer, of course, will pay the least amount of money he possibly can for food, so long as the quality is comparable from Company A to Company B. Meanwhile, Company A and B will try to maximize their profits, either by charging as much as possible or by cutting their costs to produce food by as much as possible, or both. Again, this is rational.

Supply competes to fulfill demand, and if there's not enough demand, Company A or B goes out of business or tries to create more demand for their product by expanding markets or finding some other advantage for their product.

This scenario assumes a few things that may not always be true, and indeed, one basic assumption has not been true for some time now, ever since the late 80s, early 90s.

This scenario assumes a limited amount of money for the consumer. So long as personal credit markets were tight, this was how free markets worked: people had limited income, so voted for products based on whether they could afford them or not.

The twin barrel gun that shot huge holes in the capitalist system were mortgages and credit cards.

Now, both serve a purpose, when used wisely. After all, if it takes 30 years to pay off a mortgage with a reasonable cushion for your day to day living expenses, then it stands to reason it would take about 30 years to save enough to put down cash on a house, perhaps longer, since you'd be paying rent.

Likewise, credit cards allow us to buy things that we need, but can't afford to pay for right now that would take an awful lot of time to save up for, like kitchen appliances or TVs.

All this posits that eventually you'll earn enough money to pay these bills back.

Right now, that's not the case, and we're at the tail end of a cycle that could be devastating to the global economy, not to mention American independence.

Consumer debt, including mortgages, is higher than it has ever been, rivaling the national debt in magnitude.

That's unheard of, but here's the kicker: not only is it higher than the current savings level for Americans, but there's speculation now that, at present income levels, there is no way America (as a whole) will ever earn enough money to pay down their personal debt.

What happened over the past twenty odd years is probably going to go down in history as mankind's greatest economic folly.

First, let's look in the mortgage market. People started borrowing more and more of their purchase price (you used to have to put down 20%, then 10, and then five, and now, nothing), because banks were having a hard time lending money to people after the recession of the early 80s.

The housing market had collapsed, you see.

By lending more and more money, banks were setting up a vicious cycle, where people had little to no equity to lose in their houses. Rather than homestead and be satisfied with the house they had, they would trade up.

Why? It really didn't cost them anything. What this triggered was a housing market that slowly caught fire, as prices scaled upwards when people started to trade up in house size and price. This attracted more and more buyers, who were offered easier and easier credit as banks were forced to compete with cutthroat lending policies.

All this was fine, so long as housing prices continued to spiral upwards. Sure, we'd had adjustments in housing prices, but over the long run, a house was the best investment anyone could make. You were guaranteed to make money.

Over the long term, however. What we started seeing was people taking advantage of some of these teaser loans that banks felt compelled out of greed to offer: five year adjustable rate mortgages with ultralow interest-only payments until the five year adjustment period had passed.

By then, people moved on and bought a new house with, you guessed it!-- a five year adjustable rate mortgage.

In other words, they kept playing a shell game with the bank's equity.

But notice what else happens here: as people spend less and less income and provide less and less equity in their houses, they are free to spend more and more disposable income on other things: Nike sneakers, iPods, computers, flat screen TVs.

All paid by with credit cards. So long as a consumer was able to make the minimum monthly payment, no one would deny them more credit, despite the fact that not only did they have no real equity to look to in case things fell apart, but they're incomes weren't keeping pace with even the minimal inflation that the economy was suffering.

So people stretched a rubber band in two directions at the same time, and it's only now those bands are breaking. There are a combination of factors, to be sure, as to why the rubber bands chose now to break, but underneath it all, they had to break sometime, so why not now as opposed to two years ago, or two years from now?

The solutions for this are not pretty. It's a little like trying to solve a jigsaw puzzle when thirty percent of the pieces are missing. Bottom line is, there ain't no going back to a time when this nation was healthy, not anytime soon, and certainly, business will never been "usual" again.

First and foremost, don't buy any solution that says we can "spend" our way out of this with lower taxes and more economic activity. People can't afford the debt they have already, and they've been conditioned to spend more using debt. They probably don't even remember how to save a buck or two!

Second, keep in mind that bankruptcy laws were changed, with the support of McCain and Obama, to limit individual bankruptcies even further. So that debt relief tap has been turned off, for now. Any attempt to revisit that issue will be met with very stiff resistance by banks.

Third, and most important, keep in mind that with no disposable income, as people try to repay their mortgage balances that weren't covered in the sale of their houses, and have to pay real money to have a roof over their heads and food on the table, there's going to be precious little economic boost to be had. Too, rising gas, food and health care costs will sponge up quickly any left over money.

