The Two-Income Trap (22 page)

Consider the example set by Citibank, America’s largest credit card issuer. In 1990, I [Elizabeth] was hired as a one-day consultant by Citibank to address a gathering of some forty senior lending executives. The task: use my research to suggest policies that would help Citibank cut its losses from cardholders in financial trouble. I arrived at Citibank’s New York headquarters with dozens of graphs and charts tucked in my file folders. I was ushered into a large, brightly lit conference room where each chair was filled by someone outfitted in a starched shirt, silk tie, and dark suit. The executives stayed with me all day, eating lunch at the conference tables as we continued our discussions about the effects of unemployment on loan defaults and the rising number of bankruptcies among two-earner families. As the afternoon came to a close, I summarized my recommendations. The short version could be boiled down to a single, not very startling, idea: Stop
lending money to families that are already in obvious financial trouble. This would have been quite easy to implement. Citibank had reams of data on most of its borrowers, particularly those who had black marks on their credit reports. I suggested that the policy could be put in place within a few short months, potentially cutting Citibank’s bankruptcy-related losses by as much as 50 percent.
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There were interested murmurs around the room, and several hands eagerly shot up. But before I could call on anyone, one slightly older man spoke up. He had been silent throughout the long day, leaning back in his chair and giving me a faintly bemused smile. “Professor Warren,” he began. The room hushed immediately, and I suddenly realized that I had been oblivious to the corporate pecking order; this was the guy who outranked everyone else in the room. “We appreciate your presentation. We really do. But we have no interest in cutting back on our lending to these people. They are the ones who provide most of our profits.”
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With that, he got up, and the meeting was over. I was ushered out, and I never heard from Citibank again—except to get my monthly credit card bills.

Citibank understood the new economics of consumer credit. Credit card issuers make their profits from lending lots of money and charging hefty fees to families that are financially strapped. More than 75 percent of credit card profits come from people who make those low, minimum monthly payments.
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And who makes minimum monthly payments at 26 percent interest? Who pays late fees, overbalance charges, and cash advance premiums? Families that can barely make ends meet, households precariously balanced between financial survival and complete collapse. These are the families that are singled out by the lending industry, barraged with special offers, personalized advertisements, and home phone calls, all with one objective in mind:
get them to borrow more money.

After he suffered a heart attack, missed several months’ work, and fell behind on his mortgage, Jamal Dupree (from chapter 4) got the hard sell from his mortgage lender. When Jamal missed a payment, the mortgage company sent him dozens of personalized letters with a
single goal—to persuade him to take out yet another mortgage. “They’d send out a notice, saying ‘you need a vacation, take out this thousand dollars and pay it back in ninety days.’ If you didn’t pay it back in ninety days, they charged you 22 percent interest.” When he didn’t respond to the mailers, the mortgage company started calling Jamal at home, as often as four times a week. Again, the company wasn’t calling to collect the payments he had already missed; it was calling to sign him up for even more debt. Jamal resisted, but his mortgage lender didn’t let up. “When I turned them down, they called my wife [at work], trying to get her to talk me into it.”

The strategy used by today’s lenders exactly reverses the approach bankers used a generation ago when their main goal was to be repaid on time, not to string along the payments for as long as possible. Herring Hardware may have collected most of its debts—even during the Great Depression—but its lending policies were radically different from those embraced by today’s major lenders. Unlike today’s mega-banks, Herring Hardware
stopped
making loans when a family got in trouble. Grandfather Herring would never have dreamed of sending a flyer in the mail cheerfully suggesting, “Fred, you’re behind on your payments for the fertilizer. Can we lend you the money for a new cook-stove?” Nor would the local bank have suggested a second mortgage to the family that had just missed a payment on its first mortgage.
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There is another important difference. When families arranged credit in my grandfather’s store, he charged them a simple 1 percent per month. Neither he nor the bank had any penalty fees or shifting rates of interest. When someone missed a payment, the rate was still 1 percent a month. Today, that practice has disappeared. Like Jamal’s mortgage lender, many banks routinely double or even triple the interest rate the moment someone is a few days late with a payment. Then there are the fees. This year credit card companies will charge more than
$7 billion
in late fees (quadruple what they charged less than ten years ago)—a penalty unheard of in my grandfather’s day.
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Moreover, when my grandfather got a check in the mail, he applied it to the principal balance on the loan; he wouldn’t have dreamed of
telling those families that with compounded interest at the new rates and special overbalance fees and late-payment penalties, they now owed $4,000 for their original $800 purchase.

