House of Cards
Dick and Jane are average working-class Americans. They earn less than they did 20 years ago, and consequently they faced a dilemma this past year. They had almost no money for presents on birthdays, anniversaries, or holidays and their existing credit cards were maxed out. But Dick and Jane received a new Chase Visa card in the mail. The card had a $2,000 credit limit and a 19.5 percent interest rate. Dick and Jane decided they don't want these special times to pass them by, so they whipped out their plastic. Soon they'd added another $2,000 to the $384 billion in outstanding credit card debt carried by Americans. If they make the minimum monthly payments required by Citibank, they will pay off their $2,000 debt by May 1, 2028. Through those years Dick and Jane will also have paid the bank's owners a total of $6,358.88 in interest fees. One hundred years ago, Dick and Jane might have run up that crippling debt while shopping at a company store, keeping them in thrall to usurious employers. Today, credit cards are the company stores of the new economy. And they have created a new order of debt peonage, keeping Americans permanently in hock to the nation's high-flying bankers. With U.S. wages stagnant or falling, low- and middle-income Americans are increasingly using credit cards to maintain their standard of living. It is impossible, of course, for cash-strapped Americans to borrow themselves into a higher income bracket. And eventually, this financial house of cards must come tumbling down. But the financial institutions that help people construct these unstable debt structures see things differently. Thomas Layman, the chief economist at Visa U.S.A., recently told the Wall Street Journal that "when consumers hit a rough spot, they don't have to stop spending altogether as they did 10 years ago. That's the beauty of the card as a payment vehicle." Though beautiful to bankers, credit cards have a dark side. In the United States 120 million people hold a total of 1.1 billion bank, retail and gas credit cards. About 89 million people in the United States carry a Visa or Mastercard, the two most popular credit cards. Of these cardholders -Ñ who own a combined total of 319 million Visas and Mastercards -Ñ 30 million promptly pay off all charges. The other 59 million cardholders carry an outstanding balance from month to month. On average, each of these cardholders owes $3,900 on three or four cards that charge 18 percent interest. Currently, Americans owe a total of $384 billion in outstanding debt on all major credit cards, 14 percent more than they owed at the beginning of the year. During the same period, people's income increased by only 3 percent. And that gap has created some serious problems. In the second quarter of 1995, the amount of credit card debt more than 90 days past due was 35 percent greater than the year before. Further, in October, consumer loan shark shops -Ñ outfits like the Money Store and American General Finance -Ñ reported a rise in defaults on consumer loans. That news sent bank stocks tumbling and spurred concern among policy-makers. On Capitol Hill, Rep. Joseph P. Kennedy II (D-MA) responded by convening a forum that examined the hardship caused by the increasing consumer debt burden and the ominous implications for the national economy. "High debt could be hurting retail sales during a period that is crucial to the health of our economy," Kennedy said, in announcing the December 14 forum. In testimony prepared for the forum, consumer advocate Ralph Nader renewed his call for the creation of "financial consumer associations" that would challenge the predatory practices of today's consumer finance companies. These nonprofit associations, which Nader has been advocating for 20 years, would educate consumers, lobby state and national legislatures for more progressive banking laws, and represent citizens in complex financial litigation. The need for Nader's associations has never been more urgent. In recent years, the nation's consumer finance industry has become more sophisticated in extracting its pound of fleshÑand credit card companies have had the sharpest knives. The companies have devised increasingly elaborate penalties to impose on cardholders. Even "good" consumers are paying a price. Every issue of Bankcard Consumer News, the newsletter of the Salem, Va.