If we hadn't squandered a few trillion in Iraq, there's a chance we might have the funds in place to have some effective solutions that could speed up and perhaps bolster the recovery, as anemic as it will be. You'll hear a lot of short term hype, but fundamentally, the consumer is ruined.

We owed our children better than we've given them. We've ruined their environment, endangered them with our hubris over global warming, and had until this administration passed along a manageable but difficult economic timebomb.

Which just exploded. In our faces.

I Had My Heart Broken Last Night

By a movie: Maxed Out.

The film, released in 2006, has proven to be more timely as the years have passed:

Maxed Out takes viewers on a journey deep inside the American style of debt, where things seem fine as long as the minimum monthly payment arrives on time. With coverage that spans from small American towns all the way to the White House, the film shows how the modern financial industry really works, explains the true definition of "preferred customer" and tells us why the poor are getting poorer while the rich keep getting richer. Hilarious, shocking and incisive, Maxed Out paints a picture of a national nightmare which is all too real for most of us."

You'd have to have a heart of stone not to be affected by some of the stories in this expose, juxtaposed against some of the cruel, callous and officious bullshit spewed by the people who are roasting, toasting, and burning to a crisp those who are least capable of handling the credit so cynically ladled on them by predatory lenders.

If you want an idea of why the subprime market worked so well despite nearly every single rational thought, this movie gets under the mechanics and tinkers with the very soul of why credit cards exist, how they work, and what the banks and their cronies in Congress and the Bush administration wish would happen to you.

Yes. You. There's not a one of us in this country, with the possible exception of the uberrich and propertied, who couldn't but for the grace of God be one of these stories: white, black, urban, suburban, rural...everyone could fall prey to these sharks with silk tongues wearing silk suits:

The most profitable niche of the industry is called "alternative" or "sub-prime"—euphemisms for a business formerly known as loan-sharking. They target those with less than perfect credit-people like Mark Mumma, whose frustration with the sub-prime credit card issuer Providian caused him to start the website www.providianfinancialsucks.com. From 2000-2002, Providian paid over $400 million to settle charges that it defrauded its customers. Soon after, a Providian director and the chairman of its compliance committee was appointed corporate crime czar by George W. Bush.

Right now, in this country people are going broke at a faster rate than they did during the Great Depression.

Sink your teeth into that statement for a moment. The event that triggered your parents and grandparents to squeeze each and every dollar for all it was worth was nothing compared to the firestorm headed our way: it could create a permanent underclass along the lines of sharecroppers of the post-Civil War South.

The stories in "Maxed Out" will leave you breathlessly angry and crying from rage and sympathy. As director James Scurlock puts it:

We're all led to believe that people get into financial trouble because they are irresponsible, but I've learned that most people are getting in trouble because the banks and credit card companies are setting their customers up to fail. Why? The more credit they give us, the more credit we need. When we inevitably fall behind, they can charge the huge late fees and the over-limit fees and the stratospheric interest rates that drive their profits.

I highly, highly, recommend this film. It will scare you into taking care to clean up your debts now.

A Novel Approach

One thing I value in my quest to seek the office of NotPresident (see sidebar to the right to make campaign contributions) is novel ideas to solve stubborn or impopsing problems. As you are no doubt aware, I've put you to sleep bored you to tears spent many days talking about mortgage defaults and the plight of the middle and working classes who are loaded up with debt and have very shaky incomes to pay them off with.

So when the latest Democracy Journal was delivered to my inbox this week, I found an amazingly simple idea from Elizabeth Warren, the nation's premier expert on middle class bankruptcies: a Financial Products Safety Commission

I t is impossible to buy a toaster that has a one-in-five chance of bursting into flames and burning down your house. But it is possible to refinance an existing home with a mortgage that has the same one-in-five chance of putting the family out on the street–and the mortgage won’t even carry a disclosure of that fact to the homeowner. Similarly, it’s impossible to change the price on a toaster once it has been purchased. But long after the papers have been signed, it is possible to triple the price of the credit used to finance the purchase of that appliance, even if the customer meets all the credit terms, in full and on time. Why are consumers safe when they purchase tangible consumer products with cash, but when they sign up for routine financial products like mortgages and credit cards they are left at the mercy of their creditors?

The difference between the two markets is regulation. Although considered an epithet in Washington since Ronald Reagan swept into the White House, the "R-word" supports a booming market in tangible consumer goods. Nearly every product sold in America has passed basic safety regulations well in advance of reaching store shelves. Credit products, by comparison, are regulated by a tattered patchwork of federal and state laws that have failed to adapt to changing markets. Moreover, thanks to effective regulation, innovation in the market for physical products has led to more safety and cutting-edge features. By comparison, innovation in financial products has produced incomprehensible terms and sharp practices that have left families at the mercy of those who write the contracts.

