Credit crunch

I went to a Liberty Fund conference on consumer credit this weekend, where a good time was had by all. This brought a number of thoughts to the fore, which I scribble down in no particular order:

1) There is an enormous amount of moral panic about debt in western society. (I presume in other societies too, but I don't know.) Over and over, the fact that people can and will make bad decisions about debt is presented as a legal reason for restricting their choices. Yet when I think about the bad decisions my friends have made, and the consequences on their lives, getting in over their head with credit cards or a house is probably the last thing on the list. Unless you are in a position that requires some sort of security clearance, the worst thing that happens to you if you borrow too much money is . . . you will find it harder to borrow more money. Much worse consequences have come from marrying the wrong people, procreating at the wrong time, majoring in the wrong subject, taking the wrong job, or choosing the wrong hobby. Yet almost everyone, including liberals, would be repulsed by the notion of trying to "fix" this problem by curtailing liberties--should we require poor people to get counseling before they change jobs?

2) The moral panic results in a huge amount of paternalism about debt. Credit alarmists frequently focus on college students, with the implication that they are still children who needed to be walled off from bad credit decisions. This is bad enough, but at least they're arguably still growing up. It becomes truly offensive when that attitude often spills over to other groups--minorities, the poor--who are also spoken of the way we talk about children: as people who presumptively cannot make good decisions. Better to restrict their options than let them make a bad decision.

Poor people are more likely to make bad decisions about credit than the more affluent, because people with bad decision-making skills are more likely to become poor, and also because the affluent have more knowledge about credit that they tend to transmit to their friends and offspring. The question is not whether some people will deeply regret their decision to borrow; it is whether you or they are more likely to correctly assess their situation. My money's on them.

3) The moral panic also extends to people who meet those needs: we view paycheck lenders as in broadly the same class as pimps, casino owners, and drug dealers. Particularly disturbing seems to be the notion that people make profits providing money to the poor. Yet there's little evidence that payday lenders make especially high profits; even non-profits who try to get into the business have found themselves charging interest rates they previously regarded as usurious. Poor people are, in fact, poor lending risks; the high interest rate compensates for the high default rate.

4) Many of the provisions supposed to "help" the poor with their credit end up helping the middle class. For example, capping interest rates means that people who cannot be profitably lent to at lower rates will be denied credit altogether. Some of them will benefit, because they will not borrow money that would have made them worse off. More of them will be pushed into worse alternatives: pawn shops, loan sharks. Meanwhile, the capital will towards the better credit risks, lowering interest rates for them.

5) A huge problem with reporting on credit markets, as with so many other issues, is that current harms are highly visible, but current helps are largely invisible. Because of our deep shame about debt, people who are in financial trouble rarely say so unless it is made public against their will--i.e., their house or car is repossessed. So the person who has been pushed into bankruptcy by high credit card debt tells her story to the New York Times; the person who managed to finesse a personal crisis with Mastercard keeps quiet and thanks their lucky stars.

6) America, more than any other countries, is a nation of debtors. Our laws and institutions are uniquely debt-friendly, from 30-year fixed rate mortgages with no prepayment penalty (a happy fantasy in other places) to remarkably easy bankruptcy. Even after our "draconian" reform, American consumer bankruptcy remains by far the easiest in the world; at least in 2005, when I wrote about it, no other country even had Chapter 7.

7) There's a remarkable tendency to view credit as the root of problems even when the causal links aren't particularly good. Expensive credit is more a symptom of poverty than a cause of it. And most American commentators view the housing bubble as a result of excessive credit (either from Fed stimulus or overseas savers). Yet Europe, where credit is much tighter, has had much more spectacular housing bubbles than we have. Having the price of your house fall 25% is a big problem even if you don't have a pricey subprime mortgage.

8) There's an enormous amount of folk mythology in the reconstruction of events in the debt markets. This is certainly exacerbated, and perhaps caused, by the fact that journalists writing about debt almost always find some incredibly photogenic family who were defrauded. In many peoples' minds, this is constructed into a narrative of innocent borrowers victimized by predatory lenders. On the flip side, others paint a picture of speculators committing fraud to secure unwise loans. These narratives are then presented as uncontested fact by commentators.

I am aware of no data that shows how many people were defrauded by their mortgage brokers, versus simply taking on an unwise amount of debt; or how many houses in default are owned by flippers who were speculating on price increases. I am aware of a lot of people confidently stating that one, or the other, is the problem in the subprime market.

9) Credit does have a lot of spillover effects--if everyone else defaults on their mortgage, the price of your house will go down and the price of your borrowing will go up.

10) People who want to use regulation to keep other people from taking on debt they can't pay forget that lenders also want to keep those people from taking on debt they can't pay--and the lenders have a lot more information about those people than regulators ever will. If you can find a reliable way to separate the people who will default from those who won't, I promise that the banks will use it. If not, the only way you can stop those people from defaulting is to deny credit to broad classes of people, the majority of whom would not have defaulted.

11) It's not clear to me how much consumer credit changes net happiness, rather than simply time-shifting the pleasure and the work required to obtain it. If time shifting payment back actually causes us to misprice the good (because we erroneously put it in the "free" mental basket), then debt is actually a hedonic negative. On the other hand if it allows you to peg your activities to the hedonically maximizing time (take a lavish European vacation before you have kids), then it's a plus. Or it could just be a wash.

I suspect that some of our strong cultural preference for deferring gratification is simple puritanism: as someone once said, "if the hangover preceded the inebriation, drunkeness would be regarded as a virtue". This has probably made us as a society vastly richer than we otherwise would be. But we're pretty rich now. Can't we take a break?