-based consumer group Bankcard Holders of America, is crammed with new credit card horror stories. Recently Bankcard Consumer News reported that Capital One Bank Visa, based in Richmond, Va., raised the interest rate on a cardholder -Ñ a woman who had a perfect payment record -Ñ to 24.9 percent because she increased the amount of debt that she owed on other credit cards. This is a regular practice at Capital One, which every six months runs credit reports on its 6 million customers to ferret out damning financial information. Many banks now terminate cardholders who don't charge enough or who pay their balance promptly. Last June, Bank1One, of Columbus, Ohio, canceled the cards of 100,000 people because they weren't charging enough -Ñ after all, credit card bankers lose money on cardholders who don't go into debt. But even as the industry sheds its unprofitable cardholders it aggressively seeks new marks. In 1994, credit card issuers mailed more than 2.5 billion solicitations to consumers. And in just the first quarter of 1995, the companies sent out 1.2 billion solicitations. At college campuses across the nation, Visa and Mastercard hire students to flog their cards to other students. Janice Shields, a former accounting professor at Bloomsburg University in Pennsylvania, looks back in disgust at the marketing tactics of the credit card companies. "They paid student organizations to set up tables in the student union," says Shields, who now works as a consumer banking analyst at Ralph Nader's Center for the Study of Responsive Law in Washington, D.C. "At Bloomsburg University we would have two or three credit card companies a day. And now they are in the high schools." Federal Reserve Gov. Lawrence Lindsey, another speaker at Kennedy's forum, has also expressed concerns about the deluge of credit cards and the steady rise in consumer debt. "It is not appropriate for me to tell people not to use their credit cards as much," Lindsey told the Wall Street Journal in September, "but it is my responsibility to tell bankers not to put out so many solicitations [for new cards]." But such solicitations work. According to the Nilson Report, a California -- based financial newsletter, by the year 2000 Visa and Mastercard alone will have added another 107 million cards to the 319 million now in circulation. And in those five years the total outstanding consumer debt on the nation's two leading cards is projected to jump 60 percent, from $244 billion to $390 billion. The banking industry defends its credit card practices by saying that the public's consumer debt is still manageable. Bankers point out that the current balance of $384 billion in outstanding credit card debt represents only one-third of the $1.02 trillion in total credit available to cardholders. With $636 billion in credit still open to the nation's consumers, bankers believe that significant leeway remains in the credit card market. As the Journal itself noted, even if Americans "do get strapped making those monthly credit card payments they have more untapped credit than ever before, in effect allowing them to borrow to pay for previous borrowing." But despite what the Journal says, people can't borrow themselves out of debt, especially when they're paying 24 percent interest. Banking analyst Shields says the time has come for "consumers to fight back and demand a cap on interest rates." At one time state usury laws set tough limits on predatory lending rates. But those state laws were pre-empted in 1980, when Congress passed the Depository Institutions Deregulation and Monetary Control Act, which abolished usury ceilings. Although that law allowed states to supersede the federal statute and set their own usury ceilings, few have done so. Arkansas is one that did. It has the nation's toughest usury law. That law has been defended time and again -Ñ most recently in 1990, when citizens disregarded Gov. Bill Clinton's calls for deregulation and voted overwhelmingly to keep their usury ceiling intact. Arkansas will not let credit card interest rates climb more than 5 percent above the Federal Reserve's discount rate, the rate at which banks borrow money from the Fed. With the current discount rate at 5.25 percent, interest rates on loans in Arkansas are limited to just 10.25 percent. But state banking laws do not apply to credit cards issued by out-of-state banks. In 1978, the U.S. Supreme Court ruled that credit card issuers based in loosely regulated states were free to disseminate their cards, along with their toothless banking laws, across the nation. Opponents of usury laws contend that such regulations are market barriers that deprive high-risk borrowers of access to credit. Kathleen Keest, who follows consumer lending for the National Consumer Law Center in Boston, says this argument is bunk. In The Cost of Credit: Regulation and Legal Challenges, Keest writes that "reasonable usury statutes undoubtedly benefit more borrowers by limiting ... interest rates than they harm by restricting credit."Bankers also argue that usury laws are unnecessary because federal law already forces the full disclosure of credit terms. And, they claim, Americans should be free to decide for themselves what credit terms are appropriate for them. To that