The Case for Debt

Public anxiety over “excessive” consumer debt has a long, and misguided, history. By Virginia Postrel

For many poor Americans, credit cards can still be a better deal than payday loans and pawnshops. (Photo credit: Philip James Corwin/Corbis)

A couple of weeks after last Christmas, a newspaper reporter telephoned Todd Zywicki, a George Mason University law professor who studies bankruptcy and consumer credit. How, she wanted to know, were American families going to pay the huge credit-card bills they’d run up buying presents? Well, Zywicki responded, how had they paid their Christmas bills the previous year, and the year before that, and the year before that? “It never occurred to her that this was an old story,” he says.

Or, as we in the journalism business call it, an evergreen: always in season. Through good times and bad, Americans predictably rack up consumer debt, and that debt predictably generates public and private hand-wringing about how it will ever get paid. When two Federal Reserve economists examined all the New York Times articles on consumer credit from 1950 to 1995, they found that 60 percent were negative. The pessimistic tilt was even greater—topping 80 percent—when journalists generated their own stories rather than reporting on statements by politicians, business executives, or academics.

The evergreen story of people in debt becomes even sexier in an economic downturn, when debts inevitably get harder to pay. Witness a recent Times feature on “The Debt Trap,” described as “a series about the surge in consumer debt and the lenders who made it possible.” On the subject of credit, bad news sells.

Certainly politicians think so. “Over the past 15 years, average household credit-card debt has tripled. The typical family is now nearly $10,000 in the red,” said Barack Obama, decrying a “debt crisis” caused by “credit-card companies … pushing [consumers] over the edge.” At hearings last December, Senator Norm Coleman, the Minnesota Republican, declared, “This easy credit has gotten a lot of people in trouble.” He could have said the same thing anytime in the past century and been applauded for it. Today’s sluggish economy, home-equity- line-of-credit craze, and subprime-mortgage mess have amplified concerns about the general level of indebtedness. But while it’s true that, thanks in large part to declining home prices, American homeowners hold less equity in their homes than they used to, the subprime meltdown is less a problem of consumer credit than of new financial instruments and the difficulty of tracking mortgages that have been sold, then broken up and repackaged into derivative securities. And on closer examination, what looks like “unprecedented” consumer indebtedness turns out to have ample precedent, as do the anxiety and moralizing that accompany it.

Studying “Middletown” in the 1920s, Robert S. Lynd and Helen Merrell Lynd deplored the “rise and spread of the dollar-down-and-so-much-per plan,” which extended credit for such extravagances as cars, electric washing machines, and “$200 over-stuffed living-room suites … to persons of whom frequently little is known as to their intention or ability to pay.” In 1943, Jesse Rainsford Sprague, a defender of installment buying, nonetheless worried that the “temptations of easy credit” were luring young people to take out bank loans, rather than save, for vacations. Of one stenographer, he noted, “Had the young lady spent less on lip rouge and blood-red fingernail paint, she might have been in a position to pay cash for her holiday.”

“As the result of the consumer credit explosion, the total private debt is certainly greater than the combined private debt of man throughout history. Never have so many owed so much,” declared Hillel Black in Buy Now, Pay Later, published in 1961—more than a decade before using bank credit cards like MasterCard and Visa became common. Employing the big, scary numbers and dizzying examples typical of such critiques, Black elaborated:

Currently about one hundred million Americans are participating in the buy-now, pay-later binge. Furthermore, they can, if they wish, do anything and everything on credit. Babies are being born on the installment plan, children go through college on time, even funerals are paid for on what the English quaintly call “the never never.” Through debt people are buying hairpins, toothpaste, mink coats, girdles, tickets to baseball games, religious medallions, hi-fi equipment, safaris in Africa … The result has been a consumer credit explosion that makes the population explosion seem small by comparison.

Black was right about the trend but wrong about its significance. The expansion of consumer credit is one of the great economic achievements of the past century. One institutional and technological innovation after another has made borrowing easier and cheaper for rich and poor alike. With each development have come fears—sometimes fueled by the unforeseen problems that inevitably accompany new practices—that this is the change that surely will lead to disaster. Yet a half century after Black’s warnings, doomsday has not arrived, the “consumer-credit explosion” continues, and most consumers are much better off.

Gone are the up-front fees and intrusive interviews that used to be standard before taking out personal bank loans or establishing store credit. Except for those offering airline miles, most credit cards no longer have annual fees, while intense competition for new customers—think of all that annoying junk mail—has driven down the average interest rate, from 17.4 percent in 1992 to 13.1 percent in 2007. Today’s consumer credit is flexible, convenient, impersonal, and (excluding car loans and mortgages) largely unsecured. With a credit card, you can rent a $40,000 automobile, buy goods online from complete strangers, finance a business, make ends meet while you’re out of work, purchase a $5,000 wedding gown or a 10-cent photocopy—all without completing any forms or explaining yourself to anyone. And despite recent legal revisions, even bankruptcy is less painful than in the days of buying on time. If you default on your Visa bill, nobody comes to repossess your refrigerator or auction off your shoes. The biggest penalty you’ll face is trouble getting future credit.

