INTERVIEW / ROBERT MANNING Avoiding a house of (credit) cards

By Silja J.A. Talvi Special to The Christian Science Monitor

For the past 15 years, economic sociologist Robert Manning has been fascinated by ever-increasing levels of American debt. From the meteoric rise in personal bankruptcies (which peaked at 1.4 million in 1998), to historic levels of national debt, Mr. Manning has explored the social and structural implications of what he has called America's "addiction to credit."

At the beginning of the new millennium, explains Manning in his book "Credit Card Nation: The Consequences of America's Addiction to Credit" (Basic Books), a profound transformation in attitudes toward credit and debt has already taken place.

The once-prevalent Puritan work ethic that emphasized saving over consumption has given way to widespread credit use, says Manning, pointing out that US consumer debt is now at an astonishing $6.5 trillion. The Monitor recently caught up with Manning, who is now a humanities professor at the Rochester Institute of Technology in New York.

If I'm not in debt, why should I be concerned about all of the other Americans who are?

BOB STAAKE There's a short-term reason and a long-term reason. The short-term reason is that this is a cultural revolution that's occurring before our very eyes.... I don't think [most people] understand how swift and systematic the [shift] in cultural attitudes toward consumer credit and debt has been in such a short period of time.

There's been a transformation of American attitudes because [banks] have turned the idea of the social responsibility previously associated with credit and debt on its head. Before, you were only getting credit if you had proved yourself worthy by having a good credit history or by having a job. Now, the industry has allowed people to get credit without ever having had a job.

In the long term, there's going to be an even more serious crisis of underfunding for retirement. The fact is that we have a negative savings rate, and that the average household is $12,000 in debt. That means that the average interest paid by each household is $2,000. That's an amount they should be paying toward their tax-deductible IRA, and instead it's going to [credit-card companies].

The American consumer world is dividing into three camps: those who are able to save and be debt free; those who are credit dependent and who could cut back on their discretionary purchases; and those people who are credit dependent because they have no other choice.

What is your own approach toward credit cards? Do you use them?

I do use credit cards.... If you know how to use them, they have a lot of advantages. I make credit cards work for me instead of me working for the credit cards.

Before, we used to have a very clear distinction between good and bad debt. Good debt would be buying a home or paying for college. Now, with all this marketing and immediate gratification and "just do it" consumption, it has been skewed so that more debt is socially acceptable and that credit cards are actually your friends. And that's the real problem - that people are buying things with credit cards that they wouldn't have bought with cash.

Is there a good mental approach that someone who is heavily in debt should take toward handling credit?

That's really a key issue, because with a lot of people with credit-card debt, it's often a manifestation of other problems.

The first step is, you've got to figure out why you're in debt. Is there a personal or a social reason? Some people are overcompensating for their childhood where they came from circumstances where their parents were too frugal. Some people are going through status anxiety, trying to fit in with a different social circle, which they cannot possibly afford. There are a whole host of issues.

What is the "triangle of debt," and what aspect of the triangle do you think Americans might find most surprising?

The triangle consists of consumer, corporate, and federal/national debt. What would strike most Americans is that consumer debt is higher than the federal debt.

What should strike people is that all sectors of society are in debt. Before, there had always been one aspect of the triangle that had been saving money. That made up for fluctuations in the national or consumer or corporate debt. But when all segments of the triangle are in debt, it's clear that the US as a society and as an economy is very vulnerable.

If Congress passes the Bankruptcy Reform Act and it is signed into law, what kinds of general changes can Americans expect if they opt to file for bankruptcy protection?

They're going to have to pay more of their debts back, at least 10 percent of them. For the poorest of poor, they probably aren't going to be able afford the paperwork, because it will be more costly. That will force more people into the underground economy.

It will have a pretty seriously negative impact on small businesses. It's going to force businesses to liquidate, particularly with a slowdown in the economy, because they're only going to have 179 days to have a reorganization plan and repay it, whereas big corporations have the resources and the legal teams to go directly to a bankruptcy judge to request extensions.

