Banking on consumer debt

As the economic crisis continues to worsen and the official national unemployment rate inches well over 10 percent, more and more Americans are faced with more and more debt. Even more troublesome, though, is the fact that more and more Americans are stuck in a debt cycle – with very little prospect of getting out.

The largely overlooked distinction here is quite important.

The first scenario is a temporary situation where the borrower pays on the interest and principal with the expectation of eventually being debt free. Additionally, most of this debt is secured, i.e. the car, and fixed.

The second scenario is a semi-permanent situation where the borrower primarily pays debt interest without the expectation of eventually being debt free. Most of this debt is unsecured, i.e. the credit card, and adjustable.

Put another way, the debt cycle is a transition from periods of low debt into periods of high debt, eventually resulting in debt spending above and beyond actual income.

Furthermore, working-class folks, especially people of color, are affected disproportionately by high interest rates, making the principal-to-interest pay-off ratio unsustainable. Additionally, communities of color are also disproportionately targeted by pay-day loan and title loan companies, who can charge interest rates as high as the imagination (some charging as much as 500 percent in St. Louis), are largely unregulated and in most states are not required to negotiate debt pay-off plans in good faith.

However, according to an article in The New York Times, we shouldn’t be surprised by this. In fact, we should see it as a logical byproduct of a new lender customer paradigm. “Behind the big increase in consumer debt is a major shift in the way lenders approach their business. In earlier years, actually being repaid by borrowers was crucial to lenders. Now, because so much consumer debt is packaged into securities and sold to investors, repayment of the loans takes on less importance to those lenders than the fees and charges generated when loans are made,” renegotiated or defaulted on.

In other words, lenders don’t expect to be paid back; they don’t expect borrowers to eventually be debt free. Furthermore, they want borrowers who are unlikely to pay back loans because the real money is in the fees and charges accumulated over a lifetime of debt spending. Additionally, high-risk borrowers are targeted more aggressively precisely because they are more likely to default on their loans and accumulate more and more fees and charges – aggravating the cycle of debt borrowing.

As the Times article noted, “Lenders have been eager to expand their reach. They have honed sophisticated marketing tactics, gathering personal financial data to tailor their pitches. They have spent hundreds of millions of dollars on advertising campaigns that make debt sound desirable and risk free.”

While businesses comb through an array of sources, including bank and court records, to create detailed profiles of the financial lives of ordinary Americans, banks, credit card issuers and mortgage brokers compete to win over new customers, or as one economist put it, “perpetual earning assets.” These companies now see the lender-customer paradigm as a long-term relationship, akin to indentured servitude – of course without the physical chains.

Undoubtedly, says the article, the “marketplace for personal data has been a crucial factor in powering the unrivaled lending machine in the United States. European countries, by contrast, have far stricter laws limiting the sale of personal information. Those countries also have far fewer per-capita debt levels.”

Not surprisingly, these lending practices that target at-risk borrowers have generated tens of billions in profits for the nation’s financial companies, while helping to send our economy into the greatest recession since the Great Depression.

In fact, bankruptcies are up for the third consecutive year in a row. More than 1.3 million people filed for bankruptcy during the 2009 fiscal year, marking a 35 percent increase in filings from 2008, and business bankruptcies are up 65 percent.

Additionally, the current economic crisis has another unique byproduct. While individual bankruptcies are up considerably, the amount of unsecured debt far exceeds that seen in previous recessions.

Not only did working-class folks have far less debt during the last economic downturn, they had far less unsecured debt, i.e. credit card debt. A 2008 study (which obviously doesn’t capture the current crisis in its entirety) found that the typical family who filed for bankruptcy in 2007 was carrying 44 percent more unsecured debt than in 2001. Undoubtedly, that amount has increased through the current crisis.

Plummeting home values, stagnant wages and joblessness – on top of already increased levels of debt spending – have changed the characteristics of who can ride out the storm.

So while banks, credit card companies and retail stores literally mail out billions of loan offers every year, in addition to the thousands of telemarketing calls, e-mails and spam, and while we are bombarded every day with hundreds of commercials urging us to buy, buy, buy, is it any wonder working class folks are in debt?

Fortunately, the Obama administration is taking steps to reign in and regulate financial institutions that target those most in need and profit off of the cycle of debt.