Sharp practices such as raising your interest rate on one credit card because you were a day late on another one, and raising it to some usurious rate of near 25%, only because some states in the nation allow that (most do not, but it's based on the state where the card company operates. Hullo, South Dakota!).

Why do people go into debt? Basically, debt is an advance on your income, with the promise to pay it back over time. Usually, you do this when you need to buy something, like a house or a car, that will last a long time and costs a lot of money.

But credit is also a trap, more so for people who get addicted to the feeling of wealth one gets from being flush with cash and able to buy things.

Consumers can enter the market to buy physical products confident that they won’t be tricked into buying exploding toasters and other unreasonably dangerous products. They can concentrate their shopping efforts in other directions, helping to drive a competitive market that keeps costs low and encourages innovation in convenience, durability, and style. Consumers entering the market to buy financial products should enjoy the same protection. Just as the Consumer Product Safety Commission (CPSC) protects buyers of goods and supports a competitive market, we need the same for consumers of financial products – a new regulatory regime, and even a new regulatory body, to protect consumers who use credit cards, home mortgages, car loans, and a host of other products. The time has come to put scaremongering to rest and to recognize that regulation can often support and advance efficient and more dynamic markets.

Isn't my credit rating at least as important as the fact that my house might burn down from a faulty toaster?

Particularly given the recent changes to the bankruptcy law that make it less likely that a consumer will ever be discharged from his debts if he gets in too deep over his head, this proposal is now more vital than ever. Things are only going to get worse for people as banks compete harder in a tighter mortgage and credit market for consumer dollars.

Americans are drowning in debt. One in four families say they are worried about how they will pay their credit card bills this month. Nearly half of all credit card holders have missed payments in the past year, and an additional 2.1 million families missed at least one mortgage payment. Last year, 1.2 million families lost their homes in foreclosure, and another 1.5 million families are likely headed into mortgage foreclosure this year.

Families’ troubles are compounded by substantial changes in the credit market that have made debt instruments far riskier for consumers than they were a generation ago. The effective deregulation of interest rates, coupled with innovations in credit charges (e.g., teaser rates, negative amortization, increased use of fees, cross-default clauses, penalty interest rates, and two-cycle billing), have turned ordinary credit transactions into devilishly complex financial undertakings. Aggressive marketing, almost nonexistent in the 1970s, compounds the difficulty, shaping consumer demand in unexpected and costly directions. And yet consumer capacity–measured both by available time and expertise–has not expanded to meet the demands of a changing credit marketplace. Instead, consumers sign on to credit products with only a vague understanding of the terms.

Indeed. To most of us, the language in a credit card agreement may as well be Sanskrit, for all we understand of it. The Schumer box, which is supposed to summarize the rates included in the agreement in plain English, can't possibly cover all the contingencies that are spoken about in the small print in which those rates may change.

Will this proposal ever see the light of day? I doubt it, without a concerted effort on the part of consumers and advocacy groups. Banks and other financial institutions make enormous contributions to politicians of both parties, precisely to keep regulations as lax as possible.

But something needs to be done and soon. Consumer debt to the United States is as big a problem as global warming is to the planet: it could cause the entire meltdown and collapse of the US economy, which is run on the fuel of consumer spending. For sure, the economy is going to take massive hits over the next several years as the mortgage market contracts, which will create opportunities for the fleecing of Americans, both legally and fraudulently, by legitimate financial concerns and, to put it politely, shady lenders and Nigerian princes whose money is trapped in Lagos.

It currently costs the American consumer $89 billion just to make the interest payments and fees on credit card debt. That doesn't include auto loans and mortgages, you'll notice. That's money that could be spent on shoes, books, clothing and laundry. Pretty essential stuff, and I chose those because they rank only slightly higher, in toto, than credit card servicing costs to the average Amerian family.

Yet, most people can tell you who makes quality clothes and shoes, or writes books worth reading.

We need an agency, not to protect Americans from falling into bankruptcy, that would be way too hard to do, but to help Americans understand what they are getting themselves into long before they get into trouble. Loan and credit language is deliberately obtuse, and that's the equivalent of putting rat poison into a teddy bear.

And poison is precisely what this language is designed to sugar-coat, or at least obscure. Most card companies will do as they damned well please, no matter how much you beg or complain, and the legal recourses you have are usually stacked in the lenders favor. You can't take them to court, you have to go to an arbiter that they get to choose. And so on.

I could go on, but Ms. Warren states the case more plainly than I could. What troubles me most about this is, its such an obvious solution to a pressing problem that it should be getting much more attention than some backwater webjournal and blog.

Spread the word, folks. We need this. Now.