The SV Blog

Television Messages

2010-11-06T23:27:00.001-04:00

I don't watch television often, but a recent evening spent in front of the tube gave a sad indication of where we are today. Three kinds of commercials came on over and over again: advertisements for Consolidated Credit counseling services, tax relief counseling, and law firms seeking class action clients for law suits against the manufacturers of various medical products. The common theme in all three is a quick fix for financial problems, the same motivation that makes gambling so attractive to so many.

Many people who were carrying debt while employed are now out of work and desperate for a way out from under their financial obligations. Personal bankruptcies have been rising steadily since 2005, and the most recent statistics show that in March of this year, filings hit just under 1.5 million for the previous 12-month period. Because, on average, one third of these filings were married couples filing jointly, approximately 2 million people were involved in personal bankruptcies last year. With that much financial misery around, merchants of the quick fix enjoy one of the few growth industries.

Not So Fugal After All

2010-09-25T15:01:00.001-04:00

For some months now there have been reports of declines in credit card debt, which have been interpreted as evidence of greater thrift and caution on the part of American consumers. The economy is in trouble, and in hard times card holders are keeping their credit cards close.

But gradually a different picture has emerged. Much of the decrease in total indebtedness appears to come from bank write-offs. Banks have begun to “charge off” debt they believe is unlikely to ever be repaid. Here Michelle Singletary report on this write-off phenomenon, poking a hole in the early analysis, and in today’s New York Times,Christine Hauser provides more evidence that, rather than a sign of greater self-control among consumers, the decline in credit card debt is an indication of the sad state of affairs at the bank:

A study released last week by Evolution Finance’s CardHub.com, calculated that financial institutions charged off about $20 billion each quarter from early 2009 through early 2010, about equal to the amount of the decline in outstanding credit card debt.

So will we ever learn to be more thrifty? There are plenty of reasons to hold back spending now, but the urge to swipe remains a powerful force. The psychology of spending in the contemporary world is largely unchanged by the current economic conditions. Furthermore, the broad cultural changes that would bring about different attitudes about spending, thrift, and consumption have yet to emerge. I wouldn’t hold my breath.

The Blockbuster Bankruptcy and the Physics of Spending

2010-09-24T00:11:00.001-04:00

Today the word came down that Blockbuster Video had filed for chapter 11 bankruptcy protection. A company founded in 1985 and once the dominant video rental company in the country had fallen. The reason, of course, was Netflix and the physics of spending.

In Going Broke: Why American’s Can’t Hold On To Their Money I identified the five most important variables in what I called, The Physics of Spending. Blockbuster became victim to two of these: Time and Effort.

When videos came almost exclusively in VHS format we travelled to the store to rent them. Mailing these bulky tapes would have been difficult, and no company ever attempted that approach. Blockbuster offered us a wide variety of choices and a quick turnaround—a few minutes to the store and back—in return for the effort it took to go out and get the video. Yes, we were sometimes frustrated when we discovered that all the copies of the video we wanted were rented or that the store did not have the movie we were looking for. But often there was something else on the shelf that was suitable.

When DVDs became the dominant movie format and Netflix discovered a simple way to mail disks, Blockbuster’s days were numbered. True, you had to wait longer to receive your video, but it took almost no effort at all. The video was delivered to your mailbox and could be returned in the out-going mail. Furthermore, the selection was much larger than your local Blockbuster could possibly offer, and the frustration of delay was mitigated by offering the option of ordering more than one video at a time. Eventually Netflix made it possible to watch some movies instantly on your computer for no additional cost.

In today’s consumer world, the effort variable often trumps the time variable. People will gladly wait for a purchase that saves them effort. Amazon.com and the entire world of internet shopping is proof of this principle. If you need more evidence, go to your local fast food restaurant at lunchtime. In most cases there will be a very long line of cars waiting to be served at the drive-through window. See, for example, the picture in an earlier blog entry called “Drive-through Windows, the Large Muscle Hierarchy, & Spending.” Many of the people in these lines of cars could get their food more quickly by parking the car and walking into the store. But they don’t. They would rather wait in comfort.

Much has been written about the brilliance of Netflix’s DVD shipping system and its software designed to recommend videos based on your prior ratings, but the primary cause of Blockbuster’s defeat was the ability to mail DVDs and the physics of spending. Less effort is worth the wait.

Lashing Your Credit Card to the Mast

2010-08-15T08:14:00.001-04:00

In the final chapter of my 2008 book Going Broke: Why Americans Can’t Hold On To Their Money, I gave a number of suggestions for staying out of debt. Some of them were tips for individual consumers, but others were government or business policy changes that would help consumers achieve greater self control and be more thrifty. One of these suggestions was to harness modern technology to help credit card users from getting into trouble. Drawing upon ideas of several other psychologists and economists, I proposed that consumers be allowed to voluntarily program credit cards to only work on certain days of the week or times of day. Certain purchases would always be allowed (e.g., medical facilities and gas stations), but other purchases would have to be put off to designated shopping days and times, thereby diminishing the likelihood of impulsive spending.

Now, MasterCard and Citigroup will for the first time introduce a similar program called inControl. In a New York Times article entitled “Your Card Has Been Declined, Just as You Wanted,” Ron Lieber writes about a program that is far more flexible and potentially valuable than the one I proposed in Going Broke. Cardholders will be able to set a monthly budget for restaurant dining, and after that budget has been exceeded, further purchases will be declined. Consumers could also simply set a figure for their total monthly disposable income and have the card shut off when that number has been met. Of course, the consumer can call the bank to have the limit removed, and there is no obstacle to going to an ATM to get cash from your credit card. But this kind of voluntary self-control device has the potential to help many people stay within their budgets.

Lieber asks the obvious question:

Still, this is the sort of service that makes you slap your forehead and wonder why it didn’t exist before. It has the potential to solve the core problem with budgeting: it’s easy to make a spreadsheet and track what you spend, but it’s awfully hard to stick to the plan.

Of course, the unstated answer to Lieber’s question is that this program was not available before because consumers’ struggles with self-control and budgeting reaped enormous profits for the banks. As Lieber points out, Citigroup and other banking institutions are trying to boost their reputations in the wake of the financial meltdown, and consumer-friendly credit card programs are thought to be particularly attractive to banks at this time.

There is also good evidence that, given a chance, many consumers will make banking decisions that improve their self-control and make them more thrifty. Like Ulysses, who had his men tie him to the mast of his ship so that he could hear the sirens’ songs without being destroyed by them, many consumers will act to limit their choices in order to make it easier to be good.

For example, new Federal Reserve regulations implemented by the Obama administration that go into effect today forbid banks from automatically enrolling customers in overdraft protection programs that charge $35 or more for each overdraft. So banks are now forced to offer accounts without overdraft protection and must ask customers to opt-in: to choose to have no protection or to enroll in some kind of overdraft protection program. Interestingly, CNN is reporting “many customers are choosing to risk having their card declined rather than face a $35 overdraft fee.” This is a good trend which suggests that MasterCard’s inControl program will be embraced by many cardholders. Many consumers are willing to put voluntary limits on their spending, and finally, the banks are beginning to provide programs that have the potential to help cardholders achieve financial stability.

Nine Years of Lobbying Yields a Five Year Break

2010-07-05T18:04:00.000-04:00

In 2005, soon after George W. Bush’s reelection, a bankruptcy bill that had been pushed by the banking and credit card industries for nine years finally passed and became law. The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) introduced additional restrictions and requirements for individuals hoping to file for personal bankruptcy and was advertised as a protection against irresponsible borrowers that would safeguard the availability of credit for the rest of us. The new rules did have a substantial effect, momentarily cutting bankruptcies in half, but as time passed and the economy worsened, bankruptcies gradually edged upwards toward their previous levels.

Now comes the word there were 770,117 personal bankruptcy cases during the first half of this year and the American Bankruptcy Institute predicts a total of 1.6 million bankruptcies for all of 2010. In 2005, the year the new law was introduced, there were a record 2 million bankruptcies, but that was an artificial peak caused by a run to declare bankruptcy before the new rules went into effect in October of 2005. Prior to his highly atypical year, bankruptcies hovered around 1.6 million in 2003 and 2004. So now, a mere five years after the law was introduced, bankruptcies are back to their pre-BAPCPA levels.

What does this episode tell us? That the remarkably high bankruptcy rate in the United States is not a function of the easy process of declaring. The 2005 law made filing much more onerous. Rather, as Samuel Gerdano, excutive director of the ABI put it: "Years of rising consumer debt and low savings rates, combined with the housing and unemployment crisis, are causing bankruptcy levels not seen since the 2005."

Until these underlying problems are solved, tinkering with the bankruptcy laws will have little effect.

Cortney Munna Responds

2010-06-01T19:42:00.001-04:00

Cortney Munna, the debt-burdened NYU graduate featured in a recent New York Times profile and in my last blog post responds today to the more than 600 comments posted to the original Times article. She writes very eloquently and accepts responsibility for her plight, although she says she wants to fight to “re-write the rules of the student loan game as it relates to loan underwriting, counseling and the bankruptcy laws.”

She also points to the need for better information:

As far as why I let the debt amass as I did: Frankly, I was uninformed. For this, I blame myself and my family for not looking beyond the school for information, and I blame the school for not offering clearer information about the differences in lending sources.

In retrospect, it’s absolutely clear to me that I should have thought more about the cost of the education versus career prospects. I didn’t think of it as a purchase. It was always just the next step to take: Get into good school. Get decent scholarship. Work hard.

And have it all pay off in the end.

A Costly College Education

2010-06-01T08:01:00.002-04:00

The college commencement addresses have all been delivered, and new graduates are faced with the realities of a slower economy and no diminution in the accumulation of student debt. Ron Leiber of The New York Times recently profiled Cortney Munna, a 2005 NYU graduate who is carrying almost $100,000 in student loan debt. Today National Public Radio ran a story about Heather Lefebvre, a 2010 summa cum laude graduate of Brandeis University who is burdened with $85,000 in student loan debt.

This graphic, which accompanied the web version of the NPR story, shows that student debt is a growth industry. So grads are getting hit with more debt than ever and the worst economy any graduating class has faced in several years. To make matters worse, student loan debt cannot be discharged by bankruptcy.

Leiber’s article for the Times asks the question, who is to blame? After interviewing Munna’s mother, herself a student loan borrower, the lending agencies, and the NYU financial aid office, he finds no one willing to take responsibility for Munna’s predicament. As usual, blame falls back on the borrower, but is that entirely fair? Education is supposed to be an investment that will bring future benefits, both economic and non-economic, but does the return on investment justify the expense? The question is not whether college is a good investment or not. In general, college is a very good investment. The real question is whether the marginally better education obtained at expensive schools like NYU and Brandeis is worth the added debt for students who can must borrow. State schools are the workhorses of our educational system, and they are much less costly. Are pricy private schools worth it? Of course, few of the schools will answer this question realistically, so it is foolish to look for the pricier colleges and universities to provide wise counsel to students like Munna and Lefebvre. Meanwhile, we are constantly encouraging young people to reach for the stars and not settle for less than the best.