In an era when lenders routinely target the almost-bankrupt for extra loans, how do they ensure that they will get their money back? Corporate lenders don’t have “Jimmy the finger-breaker” on retainer, but they do have thousands of trained professionals who do nothing but hound families for money.
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Most of the time, these agents make their living by calling families at home, reminding them that they are late on their bills and pressing them to make a payment. (Or, in the case of Jamal Dupree, urging them to take on a second loan to pay off the first.) But when a simple request isn’t enough, they, too, use tougher tactics.

Sears, America’s fourth-largest retail chain, got caught threatening to nab a battery from a Massachusetts family’s car unless the family promised to send Sears some money—money that the family no longer owed.
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This was in clear violation of the law.
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The family had filed for bankruptcy protection, so Sears was legally barred from further collection efforts. Aside from that, it is reasonable to wonder: What could Sears possibly want with a used car battery? Or with the used dehumidifiers, mattresses, and Walkmans the company had threatened to take back from thousands of other families?
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Sears was not in the business of selling used household goods. And it would have cost the company several hundred dollars to hire a repo man and send a truck to someone’s door—far more than a used Walkman or car battery would be worth.
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Sears almost certainly didn’t want those goods; the company wanted the money people would pay to keep the Sears repo man away. The company probably hoped that some families were unaware of their legal rights, and that if they were frightened enough, they just might keep making payments on old bills, even after those bills had been discharged in bankruptcy. FBI Special Agent in Charge Barry Mawn described the Sears case
as an example of “Corporate America blindly [pursuing] profitability over its obligation to treat the consuming public with fairness and honesty.”
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And Sears was not alone: AT&T, General Electric Credit, Federated Department Stores (owner of Macy’s), J.C. Penney, Circuit City, Tandy (owner of Radio Shack), and General Motors also paid multimillion dollar fines for making collection threats against families whose debts had been forgiven in the bankruptcy courts.
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But these companies were punished for pursuing families that were under the protection of the bankruptcy courts, not for aggressive collection tactics per se. Indeed, many aggressive collection tactics are perfectly legal. For example, Sears, unlike J.C. Penney, issues credit cards that add some special touches in the fine print. Whenever a customer purchases something on a Sears card, the goods become collateral against the loan. That means that Sears is within its legal rights to repossess (or to threaten to repossess) everything the family bought with the card if it falls behind on its bills. Even when those threats are patently absurd.

