No discussion of credit woes in the American economy is complete without a raging flame war between those who believe government should prevent "predatory" lenders from taking unfair advantage of borrowers, and those who believe that borrowers who can't pay what they owe are deadbeats who deserve to be publicly mocked, if not shackled and thrown directly into debtor's prison.
Echoes of this hallowed clash can be heard in the ongoing debate over what to do with all those subprime mortgage borrowers currently experiencing the joys of resetting ARMs and receiving foreclosure notices in their mail. Let 'em rot in a dungeon built from their own stupidity, cry those who always pay their credit card bills on time and never fail to read the fine print. Most of 'em are scammers who knowingly abused the system, they say. Either that, or recklessly foolish to the point where they deserve nothing less than a night in the stockade.
If you happened to follow the tos and fros in the debate over the new federal bankruptcy law passed in 2005, which made it much harder for Americans to declare personal bankruptcy, you will no doubt find this rhetoric familiar. The credit industry, which lobbied hard for bankruptcy "reform," framed the issue as one in which something had to be done about all those immoral people running up credit card bills that they knew they wouldn't be able to pay back. And why not? They could always escape their debts by declaring bankruptcy.
Never mind that there was next to zero empirical data supporting this argument. The credit industry won the day. Some day soon, now that Americans are once again running up their credit card bills as they try to find a way to keep afloat without the help of magically appreciating home prices, we may find out exactly how smart this "reform" will turn out to be. In the meantime, it might be useful to go back and review exactly how the credit card industry treated, in practice, Americans who had already declared bankruptcy, even as it was castigating them, in rhetoric, as wastrels and scoundrels.
Surprise! Bankrupt Americans get all kinds of love from the credit industry. According to data compiled and analyzed by Katherine Porter, a law professor at the University of Iowa, in the superb "Bankrupt Profits: The Credit Industry's Business Model for Post-bankruptcy Lending":
...Creditors repeatedly solicit debtors to borrow after bankruptcy. Families receive dozens of offers for new credit in each month immediately after their bankruptcy discharge. Some offers specifically target these families based on their recent financial problems, using bankruptcy as an advertising lure. Other credit offers emanate from the very same lenders that the families could not repay before bankruptcy. While not every lender will accept a "profligate" bankrupt as a customer, debtors report being overwhelmed after bankruptcy with a variety of credit solicitations from many sources. Lenders offer families most types of secured and unsecured loans.
Survey data compiled by the Consumer Bankruptcy Project reveals:
- Just one year after bankruptcy, 96.1 percent of debtors were recipients of credit solicitations.
- One year post-bankruptcy, these families reported that creditors sent them an average of more than fourteen credit offers per month.
- Industry researchers report that the average American gets six credit offers each month.
- A vast majority of debtors had received credit solicitations that specifically mentioned their bankruptcy. Nearly 88 percent of debtors reported that lenders had referenced the debtor's bankruptcy in their credit marketing.
Why? Why would a credit industry that was lobbying Congress to protect it from being abused engage in such willful self-flagellation?
In the first year after filing, many families face financial difficulty and must cope with declining or stagnant incomes. People in financial distress are more likely to have revolving accounts, to have exceeded their credit limit, and to use cash advances (which carry a higher interest rate), creating what some researchers have termed "attractive cash flows."
These families may be slow to pay; they may make only small payments; they may incur huge fees; and their balances may negatively amortize. But they cannot seek bankruptcy relief. It is precisely this constellation of features that makes post-bankruptcy families particularly profitable for lenders.
The pitiful truth is that, if you are in financial distress, you are flashing dollar signs at credit issuers.
According to Porter, decades of research indicate that "job problems, illness/injury or family break-up were pandemic in the bankrupt population." In other words, people tend to declare bankruptcy because traumatic financial events force them to do so, not because it was their plan all along. And the credit industry knows that.
The strong overall pattern of credit offers to bankruptcy debtors suggests that creditors themselves reject a view of bankruptcy filers as either immoral individuals who chronically fail to honor their obligations or as strategic actors who are apt to abuse legal protections to avoid debts.
And where do we end up?
If lenders' intense solicitation of such customers indeed is driven by these families' propensity to pay late, go over the limit, and revolve large balances, society may wish to prohibit or constrain such lending.
Well, that's what a civilized society might wish to do. What the United States will ultimately decide is another question.
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