One point that comes from these examples, is choice of major. Many of my liberal arts students come from wealthy families, and I know that they will be fine no matter what happens. But students like Munna and Lefebvre are not wealthy. Munna had an interdisciplinary major of religious and women’s studies, and Lefebvre was a double major in English and creative writing. I know many parents urge their children to diversify their majors, making certain that at least one major has the potential to lead to a job. If you are going to double major, choosing two quite different majors (English and biology, or religious studies and psychology) might improve chances of post-graduate employment. I was an English major, and I still believe that a basic liberal arts education is good preparation for both civic life and a wide variety of employment paths. But I went to state schools, emerged from college without debt, and benefited from good economic times. These things are not true for today’s graduates.

Desperate for Money in Oakland

2010-02-17T21:50:00.001-05:00

While checking my email and enjoying a Venti-sized Pike Place Roast at a Starbucks near the Oakland International Airport, I spied the sign above on a building across the street. Title loans are typically short-term loans at very high interest rates. For example, a 30-day loan at 25% interest is the equivalent of 300% APR. Some title loans have APRs of over 600%.

In return for fast cash with few questions asked, the borrower must have a car that is owned outright and must sign over the title of the car as security on the loan. If the principle and interest are not paid off on time, the borrower can usually roll over the loan to a new due date, but if he or she is delinquent on the loan, the borrower can lose the car.

Seeing a sign like this one led me to ask, “What kind of trouble must you be in to borrow against your car for cash in 15 minutes?” The patrons of this institution inhabit the dark corners of our economy, and lenders like this one are happy to take advantage of their desperation. Right across from Starbucks.

The morality of ditching your obligations

2010-01-14T07:08:00.003-05:00

In a piece entitled “Walk Away From Your Mortgage” by New York Times writer Roger Lowenstein makes an interesting point about the recent boom in foreclosures. The economy has gone into recession, and many people have lost their jobs and are simply unable to pay their mortgages. Furthermore, it is estimated that over 10 million Americans currently owe more on their mortgages than their houses are worth (this represents a quarter of all mortgages), and there is a trend towards people who could pay their mortgages simply walking away. This group, whose actual size is unclear, has been vilified in the press and by politicians of all stripes. Those who simply choose to walk away from their mortgages, not because they have to but because it makes economic sense, have been labelled irresponsible and immoral.

But Lowenstein points out an interesting contradiction. Businesses walk away from similar obligations all the time. The investment firm Morgan Stanley recently decided to stop making payments on five San Francisco office buildings simply because the investment did not make sense. As Lowenstein points out, “Nobody has said Morgan Stanley is immoral — perhaps because no one assumed it was moral to begin with.” Another argument for holding onto your home is that foreclosures bring down the prices of homes in the area. But oil speculators drive up the price of gas for all of us, and those who sell stock, decrease the value of other people’s savings and retirement accounts. All of our economic decisions are interconnected, but not all are infused with moral obligation.

So homeowners are expected to be moral, while businesses are free to be self-interested economic entities. Not homo economicus but corpo economicus. Furthermore, Lowenstein points out that those who walk away from their mortgages are not avoiding the consequences of their decisions. The consequence of not paying is written into the mortgage—surrendering the house—and homeowners who foreclose are suffering this consequence.

Finally, Lowenstein argues that homeowners should feel free to foreclose on a house that is worth less than the mortgage. Housing prices are not likely to recover for a long time, and throughout the financial world, it appears that moral motivations, social bonds, and social consciousness have decreasing influence on our decisions.

There is a sad reality to this article. One cause of our current economic crisis is the breakdown of local banking and personal relationships between mortgage issuers and homeowners, as well as between borrowers and credit card companies. Each has acted like the self-interested homo economicus of neoclassical economics, and often the self-interested action of one was at the expense of another—a kind of social zero-sum. But Lowenstein argues that, in this economic prisoner’s dilemma, there is no reason for the homeowner to cooperate when everyone else is defecting. Sadly, he has a point.

Pre-paid Debit Card Fees Soak Low-income Users

2009-10-06T08:58:00.000-04:00

I recently got a new cell phone, and after I sent in several pages of documentation, my rebate was mailed in the form of a pre-paid debit card. These financial products and their close cousins pre-paid gift cards are becoming ubiquitous. Gift cards can be purchased at the grocery store and many other places. Pre-paid debit cards are particularly popular with low-income consumers who are unable to open a conventional bank account or get a credit card. But as this New York Times article suggests there are many hidden fees and deductions that make this a very expensive form of banking. Recent credit card reforms passed since Barack Obama became President did not touch the pre-paid debit card market.

It is particularly concerning that some employers—including WalMart—have begun paying employees with prepaid debit cards. This policy must be a boon to the credit card companies, but it is no bargain for the employees.

Bankruptcies Top A Million

2009-10-03T09:12:00.000-04:00

The 2005 bankruptcy reform bill had a strong impact when it was first implemented, knocking down the rate of personal bankruptcies in the US to approximately a third of what it had been, but the basic problems of consumerism and easy credit where not touched by the bill. As a result, it was just a matter of time before rates would climb back up, and they have--quite steadily since the introduction of the bill.

Now with the added impact of unemployment and the economic decline, rates have taken off again. As the October 2nd Wall Street Journal article below indicates, we had over a million personal bankruptcies in the first nine months of 2009. A rate that is very close to that just prior to the 2005 bill and one that will likely bring us to 1.4 million bankruptcies by the end of this year.

In addition, the bankruptcy statistics always underestimate the pain by approximately 25 percent. On average, approximately a third of all personal bankruptcies are married couples filing together.

--------------------------

Personal Bankruptcy Filings Soar
By SARA MURRAY

Consumer bankruptcies topped one million for the first nine months of this year, the highest point since the system was overhauled in 2005.

The number of personal bankruptcy filings for the nine months rose to 1,046,449 as of Sept. 30, the American Bankruptcy Institute, an organization made up of attorneys, accountants and other bankruptcy professionals, said Friday, using data from the National Bankruptcy Research Center. There were 773,810 personal bankruptcy filings for the same time period in 2008.

September's filings reached 124,790, 41% higher than the same month last year.

The 2005 revamp was intended to make it harder for Americans to shed their debts by filing for bankruptcy. In that year, before the law took effect, there were 1.35 million bankruptcy filings in the first nine months.

But a tough economic climate has sent filings soaring again and ABI expects personal bankruptcies to exceed 1.4 million by the end of the year. "Bankruptcy filings continue to climb as consumers look to shelter themselves from the effects of rising unemployment rates and housing debt," the institute's Executive Director Samuel J. Gerdano said.

Write to Sara Murray at sara.murray@wsj.com

WSJ: Student Debt Grows Dramatically

2009-09-03T08:59:00.003-04:00

From the Wall Street Journal, Sept 3, 2009:

Students Borrow More Than Ever for College

Heavy Debt Loads Mean Many Young People Can't Live Life They Expected

By ANNE MARIE CHAKER

Students are borrowing dramatically more to pay for college, accelerating a trend that has wide-ranging implications for a generation of young people.

New numbers from the U.S. Education Department show that federal student-loan disbursements—the total amount borrowed by students and received by schools—in the 2008-09 academic year grew about 25% over the previous year, to $75.1 billion. The amount of money students borrow has long been on the rise. But last year far surpassed past increases, which ranged from as low as 1.7% in the 1998-99 school year to almost 17% in 1994-95, according to figures used in President Barack Obama's proposed 2010 budget.

The sharp growth is "definitely above expectations," says Robert Shireman, deputy undersecretary of the Education Department. "But we're also in an economic situation that nobody predicted." The eye-opening increase in borrowing is largely due to the dire economic environment, which is causing more people to seek federal loans, he says.

The new numbers highlight how debt has become commonplace in paying for higher education. Today, two-thirds of college students borrow to pay for college, and their average debt load is $23,186 by the time they graduate, according to an analysis of the government's National Postsecondary Student Aid Study, conducted by financial-aid expert Mark Kantrowitz. Only a dozen years earlier, according to the study, 58% of students borrowed to pay for college, and the average amount borrowed was $13,172.

The ripple effects for today's heavily indebted young people are becoming palpable. A growing body of research suggests that tough loan payments are affecting major life decisions by recent graduates, forcing them to put off traditional milestones—from buying a first home to even marriage and having children.

Also, the rising levels of borrowing may ironically be contributing to the accelerating cost of college, say some college-finance experts. Loans can give colleges an artificial sense of a family's ability to pay tuition. To some extent, that false sense of security gets built into the assumptions schools make when setting prices, say experts. The idea is that as prices rise, families borrow more and more, spurring prices to rise further, which in turn requires more borrowing. Barmak Nassirian, associate executive director of the American Association of Collegiate Registrars and Admissions Officers, says this phenomenon is playing a role in why tuition grows at about twice the rate of inflation. "Instead of imposing tougher choices" on college costs, he says, it's "easier to raise prices...because this additional loan amount is made available."

These and other impacts are likely to continue to spiral for future generations of tuition payers, college finance experts say. It is unclear whether we have seen the worst of it. Mr. Kantrowitz predicts the rate of increase will slow to 12% for the 2009-10 school year due mainly to what he expects to be a rebounding economy. On the other hand, Mark Zandi, chief economist for Moody's Economy.com, says he thinks unemployment rates will be at least as high as they are now, and housing prices will fall further, making it difficult for families to borrow against home equity.

"Growth in student lending can remain very strong, at least through the next school year," Mr. Zandi predicts.

The total borrowing limit for dependent undergraduates who take out federal Stafford loans—the most popular federal aid program—grew to $31,000 this past school year from $23,000. Raised limits in federal loans may have siphoned some borrowing away from riskier—and costlier—private loans, which are now harder to get due to the retrenchment of that business. The move away from these risky loans may be one bright spot in an otherwise frenzied student credit environment, Mr. Kantrowitz says.

Still, students cringe when they think of what they will owe by the time they graduate. Kordi Solo, a senior majoring in journalism at Central Michigan University, expects to owe about $60,000 in student loans by the time she graduates in the spring. She had hoped to owe much less, but her father, a construction worker, has been out of work since last fall. She worries about the ramifications that debt will have on her future—whether it is being able to afford health insurance or qualifying for future loans.

Zack Leshetz, a 30-year-old lawyer in Fort Lauderdale, Fla., has $175,000 in student loans from his seven years in college and law school. Lately he has had his eye on the real-estate market. "Everyone says that it's a great time to buy a house," he says. But that is not an option right now, he says, thanks to $800 a month in payments—and another chunk of student loans in forbearance, which means payments are halted while interest accrues. "I find myself living paycheck to paycheck," he says.

He has also been engaged since March, but has held off on marriage. "There's no way I can pay for a dream wedding, or even just a regular wedding," Mr. Leshetz says. "I feel like I'm putting my entire life on hold."

"There are no guarantees about how easily you'll be able to pay off your student loans," says Lauren Asher, president of the Institute for College Access and Success.

These students' experiences are mirrored in research by Mathew Greenwald & Associates Inc. for investment-management firm AllianceBernstein LP. In a 2006 survey of 1,508 graduates under age 35, 39% of college graduates say it will take them more than 10 years to pay off their household's education-related debt. The survey says that this has caused a delay in certain key "rites of passage" associated with adulthood. Forty-four percent of respondents said they delayed buying a house because of their student loans, while 28% delayed having children.

