The biggest banks in the United States have been engaging in practices designed to nudge US economic policy and banking regulation toward permitting nearly any sort of interest-rate manipulation and ignoring, or erasing, necessary anti-usury laws. It’s been part of a concerted effort to try to shape policy to make it easier for banks to come into fresh money and claim new levels of profit from what would otherwise be considered escalating risk.
We are often told it is the borrower who is responsible for all choices involved in any lending relationship. Taken dispassionately, this seems an odd analysis, considering the relationship cannot begin if the lender does not voluntarily choose to lend to that particular borrower. Banks argue that they attempt to allow credit to “flow” to as many borrowers as possible, in the interest of the general welfare, but that they must impose strict disincentives on borrowing beyond one’s means, such as penalties and aggressively escalating punitive interest rates for borrowers with poor credit or who fail to pay on time, even once.
Again, this sounds reasonable at first blush, but when we look at the mathematics involved —and the banks claim to have no real role in any of this other than mastery of the mathematics—, we tend to find that the banks’
system of rates, plus fees, plus penalties, is not designed to keep the credit relationship healthy, but rather to keep it as unhealthy as possible for the borrower. The goal is quite visibly to extract the maximum amount of interest over the longest possible period of time, from the borrower, period.
That maximum amount of interest over the longest possible period of time is then counted by the lending bank as an “asset”, a future amount of profit or concrete wealth it expects to receive. The problem is: there comes a moment at which rates of interest are so high that the legitimacy of related transactions becomes mathematically unsustainable. The loan cannot be paid back by the borrower.
The borrower may have the information necessary to calculate how much a single dollar borrowed on a credit card may cost over time, even to plot out a “worst case scenario”, but the language of credit card contracts is deliberately structured to give the borrower a rosier picture of the service being provided and to downplay the likelihood that the average borrower might fall afoul of the credit contract’s punitive measures.
It is the banks that structure the credit card plans and design them so that the least able to pay will be trapped into paying the highest rates of interest over the longest period of time. This is a gamble, and clearly one in which the banks are running the greatest risk of not achieving their projected return on a given credit investment.
Usury —the charging of unpayable and irrational rates of return on loans— is a crime, because in real terms, such loans cannot be enforced except through violence and extortion. Legalized usury, through the banks, is in part a fraudulent claim of future income, because there is no way to secure the full amount of the return claimed as inevitable, or even probable, repayment by the lending institution.
Adjustable rate mortgages were misused in much the same way: where they have a very legitimate place in the financial and credit markets, ARMs were taken advantage of by banks in order to claim far higher than sustainable rates of return on genuinely risky investments. This sort of exaggerated claim of future wealth is akin to a bank “borrowing too much” or “getting in over its head”. Abuse of lending markets has led to banks becoming deadbeats, but so far, they have refused to take the blame for making not just bad bets, but false bets based on mathematically impossible claims.
In this environment, credit cards became little more than an excuse for major US banks to ignore the mathematics behind their financial projections and justify impossible-to-repay interest assessments against troubled borrowers. That there was some legal justification for such behavior does not mean it was fiscally responsible behavior, or that it should have any place in an ethical banking culture.
Regulators should have been on the heels of every bank with such impossible-to-repay rates on credit cards and mortgages, but they were distracted by the fact that such accounts had been resold and bundled and turned into surprisingly lucrative “investment packages” or “financial instruments”. While regulators understood that certain lending relationships were unsustainable at the profit margins claimed, it appeared to many that financial speculation would more than cover any such risk, and would turn those bad bets into windfall profits.
But repayment is necessary to sustain the notion of profitability from compounded financial investment in high-interest loans —credit cards, mortgages or otherwise—, and when massive numbers of credit defaults started occurring simultaneously, the house of cards, as it were, started to come apart.
The system of legalized usury that had taken root in the US banking system was built on a foundation of good intentions, to make credit available to more people and therefore to expand the buying power of a vast middle class. The problem is that the lending policies used to enable this were not designed to achieve that laudable goal, but rather to force consumers into devoting ever larger percentages of their income to debt repayment.
This had a consequent crippling effect on the real sustainable buying power of the average consumer or household and began impacting, very seriously, the degree to which individuals would be able to make free personal choices about not just their spending habits, but their personal lives. Higher debt obligation means less freedom of choice in employment; one is driven by a need to cover costs.