argument, Keest counters that in a country like the United States, where, according to the Department of Education, 40 percent of the population is functionally illiterate, "the concept of disclosure begins to lose meaning." But attempts to control the growth of the consumer credit market pose serious risks. Deficit spending by families like Dick and Jane's helps fuel the national economy. And if lower-income borrowers curtail their spending, the consequent loss of economic stimulus could cause the nation to spiral into a recession or worse. In a sense, Americans are damned if they stop buying on credit -Ñ which would cause a national recession -Ñ and damned if they don't. Lindsey, at the Federal Reserve, has begun to issue such warnings. In a talk last January to the National Economists Club, Lindsey warned that the current expansion of credit card debt "was unsustainable" and he predicted "a sharp slowdown in consumption and overall economic activity" in the "not too distant future." He concluded his speech this way: "Grantors of consumer credit by now have collectively taken on a macroeconomic responsibility they did not seek. The evidence indicates that the old liquidity constraint [that one did not spend beyond one's means] that used to discipline household consumption behavior has been replaced by a new constraint -Ñ the credit card limit. To the extent that this is the case, the willingness of the industry to extend credit in ever greater quantities will determine in a major way the duration of the current consumer spending binge, the ultimate extent to which consumers become overextended, and therefore the depth of the next macroeconomic downturn." And that could be very deep indeed. In 1979, a year of double-digit inflation, Jimmy Carter urged Americans to stop using their credit cards and help him fight inflation. Within days the White House was inundated with cut-up cards. As William Greider wrote in Secrets of the Temple, this action, combined with new Federal Reserve policies that hiked interest rates and shrank the money supply, precipitated the 1980 recession. Within three months, the GNP had shrunk by 10 percent, and the United States had entered the worst recession since the Great Depression. Of course, at the time the number of credit card holders was vastly smaller than today. The unprecedented volume of consumer debt owed by working Americans is also -Ñ.and no less disturbingly -Ñ a key factor in the upward transfer of wealth the country has experienced in recent years. "Credit cards are a useful way of telling the story about the growing gap between rich and poor in America," says Tom Schlesinger, director of the Southern Finance Project, an independent research center that monitors financial markets. "Lower- to middle-income households are just being deluged in debt. And that is both a cause and a consequence of wage-income stagnation. As more and more people see their income stagnating, they are having to resort to more and more borrowing." And in the process, they're becoming poorer and poorer. This year total consumer credit debt payments reached a record 19.8 percent of after-tax income. (Visa and Mastercard alone received a whopping 7.5 percent of Americans' after-tax income.) And the nation's debt burden is not distributed evenly. Lower-income Americans bear a disproportionate percentage of this load. According to the Federal Reserve, the share of the nation's consumer debt owed by households with annual incomes under $30,000 rose from 20.6 percent in 1989 to 30.9 percent in 1992, and is undoubtedly higher today. We are in danger of becoming a nation of paupers, who -Ñ in addition to signing up for ever more loans -Ñ are willing to compound our problems by signing off on the political process that provides the one real chance to set the terms of our economic future. Should we fail to act, the majority of Americans will face a bleak future. If the trends of the last 15 years continue, as they show every sign of doing, by 2004 the richest 3.3 percent of Americans will receive 30.6 percent of the national income, while the bottom 96.7 percent of the citizenry will receive only 69.4 percent of the national income. One way people might gain control of their domestic finances is not through reform of current financial institutions but through the creation of new ones. Shields, at Nader's office, says she'd like to see the establishment of cooperative consumer banks. "The banking industry has pushed for interstate banking and now that we have it, I think we should use that to consumer advantage," says Shields. "Why can't we form a national consumer bank -Ñ a bank that would compete with the Bank of America and First Chicago, both of which charge customers to use a teller? I think it would work." If it doesn't, not much else will.