"Loans have gone from being the exception to being the norm for most students," says Mr. Nassirian. He laments that, rather than fixing the problem of sticker price, policy makers typically tweak student-aid programs to make it easier for students and families to continue to borrow more.

Attacking the problem of cost is thorny because it is politically difficult to get all the interested parties -- which include federal and state governments, foundations and private institutions—to agree. "There are so many stakeholders, different explanations at different schools as to what's happening with cost, that it becomes politically dicey," says Christine Lindstrom, higher-education program director for U.S. Public Interest Research Group, which advocates for consumers. Also, colleges can be big employers in congressional districts, making it challenging for politicians who represent them to also take them on. "You're not going to win friends if you're alienating them," she says.

Some Republicans made attempts at controlling tuition increases when they held the majority in Congress. Rep. Howard P. "Buck" McKeon of California championed legislation in 2003 that would have penalized colleges for raising tuition too much by taking away federal subsidies. Though the bill died, he plans to continue pursuing the issue in the upcoming Congress, a spokeswoman says.

Some recent graduates say they wish they had known more about the consequences of debt before taking it on. Lillian Russell graduated from law school at the University of Pittsburgh last year with $181,000 in debt from her seven years in school. She has spent much of the past year looking for work. In recent weeks, she found a job clerking at a small law office. While she settles into her job, she has deferred payments on most of her federal loans, though interest continues to accrue.

"I wish I had considered the long-term impacts of what I was getting into," Ms. Russell says. When she entered school, "the idea was I'd take out the loans, get a job, and pay it back," she says.

It seemed straightforward. But as the economy has soured, "I feel like it's shifted a lot of my life goals," says Ms. Russell, from buying a house to starting a family. "I'm really concerned about handling this obligation while taking on new ones."

Write to Anne Marie Chaker at anne-marie.chaker@wsj.com

Mortgages Drifting in the Tide

2009-03-07T10:19:00.001-05:00

On March 5th the New York Times printed this graphic showing the percentage of loans in default for various types of mortgages—ranging from conventional “prime” mortgages to “subprime”—as a function of the current ratio of all the mortgages on the home to the value of the home. The dancing waves at the 100%-level separate the houses that are “underwater”—valued at less than the amount owed on the mortgage—from those that have equity beyond the value of the loan.

The graphic is based on data from November 2008 to January 2009, and it accompanied an opinion piece by John D. Geanakoplos and Susan P. Koniak arguing that the best plan for solving the mortgage crisis would not be the interest payment reductions proposed by the Obama administration but reductions of principle. The argument proposed by Geanakoplos and Koniak is more radical but has merit, but I am struck by the orderliness of the graphic and the underlying debate about choice and personal responsibility hidden within it.

The axes of the graph are arranged in an unusual fashion so that those most underwater can be shown at the bottom of the graph. Four lines indicating different types of mortgages stream down from the upper left-hand corner, the point that represents a paid-off mortgage. The lines taper off to the right as they fall, as if they are blowing in a gentle breeze or slowly drifting in the tide. As the line moves to the right, more people are in default on their loans. The prime mortgage line hangs fairly tightly to the left. Even when their loans represent over 200% of the value of their homes only 4% of these homeowners are in default. In most cases, these borrowers had good credit ratings and a down payments when they bought their houses, and the overwhelming majority have maintained their good records.

But the subprime mortgage line on the far right is the most interesting. For some, these loans and the banking institutions who offered them are the source of our recent economic problems. The banks sold shady and deceptive loans to people how could not afford them, and the drifting line on the right is the result. High levels of defaults that caused the foreclosures, that caused the banking meltdown, that cause the stock market crash, that caused the layoffs, etc, etc. But look more closely at the subprime line. At the very worst point on the lowest point, people whose homes are worth less than half the value of their loans are defaulting at a rate of approximately 12%. A high rate, indeed, but flip it over. More than eight-eight percent of all people in these desperate circumstances are paying there mortgages on time.

The bankers would say borrowers who default on their loans are the ones who bear the responsibility for failure. These homeowners signed on the bottom line and then welched on their promises to pay. The subprime mortgage industry (many representatives of which have now gone out of business) argued that, had they not introduced these subprime mortgages to the public, many people would be denied the benefits of homeownership. Look at the 88% who are still in homes and still paying.

But this right-most line begs the question, at what cost? Is it fair for the majority to benefit at such a severe cost to the other 12%? Are these good enough odds? As it turns out, the answer is no. These mortgages were fragile enough that when bundled together into securities investments, they eventually fell apart. It turns out that subprime loans are a bad bet. Unable to weather a down-turn in real estate prices. Eight-eight percent may sound good, but it is not good enough.

More Adventures in Debt

2009-02-22T21:42:00.000-05:00

Buying gas today, I noticed a sticker on the pump: “Now you can prepay with your credit card at the pump.” All self service pumps are designed to accept credit cards, so why would you prepay a fixed amount of money rather than just swiping your card and pumping? My guess is more people are bumping up against their credit limits. They know they have just a little room left on the card, so they want more control over the amount they spend. Rather than having to watch the mounting total and time the shutoff to the desired expenditure, prepaying guarantees that you hit the right amount. Furthermore, some people with just a small amount of juice left on their cards or who risk the possibility of having the purchase denied might rather prepay, wait to see whether the purchase is approved, and then either pump with confidence or move on.

As mentioned in my previous post, “Pay with Two Credit Cards,” in today’s economy, merchants need to make special accommodations for the growing number of people in trouble with debt.

The Detritus of Consumption

2008-12-09T08:47:00.001-05:00

An unanticipated effect of the economic downturn: recyclables with no place to go. As the economy tanks, the demand for recyclable cardboard, plastic, and metal has fallen away. According to a front page article in yesterday’s NY Times, the market for junk has collapsed at a far more drastic rate than the stock market. On the West Coast, mixed paper that was bringing in $105 a ton in October now sells for $25. The recycler that Harvard University sends its junk to used to pay $10 a ton but now charges $20 a ton.

Our recycling system is a house of cards built on consumerism, a system that puts all its energy into the front end of the purchasing sequence. The crucial moment is when the shopper lifts the bottle of juice off the shelf and into the shopping cart. The more the bottle weighs, the fewer units will be sold. Fifty years ago, Sylan Goldman, a grocery store owner in Oklahoma, noticed his customers left the store when their hand baskets were full. To subvert this limitation, he mounted two hand baskets on a folding metal frame and thus was born the shopping cart.

Manufacturers and retailers understand the physics of consumption. The physical effort of a purchase strongly affects sales. For people in cars, drive-thru windows are easier than walking. So when it became possible to package products in inexpensive, light plastic containers, manufacturers switched. Glass bottles were ditched in favor of plastic “recyclable” containers, many of which now overfill our landfills. Business people know that maximizing consumer convenience maximizes profits. Furthermore, the life of the container after the product has been consumed has no affect on the manufacturer’s bottom line. Unless producers are required to bear the cost of recycling or storing used containers, this is a negative externality: a cost of production borne by someone else.

Interestingly, the Times article notes that demand for glass has not declined. According to Wikipedia, glass and aluminum are much easier to recycle than plastics. Both can be recycled indefinitely. Perhaps this is the moment to bring back reusable and recyclable glass and aluminum containers. They would have the dual effect of decreasing consumption—at this point in our history, a very desirable goal itself—and reducing the size of our junk heaps.

The Myth of Establishing Your Good Credit

2008-10-23T07:58:00.000-04:00

One of the standard maxims mouthed by personal financial advisors is the need to establish your good credit. Young people are advised to get a credit card and use it, being careful to pay off the balances regularly, with the goal of creating a good credit record. The person who fails to do this is said to risk not being able to get a house in the future or achieve any number of other goals.

This has always struck me as crazy advice. First, it puts young people at risk of doing the opposite—getting into trouble with credit cards—in the name of a rather abstract goal. Second—and most importantly—for many years now there has been little problem getting credit. Indeed the problem has been the availability of too much credit. At the end of the housing boom, people were able to get home mortgages without having any assets or income, and anybody can get a credit card with a shockingly high credit limit. When I interviewed debtors for Going Broke, many told people me they continued to receive credit card offers after declaring bankruptcy and had little trouble getting credit. So why is it so important to establish good credit? Perhaps this was a valuable goal in the bygone era when lenders actually cared about the credit worthiness of their customers, but a loan is no longer a social bond. It is merely a product to be sold for a short-term gain.

Given the recent credit crisis and Wall Street tumble, one might assume this picture had changed. Not so. The latest installment in the New York Times debt series documents the continuing—and perhaps increasing—practice of preying upon people who have recently declared bankruptcy. Using sophisticated data mining techniques, banks are targeting people who have experienced recent debt problems with credit card offers. If there is a credit freeze, it has not hit individual consumers. Consumer debt is still a profitable engine for many banks, and the industry is discovering ever more innovative methods of finding vulnerable potential customers.

The Paulson Bailout Plan: A Profiles in Courage Moment

2008-09-23T08:27:00.001-04:00

This may be the most important vote since the authorization of the Iraq war, and in many respects, the atmosphere is similar. Congressional leaders have been churned up by a worsening economic picture and the drama of last Thursday’s emergency meeting with Henry Paulson and Ben Bernanke, where lawmakers were told there was a serious risk of massive failures within days and that casualties could go beyond the banking industry to large “brand-name companies.” Senator Christopher Dodd described it as “as sobering a meeting as any of us have ever attended in our careers here.”

Furthermore, this is an election year, and Congress is set to go home and resume campaigning at the end of the week. So a plan to save the economy and bailout the financial firms that got us into this mess will be hammered out very hastily in the heat of emotion. And, like the Iraq war vote, decisions made this week will haunt us for years.

The amount of money at stake is staggering. $700 billion is more than the cost of the war in Iraq to date, more than the entire 2009 budget for medicaid and medicare, more than the 2009 budget for social security, and just under the 2009 military budget. It represents $2000 for every man, woman, and child in the country--above and beyond what we already pay for the actual services of the federal government. And for what? To keep us all from being damaged even more than we have already by the irresponsible business practices of the financial industry we are bailing out.

The great majority of our leaders failed us in the Iraq authorization vote. They made political decisions based on the emotion of the moment. Let’s hope they do better this time. If this deal does not go far enough to reign in the unfettered business practices that got us here, then our leaders must have the courage to walk away. This time, the administration cannot be given a blank check. The deal must provide strong oversight and powerful safeguards against future crises, or we must be willing to say, “No deal.”

Homeownership & the American Dream

2008-09-09T07:35:00.001-04:00

Home ownership is perhaps the most tangible symbol of the American Dream, but in recent years it has been oversold. Many people who later wished they had remained renters were sold enticing low-interest mortgages. Thanks to an economic downturn, insufficient regulation of the mortgage lending and mortgage investment industries, and good old fashion overconfidence in the security of real estate investments, many of those same people are now headed back to rented dwellings, but too often their path will run through foreclosure.