It'll also have a serious impact on young people who are now experiencing high rates of bankruptcies and who have high student loans, don't own a home, and only have entry-level salaries.

Describe the relationship between colleges and credit-card companies.

I see it really as a duplicitous union between credit-card companies and college administrators where they basically say [to students], "Well, you're in college, but it's the best investment you're ever going to make, so you shouldn't worry about how much debt you're going to get into."

And the credit-card companies follow that up with "you're going to [eventually] get a full-time job, so what's another $5,000 now?"

College administrators have crossed the line because now they make millions of dollars in exclusive marketing agreements [with credit-card companies].... [And] they're also making millions more by being able to raise tuition and prices on campus and knowing that students will make up the difference with their credit cards. The bookstore, for instance, raises textbook prices by 25 percent, and then they put an application for a credit card in the book bag.

• Americans need help on spending

Hey big spender, take this quiz

Are you a member of America's growing number of overspenders?

If so, you may fit into one of two categories:

• Those who spend beyond, sometimes way beyond, their income and/or ability to repay.

• Those who pay too much for things because they failed to comparison shop.

Those groupings come from the Institute of Consumer Financial Education (ICFE), a San Diego-based nonprofit group helping consumers become better spenders, regular savers, and wise users of credit.

To help determine if you are an overspender, answer the following questions pertaining to your spending techniques. The ICFE lists five possible responses to each statement:

1. Totally like me.

2. A lot like me.

3. Equally like and unlike me.

4.A little like me.

5. Not like me at all.

Should a statement not apply to your situation, skip it and adjust the scoring accordingly:

1. I always live within my income range.

2. Each income period, I set aside at least 10 percent for savings.

3. My finances are managed according to a written spending plan.

4. All household and grocery spending is planned in advance and done with a list.

5. I rarely make more than one trip a week to the grocery store.

6. Grocery and other coupons and rebate offers are utilized whenever possible.

7. Comparison shopping for quality, value, price, etc. is something I/wedo for practically every purchase, large or small.

8. I have no revolving debt carried on credit or charge cards.

9. I have not had an overdraft of my checking account or paid late fees on a credit card.

10. I regularly contribute to an employer-sponsored retirement plan, an IRA or a 401(k) plan.

Scoring your spending techniques

10-15 Very good. Time to teach others how you do it.

16-20Pretty good. Concentrate on improving a few of the weaker areas.

21-35 Average. An hour a week devoted to improving spending will create greater savings.

36-40Lousy. Immediate changes required, now, to avoid a financial disaster.

41-50 Atrocious! Time to contact a credit counselor.

http://www.csmonitor.com/durable/2001/08/06/p16s1.htm

-- Martin Thompson (mthom1927@aol.com), August 06, 2001

Answers

Headline: Living on borrowed time: U.S. lenders keep loaning despite downturn

Source: Cecily Fraser, CBS MarketWarch.com, 3 August 2001

URL: http://cbs.marketwatch.com/news/story.asp?guid=%7BDA1E6518% 2DB470%2D4895%2DB0A6%2DCD7807310DAD%7D&siteid=mktw

U.S. consumers' creditworthiness has deteriorated with the economy, but that hasn't curbed the rate at which lenders are feeding the nation's dependency on debt.

Despite increased unemployment and home foreclosures, record personal bankruptcies and massive stock market losses, America's financial institutions boosted consumer loans by 10 percent to $1.59 trillion in the last year.

The rise is driving the average household to spend 14.3 percent of take-home pay on debts -- and raising the specter of a looming credit crisis if the economy continues to worsen. Lenders are "foisting credit upon people who not only don't necessarily deserve it, but who are not technically credit-worthy borrowers perhaps at any interest rate," said Keith Gumbinger, vice president of HSH Associates, a publisher of mortgage and consumer loan information.