So why do we worry so much? For starters, the very success of consumer credit makes us uncomfortable. As borrowers, we may feel guilty about running up debt, anxious about making payments, and resentful of the constraints that old obligations (and old credit records) impose on our current choices. We may find it too easy to buy things we may later regret. In theory at least, we might prefer the days when paternalistic—or snobby—salesclerks checked our spending. “Our store manager’s duty is to protect the buyer from unwise expenditures,” wrote the retailer Julian Goldman in 1930.

If a woman patron selects a gown or a wrap which is beyond her means, the store manager advises against the purchase. He knows, because the customer—conforming to the rule from which there is no deviation—has confidentially explained her circumstances in full detail … The friendly, intimate, patient, personal interview is the key to our sales operation.

On second thought, why should your economic choices be the store manager’s business? Practicality aside, anonymous databases and credit scores are a lot less intrusive.

When credit is cheaper to use and easier to arrange, people do use more of it. Hence those big, scary numbers, which grow along with the economy and the population. Contrary to a common perception, however, the people driving up the totals aren’t primarily the financially strapped. They’re “high-wealth consumers in their prime earning years,” observes Andrew Kish, an economist at the Philadelphia Federal Reserve. Almost half the growth in debt between 1989 and 2004 (the most recent year for which data are available) came from the highest-income 20 percent of American households. (By contrast, the bottom 20 percent held about 3 percent of consumer debt—an increase from 1.9 percent—and accounted for a bare 4.5 percent of the growth.) If the rich are getting richer, it makes sense that they’re also running up more debt. They can reasonably expect to pay it.

These affluent families also account for half of the outstanding consumer debt. So the $10,000 average that Obama cited isn’t in fact owed by the “typical” family with an average income. That figure is calculated by spreading the much larger debts of the rich over the population as a whole. All by herself, Cindy McCain owed at least $200,000 on two American Express cards, according to her husband’s campaign disclosure documents. That sounds terrifying until you realize that this wealthy woman pays her monthly AmEx bills in full.

Like those of Mrs. McCain, some of the credit-card balances included in government statistics aren’t really debt at all. They’re temporary charges for convenience’s sake. Nowadays, credit cards are easier to use than cash—no fumbling for change while other shoppers wait impatiently behind you. Plus, companies offer rewards points and frequent-flier miles, and they give you a free float period if you pay your balance in full. So people who don’t need to borrow money use their credit cards as a convenience, running up charges over the course of a month and paying everything off when the bill comes due. Whatever they owe on the day that debt statistics are collected goes into the total figures on consumer credit. This “convenience use” grew from about 6 percent of total credit-card debt in 1992 to 11 percent in 2001, calculates Kathleen Johnson, a Fed economist. That growth was two and a half times the growth rate for credit-card borrowing overall.

Of course, rich people and families who pay their bills every month aren’t the only Americans with debts, and they certainly aren’t the ones whose sad stories make the news. But financial innovations have also made lower-cost credit more available to lower-income people. Even those much-criticized payday loans cost less than pawnshop loans or bounced-check fees. Credit cards are cheaper still.

And credit-card companies have changed their lending policies in ways that make credit more accessible—but also more complicated. Credit-card prices used to be “high and simple,” notes another study by the Philadelphia Fed. Everybody paid the same rate, regardless of credit risk. If you carried a balance but reliably paid your bills, you were subsidizing borrowers who weren’t so dependable. But because the interest rate wasn’t high enough to cover the riskiest potential customers, generally those with lower incomes or frequent unemployment, they were cut out of the credit-card market altogether.

Now, instead of charging everyone the same, companies adjust the interest rates according to customers’ credit scores. They also charge special fees for late payments, purchases that exceed a credit limit, foreign-currency transactions, phone payments, and so forth. This structure makes it profitable to extend credit to high-risk borrowers, including those with low incomes. It’s more inclusive, and arguably fairer, since it eliminates cross-subsidies. But it’s also hard to explain. Hence Obama’s complaints that credit-card contracts “have gone from being one page long a few decades ago to more than 30 pages long today.”

Of course, in the good old days of one-page contracts, politicians still decried easy credit and demanded more consumer information. Ever wonder why your credit-card agreement’s easy-to-read “Schumer Box” specifies a minimum finance charge of, say, 50 cents? You’ve probably never thought twice about that charge, but back in the late 1980s, then-Congressman Charles Schumer and his colleagues thought that telling consumers the minimum charge was very important.

And back in those good old days, of course, some people still couldn’t make their credit-card payments. Others worried that they’d never get out of debt. Still others felt guilty about buying luxuries even when they could afford them. Forms of credit may change, but credit anxiety, alas, does not.