As the graph below suggests, the US experienced a rapid acceleration in home purchases beginning in 1992 and topping out at 69 percent in 2003. Since that time the rate has declined to the present 68 percent, and it may drop further. Recent history suggests the line may have been pushed up too high, and the current economy is making a correction.

There is no reason why the American Dream should be dependent upon home ownership. Internationally homeownership rates vary widely and are not particularly tied to standards of living. For example, Germany, a country that enjoys a standard of living (measured in GDP per capita) of $23,819, has a homeownership rate of 42 percent, whereas in Slovenia (GDP per capita of $19,200) 82 percent of people own their homes. Several of the countries of old Europe (e.g., France, Denmark, Austria) have homeownership rates that are over 10 percent below those of the United States.

Owning your own home is a greater financial risk than many thought, and too much risk can make the dream—when defined as owning your own home—a bad bet. But happiness and security can come in different shapes, and life in a rented home can be just as happy as life in a mortgaged home.

Joe Biden & MBNA

2008-08-25T08:57:00.002-04:00

I am a strong supporter of Barack Obama’s campaign, and I am very pleased with his selection of Joseph Biden for Vice President. Biden will bring needed experience, respect, and fire to the campaign. But Joe Biden is from Delaware, the home of MBNA, the credit card giant, now owned by Bank of America.

All politicians have warts of one kind or another, and as a citizen it is all but impossible to find a political leader with whom you always agree. But as someone who is concerned about Americans who struggle with debt, I find Biden’s stance on bankruptcy reform particularly troubling. He has been a consistent supporter of the credit card industry’s efforts to make bankruptcy rules more stringent and to make the process of declaring personal bankruptcy more onerous and more expensive. After nine years of lobbying, the banks were able get a new, tougher bankruptcy bill through Congress, and President Bush signed it into law in 2005.

Barack Obama voted against the bankruptcy bill and has been a steady opponent of the credit card industry, but Biden’s stance on this issue is a blemish on an otherwise very respectable voting history. Unfortunately, now that the economy is in a tailspin and foreclosures are bursting out all over, the hurdles imposed in the 2005 bankruptcy bill are making life even more difficult for many debt-burdened consumers who could use the second chance that bankruptcy is designed to provide.

To make matters worse, there is at least the appearance of an improper relationship between Biden and MBNA. Today, the NY Times is reporting that Hunter Biden, the senator’s son and an attorney, worked for MBNA for from 2001 to 2005, a period that coincides with the credit card industry’s bankruptcy lobbying effort. The Obama campaign is defending this messy bit of Biden history, but it is a troubling episode that provides yet another example of the pernicious influence of big money in our government.

Appearance on The NewsHour with Jim Lehrer

2008-08-22T18:25:00.006-04:00

As part of series conversations on the economy, I appeared on the Monday, August 18th edition of The NewsHour with Jim Lehrer. A transcript of the interview, as well as audio files and streaming video can be found here.

Exporting Credit Card Debt

2008-08-10T09:06:00.002-04:00

I am often asked why credit card debt is such an American problem, and my usual answer is that, with some exceptions, other countries haven’t caught up with us yet. We lead the pack in indebtedness. The latest installment in the NY Times series on debt shows how the rest of the world is catching up. For some time, the UK and its former colonies (US, South Africa, and Australia) have had debt problems, but now credit cards, and the problems associated with them are spreading to Asia and Latin America. The article highlights problems in Turkey and South Korea.

Few American exports have proved as popular as credit cards. In just a generation, they have gone from a totem of Western affluence to an everyday accessory in Brazil, Mexico, India, China, South Korea and elsewhere. More than two-thirds of the world’s 3.67 billion payment cards circulate abroad.

The world map displayed below shows an expanding pattern of debt. Most of the light areas that have no debt are third-world countries where poverty is so desperate that credit cards would have no purpose. As time passes, this map is likely to go in one direction only: toward darker shades of green and increased credit card debt. It is troubling to think of a future world economy in which every developed nation has a citizenry strapped with debt and chained to their jobs in an effort to meet their monthly obligations. Is this an export the rest of the world really wants?

Pay With Two Credit Cards

2008-07-29T08:41:00.000-04:00

Today I ordered an accessory from the Apple Computer website and noticed something I had not seen before. During the checkout process a “pay with two credit cards” button appeared. Curious, I clicked the button and discovered an option that allows customers to split the cost of their purchases across two credit cards with the flexibility to decide how much of the total to put on each one.

The splitting of online purchases may be more common than I am aware, but this is the first I had seen this option. Of course, Apple sells items that can cost several thousand dollars and, as a result, will often be out of reach for someone with a modest credit limit. Young college students purchasing a computer might not have enough juice in their accounts to handle the bill. But I suspect this payment option is also an indication of the kind of debt-juggling many consumers undertake on a daily basis. By offering the card-splitting option, Apple makes it possible for the buyer who is near the limit on several credit cards to cobble together enough credit to float the purchase of a new iPod or laptop. People who are living this close to their credit limits may represent a relatively small segment of the potential sales market, but from Apple’s point of view, allowing card-splitting is a very simple way to increase sales. Unfortunately, for the consumer who struggling to managing temptation and debt, this system removes one more natural barrier to indulgence.

PS Curiosity has its costs. After clicking the “pay with two cards“ button it took me several minutes to escape from that detour and pay for my item with a single card. Caveat emptor.

Free Markets, Banks, Personal Responsibility, & Self-control

2008-07-28T10:19:00.003-04:00

In his column today, Paul Krugman makes the point that the housing bill passed last week and due for Presidential signature this week does not fix an important underlying problem. The bill provides a way for some homeowners to avoid foreclosure by refinancing their adjustable rate mortgages with smaller fixed rate loans, and it will provide additional support for the mortgage backers Fannie and Freddie Mac. But, in a piece called “Another Temporary Fix,” Krugman argues that future problems will not be avoided until and unless new banking regulations are introduced:

The back story to the current crisis is the way traditional banks — banks with federally insured deposits, which are limited in the risks they’re allowed to take and the amount of leverage they can take on — have been pushed aside by unregulated financial players. We were assured by the likes of Alan Greenspan that this was no problem: the market would enforce disciplined risk-taking, and anyway, taxpayer funds weren’t on the line.

And then reality struck.

From a psychological point of view, it is interesting to think about banking regulation and self-control. The pro-business free-market view places great stock in personal responsibility. We are all on our own, and those who fail fail because it is their own fault. In one sense, they are supposed to fail because they are responsible and no one else should have to take the blame. Certainly this is the conservative view of personal debt.

But sometimes personal failures have public effects. Call me a cynic, but I believe there would not be a housing bill but for the fact that the housing crisis affects us all. Everyone’s equity goes down when the real estate market collapses, and foreclosures at the rates we’ve seen are having a profound effect on the economy as a whole. In contrast, personal consumer debt and bankruptcy is a much more private phenomenon. We had over a million personal bankruptcies per year for many years, and yet all those individual tragedies were almost invisible. Now because, innocent people are being affected, politicians have the moral traction to get a bill passed. Of course, many the debtors who face bankruptcy are also innocent victims of a volatile economic environment, but that is another story.

Krugman’s column suggests that businesses, specifically banks, have failures of self-control, too. In a free market environment, failures of corporate responsibility are likely to occur, and regulations are justified to protect us all from the troubles these failures bring. Recently, new financial institutions have sprouted up outside the bounds of existing regulations, and it is, in fact, these institutions that have been source of many of our current woes. Rather than being quietly fixed by the wisdom of the marketplace, these failures have had powerful reverberations throughout the economy.

Problems of self-control abound, for individual consumers and for banks. The current crisis suggests that external controls can be very helpful for banks, just as they are for the rest of us. It is much easier to do the right thing if the environment pushes you in that direction. Where there are inadequate natural constraints in the marketplace, regulations can play a very valuable role, and recent events have reaffirmed the importance of banking regulation.

NY Times Debt Series

2008-07-19T15:17:00.001-04:00

Tomorrow’s NY Times features a very good series on personal debt and, in particular, the changes in lending practices that have earned millions for the banking industry and socked consumers with enormous levels of debt. Some of the interesting bits include:

Average credit card interest rates have risen from 17.7 percent in 2005 to 19.1 percent last year.

Average late fees rose from $13 in 1994 to $35 today.

In the same period, the fee charged for exceeding your credit limit rose from $11 to $26.

In 1957, 42 percent of families had no debts; today 24 percent of families have no debts.

In 1957, 53 percent of homeowners had no mortgage debt; today 31 percent of homeowners have no mortgage debt.

The story includes the case history of a woman who lost her home and an interactive calculator for determining how your level of debt compares to the national average.

Gas & Housing Prices

2008-07-15T08:08:00.002-04:00

In Going Broke and in this blog (see the July 7 post below) I have described the post-World War II expansion of suburban lifestyles and the popularization of single-use zoning and single-family homes that were many miles down the interstate from work. Sprawl made us dependent upon our cars to satisfy any need that was outside the house, but the wide use of automobiles also reduced the physical effort of traveling to the marketplace by providing us with moving chairs to sit on in climate-controlled environments. In addition, the popularization of drive-through windows meant that many purchases could be made without getting out of the car. The effects of these trends can be seen in our waistlines and bank balances.

Then came the gas crisis. Suddenly our car culture has become very expensive, and as this video from the urban development group CEOs for Cities shows, gas prices have affected housing costs in suburbia. For many years, houses far out from the city center were cheaper than houses close in. In most areas, that may still be true, but the high cost of gas is turning that equation on its head. The gas crisis did not cause the mortgage crisis, but growing transportation prices have undoubtedly worsened the mortgage crisis in some suburban areas.

How We Made Gas a Necessity

2008-07-07T10:31:00.001-04:00

Gas prices continue to be the hot topic. Oil has hit $140 a barrel, and many people are projecting $200 a barrel prices by the end of 2008. As long as gasoline is considered a necessity—something we have no choice but to buy—demand will be relatively “inelastic” with respect to price. The drop off in demand will not be proportional to the increase in price because most people see no alternative to automobile transportation. As a result, we are going to be beaten down by any price increases that come along.

If gas is a necessity, we have ourselves to blame. The Interstate Highway act of 1956 made it possible to live far from work, and single use zoning created towns where housing was segregated from business and retail districts. Finally, FHA mortgage programs favored single-family dwellings over multiple-unit housing. The result was the great suburban expansion of the post-World War II era. Finally, for many years the automobile business was the leading industry in the US, and public transportation systems were discouraged. Today, few of us can walk from our homes to work or even the grocery store, and we are almost completely dependent upon internal combustion engines. Unfortunate, half a century later, both the cars and the fuel are likely to come from abroad, and we have no choice but to buy them.

In the long run, we will be much better off if we go back to a more European style of village- or town-focused life that makes better use of public transportation, as well as foot and bicycle travel. As higher gas prices hit in 2008, demand for gasoline dropped off the more in the UK than in other areas of Europe and the US. Why? Because the British have more alternative forms of transportation. An oil industry analyst quoted in a recent Daily Telegraph article put it this way:

They are switching to public transport, which is much easier to do in Britain than in America, where people living in the suburbs often have to drive whether or not they want to.