Banks have sustained their lending pace despite added risks on the strength of the Federal Reserve's 2.75 percent cut in interest rates, which has boosted their profit margins. "The margin expansion is, from a profitability perspective, largely mitigating the impact of higher losses and higher delinquencies," said Todd Pitsinger, an analyst at Friedman, Billings, Ramsey.

Bank of America and Citigroup credited reduced interest rates with helping second-quarter profit climb, even as their other business segments were hit by the slack economy. But problem loans are also rising. Provisions for credit losses at Bank of America rose to $800 million from $470 million a year ago, while charge-offs, or loans written off as "uncollectible," jumped nearly 50 percent to $787 million. Consumer charge-offs climbed $96 million, partly because of an increase in bankruptcy filings in the first half of the year, the nation's No. 3 bank said.

As credit quality slides, many banks are showing little concern about mounting losses on consumer loans because of a profit windfall from the Fed's handout, said Robert McKinley, chief executive of CardWeb.com. "With the spread widening, the comfort factor with assuming risk is a little bit higher than it normally would be."

Lenders' flowing credit spigots could lead to severe financial pain for overextended families and card issuers at a time when the jobless rate is rising. Write-offs by credit card companies and mortgage loan delinquencies are increasing steadily, and could spike higher if the jobless rate surpasses 5 percent as some economists predict.

If issuers are pumping credit into the Christmas season and the economy is still sputtering, "that's not smart money and could come back to haunt the industry," McKinley said.

The charge-off rate for the credit card industry jumped to 6.4 percent in June from 5.5 percent in April and 5.1 percent a year earlier, Pitsinger said.

Bankruptcy filings typically make up 35 to 50 percent of the charge- off rate, according to Moody's Investors Service. Many debtors have been rushing to declare themselves insolvent before the new bankruptcy reform bill becomes law. "To the extent charge-offs lift, say through 7 percent, it becomes a much greater concern," Pitsinger said.

Experts said the entire lending industry has been emboldened by proposed bankruptcy law reforms that would keep more loan defaulters on the hook for repayment.

Trade groups are "pressing for bankruptcy reform in an effort to save themselves from themselves," Gumbinger said. "Consumers always need to protect themselves, but unsophisticated borrowers are still going to get drawn in by those easy credit terms like 'No money down, no financing 'til next year, no monthly payments.'"

Deep pockets

Lenders "are their own worst enemies and in many instances have fostered far too much debt for people who cannot manage it," Gumbinger said. Over the past 20 years, personal debt has risen 280 percent, compared to a 165 percent increase in income, according to SMR Research.

McKinley estimates that 40 percent of credit card holders paid off balances in the first six months of the year, down from 44 percent in 2000. During the credit crunch in the early 90s, almost 30 percent were able to make good on financial obligations.

Many people fail to realize they're borrowing to make up for monthly shortfalls, said Steve Rhode, president of debt counseling group MyVesta.org.

"Most Americans never realize there's a financial problem until they can't make a payment and then their knee-jerk reaction is to borrow their way out of debt, which is one of the reasons we've seen so much home-equity lending over the past few years."

Overall, delinquencies on bank card, home equity and auto loans rose to 2.4 percent in the first quarter from 2.14 percent a year earlier, the American Bankers Association reports. The bulk of the increase comes from overdue payments on auto and home-equity loans. Yet 10 percent more consumers were able to pay down credit cards -- a jump the ABA attributes to increased spending power following a refinancing boom in the mortgage market. "It makes a lot of sense because the average credit card rate is almost twice the rate of a first mortgage today," ABA chief economist Jim Chessen said.

Yet many consumers may be flirting with disaster. A recent count shows that Americans have racked up more than $5 trillion in mortgage debt, up from $1 trillion in 1981, according to SMR Research.

The danger is that, should the economy sour further, loan defaults will soar because most Americans are ill prepared to ride out a rough spell, Rhode said. "Four out of 10 Americans have less than $1,000 they can get their hands on, so we are truly living paycheck-to- paycheck."

