Television Messages

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

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

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

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

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

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

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.