Consider also the use of bicycles in the UK. The photograph below is of the train station in Cambridge, England, where commuters deposit their bikes on their way to work in London or elsewhere.

Cambridge is a town of approximately 130,000 people 50 miles northeast of London, and it is thought to have the highest level of bicycle use in the country. According to the 2001 census, 25% of citizens said they used bicycles to get to work each day. With gas prices on the rise, one can only assume that figure has gone up. For Cambridge residence, gas-powered transportation is not a daily necessity.

When Americans have greater choice about whether or not to get into their cars, they will far less vulnerable to fluctuations in the price of a commodity we must by from foreign suppliers. But if we are to create more transportation choices, we will need to make substantial investments in infrastructure, reversing some of the transportation and housing trends of the last 50 years. The good news is that, with a sagging economy, this an excellent time to make those investments.

Loan Delinquencies Spread to Other Forms of Consumer Credit

2008-06-22T11:29:00.002-04:00

The economic downturn and home mortgage crisis is being felt in other areas of the banking industry, and the result may be a second wave of bank failures, this time in regional and local banks. In an article entitled, “New Crisis Threatens Healthy Banks,” the Washington Post reports that delinquencies are up in credit card payments (which had been previously reported), home equity loans, and—most strikingly—construction loans (see the Post graphic below). Many smaller banks that avoided the subprime mortgage market are, nonetheless, mainstays of the home equity and construction loan business in their areas. As a result, this spread of delinquencies may lead to problems for these smaller institutions.

Although we were not hearing anything about it at the time, this graph also shows that delinquencies in construction loans actually led the foreclosure crisis. The uptick in construction loan delinquencies appears to begin in mid-2006, which is before the current crisis began. In contrast, the consumer aspects of the crisis hit a year later in mid-2007, just as foreclosures began to soar. The graph below, which comes from econoday.com, shows that mortgage interest rates bottomed out in 2005 and and began to rise in late 2005 and early 2006. New home sales fell accordingly, and delinquencies in construction loans followed.

All of this dramatizes the powerful role of the real estate market in stimulating our current economic difficulties. Of course, once these real estate trends got the ball rolling, our sleeping problems with consumer debt (home equity loans & credit cards) just made matters worse. Much worse.

How Do We Change Values?

2008-06-13T08:02:00.003-04:00

On Tuesday of this week, David Brooks had a very good column called “The Great Seduction” about the America’s epidemic of personal debt. The article is based on a new report issued jointly by the Institute for American Values (which concerns itself with marriage and divorce, among other things) and a number of other think tanks, including Demos and the New America Foundation. The report and Brooks’ column make a number of very good recommendations, such as credit card reform, regulation of payday lenders, and programs to promote saving. But at the end of the column Brooks returns to one of his regular themes:

There are dozens of things that could be done. But the most important is to shift values. Franklin made it prestigious to embrace certain bourgeois virtues. Now it’s socially acceptable to undermine those virtues. It’s considered normal to play the debt game and imagine that decisions made today will have no consequences for the future.

He is, of course, correct, but the difficulty is knowing how to change values. We can state our values and identify our chosen virtues, much as Franklin did, but merely calling for a kind of behavior does not always do the trick. Values often follow behavior, rather than the other way around. We acquire many virtues by practicing them. Parents model truthful statements, hard work, and thrift, and they reward us for following their lead. Our modern problem stems from those instances—and there are many—when our behavior is molded by commercial and technological developments, and a new and less virtuous value results.

Take, for example, pornography. Once a very seamy commodity consumed by only the most depraved members of the community. To find it, you had to go into parts of town most people preferred not to visit. Then came the VCR. With the introduction of videocassettes that could be watched at home in privacy, many of the social barriers were removed. Distribution took a further leap forward with hotel and home cable systems, and finally, the internet really brought pornography home. The result is that, despite our highly religious society (compared, for example, to Europe), pornography has become much more acceptable than it was thirty years ago. Jenna Jameson has written a bestselling book How to Make Love Like a Porn Star, and the line between acceptable celebrity and unacceptable celebrity has been blurred. Porn has come out of the closet, driven not by a change in values but by a change in technology. Behavior that is popular begins to appear normal. Today, only child pornography is truly beyond the pale.

So the problem with thrift is that debt is the new pornography. Actually the two have come along together. The introduction of credit cards, 800-telephone numbers, home shopping channels, and the internet have served to eliminate many of the natural barriers to indebtedness. We live in a consumer society that depends on spending and has made it easy to act impulsively 24-hours a day. Popularizing thrift as a virtue is important, but unless we also find ways to encourage virtuous behavior, we are unlikely to demonstrate those values. Brooks’ column—and the report upon which it is based—make many good suggestions, but we also need to acknowledge the powerful effect of the contemporary marketplace on our choices to spend and save. If we can make it easier to show virtuous behavior, the change of values Brooks seeks will follow.

Mortgage Bankers Association: Worst Quarter in Twenty-five Years

2008-06-05T20:01:00.001-04:00

According to a new report from the Mortgage Bankers Association, fully 1 in 10 American homeowners are now in foreclosure or behind on their payments. Furthermore, the problems are not limited to the subprime sector but are evident at all levels of the mortgage industry. Many borrowers with previously perfect records are now falling behind on their payments. In the first quarter of this year, 2.47 % of homes were in foreclosure, up from 2.0 % in the previous quarter. The mortgage crisis has not yet hit bottom.

So where is the response? Where is Ben Bernanke? Where is Congress? Where is the President? Bear Stearns was an instant, over the weekend bailout, but when it comes to the problems of everyday homeowners, you're on your own. We’ve got an 800-number for you, but beyond that we’ve got a big nothing.

The Arbitrary Pricing of Branded Products

2008-05-30T11:05:00.000-04:00

Yesterday’s NY Times ran a story in Thursday Style called “Dress for Less and Less.” The article’s premise is that, despite rising prices for food and gasoline, the cost of clothing has gone down. As examples, the author, Eric Wilson, cites Levi 501 jeans that were $50 in 1998 and are $46 2008 and Lacoste polo shirts that went from $95 to $75 in the same time period.

It is difficult to take such a story seriously. All the products mentioned are highly branded, in most cases high-end or designer goods (Vuitton, Ralph Lauren, Brooks Brothers), and quite expensive. Most middle class shoppers will not be paying $325 for a DVF wrap dress, and I have never paid even half of $75 for a polo shirt. But the interesting question is why? Why have these clothing prices come down? Wilson gives two explanations:

Over all, apparel prices have gone down primarily because of two factors: the overwhelming movement of manufacturing to countries with cheaper labor, where the clothes are made, and increased competition between traditional retailers and discounters, where the clothes are sold.

The outsourcing of jobs provides savings for all clothing manufacturers, and the article does not assert that discount prices have moved down to a similar degree. So the answer is price competition. Cheaper non-branded goods are being offered by discounters, and, in some cases, discounters are selling the same items for less. The elasticity of price for these more expensive products reveals the premium we pay for brand name goods and how arbitrarily manufacturers and retailers set their prices. Despite somewhat lower prices today, we can assume these branded items are still profitable—else they would not be sold. The profits are just a little smaller than they used to be.

The Psychology of Netflix

2008-05-23T07:15:00.002-04:00

The spending response is strongly affected by two variables: effort and time. The Netflix system of DVD rental by mail has succeeded by reducing both. Before Netflix, renting a movie required a trip to the video rental store, which took both time and effort. Ordering online meant that by planning ahead you could always have a movie on hand, so you could watch a movie without going out to get it. Furthermore, Netflix’s enormous selection and sophisticated searching and recommendation system make it much more likely you will find movies you really want to see.

The one drawback of the Netflix system is that you cannot be completely impulsive. The movies you order come in the mail, so at very least, your viewing selection must take place a day or two before you watch. You have to plan ahead. Finally, even if you have one of the Netflix plans that allows you to have several movies on hand at a time, a serious weekend movie binge can burn through your stack of DVDs, forcing you to wait until the postal service has time to replenished your supply.

So Netflix is an incompletely impulsive indulgence. You cannot make a movie choice on a whim, click, and immediately start watching, but several companies have been working on this “problem,” wrestling with various technical hurdles in an effort to provide their customers with unfettered indulgence. Yesterday, the NY Times reported that Netflix will now offer a $100 box that will connect to your television and allow downloading of good quality movies over the internet. You use your computer to do the ordering, but you watch the movie on your TV. For those who use it, almost complete impulsivity will be possible. If a friend tells you that you should see a particular film you have never seen before, you can begin watching it in a matter of seconds. Furthermore, once you have purchased the box, you will be able to view as many movies as you want without extra charge. The service will be a free feature of your Netflix subscription and there is no limit to the number of movies you can watch. So, although the thought of the ultimate couch potato, endless weekend movie binge is a bit worrisome, it will now be possible. No need to get out of your pajamas.

For Netflix, the advantage of this system is protection against losing customers to Apple or Tivo, but the effect of this innovation (do we call this progress?) on the consumer will be more movie-watching. The pause in the action created by the postal system will be stripped away, and impulsive and completely uninhibited movie indulgence will be possible. Is this a good thing? Yes and no.

Media Packaging of Good and Bad Economic News

2008-05-19T10:39:00.001-04:00

No matter how bad it gets, there are always experts out there willing to put an upbeat spin on the economy, and the media seems to have a bias in favor of positive economic news. In local news, “if it bleeds, it leads” is the defining rule, but when it comes to economic news, we always want to hear that things will be just fine.

Today the CNN webpage is running an Associated Press article with the headline “Economists see credit crisis nearing end,” a happy thought, indeed, but the first paragraph is much less cheery:

WASHINGTON (AP) -- First the good news: The worst of the painful housing slump and the credit crunch might come to an end this year. Now the bad: The economy will weaken further and unemployment will rise.

Like this passage, much of what follows in the article, based on a report from the National Association for Business Economics, is just as mixed. Again, the more optimistic view of the “credit crunch” is really a statement aimed at investors and business people hoping to find money to borrow. There is no “credit crunch” for everyday folks. Instead, there is a debt crunch, and the article predicts increasing unemployment and, to make matters worse, reports that economists are uncertainty about whether housing prices will hit bottom by the end of the year.

The real world for most consumers is hinted at in a paragraph added at the bottom of the article. CNN’s “ireport” team makes the following appeal:

Are you buried under a pile of debt and need help getting out? Did you recently manage to pull yourself out of debt and want to share your story? Tell us about your experience with debt and how the current credit crisis is affecting you. Send us your photos and videos, or email us to share your story.

Personal debt is still a hot story line because there is so much of it out there, but it would be nice to put a happy spin on a dismal circumstance. So please send us a few success stories.

Consumer Choice: Dumping Starbucks and Whole Foods

2008-05-15T08:43:00.000-04:00

As people begin to feel pinched, it is interesting to see how the retail economy is affected. Where are consumers cutting back and—equally as interesting—where are they not? Earlier in the month we heard that Starbucks had experienced a 21% drop in earnings. If there is a single suggestion that personal finance advisors give so often that it has become laughably hackneyed it is to stop buying coffee at Startbucks. “Those latte grandes add up.” Well, it would appear that someone has been listening. Many other coffee options are available, and even without going so far as to brew coffee at home, the caffeine addict can easily steer clear of Starbucks and find cheaper beverages nearby. Demand for Starbucks coffee is highly elastic. Similarly, Whole Foods is experiencing a significant slump. When the going gets tough, higher-priced organic foods look like a luxury.

