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Credit Card Debt and Subprime Mortgages: Who’s to Blame?

This story is a follow-up to “On Not Owning a Credit Card” and was originally posted on New Deal 2.0.

By Bryce Covert

A few weeks ago I wrote a post about my personal decision to stay away from credit cards and my struggle with a society that is rigged in favor of them. The post didn’t advocate getting rid of credit cards; it advocated getting rid of a credit score system and other incentives that make it difficult not to have one.

The comments section for the post on reddit had a variety of opinions in response, both positive and negative. But many of them used the words “dumb,” “idiot,” “lazy,” “stupid.” They used words such as “responsibility” and “discipline” and “self-control.” The crux of these arguments is that those who get into heavy credit card debt are financially illiterate (or just plain naive). This viewpoint rests the blame of soaring American credit card debt on those who get the cards, rather than the companies who issue them. There is of course a grain of truth in this — many people who have credit card debt spend beyond their means. And there are ways to be savvy about credit cards and not run up a balance.

But that is not what a credit card company wants, and you may in fact find yourself rejected from getting a card if you are that responsible. You are far outside the sweet spot, or what Ronald J. Mann, a professor of law at UT Austin, calls the “sweat box”:  “the spectrum from those who carry balances, to those who routinely make minimum payments, to those who miss payments altogether… [where] the interest rates that borrowers pay…greatly exceed the cost of the lender’s funds.” Mann wrote a paper in 2006, right after Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act. Proponents of the act relied heavily on a moral argument: that it is shameful Americans could ‘easily’ walk away from their debt by filing for bankruptcy. Those pushing the reforms were concerned that consumers used bankruptcy as a convenient part of financial planning, not as a last resort. Thus the rules for filing had to be tightened.

But Mann smelled something fishy: the credit card companies had lobbied heavily and expensively with this bill. But the bill was unlikely to return enough income through increased bankruptcy payouts to justify the expense of lobbying. In fact, it had none of the effects you might think credit card companies would want: deterring risky borrowing, increasing bankruptcy payouts, or lowing bankruptcy filing rates. So why did they do it? It turns out that the major outcome of this bill, and all that lobbying, was to delay consumers from filing for bankruptcy. The credit card companies weren’t worried about losing money when a customer defaulted; they were worried that too many defaults too early led to lower profits. This is where credit card companies make their money. Not off of customers who are so irresponsible as to default right away, not off of customers who are so responsible that they pay their bills on time. Rather, off of those who are just bad enough to drag out their balances for a long period of time. And that’s where they want to keep you — in the sweat box.

Credit cards have evolved along the same path as mortgages. As Elizabeth Warren, tireless consumer advocate, puts it: “The financial industry has perfected the art of offering mortgages, credit cards, and check-overdrafts laden with hidden terms that obscure price and risk.” Need proof? The average credit card contract has bloated up to 30 pages, from a page and a half in the early 1980s. Issuers advertise a single interest rate and then bury the real details in the contract. (It’s no coincidence that the landmark Marquette Nat. Bank of Minneapolis v. First of Omaha Service Corp. case was decided in 1978, which said that states could no longer regulate interest rates on nationally-chartered banks, leading them to easily find the laxest state laws and regulators.) Similarly, to quote Elizabeth Warren again, “More than half of the families that ended up with high-priced, high-risk subprime mortgages would have qualified for safer, cheaper prime loans.” Wonder why that is. Maybe all those families were interested in high-stakes gambling with their houses? “A recent Federal Trade Commission survey found that many consumers do not understand, or can even indentify, key mortgage terms.” Hmm, maybe not.

The responses to my credit card post mimic the response to the subprime mortgage catastrophe, which placed the blame on homeowners who got mortgages without the adequate funds to pay them back. Again, there is truth in this viewpoint. It is true that many people with little to no income bought houses that they couldn’t afford. But why were so many of these mortgages given out? Who gave them? And what were their motives?

Gary Rivlin may answer some of these questions in the chapter “The Birth of the Predatory Lender” in his book Broke USA. He writes about the early 1990s, when nonbank lenders started to realize that there were profits to be made from low-income neighborhoods. They preyed upon the poor, as “the typical customer…didn’t feel ripped off paying interest rates of 20% or more but instead felt grateful that finally, someone was saying yes.” A lawyer working to help some of these customers climb out of their debt “suspected that the lender was more interested in seizing homes through judgments of default than in accruing steady profits through regular monthly payments.” And indeed, Fleet, one of the first large banks get into the business, “lost $17,000 per home on the 101 homes it sold at a loss, [but] it made an average of $32,000 per home on 194 homes.” Again the story of relaxed regulation in the 80s comes to play: the state caps on interest rates banks could charge on mortgages were barred in 1980. Two years later, Reagan went further and gave lenders the ability to sell creative home loans, including balloon mortgages and adjustable-rate mortgages. A whole new lingo emerged: “packing” a loan, in which a salesperson was able to load it up with points and fees and credit insurance; “flipping,” in which a broker could convince customers to refinance loans again and again, each time adding more points and fees; and all of these practices falling under “equity stripping,” in which banks siphoned off the equity customers had in their homes. The cards were stacked against mortgage customers so that banks could profit. By the turn of this century, “Increasingly, mainstream banks were revving up profits by purchasing or starting a subprime subsidiary,” Rivlin recalls. And we all know how that turned out.

It’s tantalizingly easy to place the blame for huge problems like credit card debt and subprime mortgages on individual consumers. The solution to that is for them to “just man up,” as one of the reddit readers suggested. And as I said above, individual responsibility will always be a factor when it comes to these issues. In Elizabeth Warren’s words: “Nothing will ever replace the role of personal responsibility. The FDA cannot prevent drug overdoses, and the CFPA cannot stop overspending. Instead, creating safer marketplaces is about making certain that the products themselves don’t become the source of trouble.” And therein lies the rub. It is far more difficult to think and talk about the system in which so many of these decisions are taking place.

The flood of comments and reactions to my piece heartens me, however, for two reasons. One is that people who had similar stories to mine came out of the woodworks. Friends, family, coworkers, strangers all started telling me how they either stayed away from credit cards for similar reasons or got into debt early on, found a way out, and then stayed away. The second heartening thing is that clearly this is something that people care about. President Obama just signed sweeping financial regulation into law, and whether or not it’s strong enough to prevent another crisis, the new Consumer Financial Protection Bureau promises to right many of the wrongs listed above. Contracts will become clearer. Regulators will do a better job of regulating these products. Consumers will actually be able to compare credit products, because they will really understand them, and innovation and competition can come back to the market. But none of this will deal with the problem my original post addressed, which is the way our society tethers its people to debt products. If so many people care, so many people wish to be credit card-free, maybe this can change too.

Bryce Covert is Assistant Editor at New Deal 2.0.