For lender's part, the flow of credit continues apace. Mortgage and credit card lenders are fairly sheltered from risks associated with borrowing, experts said.

Credit card divisions at banks are typically responsible for generating up to 60 percent of the institution's earnings, while mortgage brokers benefit by lending against the highly appreciable housing market.

Consumer loans are highly profitable and outweigh the prospect of heavy losses from high-risk borrowers, Gumbinger said. "If you can borrow money from liquid capital markets down into the low to mid- single digits and lend it out triple at that, even with losses, you stand to make an awful lot of money," he said.

Vital signs

Some credit card lenders are starting to get more tightfisted by charging higher interest rates or changing the terms on riskier loans. A Fed survey released in May found that 20 percent of banks placed stricter standards and terms on consumer loans, compared to 12 percent in January. About 19 percent lowered credit limits on loans.

Credit card issuers such as Providian, Capital One and Metris Companies continue to "show discipline" toward high-risk consumers, Pitsinger said. Conversely, these same issuers are also showing a propensity "to extend credit lines to their most consistent borrowers" despite added risks of economic hardship. Credit card lenders "are still out there in there in a vibrant way extending credit to their best customers," he said.

In the first quarter, mortgage volume among large prime lenders such as Countrywide, Wells Fargo and Washington Mutual skyrocketed 100 percent from last year, according to John Bancroft, managing editor at Inside B&C Lending, an industry newsletter.

"Interest rates are lower and people are still interested in refinancing their debt," Bancroft said. "The weakening economy hasn't hit the mortgage sector in terms of loan performance and house prices have been pretty good.

Sub-prime loan originations among the top 25 lenders such as Household Financial and Bank of America were up about 20 percent in the first quarter from last year, he said.

Overall, mortgage lending underwriting requirements "haven't gotten tougher at this point" as low mortgage rates have kept the housing market solid during the economic slump. Plus, a shakeout in the sub- prime market, which typically caters to high-risk borrowers, has helped to reduce unfair lending practices.

"So much of the business is now in the hands of large, well- capitalized institutions that many people feel sub-prime credit standards are in pretty good shape right now," Bancroft said. "Delinquency and loss rates are what people expect."

Bankruptcy boom

The American Bankruptcy Institute expects a record 1.5 million people to declare themselves insolvent this year. First-quarter filings reached 366,841 -- the highest level recorded for the period -- from 312,335 last year.

A bill passed by the Republican-led House at the urging of banks and credit-card companies would make it more difficult to file for Chapter 7 bankruptcy, an option that clears most debts. Instead, more people would file under Chapter 11, which calls for repayment of at least 25 percent of the debt over five years.

"While one argument was in the past that one of the reasons the bankruptcy rate was increasing was of bad economic times, what I actually see are people who are spending more because they are so confident about the economy," Rhode said.

The proposed law will likely reduce the number of filings, but still doesn't address factors beyond the bankruptcy code such as consumer confidence, said ABI's executive director Sam Gerdano.

Consumer spending, which accounts for two-thirds of total U.S. output, is vital to the economy's health.

"The problem for much of the '90s is people were engaging in the spending without adding to their household net worth or doing it excess of their income gains," Gerdano said.

At the current spending rate, it's questionable whether Americans will ever be able to pay down mounting financial obligations. Recasting debt is becoming the popular pastime, Gumbinger said.

Ultimately, the state of personal credit in the U.S. is tangled in a Catch-22 situation because while the Fed is taking necessary steps to keep lenders lending, it's debt-ridden consumers that continue to buy new homes and cars to keep the economy afloat.

Lending is a "business and it's a two-way street," McKinley said. "There's a lot of careless consumers and greedy banks."

*********************

Cecily Fraser is Assistant Personal Finance Editor for CBS.MarketWatch.com in San Francisco.

-- Andre Weltman (aweltman@state.pa.us), August 07, 2001.