On the other hand, discounters are doing quite well. Walmart and TJMaxx are expected to show very good earnings. All of this points to a shift in consumer choice that provides clear evidence of an economic down-turn.

Humor: From The New Yorker

2008-05-08T14:14:00.005-04:00

Continuing Mortgage Woes

2008-05-06T09:13:00.001-04:00

The stock market may be leveling out for now, but as the New York Times reports today real estate prices continue to plummet. Now there are new concerns about mortgage backers Fannie Mae and Freddie Mac. These corporations were created by Congress but are privately owned, and in recent months they have been providing some stability to the shaky mortgage market. Now there are new concerns that Fannie and Freddie do not have enough cash on hand to secure their investments and have been using questionable accounting practices in an effort to satisfy shareholders.

Because Fannie Mae and Freddie Mac are independent of the government, no taxpayer funds are currently obligated in any collapse of these institutions, but given their importance in the mortgage market, it is unlikely the Fed would just stand by. As Charles Duhigg, author of the Times article, put it: “ if Fannie or Freddie fail, taxpayers would probably have to bail them out at a staggering cost.” That phrase “staggering cost” is more than a bit worrisome. The graphic accompanying the Times article (see below) shows that Fannie Mae’s liabilities alone include $2.1 trillion dollars in mortgage guarantees and another $800 billion in outstanding debt. Freddie Mac holdings are similar. Yikes!

So, we are not out of the woods yet, and other shoes may drop before the subprime mess bottoms out.

Today in Krugman

2008-05-05T08:19:00.002-04:00

Today Paul Krugman sums up the current state of the financial markets in a column called “Success Breeds Failure.” He attributes the recent market panic to the introduction of new financial instruments by institutions that escaped regulation because they managed to avoid being banks. Operating in a new frontier, these institutions took great risks, and when things began to come apart at Bear Stearns, Fed Chairman Ben Bernanke was forced to act quickly.

Krugman praises Bernanke’s response to Bear Stearns and credits him for what appears to be the current stabilization of the market. But Krugman also worries that the motivation for much needed regulatory oversight has ebbed away with the crisis and that, as a result, the next debacle will be much worse. Krugman is undoubtedly correct. We seem to live in a political-financial world that responds only to today’s financial drama, and the financial services industry, believing that everything has worked out OK, is back to vigorously fighting the threat of regulation.

Of course, stabilizing the market is only one part of our current financial problem. Those who are not in the investment class are still losing their homes and jobs in great numbers. Where is the relief for them?

Why is the Fed Attacking Credit Cards Now?

2008-05-02T08:25:00.002-04:00

This morning the Washington Post reports that the Federal Reserve, which has previously been reluctant to regulate the credit card industry, has announced plans to eliminate many abuses, such as universal default. Credit card bills have been introduced in both houses of congress and hearings were recently conducted in the House of Representatives. So now federal-level attacks on the industry are coming from three directions.

Why is the Fed taking action (or promising to take action) now? First, consumer anger about credit cards has been building for some time, and the subprime lending crisis has drawn attention to the problem of predatory lending generally. Second, I suspect the Fed is also responding to criticisms that its recent bailout of Bear Stearns was a big, expensive move that served the upper end of the economy—Wall Street investors—and did little for consumers who happen to be really hurting as real estate values plummet, gas prices skyrocket, and a recession looms. So here was an issue that has suddenly become rather uncontroversial, and the promise of action now might polish the Fed’s image with consumers. They might have waited to make this announcement until the end of the year, when the details of the regulations “could be” finalized, but the Fed needs some image enhancement now.

Rep. Carolyn Mahoney (D-NY) expresses considerable skepticism about the seriousness of the Fed’s resolve. She has recently introduced a Credit Card Holders’ Bill of Rights in the House, and she is undoubtedly concerned that the Fed’s actions will take votes away from her bill. Worst case scenario: regulatory bills do not pass through congress, and the Fed’s actions end up being an inadequate response to the problem. A reasonable concern.

What is the least surprising aspect of this story? You guessed it, the credit card companies object.

Our Future Financial Selves

2008-04-28T13:10:00.004-04:00

Today NPR’s Morning Edition carried an Interesting report on debt (you can find the story and audio here). Economist and Financial Times reporter Tim Harford described credit and saving in terms of our future and present “selves.” Harford said: "Debt is your future self sending you money back in time.“ (Economist Thomas Schelling also uses the symbolic conflict between our current and future selves to describe problems of self-control.) Harford gets at the crux of the issue when he goes on to say: ”So the question is, are you and your future self both happy with the deal?“

Only your present self is in the position to make decisions and take actions, and yet the choices you make in the present often obligate your future self. So what would we say about all those financial decisions looking back on them with the wisdom of the future? Harford also described saving as your present self sending money to your future self, and argued that it is possible to save too much (when you have little income). Unfortunately, not being able to save enough, rather than too much, is the problem for far too many Americans. But Harford is exactly right when he says the challenge is to find the right balance between the needs of our present and future selves—a particularly difficult challenge in a world as uncertain as this one.

Something Happened in the 1970s Redux. The graphic below, which was posted on the NPR website to accompany this story, shows two interesting things. First, as I discussed in an earlier blog entry, the real uptick in consumer debt begins in the mid-1970s. This would be even easier to see if the graph extended farther to the left, perhaps beginning in 1950. Second, because the graph superimposes periods of economic recession, it shows that consumer debt often increases even in bad economic times. This is particularly obvious in the most recent recession of the early 2000s, but it can also be seen in the period of 1981-83. We have a troubled relationship with debt that transcends the current economic environment.

Indian Debt Collectors & More

2008-04-24T08:55:00.002-04:00

Today’s New York Times has an article by Heather Timmons about debt collection agencies using phone banks in India to make calls to delinquent credit card customers in the US. Delinquencies were up to 4.5 percent of accounts in the fourth quarter of 2007, from 3.5 two years earlier. Foreign collections calling represents a small fraction of the overall collection business, but bill chasing is just the latest industry to be outsourced to India. These are boom times for the financial misery business, and the influx of well-paying call center jobs has created a group of Indian workers who, as Timmons writes, “are amassing some of the status symbols that probably got their clients into trouble in the first place— new scooters, iPods, Swatch watches and exotic vacations.”

The movement of collections jobs to India is news, but the article includes a couple of other points that I find much more interesting:

Collections agents are targeting customers’ economic stimulus package rebate checks. On the one hand, this sounds like a ruthless collections technique. You know the debtor is expecting a windfall, so you ask him or her to turn that money into a payment on a credit card. On the other hand, this is precisely what these people should do with their rebate checks. The stimulus package is supposed to be a bit of fuel for the consumer economy, given out in the hope that people will continue spending. But spending is what got delinquent credit card customers into trouble, so they would be much better off paying down debt. This won’t help the economy, but debt-ridden consumers have already done more than they can afford for the sake of the economy. It is time for them to take better care of their personal economies. Collections callers are a hated group who often employ abusive and unethical techniques to track down and intimidate their prey, but here is an unusual case where the interests of both the collection agency and customer are in concert.

According to Timmons’ article, industry analysts are seeing a new trend: “People are walking away from their homes and hanging on to their credit cards, because that is their lifeline.” If this is a valid observation—and I think it is—it shows the centrality of credit cards in our lives, a point I made in a recent op-ed, “Our Love-Hate Relationship With Plastic.” I also believe that, unlike the current foreclosure trend, the bankruptcy boom of a few years ago was a renters’ phenomena. Renters have no choice but to give up their credit cards. They are a lower income group who are more likely to be living in relatively inexpensive housing, and their debts are credit cards and other forms of commercial loans. Many of those who are now in trouble with their mortgages may be people whose incomes are not really sufficient to handle home ownership: homeowners who should be renters. But it is interesting to note that, for debtors who have a choice, walking away from the home and mortgage—as difficult as that decision must be—is often more attractive than giving up credit cards.

A final random bit: the novelist Stanley Elkin wrote a wonderful novel or short story about a telephone bill collector, but for the life of me, I can’t remember the title. Will do some more research and report back.

Priceless: Good Debt, Bad Debt

2008-04-17T07:43:00.003-04:00

MasterCard has a new version of its Priceless advertising campaign in Condé Nast magazines. This long-running promotion is noteworthy for its attempt to encourage a very different attitude toward borrowing.

Once all lending at interest was taboo. The word usury was applied to any loan that required interest payments, and usury was prohibited by all the world’s great religions. Somewhat ironically it was Calvin and the Puritans who removed much of the stigma associated with lending, and today Islam is the only popular religion still maintaining that “Money does not beget money.”

But even as borrowing and lending began to come out from behind the veil of shame, there was a clear distinction between good and bad borrowing. Adam Smith, the 18th Century Scottish economist and father of classical free market philosophy wrote in his Wealth of Nations:


  The man who borrows to spend will soon be ruined.

Until the early 20th Century, there was a clear distinction between “productive” and “consumptive” lending. It was considered acceptable to borrow money to purchase durable goods of lasting value or to invest in something that would bring future income, but borrowing money merely to spend was reckless and immoral.

I suspect that part of this view of good and bad debt stems from a wise assessment of human nature. Most consumptive acts pass quickly—long before the debt is likely to be repaid. In contrast the durable good or the income derived from investment lasts longer and stands as a reminder of the loan. The homeowner who enjoys living in her house each day pays her mortgage to sustain that enjoyment. Similarly, each time the college graduate gets paid, he has a reminder of the value derived from his student loans. In contrast, meals bought with a credit card are forgotten long before the bill arrives.

MasterCard’s ongoing Priceless campaign has sought to change our attitudes about borrowing in two ways. First, it promotes the normality of indulging in luxuries with images of people happily enjoying extravagances. These are not things we need; these are crazy imaginings of desire. The current Priceless Search campaign has people searching for their own priceless indulgences. The magazines include a heavy paper envelope stuck between the pages that contains a card—essentially a lottery ticket—that might mean you have won a wonderful, priceless indulgence. The prize offered in my New Yorker was a commissioned portrait of me painted by Julian Schnabel. My card said “Keep Searching” and told me that I had not won. I suppose I should go out and buy another magazine.

Perhaps most importantly, the Priceless campaign promotes the view that it is acceptable—even admirable—to use credit to pay for fleeting experiences. Taking your kids on an expensive outing is “priceless.” The other prizes offered in the Priceless Search campaign are a multi-continent culinary tour with noted chef David Bouley and a globe-trotting trip for two to explore the seven wonders of the world. Although these are contest prizes, the message is obvious. Indulgence is an acceptable way to use credit. Peek experiences are worthy goals and justifiable objects of indebtedness. Unfortunately, for many Americans Adam Smith’s words are more instructive. Borrowing to spend is—and has been—the road to ruin.

The Mortgage Crisis Morality Play

2008-04-07T22:24:00.002-04:00

The foreclosure crisis has created a kind of Rorschach test of moral judgment. Different observers look at the same events and make very different assessments of fault and responsibility. Furthermore, more than any recent issue, the cutting point is social class.