Consider, for example, a conversation we had with “Sally,” a former Sears collection agent in the Boston area. Sally’s job was to call families that had fallen behind and to pressure them to pay up. One incident particularly stood out in Sally’s memory. When another Sears agent threatened to repossess a mattress from a woman who was delinquent on her payments, the customer in question stuck to her guns. “You will not. It isn’t worth anything. Besides, you can’t even sell a used mattress. It’s not legal.”
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Sally’s coworker was quick on her feet. “We’ll come and get it because we can. And then,
we’ll set it on fire and burn it up
. It won’t give us anything, but you won’t have it either.” The woman caved in and sent Sears a check for $50. According to Sally, the story was widely told and retold in her department and praised by the department manager as an example of “real initiative.” Since we only have Sally’s word, we can’t confirm the facts of her account, but it is a matter of public record that Sears has threatened to repossess used mattresses from other families.
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Sally’s real expertise wasn’t collecting from the living. She spent most of her days collecting from the dead—or at least the family members of the dead. When a person dies, only a cosigner on the account is liable for the bill. If no one has cosigned, the store can repossess the goods (if the original contract permitted this) or collect from the estate of the deceased, but they cannot hold other family members liable for the debt. The company is not, however, prohibited from
trying
to collect from the family. So Sally’s job was to call the adult children or grieving widows of customers who had died leaving an outstanding bill. She typically started a call with something gentle and confidential. “Mabel was a longtime member of the Sears family, and we’re sure she would have wanted her bills to be paid.” Sally then read from a list of purchases Mabel had made on her Sears card, inserting some personal comments. “I see she bought eyeglasses. And some baby clothes—I love those sweet little sweaters and matching caps, don’t you?” If the soft sell didn’t work, Sally would turn up the heat, threatening to send a collection agent who would plow through the deceased’s closets and drawers and “take back what belonged to Sears.” If that wasn’t enough, there was a final warning that must have sent many families running for the checkbook: She threatened to reclaim every gift ever purchased on the Sears card. Again, the claim seems ridiculous; how would a Sears agent ever figure out that Mabel had given the frilly dress to her grandniece in Detroit, while the Walkman had gone to a greatgrandson in Denver? But these threats were put to grieving family members who had just lost a loved one, not to battle-hardened debt-dodgers who were primed to defend themselves. Not surprisingly, Sally said that most families paid.

We remind the reader that we have only Sally’s word to go on. It is possible that she wasn’t telling the whole truth or that she had an ax to grind. But a statement by former Sears CEO Arthur C. Martinez is certainly in keeping with Sally’s story. He explained the company’s aggressive debt collection practices this way: “We have an old-fashioned view. People should pay for what they take.”
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As he touted that “oldfashioned
view” of debt, Mr. Martinez seemed oddly blind to the fact that Sears is no longer an “old-fashioned” merchant. At the time Mr. Martinez made his statement, Sears reportedly earned
more
money from the interest and late fees the company charged its credit cardholders than it earned from selling merchandise.
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In other words, Sears kept all those stores open and sold all those Lady Kenmore washing machines and Craftsman tools in the hope that its customers would buy on credit and pay over time. Merchants like my grandfather used to offer credit as a way to increase store purchases. For stores like Sears, that formula has been turned upside-down: Store purchases have become a way to increase credit card debt. That’s not “old-fashioned” at all; indeed, it is possible only in the new world of uncapped interest rates and deregulated lending.

The problems posed by families deep in debt may seem intractable, or at least so deeply embedded that only a complex, expensive array of regulations and laws could turn things around. But this is one problem that isn’t so hard to solve. The consumer-credit monster could be beaten back if Congress would enact a simple provision into law—a provision that wouldn’t require the creation of vast new oversight committees or contentious battles in the Supreme Court
.
Congress could simply revive the usury laws that served this country since the American Revolution. Federal law could be amended to close the loopholes that let one state override the lending rules of another.
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Alternatively, Congress could impose a uniform rate to apply across the country. Such a provision would enable the states or the federal government to reimpose meaningful limits on interest rates.

Consumer lenders balk at the notion of reregulation, immediately claiming that tighter limits on interest rates would put America at risk for another banking disaster like the Savings and Loan (S&L) crisis of the late 1970s. Hemmed in by high inflation rates and low limits on interest rates, the S&Ls (which issued most home mortgages)
found themselves hemorrhaging money.
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But the real problem was inflation, not usury rates per se, which had worked reasonably well for centuries. At the time, usury limits in most states were fixed at a specific number, and they hadn’t been written with double-digit inflation in mind. But that would be an easy problem to solve. To avoid a repeat of the S&L crisis, all that is needed is to tie the limit on interest rates to the inflation rate or the prime rate (which changes with inflation) so that the two never get too far out of sync. (To keep a check on fees, points, and all the other hidden charges, these costs should be included in the interest calculations up front.) That way, mortgage and credit card interest rates would be higher when inflation is rampant, but they would come right back down when the inflation monster is tamed. The ceiling on interest rates would float up and down, but it would always be tethered to the lender’s cost of funds. That way, banks would always be able to lend profitably,
and
consumers would always be protected from unreasonable rates.