Higher debt obligation also means that one’s private property is less one’s own. Consumers were encouraged to cover their escalating expenses by borrowing more. By refinancing a home mortgage, for example, or opening a second, third, fourth or fifth credit card account. Aggressive borrowers were seen as lucrative investments by major banks, so they kept sending more pre-approved credit cards by mail.
In hindsight, it’s easier to see how similar this behavior was to a loan-shark spotting a poor desperate soul whom he could subject to chronic indenture. But at the time, the “everybody’s doing it” mentality dampened the alarm bells some analysts, some politicians and some consumer advocates were sounding. The regulators missed the boat, and the evolution of legalized usury got too far along to be reversed simply by force of will or on ethical grounds.
The entire financial system came to be rooted in untenable claims about exorbitant future revenues to be derived from lending and from resale and reinvestment in lending relationships. Yet the banks wanted as little to do with borrowers as possible. Minimal to zero communication with borrowers regarding their needs, regarding emerging signs of difficulty, was sought. Banks treated every human soul that borrowed as a font of unending repayment at escalating rates of return.
The engineering of the system was so radicalized that credit bureaus were encouraged to issue lower credit scores to people who paid off all credit card bills in full every month, accumulating no interest and therefore serving as less profit for banks. The system was no longer about credit worthiness or ability to pay; it was structured entirely around profit-extraction potential.
This is one area regulators will be looking into, should banks fail to take the necessary steps to curb their predatory lending practices and institute reforms that might help avoid another rash of consumer bankruptcies and corresponding home foreclosures this year. This is why Pres. Obama called on the nation’s largest banks to voluntarily institute sweeping reforms to their credit card systems, because the credit card system has come to signify a grave threat to near-term economic recovery and long-term prosperity.
Nearly $1 trillion in outstanding credit card debt may prove to be the next credit default meltdown, causing a vast ripple effect throughout the US and international banking systems. Last fall, Business Week reported that “The consumer debt bomb is already beginning to spread shrapnel through the financial markets,” and that “Credit card companies were unable to collect $41 billion in credit card debt in 2008 and are expected to lose another $96 billion in 2009?.
Should those projections for 2009 become a reality —and they are more likely to become reality due to escalating job losses and the refusal of banks to act to prevent foreclosures and bankruptcies—, the current recession would deepen, as record numbers of consumers file for bankruptcy, lose their homes, and are impacted by wave after wave of further layoffs, spurred by businesses’ inability to borrow from banks trying to prevent further losses by not lending.
Proposals linked to Pres. Obama’s call for a return to reason and to fair treatment in consumer lending include:
1. Strong consumer protections against “any time, any reason” credit card rate hikes.
2. “Plain Jane” credit card statements, especially regarding how fees are structured. The President went out of his way at his White House speech to warn card companies about hiding big fees in the “fine print”.
3. A central, online platform where card customers can compare credit card terms from competing vendors.
4. More regulations and oversight on credit card companies. Somewhat cryptically, Obama allowed that card companies should be able to earn a “reasonable” profit – but no word on what “reasonable” means.
In March, credit card delinquencies reached 8.5%, the highest national rate since 1984, a sign that inaction to reform credit card policies is hurting banks’ own ability to recover the money lent. A column by Jay Hancock, calling for “an end to the credit card madness”, warns in bold terms that:
Here is the less-known, conservative argument: Credit card complexity prevents users from making rational decisions about borrowing and spending, thus hurting the economy; Congress must intervene to make the system understandable.
Unfortunately, Congress might not take either course. Bills in the House and Senate would end the worst abuses but do little to stop stalker lending or cut the fine print.
Credit card practices are so out of control that even legislation that consumer groups see as a huge step (”Great news on the credit card front!”says Consumers Union) would leave plenty of room for trouble.
Pres. Obama’s call for bold credit card policy reform —including rate reductions and strict limits on the freedom of banks to arbitrarily raise rates— has led to Congress moving to debate and vote on legislation for the much needed ‘Credit Cardholders’ Bill of Rights’. Reuters reports that US lawmakers in the House of Representatives are planning to bring that legislation to a vote as early as this Thursday. Strict new regulations would be imposed, and credit card issuing banks would have until 2010 to implement the reforms.
- Originally published at CafeSentido.com, 29 April 2009
The Poet Economist 