If you search the Issues menu on John McCain’s website you will not find the words housing, mortgage, or foreclosure. Instead the candidate has an issue category called “Taxes & Economics,” and the title at the top of this page is “McCain’s Tax Cut Plan.” This is a dramatic contrast with both Democratic candidates who have extensive sections devoted to on the real estate crisis. However, elsewhere on McCain’s site you can find the text of his March 25 speech to Orange County Hispanic Small Business Roundtable, which reveals his moral judgment. Here is the crucial section:

A sustained period of rising home prices made many home lenders complacent, giving them a false sense of security and causing them to lower their lending standards. They stopped asking basic questions of their borrowers like "can you afford this home? Can you put a reasonable amount of money down?" Lenders ended up violating the basic rule of banking: don't lend people money who can't pay it back.

This is a remarkably carefully worded section. It appears to blame lenders—at least in part—for being “complacent” and signing up people who “can’t pay it back.” But who is the bad person in this narrative? The text makes it sound like the lenders’ only mistake was being too nice, which opened them up to victimization by unscrupulous borrowers. Lenders are guilty of “lowering their lending standards” to allow the riff-raff to buy homes. Further blaming of homeowners is evident later in McCain’s speech in a section on solutions:

In our effort to help deserving homeowners, no assistance should be given to speculators. Any assistance for borrowers should be focused solely on homeowners, not people who bought houses for speculative purposes, to rent or as second homes. Any assistance must be temporary and must not reward people who were irresponsible at the expense of those who weren't.

The mention of speculators is, of course, a red herring. It serves to make the victims of the housing crisis seem less sympathetic, and it will tend to discourage any relief programs. It gives the false impression that much of the current problem has been created by reckless speculators.

This kind of rhetorical strategy is reminiscent of the approach used by the banking industry during its long campaign to strengthen bankruptcy laws. In his signing ceremony statement for the 2005 bankruptcy bill President Bush said: “In recent years, too many people have abused the bankruptcy laws. They've walked away from debts even when they had the ability to repay them.” Of course, the overwhelming majority of people who filed for bankruptcy were suffering from a variety of real financial problems and were genuinely unable to handle their expenses. The focus on those who “abuse” the system strengthened the banking industry’s case but also misrepresented the problem.

McCain is using a similar victim-blaming strategy in the housing crisis. In his March 25 speech, the words “irresponsible” and “responsible” appear once each and in both cases they are used to refer to borrowers, not lenders. Don’t the lenders and the “speculators” in the securities market bear some responsibility?

The Fake and the Real

2008-04-03T09:04:00.001-04:00

The Bush Administration’s answer to the current housing and credit crisis is a fake solution. Although the new policies announced by Treasury Secretary Henry Poulson on Monday, March 31 have been widely reported in the media as “new regulation,” there is no new regulation. Poulson defended the current level of regulation of the banking industry and, instead, promoted the view that what we have here is a failure to communicate. A lack of interface among regulatory agencies. As a result, the administration has adopted what Paul Krugman calls “The Dilbert Strategy,” giving the appearance of responding by simply rearranging the organizational chart.

The Bush Administration has mastered the art of the fake response. Sometimes in the life of those in power, events demand an answer. There is trouble in the land, and the people look to their leaders for help. But President Bush and his group are advocates of small government and free markets, as a result, often they don’t really want to respond. In these cases they give the impression of caring by responding with BS. (See philosopher Harry Frankfurt’s On Bullshit)

Sometimes, if a response to a problem can serve his interests, the President responds with real, authentic policies. Examples include: tax cuts, the wars in Afghanistan and Iraq, bankruptcy reform, and the recent Wall Street woes. Fake policies include Katrina, the entire field of international diplomacy, the environment, and, most recently, the economic problems of the poor and middle class. Billions of dollars in loan guarantees—real money—is instantly moved into place when needed by the top end of the economy, but those who are losing their jobs and homes are still waiting.

Clear Differences on Foreclosures

2008-03-26T15:01:00.000-04:00

The Republican and Democratic presidential candidates have always differed on a number of issues, but recent news has revealed a clear separation on how to treat foreclosures and the economy. According to statements reported in today’s NY Times, John McCain says he is not in favor of a vigorous government response to the mortgage crisis. In contrast, both democratic candidates favor programs varying between $30 billion (Clinton) and $10 billion (Obama).

In a statement that comes close to being a lie, McCain said yesterday “it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers.” In truth, he seems only to believe half this statement. As documented later in the same article, McCain supports the Fed’s recent move to provide $29 billion in loan guarantees to support the Bear Stearn’s bailout. So, either the Bear Stearns episode was not a bailout in McCain’s view or rewarding those who act irresponsibly is fine, as long as they are wealthy investment firms and not mere citizens who are struggling to keep their homes.

Drive-Through Windows, the Large Muscle Hierarchy, & Spending

2008-03-23T16:48:00.005-04:00

The picture above was taken on March 17, 2008 at a local Dunkin’ Donuts during the lunch hour. Six cars in the drive-through line are visible from this angle, and none of them has yet to reach the speaker box where the driver can place an order. Also note the many parking spaces available for patrons ambitious enough to leave the car and walk into the store. The red car to the left is mine.

In Going Broke I suggest that physical effort is a major deterrent to many acts of spending and that the contemporary retail world has been designed to reduce the effort involved in spending. In particular, I propose the following Large Muscle Hierarchy:

Sitting is better than walking.

Walking is better than climbing stairs.

Cars put us at the top of this hierarchy. We are in the extremely desirable seated position, expending very little effort. Furthermore, we can move great distances in comfort and—when retail stores provide drive-through facilities—exchange money for goods and services. All without walking. The effects of all this convenience can be seen in our bank balances and waistlines.

Quick Help for the Powerful

2008-03-18T15:53:00.000-04:00

The economic news over the last few days has been dizzying. On Sunday (!) the Federal Reserve Board announced a plan to lend money to Wall Street investment firms and approved a deal that allowed J P Morgan Chase to buy the failing Bear Stearns Company for pennies on the dollar. Today, the Fed announced yet another decrease in interests rates. Once again, Heaven and Earth move quickly—at great taxpayer expense—to help the wealthy and powerful who gamble in the stock market, but the wheels of government move much more slowly—if at all—for the less powerful who are losing their homes and jobs, are without adequate health care, or are burdened by enormous debt.

The Fed’s actions may have been important and completely justified, but there is something very wrong with this picture. The suffering at the bottom of our economy seems to get very little attention, while the ups and downs of Wall Street grab the headlines.

Ben Bernanke, Kingmaker

2008-03-12T10:28:00.002-04:00

Yesterday the stock market shot up over 400 points, the largest one-day gain in over five years. Why? Because Ben Bernanke, the Federal Reserve Chairman, offered up $200 billion in loans to the top 20 investment banking firms in the country. Banks have been caught in a credit crunch caused by the subprime mortgage mess and need liquidity—cash that can be used to make investments. The stock market got all excited yesterday and went on a big run, and as I write this the Dow is up again this morning.

I am struck by two aspects of this story. First, there is the dizzying power of being able to move such enormous sums of money with the flick of a wrist. In contrast, the $170 billion economic stimulus package was hotly debated before Congress and the President would sign off. Of course, the rebates of the stimulus package are permanent disbursements, and the Fed is offering loans. But the imbalance in oversight and accountability is daunting. Those who serve the banking industry can move government funds quickly and with impunity. Those who serve the individual consumer must summon a great effort to do so.

The second and most important observation is that the Fed’s action is another short-term fix. There is still great worry about underlying value of mortgages in the US, and Bernanke’s action is another demonstration of the government’s responsiveness when it comes to the quick fix. But there is far greater reluctance to take on the true causes of economic instability. Why? Because some of these problems are difficult to solve (e.g., health care) and the solutions to others will be attacked by the powerful banking and business interests (e.g., mortgage lending and credit card industry reforms, wage and job security increases). Unfortunately, I have little faith that free markets will correct the kinds of problems we face today. We need a serious change of direction, away from the highly leveraged consumer-driven economy of the recent past, and it is unlikely that change will come without strong leadership.

Upside Down and Unemployed

2008-03-08T15:45:00.001-05:00

The bad economic news just keeps coming...

An Epidemic of Negative Equity
The real estate bust has engendered a new catch phrase: upside down. To be upside down is to owe more on your mortgage than your house is worth—to have negative equity. The value of your home is always supposed to be higher than the amount of your mortgage, but as real estate prices have dropped, many people—particularly those who had little equity to begin with—have found themselves upside down.

This week we learned that 10 percent of homeowners now have zero equity or are upside down. Long before the foreclosure crisis began and before the label upside down had been introduced, this particular form of financial checkmate was anticipated in “The New Road To Serfdom: An Illustrated Guide to the Coming Housing Collapse,” a May 2006 Harper’s piece by Michael Hudson. [The article is here, but only Harper’s subscribers will be able get at it.] Of course, the worry is that any economic bump—and there appears to be no shortage of them—will bring disaster to the upside downers, and without any equity to lose, many homeowners will be tempted to cut their losses by walking away from their mortgages.

More People Out of Work
Speaking of economic bumps, Friday we heard that the nation lost 63,000 jobs in February, the second drop in jobs in as many months and a much larger drop than had been expected. The unemployment rate actually fell, from 4.9 to 4.8 percent, but that was a statistical anomaly. The unemployment figures only include those who are actively looking for work. They do not include people who would like to work but have lost hope and given up looking. This last group also increased in February, so joblessness overall is on the rise. If you put these two news items together—more homeowners without equity and increased joblessness—it seems likely that, at least for the near future, foreclosures and bankruptcy will continue to rise.

Still Going Broke

2008-02-26T11:28:00.000-05:00

The week is just starting, but already the news has not been good for the American consumer. Yesterday CNN ran a story, “When Credit Puts You in Jeopardy,” which cited a Demos study showing that overall credit card debt grew by 315 percent from 1989 to 2008. In addition, CardTrack.com is reporting that the percentage of people who are delinquent on their credit card payments is the highest it has been in three years.

Then comes the news that foreclosures were up 57 percent in January over the same month last year. If there was any good news in this report it was that the month-to-month increase in foreclosure had diminshed slightly, but it is clear the foreclosure crisis will continue. Yesterday also brought news that sales of existing homes dropped for the sixth straight month and that prices are continuing to decline. As long as the real estate market is in free fall, more and more people will find themselves trapped in a house that is worth less than the mortgage. If they, like millions of others, get into a financial squeeze, selling the home to get out from under the mortgage will not be an option.

So many people are facing foreclosure that a new cottage industry has cropped up. You Walk Away is a web-based company that sells a “Protection Plan and Kit” to help homeowners through the process of foreclosure. Critics argue that this kind of business is changing consumers’ moral compasses and encouraging irresponsible behavior, but it seems to me that both irresponsible lending and irresponsible escape from obligation are the natural results of an unregulated free market system. The NPR site has a good story on this issue.

On the heels of these discouraging reports comes the news that two bills that would provide relief to holders of subprime mortgages are under attack by the mortgage industry. For a counterbalancing defense of the bills, see Elizabeth Warren’s most recent blog posting.

Finally, today CNNMoney.com is reporting that consumer confidence is at its lowest point in 14 years. In a consumer-driven economy that is very bad news indeed.

Meanwhile, as I write this the Dow Jones Industrials average is up 126 points (1.01%) on the day. Go figure. It seems to me that, more than at any time in recent history, consumers and investors live in two different worlds--worlds that are often in direct conflict. I will have more to say about this in a future post.

Something Happened in the 1970s: The Minimum Wage in Perspective

2008-02-18T15:44:00.005-05:00

While looking at some data on the US federal minimum wage, I came across an interesting trend. One of the themes of Going Broke is that something happened in America beginning in the 1970s. The symptoms were dramatic increases in rates of bankruptcy and personal indebtedness that continued right into the 21st Century, but the causes of these signs of soaring of financial misery are far from obvious. I make a case for the combined effects of several modern pressures, and one of these is economic insecurity produced by declining real wages for many workers. Now take a look at the graph below, which I constructed a few days ago.

The red line of the graph shows the actual or “nominal” minimum wage for each year since 1955, and the blue line shows that wage, adjusted for inflation, in 2007 dollars. So, for example, in 1979 the minimum wage was $2.90/hr but it had the equivalent buying power of $8.28/hr today. The overall arc of the blue line shows that, here, too, something happened in the 1970s. From 1955 through 1968, the minimum wage rose sharply, peaking out at $9.53/hr (adjusted for inflation) in 1968, but since the late 70s, the minimum wage has been on a long and jagged slide.

Last year, in the wake of Hurricane Katrina and the Democratic congressional victory of 2006, Congress and the President agreed to a plan to increase the federal minimum wage. Under the new law, the wage will increase in each of three years, topping out at $7.25/hr in the summer of 2009. The graph shows that, when the minimum wage hits this point, it will bring us back to where we were in 1982, when the nominal minimum wage was $3.35/hr. Of course, this really overestimates the increase, because by the time the summer of 2009 rolls around, inflation will undoubtedly have increased, pushing the black horizontal farther down relative to the blue line.

Most states have set their own minimum wages at rates higher than the federal rate, but as this map from the US Department of Labor shows, there are 18 states (blue, red, and yellow below) for which the federal minimum wage applies, including Louisiana and Mississippi, the states most severely affected by Hurricane Katrina. Economists argue about whether increasing the minimum wage has the negative effect of increasing unemployment. But we know that income disparity has increased over the last three decades, and it seems likely that this trend in the federal minimum wage has been a contributing factor.

Will We Begin to Spend Less and Save More?

2008-02-07T09:11:00.000-05:00

A February 5, New York Times article “Economy Fitful, Americans Start to Pay as They Go” predicts the credit crunch and downturn of the housing market will lead Americans to use credit less and save more. Writer Peter Goodman points out that many people who have been spending out of their home equity will now enter a period of forced restraint. The free ride produced by rising real estate prices and easy credit has come to an end.

Without question, many who could spend freely in the past will now be constrained by lack of equity, but if credit card debt remains as widely available as it has, the basic problem—our spending-to-savings ratio—may persist. My mailbox still contains daily credit card solicitations, and at the mall I am regularly offered store credit cards. As long as the use of credit cards is so widespread, we are likely to have a continuing problem with debt. In a service economy dependent upon consumerism, many people will respond to the impulsive voice in their heads saying, “Put it on plastic,” rather than the wise one saying, “Don’t buy it. Save your money.”

In addition, saving has gone so far out of fashion that there are few social or economic incentives for holding on to your money. If we are going to wean ourselves from plastic and protect ourselves from the uncertainties ahead, we need to create easy mechanisms for putting income away and do a much better job of selling the virtues of a well stocked savings account.

Medical Innovation is the Mother of Health Care Necessity

2008-02-01T19:12:00.000-05:00

Some things are just wants. Products or services that we would like to have—sometimes really like to have—but we know we can live without. Often these desires are created by product innovation. Steve Jobs introduces a new iPod or the iPhone, and suddenly we have wants we could never have imagined.

In The Overspent American Juliet Schor describes the gradual ratcheting up of needs. Home air conditioning was once considered a necessity by very few, but now fully 70 percent of us consider it a need. Because few of the old needs go away, technological advances create more “needs” that compete for our income. Just a few years ago, computers and cell phones were unheard of, and now they are must-have items.

But sometimes a new product becomes an immediate need. The minute it is introduced we have no choice but to buy it. This is particularly true for medical treatments. Health is the trump card. In Going Broke I give the example of Lipitor, the cholesterol-lowering statin drug, that, once introduced, became an instant necessity for millions of Americans. In 2006 Lipitor’s US sales were 12.9 billion dollars, making it was the highest-selling drug in the world. If you have high cholesterol that you are unable to bring down any other way, your doctor is very likely to prescribe Lipitor or a similar drug, and most consumers will fill the prescription because they feel they must. You can’t take chances with your health.

Now the non-partisan Congressional Budget Office has produced a report, “Technological Change and the Growth of Health Care Spending” showing that approximately half of the growth in US health care costs in recent decades comes from medical innovation: new treatments made possible by technological advances. Furthermore, the report concludes: “The nation’s long-term fiscal balance will be determined primarily by future growth in health care costs” (p. 17). This is a big problem fraught with ethical issues. How do we apportion medical services and who should pay? Medical innovation is a two-edged sword. It brings the hope of longer life and better health to many, but it also hungrily consumes more and more of our personal and national budgets. Where will this trend lead us?

Rebate or Bonus?

2008-01-31T15:39:00.000-05:00

In Going Broke,I discuss Nicholas Epley’s studies of how thinking differently about a windfall influences what we do with it. In a series of laboratory studies, Epley found that money described as a “bonus” was more likely to be spent than money described as a “rebate.”

A bonus feels like extra income, whereas a rebate feels like lost income that is being restored: a reimbursement. In “Rebate Psychology,” an excellent op-ed piece in today’s NY Times, Epley points out that the proposals for an economic stimulus package fail to take advantage of his findings. If politicians are hoping to encourage spending, they would be better off describing the $600 and $1200 disbursements as bonuses, not tax rebates. Thinking about money differently can greatly influence whether we hold on to it or let it slip away.

Epley’s research is a good example of what psychologists call a framing effect, but the larger question is, should consumers spend or save their rebates? Many Americans would be better off saving their rebates or using them to pay down debt. As a result, I am glad that Epley’s framing effects have been ignored in the current proposals. Spending a “bonus” might be good for the stock market, but for many consumers, saving the tax “rebate” would be a much wiser course of action.

Moral Hazard and the Costs of Foreclosure

2008-01-30T19:41:00.000-05:00

Today the Boston Globe reports that the City of Boston will begin pressuring mortgage companies to maintain their foreclosed, vacant properties. Many of these deteriorating buildings are in violation of city ordinances, and when safety becomes an issue, the city is forced to assume the costs of boarding buildings up or—as in the case of one home—draining a backyard pool.

The costs of maintaining foreclosed properties can be thought of as a negative externality: an expense produced by the mortgage companies’ own behavior that is borne by someone else, in this case the citizens of Boston. To the extent that we blame the foreclosure crisis on the irresponsible practices of lenders who have ventured into the risky subprime market, we can say that these costs have been unfairly unloaded onto the city. Ideally, the banks should adopt lending practices that make foreclosure less likely and factor all the costs of foreclosure—including the maintenance of vacant properties—into their business plans.

Which brings us to the concept of moral hazard: the idea that people who are shielded from the risks of their own actions behave less responsibly. Moral hazard is often applied to consumer behavior. For example, one of the arguments against supplying health insurance is that it might encourage risky behavior and the unnecessary use of healthcare services. If everyone assumed all the costs of their health-related behavior (e.g. eating, smoking, and visiting the doctor) would they behave more prudently?

The proposed responses to the foreclosure crisis also bring up issues of moral hazard. For example, would a bailout of the mortgage lenders shield them from the consequences of their unwise lending practices and inadvertently encourage that behavior? (For a discussion of these issues, see the NPR story “Subprime Bailout: Good Idea or 'Moral Hazard?”)

The question of how policies encourage or discourage prudent behavior is a constant concern. In this case, Boston City Councilor Robert Consalvo will introduce legislation that would force mortgage companies to identify who is responsible for the maintenance of empty buildings, post contact numbers, and pay a $100 annual fee for each vacant property. It is unclear whether this plan would eliminate a moral hazard in the lending industry and promote more responsible lending practices, but at very least, the City of Boston is justified in redirecting the costs of maintaining vacant foreclosed properties back to the owners.

The Prisoner's Dilemma of Tax Rebates

2008-01-29T07:40:00.000-05:00

In a January 27th post to her blog, Elizabeth Warren likens the American consumer to a battered athlete who is being asked to go back in and do it one more time for the economy. Spend to help us win the game again. The proposed stimulus package will give the athlete a boost by putting a few hundred dollars in his or her pocket. The analogy is apt, because for millions of tapped-out consumers, spending the tax rebate will just put off debt repayment and maintain their current level of vulnerability to unexpected expenses or any other bumps in the economic road ahead.

The stimulus package highlights the Prisoner’s Dilemma of our current economy. Spending is good for the economy as a whole, but saving is good for the individual consumer. We have over-fished the waters of the consumer economy, and too many individual citizens have been sacrificed in the process. Rather than spend their rebates—which, ironically, the federal government must finance with borrowed money!—Warren recommends that consumers use the rebate to pay off some of their debts. BabyBelle, a commenter to Warren’s post, says she plans to deposit the rebate in her rainy day fund. Both of these ideas are on target. The rule should be (a), if you have debt, use the rebate to pay it down or (b), if you are debt free but have little savings, save the rebate. On the other hand, if you have no debt and plenty of savings, do whatever you want with your rebate. Unfortunately, not enough Americans fit in to this enviable category.

These recommendations may not help the economy as a whole, but generally “the economy” is defined as the stock market—the current value of the portfolios of wealthy investors. When the market starts to drop, the economy is said to be taking a down-turn, and the media and politicians begin to pay attention. But for far too long the personal financial portfolios of individual middle class and poor consumers have been going south without raising an eyebrow. It is time these consumers ignore the call to bail out the rich investors and concentrate on what is best for their personal economies. Save your rebate or use it to pay down debt. Don’t spend it.

Clinton & Singletary on the Economy

2008-01-22T08:52:00.000-05:00

In a recent column entitled, “One Candidate and the Economy," Michelle Singletary, the personal finance columnist for the Washington Post, reports a conversation with Democratic presidential candidate Hillary Clinton. Clinton’s comments show that she is aware of the larger role of credit card and other commercial debt in the ongoing foreclosure crisis and general economic downturn. One of her most useful points is the need for financial education and improved financial literacy. Without blaming the victim, she recognizes that there is a serious problem of personal indebtedness and the need to help people get out from under.

This kind of article is not surprising from Michelle Singletary. She is one of the most level-headed personal finance advisors on the scene today. In a sea of useless financial advice, Singletary is an oasis of sound judgment.